March 19, 2019

March 18, 2019

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SEC Adopts Hedging Disclosure Rule

On December 18, the SEC adopted a final rule requiring companies to disclose in proxy or information statements for the election of directors any practices or policies regarding the ability of employees or directors to engage in certain hedging transactions with respect to company equity securities. This long-awaited rule implements the mandate imposed by Section 955 of the Dodd-Frank Act to provide investors with information on whether directors and employees are permitted to hedge any decrease in market value of their own company’s stock. Most companies must include this disclosure with respect to fiscal years beginning on or after July 1, 2019.

In Depth

On December 18, the US Securities and Exchange Commission (SEC) approved a final rule requiring companies to disclose in proxy or information statements for the election of directors any practices or policies regarding the ability of employees or directors to engage in certain hedging transactions with respect to company equity securities. This rule implements 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 in April 2015.

As proposed, this rule would have required disclosure of the categories of transactions a company permitted. The commission moved away from this approach in the final rule by requiring companies to disclose a fair and accurate summary of the hedging practices or policies that apply, including the categories of persons covered and any categories of hedging transactions that are specifically disallowed. Alternatively, the company must disclose the practices or policies in full.

The final rule only regulates the disclosure of hedging practices and policies; it does not direct companies to have practices or policies regarding hedging nor does it dictate the content of any such practice or policy. If the company does not have any such practices or policies, it must disclose that fact or state that hedging is generally permitted.

The adopting release notes the following highlights of the new Item 407(i) of Regulation S-K:

  • Item 407(i) of Regulation S-K will require a company to describe any practices or policies it has adopted regarding the ability of its employees (including officers) or directors to purchase securities or other 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 equity securities granted as compensation, or held directly or indirectly by the employee or director.

  • The disclosure must either disclose the practices or policies in full or provide a fair and accurate summary of the practices or policies that apply, including the categories of persons they affect and any categories of hedging transactions that are specifically permitted or specifically disallowed.

  • If the company does not have any such practices or policies, the company must disclose that fact or state that hedging transactions are generally permitted.

  • Disclosure is required with respect to equity securities of the company, any parent of the company, any subsidiary of the company, or any subsidiary of any parent of the company.

Despite requests, the American Bar Association and other commentators, the SEC declined to define what constitutes “hedging.” Instead, the final rule is framed as a principled based disclosure. The result is that the final rule arguably requires disclosure of certain types of permitted transactions as an allowed form of hedging. We previously authored a comment letter to the SEC describing several types of common transactions that could be considered to be a form hedging that are not typically prohibited under existing hedging policies.

Disclosure required by the new rule can be provided within or outside of the Compensation Disclosure and Analysis (CD&A). Companies are already required to disclose, if material, policies on hedging by named executive officers (NEO[s]) in the CD&A pursuant to Item 402(b) of Regulation S-K. If a company provides the new disclosure outside of the CD&A, the final rule provides that the company can satisfy the existing requirement with a cross reference to the new disclosure.

Given this flexibility, a company can choose to:

  • Include a new disclosure outside of the CD&A and provide the Item 402(b) NEO hedging disclosure as part of the CD&A without a cross-reference; or

  • Incorporate the new disclosure into the CD&A, either by directly including the information or by providing the new information outside of the CD&A and adding a cross-reference within the CD&A.

As a practical matter, incorporating the new disclosure into the CD&A would mean it is covered by the advisory say-on-pay vote required by the Dodd-Frank Act.

Of note, the final rule is not limited in application to equity securities granted as compensation, but covers hedging policies with respect to all equity securities held by employees, officers and directors, whether directly or indirectly. For example, this would include any shares held by an executive officer or director for the purpose of satisfying a stock ownership commitment.

The new disclosure requirements is effective with respect to proxies and information statements with respect to fiscal years beginning on or after July 1, 2019. Smaller reporting companies and emerging growth companies have been given an additional year to comply with the final rule. Foreign private issuers and listed closed-end funds are exempt from this rule.

We recommend that covered companies review their existing practices and policies with respect to hedging in light of the final rule. Specifically, consideration should be given to clarifying what types of transactions are—and are not—prohibited under hedging policies. For example, a company could modify it hedging policies by stating that only financial instruments that are “derivative securities” with respect to an issuer’s equity securities for purposes of Section 16 of the Exchange Act are prohibited hedging transactions. This type of objective standard would simplify disclosure, make it easier to ensure compliance with the policy and avoid potential claims over misleading disclosures.

© 2019 McDermott Will & Emery

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Thomas P. Conaghan, Mcdermott Will Emery law Firm,  (M&A), joint ventures, strategic investments, spin-offs,
Partner

Thomas P. Conaghan is a partner in the law firm of McDermott Will & Emery and is based in the Firm’s Washington, D.C., office.  Tom represents both publicly held and closely held businesses, underwriters and other sources of capital, corporate boards and board committees and corporate executives.  He advises both U.S. and foreign-based public companies on issues relating to public and private offerings of securities, disclosure, periodic reporting, corporate governance, executive compensation, the rules of the New York Stock Exchange and the Nasdaq Stock Market and compliance with the...

202-756-8161
Partner

Andrew C. Liazos is a partner in the law firm of McDermott Will & Emery LLP based in the Firm’s Boston office. Andrew heads the Firm's Executive Compensation Group and the Boston Employee Benefits Practice.

Andrew regularly represents Fortune 500 companies, public companies, large closely held businesses and compensation committees on all aspects of executive compensation, ERISA fiduciary matters, employee benefits in business transactions and bankruptcy, and employee stock ownership plans. He also counsels executives in employment agreement and joint venture negotiations.

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Eric Orsic, corporate, securities, attorney, McDermott Will, law firm
Partner

Eric Orsic is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office. Eric focuses his practice in the areas of mergers and acquisitions, and securities transactions and compliance.   Eric works with both public and privately-held companies to structure and negotiate business acquisitions/dispositions.  His public company transactional experience includes public equity and debt offerings, tender offers and going-private transactions.  Eric also serves as outside securities counsel to several public companies and advises on SEC compliance...

312-984-7617
Heidi Steele, Mcdermott, Corporate Securities lawyer
Partner

Heidi J. Steele Focuses her practice on corporate securities, mergers and acquisitions of public and private companies and corporate counseling. She has extensive experience in public and private equity and debt financings, compliance with disclosure and regulatory requirements, tender offers and mergers, acquisitions and dispositions. She advises public and private corporations on a variety of matters, including securities compliance.

Heidi acts as counsel for a wide range of corporate combinations. Recent transactions work includes public offerings of common...

312-984-3624
Daniel McGuire, McDermott Law Firm, Corporate Law Attorney, Washington DC
Associate

Daniel P. McGuire focuses his practice on general corporate matters, such as mergers and corporate restructuring, and securities regulation.

While in law school, Daniel served as a senior editor of the Ave Maria Law Review, and was twice elected to the Honor Board. He interned at the US Department of Justice, Environment and Natural Resources Division, in Washington, DC, and as a law clerk for the Wayne County Office of Corporation Counsel in Detroit.

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