The Securities and Exchange Commission (SEC) approved final rules on December 18, 2018 requiring the disclosure of a company's practices or policies on the ability of employees, officers, and directors to engage in certain hedging transactions. This new disclosure will be required in proxy statements or information statements relating to the election of directors during fiscal years beginning on or after July 1, 2019, unless a company is a smaller reporting or emerging growth company. Smaller reporting and emerging growth companies must comply with this new disclosure requirement during fiscal years beginning on and after July 1, 2020.
The final rules implement Section 14(j) of the Securities Exchange Act of 1934, which was enacted by Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank).
The information that must be disclosed is set forth in new Item 407(i) of Regulation S-K. This addition is intended to provide transparency about whether employees or directors are permitted to engage in transactions that mitigate or avoid the incentive alignment associated with equity ownership.
Overview of New Item 407(i) of Regulation S-K
New Item 407(i) requires a description of any practices or policies a company has adopted (whether written or not) regarding the ability of its employees (including officers) or directors 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) decreases in the market value of equity securities granted as compensation or held directly or indirectly by the employee or director.
A company can satisfy this disclosure requirement by providing a fair and accurate summary of its applicable practices and policies, including the categories of persons covered and any categories of hedging transactions that are specifically permitted or disallowed. Alternatively, a company can satisfy this disclosure requirement by disclosing its practices and policies in full.
If a company does not have hedging practices or policies in place, a company must disclose the absence of such practices or policies or state that hedging transactions are generally permitted.
The equity securities for which disclosure is required include equity securities of the company, any parent of the company, any subsidiary of the company, or any subsidiary of any parent of the company.
Where Information Must Be Disclosed
The information required by Item 407(i) of Regulation S-K must be included in proxy statements and information statements relating to the election of directors. It is not required in registration statements under the Securities Act of 1933 or the Securities Exchange Act of 1934 (Exchange Act) or in a company's Form 10-K Part III disclosure.
Since foreign private issuers are not subject to the proxy statement requirements of Section 14 of the Exchange Act, they will not be required to provide this new disclosure.
Close-end funds are also not required to provide the disclosure required by Item 407(i).
Relationship to Existing CD&A Disclosure Obligations
Item 402(b) of Regulation S-K currently lists company policies regarding hedging the economic risk of company securities ownership as one of the non-exclusive examples of disclosure that may be required in a company's compensation discussion and analysis (CD&A). The final rules include a new instruction to Item 402(b) indicating that a company may satisfy this CD&A obligation by cross referencing the information disclosed pursuant to new Item 407(i).
Affected companies must include the information required by new Item 407(i) in their proxy and information statements for the election of directors for fiscal years beginning on or after July 1, 2019. Smaller reporting and emerging growth companies must include the required information inn their proxy and information statements for fiscal years beginning on or after July 1, 2020.
While these new disclosure requirements should not be burdensome to comply with, they will encourage those companies that do not currently prohibit hedging transactions to add such a prohibition in their insider trading policies or otherwise adopt a formal policy prohibiting hedging transactions.