SEC adopts final disclosure rules on director, officer and employee hedging



December 20, 2018

Securities Law Alert

Author(s): John C. Partigan

The SEC adopted final rules requiring public companies to disclose any practices or policies regarding director, officer and employee hedging transactions with respect to the company’s equity securities. This alert discusses what companies and investors need to know.

The Securities and Exchange Commission (“SEC”) adopted final hedging disclosure rules on December 18, 2018, that implement Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) by adding a new Item 407(i) to Regulation S-K. The final rules (which have not yet been published, but are summarized in a press release issued by the SEC) require public companies to provide a summary, in their proxy statements and information statements distributed in connection with an election of directors, of any practices or policies regarding the ability of employees or directors to engage in hedging transactions with respect to the company’s equity securities, including a description of any categories of hedging transactions that are specifically permitted or disallowed. Alternatively, the company may disclose such policies or practices in full. If the company does not have any such practices or policies, the rule requires the company to disclose that fact or state that hedging transactions are generally permitted.

What transactions are covered by this disclosure?

Transactions

Under Dodd-Frank, covered transactions involve the purchase of financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange funds) that are designed to hedge or offset any decrease in the market value of equity securities. The SEC’s original proposal from 2015,[1 he extent continued in the final rules, would expand the scope of Dodd-Frank to cover all transactions with economic consequences comparable to the purchase of the financial instruments specified in the act. A short sale, for example, would not be deemed a financial instrument but could effectively hedge a decrease in the market value of equity securities. The SEC favored the principles-based approach in its proposal as a means of offering shareholders more complete disclosure, to avoid encouraging directors and employees to favor transactions not covered by the disclosure obligations, and to be consistent with the standard used in the Compensation Discussion and Analysis (“CD&A”) section of the proxy statement.

Equity securities

“Equity securities” as used in the final rules means equity securities issued by the company, any parent of the company, any subsidiary of the company or any subsidiary of any parent of the company registered under Section 12 of the Securities Exchange Act.

The final rule covers hedging against equity securities granted as compensation in addition to equity securities held, directly or indirectly, by the employee or a member of the board of directors. Therefore, the disclosure obligation would cover transactions intended to hedge a decrease in the market value of securities purchased in the open market. The SEC elected to cover all equity securities held by the employee or director based on the premise that a shareholder should be aware of whether a director’s, officer’s or employee’s interests are not aligned with the shareholders, regardless of how those equity securities were acquired.

What individuals are covered by the disclosure?

The final rule covers transactions by employees (including officers, as well as employees who generally would not be in a position to affect the share price) and directors, and their respective designees. Disclosure of hedging policies under the rule is broader than the current CD&A disclosure requirement, which is limited to hedging policies applicable to named executive officers.

Officers and directors of public companies are also subject to disclosure obligations under Section 16(a) of the Securities Exchange Act and must report hedging transactions involving one or more derivative securities on Form 4 within two business days.

What entities are required to make this disclosure?

The final rule covers any company with securities registered pursuant to Section 12 of the Securities Exchange Act, including emerging growth companies and smaller reporting companies, other than listed closed-end funds and foreign private issuers. By contrast, emerging growth companies and smaller reporting companies are not required to provide the CD&A disclosure required by Item 402(b) of Regulation S-K. The SEC acknowledged in its proposing release that this would result in greater initial costs to these companies, but did not expect the rule to constitute a substantial incremental burden. To ease the burden, the final rule provides for a delayed implementation schedule, described below.

What’s next?

Companies generally must comply with the new disclosure requirements in proxy and information statements for the election of directors during fiscal years beginning on or after July 1, 2019. Companies that qualify as “smaller reporting companies” or “emerging growth companies” (each as defined in Securities Exchange Act Rule 12b-2) must comply with the new disclosure requirements in proxy and information statements for the election of directors during fiscal years beginning on or after July 1, 2020.

In view of the upcoming disclosure deadline and in light of the issues addressed by the new rules, companies should review their existing hedging policies, or consider adopting policies regarding hedging activity of directors, officers and employees.


  1. Proposed Rule Regarding Disclosure of Hedging by Employees, Officers and Directors, Release No. 33-9723; 34-74232; IC-31450 (Feb. 9, 2015).
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