Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The SEC has proposed  rules to implement Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as codified in Section 14(j) of the Exchange Act, which requires annual meeting proxy statement disclosure of whether employees or members of the board of directors are permitted to engage in transactions to hedge or offset any decrease in the market value of equity securities granted to the employee or board member as compensation, or held directly or indirectly by the employee or board member.

In connection with the proposed rule, Commissioners Daniel M. Gallagher and Michael S. Piwowar issued a joint statement.  In the statement they note “While we ultimately voted to support the issuance of this proposal, our position should not be taken as unqualified support of the proposal in the form it was issued.  Indeed, we remain quite concerned by several aspects of the proposal, and we hope to receive robust public comment on them.”

Text of Rule

On its face the proposed rule to be included in Item 407(i) of Regulation S-K seems straightforward:

In proxy or information statements with respect to the election of directors, disclose whether the registrant permits any employees (including officers) or directors of the registrant, 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 are designed to or have the effect of hedging or offsetting any decrease in the market value of equity securities—

(1) Granted to the employee or director by the registrant as part of the compensation of the employee or director; or

(2) Held, directly or indirectly, by the employee or director.

The rule includes five instructions clarifying its application.

Transactions Covered

The proposed rule goes beyond what is required by the Dodd-Frank Act and Section 14(j) of the Exchange Act.  The SEC believes in order for the disclosure to be complete and to avoid discouraging or promoting the use of particular hedging transactions, the proposed amendment  must require disclosure of whether an issuer permits other types of transactions that have the same hedging effect as the purchase of the instruments specifically identified in Section 14(j). The proposed amendment covers all transactions that establish downside price protection – whether by purchasing or selling a security or derivative security or otherwise, consistent with the statutory purpose and providing more complete disclosure.

A proposed instruction clarifies that the company must disclose which categories of transactions it permits and which categories of transactions it prohibits.  The SEC believes disclosure of both the categories prohibited and those permitted conveys a complete understanding of the scope of hedging at the company. However, the SEC recognizes that where a company only prohibits specified hedging transactions, potentially limitless disclosure of each specific category otherwise permitted may not be meaningful. Accordingly, if a company specifically prohibits certain hedging transactions, it would disclose the categories of transactions it specifically prohibits, and could, if true, disclose that it permits all other hedging transactions in lieu of listing all of the specific categories that are permitted.

Conversely, where a company specifies only the hedging transactions that it permits, in addition to disclosing the particular categories of transactions permitted, it may, if true, disclose that it prohibits all other hedging transactions in lieu of listing all of the specific categories that are prohibited.

If a company does not permit any hedging transactions, or permits all hedging transactions, it should so state and would not need to describe them by category. An additional instruction would require a company that permits hedging transactions to disclose sufficient detail to explain the scope of such permitted transactions.

If a company permits some, but not all, of the categories of persons covered by the proposed amendment to engage in hedging transactions, the company would disclose both the categories of persons who are permitted to hedge and those who are not.

Equity Securities

The proposed rule includes an instruction to specify that the term “equity securities,” as used in proposed Item 407(i), means any equity securities (as defined in Exchange Act Section 3(a)(11) and Exchange Act Rule 3a11-1) issued by the company, any parent of the company, any subsidiary of the company or any subsidiary of any parent of the company that are registered under Section 12 of the Exchange Act.   As proposed, the disclosure requirement would apply to the equity securities issued by the company and its parents, subsidiaries or subsidiaries of the company’s parents that are registered on a national securities exchange or registered under Exchange Act Section 12(g).

Employees and Directors Subject to the Disclosure Requirements

Section 14(j) of the Exchange Act covers hedging transactions conducted by any employee or member of the board of directors or any of their designees. The SEC believes the term “employee” should be interpreted to include everyone employed by an issuer, including its officers. According to the SEC it is just as relevant for shareholders to know if officers are allowed to effectively avoid restrictions on long-term compensation as it is for directors and other employees of the company.

Relationship to CD&A

One of the non-exclusive examples currently listed in the Item 402(b) requirement for CD&A disclosure calls, in part, for disclosure of any registrant policies regarding hedging the economic risk of company securities ownership, to the extent material. The CD&A applies only to named executive officers.

To reduce potentially duplicative disclosure in proxy and information statements, the release also proposes to amend Item 402(b) of Regulation S-K to add an instruction providing that a company may satisfy its CD&A obligation to disclose material policies on hedging by named executive officers by cross referencing the information disclosed pursuant to proposed Item 407(i) to the extent that the information disclosed there satisfies this CD&A disclosure requirement.

Issuers Subject to the Rule

The SEC does not propose to exempt smaller reporting companies or emerging growth companies from Item 407(i) disclosure. The SEC stated it is  not aware of any reason why information about whether a company has policies affecting the alignment of shareholder interests with those of employees and directors would be less relevant to shareholders of an emerging growth company or a smaller reporting company than to shareholders of any other company.


Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.