On February 9, 2015, the U.S. Securities and Exchange Commission (SEC) issued a proposed rule that, if adopted, would require public companies to disclose in annual proxy statements whether their employees and board members may hedge or otherwise offset any decrease in the market value of such companies’ equity securities. The proposed rule implements Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and covers a much broader range of transactions than hedging policies adopted at most public companies. The proposed rule would not require a public company to prohibit hedging type transactions.

It is appropriate for issuers at this time to consider the extent to which the scope of their existing hedging policies differs from the proposed rule. The SEC has solicited comments on the proposed rule prior to April 14, 2015. Specific areas that are requested for comment may be found in an appendix at the end of this On the Subject.

Hedging Disclosure as “Principles Based” Corporate Governance Disclosure

The proposed rule would add the hedging disclosure rule as part of a public company’s required corporate governance disclosure under Item 407. The SEC proposes this approach, as opposed to requiring the hedging disclosure as part of the executive compensation disclosure under Item 402, because “it requires a company to provide . . . shareholders [with] insight into whether the company has policies affecting how the equity holdings and equity compensation of all of a company’s employees and directors may or may not align with shareholders’ interests” (emphasis added). Consistent with viewing hedging type transactions as a form of misalignment with shareholder interests, ensuring complete disclosure and favoring any particular type of hedging activity, the proposed rule provides a “principles-based” disclosure requirement. Specifically, disclosure is required for any transactions that have or are designed to have “economic consequences comparable” to prepaid variable forward contracts, equity swaps, collars and exchange funds that have or are designed to have the effect of hedging or offsetting. One of the more significant areas identified for comment is the scope of transactions that may be considered comparable to hedging. For now, it is clear that a pledge or loan of equity securities that does not involve a prepaid variable forward contract will not be considered a disclosable hedging transaction.

Covered Equity Securities

The securities covered by the proposed rule are not limited to just the issuer’s publicly traded stock that is listed on an exchange. Covered securities include any equity security issued by a public company, any parent or subsidiary of the public company, and any subsidiary of any parent of a public company with registered equity securities. It is not uncommon to see hedging policies that focus on just the shares of stock that the public company has listed on a national stock exchange. The proposed rule also clarifies that the disclosure requirement extends to equity securities either earned as compensation or otherwise held from whatever source acquired.

Covered Persons

As noted above, the proposed rule would extend to all employees (including officers) and directors. In addition, the rule extends to “designees,” which would appear to include fiduciaries of trusts or family limited partnerships that may be established for gift tax planning purposes. Many, if not most, hedging policies only extend to executive officers. If a public company intends to change its hedging policies in light of whatever final rule is adopted under Section 955, it is appropriate to consider what steps should be taken in order for the policy to be enforceable. Actions that may be appropriate include adding provisions in new equity awards requiring compliance with hedging policy, as may be amended from time to time, and obtaining a written acknowledgment from any designee that it will comply with the hedging policy.

Matters to Be Addressed in Disclosure

The proposed rule would not require public companies to identify in the proxy each possible type of hedging or other transaction. A public company that only prohibits certain types of hedging transactions would be able to disclose just the categories of transactions it specifically prohibits and state that it permits all other hedging transactions. On the other hand, a public company that only allows certain types of hedging transactions would be able to disclose just the categories of such permitted transactions, and state that all other hedging type transactions are prohibited. Any distinctions among different classes of persons covered by Section 955 would also need to be disclosed under the proposed rule. For example, the preamble to the proposed note provides that a company might disclose that it prohibits all hedging transactions by executive officers and directors, but does not restrict hedging transactions by other employees.

Coordination with Other Rules

Item 402 provides as an example of the kind of information that should be provided in the Compensation Discussion & Analysis (CD&A), if material, a public company’s equity or other security ownership requirements or guidelines (specifying applicable amounts and forms of ownership) and any policies regarding hedging the economic risk of such ownership. Issuers subject to this requirement (i.e., public companies other than smaller reporting companies, emerging growth companies, registered investment companies and foreign private issuers) often address their hedging policies in their CD&A disclosure. To reduce potentially duplicative disclosure, the proposed rule would allow public companies to satisfy this CD&A obligation by cross referencing to the information disclosed under Section 955 (provided that such information is presented in a manner that also satisfies this CD&A disclosure requirement). The proposed rule would be in addition to other existing proxy disclosure rules that address hedging transactions. The purchase and sale of derivative securities by officers and directors would continue to be subject to reporting under Section 16(a) of the Exchange Act within two business days on SEC Form 4. Pledges of the underlying company equity securities as collateral would also be subject to disclosure in the beneficial ownership table under Item 403.