The final rules add a new paragraph to the corporate governance disclosure requirements contained in Item 407 of Regulation S-K, and implement a mandate contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The SEC initially proposed the hedging policy disclosure rules on February 9, 2015, and we summarized the proposed rules in an earlier client alert.
The final rules require companies to disclose certain hedging policies or practices, but do not require companies to adopt any new hedging policies or to amend any existing hedging policies. Many companies had already adopted some form of hedging policy when the SEC published the proposed rules in 2015, in many cases in response to voting policies or corporate governance ratings of proxy advisory services or to pressure from institutional investors, and have been voluntarily disclosing their hedging policies as part of their corporate governance disclosure. SEC proxy rules, discussed below, have also required some hedging disclosure in the Compensation Disclosure and Analysis (CD&A) section.
Next Steps for Companies
Timing Considerations. For most calendar year-end domestic operating companies that do not qualify as “emerging growth companies” (EGCs) or “smaller reporting companies” (SRCs), the final rules will not require disclosure until proxy or information statements that include the election of directors until the 2020 proxy/annual meeting season. EGCs and SRCs are not required to comply until the 2021 proxy/annual meeting season. The final rules do not prohibit early adoption of the disclosure required by the final rules, and a company may revise its existing disclosures, or begin making new disclosures, that comply with the final rules before the final rules become applicable to the company.
Companies with Existing Hedging Policies. Based on a review of proxy statements filed from January through early December 2018, approximately 1,500 domestic operating companies have disclosed that they have adopted hedging policies that apply to directors and/or officers. Companies that have existing hedging policies may wish to:
- Review the scope of the company’s existing policy and its most recent disclosure concerning its policy; and
- Review the additional disclosure, if any, that will be required after the final rules become applicable to the company and determine whether any change in the company’s existing hedging disclosure and/or its existing hedging policy would be desirable in light of the disclosure that will be required by the final rules.
Companies without Hedging Policies. Companies that have not adopted hedging policies should be aware, as noted above, that the final rules do not require companies to adopt any hedging policy, nor that a hedging policy include any specific elements. These companies may wish to consider a variety of factors in determining how they will respond to the disclosure requirements of the final rules when they become applicable to the company, including:
- Whether any current or anticipated inputs from the company’s significant investors would favor adoption of a hedging policy;
- Whether voting policies or corporate governance scores issued by one or more proxy advisory services would favor adoption of a hedging policy; and
- If the company is considering adoption of a hedging policy, how the scope of the policy would compare to the scope of the disclosure required by the final rules. Key issues could include whether the policy would apply to:
- Directors and all company employees, or whether the policy would apply only to directors and/or the company’s named executive officers (or, alternatively, all executive officers) instead; and
- All company securities, or only to the company’s securities registered under Section 12 of the Securities Exchange Act of 1934 (1934 Act) or some other subset of the company’s equity securities.
The Final Hedging Policy Disclosure Rules
Companies Subject to the Final Rules. The final rules apply to domestic operating companies, with EGCs and SRCs subject to a one-year delay in the compliance date for the final rules. The final rules do not apply to listed closed-end funds or foreign private issuers.
Employees and Directors Covered. The final rules apply to all employees of the company, including officers, and to the company’s directors. The final rules also apply to any company practices or policies regarding designees of the company’s employees or directors. Determinations of whether someone is a designee depends on the specific facts and circumstances; neither the final rules nor the adopting release provide any guidance on this determination.
Securities Covered. The final rules apply to equity securities issued by the company, as defined in Section 3(a)(11) of the 1934 Act, without regard to how the securities were acquired. The new rules also apply to equity securities of any parent or subsidiary of the company, or any subsidiary of any parent of the company. The final rules do not limit disclosure to equity securities of the company registered under Section 12 of the 1934 Act.
Hedging Transactions Covered. The final rules apply to policies that affect the ability of employees or directors to purchase financial instruments, or otherwise engage in transactions, that hedge or offset, or are designed to hedge or offset, any decrease in the market value of company equity securities. The final rules do not define the term “hedge,” and require companies to make clear what categories of transactions the company’s policy permits and/or prohibits. The final rules do not require disclosure of specific hedging transactions, although other disclosure requirements (such as beneficial ownership disclosure) may result in disclosure of hedging transactions.
SEC Filings Covered. The final rules apply to proxy or consent solicitation materials with respect to the election of directors, without regard to whether the materials relate to an annual or special meeting of shareholders or action to be taken by written consent. The final rules also apply to information statements filed on Schedule 14C. The disclosure required by the final rules will not be deemed incorporated by reference into other SEC reports or registration statements except to the extent that the company specifically incorporates the disclosure by reference.
Disclosure Required. The final rules require a company to describe any practices or policies that the company has adopted regarding the ability of the company’s employees (including officers) or directors, or any of their designees, to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds), or otherwise engage in transactions, that hedge or offset, or are designed to hedge or offset, any decrease in the market value of registrant equity securities (a) granted to the employee or director by the company as part of the compensation of the employee or director; or (b) held, directly or indirectly, by the employee or director.
If the company does not have any practices or policies regarding hedging, the company must disclose that fact or state that the transactions described above are generally permitted.
The adopting release clarifies that the final rules apply to all company policies and practices, without regard to whether they are in written form or not.
A company can satisfy the disclosure requirement by either providing a fair and accurate summary of the applicable practices or policies, including the categories of persons they cover and any categories of transactions that are specifically permitted and/or specifically disallowed. Alternatively, companies can satisfy this requirement by disclosing their practices or policies in full.
The final rules do not require any specific location for the disclosure required by the final rules. Companies should note that including the new disclosure with the company’s existing C&DA hedging disclosure (described in the next paragraph) will result in the new disclosure being covered by the annual say-on-pay shareholder advisory vote.
Relationship to Current C&DA Disclosure. In order to avoid duplicative disclosure, the final rules amend the existing requirement that companies disclose material policies regarding hedging of economic risk of company securities ownership by a company’s named Executive Officers in the C&DA section of proxy and information statements under Item 402(b) of Regulation S-K. The final rules add an instruction stating that if the information disclosed in response to the final rules would satisfy Item 402(b)(2) of Regulation S-K, the company may refer to the information disclosed pursuant to the final rules. Because SRCs and EGCs are not required to include C&DA disclosure in their proxy statements, many SRCs and EGCs may be disclosing hedging policies for the first time after the final rules become applicable to them.
Effective Date and Compliance Date. The final rules will be effective 30 days after publication in the Federal Register. The final rules apply to proxy and information statements that relate to the election of directors at annual and special meetings during fiscal years that begin on or after July 1, 2019 (July 1, 2020 for EGCs and SRCs). In addition to proxy statements, the final rules also apply to consent solicitation materials and to information statements filed under Regulation 14A.