Following up on the post from Tuesday, Final Rules for Disclosure of Hedging Policies (Dodd-Frank), Mike Melbinger, Partner, Winston & Strawn, shares these additional insights on the Securities and Exchange Commission’s (SEC) final ruling regarding the Dodd-Frank Act Section 955.
Details on the SEC’s Final Rules on Hedging Policies (originally published Jan 7, 2019)
As I blogged at the end of last year, the SEC has adopted final rules implementing Dodd-Frank Act Section 955, “Disclosure of Hedging by Employees and Directors,” which added new Section 14(j) to the Securities Exchange Act of 1934. The final rules add a new Section 407(i) to Regulation S-K.
The SEC resisted all requests to provide a definition of hedging, instead placing that burden entirely on the company (and counsel). However, the rules make it very clear that the SEC intends the disclosure requirement to apply very broadly. “Establishing downside price protection is the essence of the transactions contemplated by Section 14(j).” The SEC declined even to state that the purchase and sale of mutual funds, index funds, and other diversified investment vehicles were excluded from the definition of hedging.
- Disclosure is not required for any policies related to consultants, because the SEC has not heard of concerns about the alignment of their interests with those of shareholders.
- The rules make it clear that equity securities for which disclosure is required are equity securities of the company, any parent of the company, any subsidiary of the company, or any subsidiary of any parentof the company, whether or not publicly traded.
The rules apply to Smaller Reporting Companies (SRCs), Emerging Growth Companies (EGCs), and Business Development Companies (BDCs), but do not apply to foreign private issuers or listed closed-end funds.
Companies generally must comply with the new disclosure requirements in proxy statements for fiscal years beginning on or after July 1, 2019. SRCs and EGCs need not comply until proxy statements for fiscal years beginning on or after July 1, 2020.
NATURE OF THE DISCLOSURE
The final rules state that a company could satisfy the new disclosure requirement either by (i) providing 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, or (ii) disclosing the practices or policies in full. Because of the potential ambiguities as to the definition as to what actions or transactions should be proscribed in the company’s policy, we are leaning toward the second alternative, if the company’s policies are not too long. There is less risk of misleading investors if the policy is disclosed word-for-word. However, companies with longer policies may decide to include only a summary
LOCATION OF DISCLOSURE
Item 402(b)(2)(xiii) of Regulation S-K already requires companies to disclose “any registrant policies regarding hedging the economic risk of such ownership.” The new finals rules do not eliminate Item 402(b)(2)(xiii), but adds an instruction to it. to allow companies to avoid the potential for duplicative disclosure in their proxy statements. Instruction 6 reads:
In proxy or information statements with respect to the election of directors, if the information disclosed pursuant to Item 407(i) would satisfy paragraph (b)(2)(xiii) of this Item, a registrant may refer to the information disclosed pursuant to Item 407(i).
The new rules indicate that companies have flexibility in where they present the new disclosure. A company could choose either to:
- include its Item 407(i) hedging policy disclosure outside of the CD&A and provide a separate Item 402(b)(2)(xiii) disclosure as part of CD&A without a cross reference, or
- incorporate the 407(i) disclosure into the CD&A, either by directly including the information or by providing the information outside of CD&A and adding a cross-reference within CD&A.
However, the new Item 407(i) disclosure will not be subject to the say-on-pay vote applicable to executive compensation except to the extent a company chooses to make it part of CD&A, either directly or pursuant to the cross-reference instruction noted above. Therefore, our instinct is to avoid making the Item 407(i) disclosure part of CD&A by not cross-referencing or directly including that disclosure in the Item 402/CD&A disclosure.
Finally, in its discussion of the final rules, the SEC indicates its view that the disclosure “will provide additional information on whether the company has practices or policies affecting the alignment of incentives for employees and directors of the company whose securities they hold.” This suggests an opportunity to turn the disclosure requirement into a positive.
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