Corporations small and large will have to explicitly disclose whether they allow board directors, officers, or other employees to hedge their holdings of company stock under a regulatory proposal approved Monday.
The proposal requires a company to reveal whether these shareholders are permitted “to hedge or offset any decrease in the market value of equity securities granted by the company as compensation” or bought in the open market, according to the Securities and Exchange Commission.
The rule is sweeping in its impact, because smaller public reporting companies, including emerging growth companies, will have to comply. Congress has in the past three years tried to exempt emerging growth companies from certain kinds of regulatory and reporting burdens.
Business development companies and registered closed-end investment companies with shares listed on a national securities exchange will also have to comply with the rule.
“The proposed rules would provide investors with additional information about the governance practices of the companies in which they invest,” said SEC Chair Mary Jo White. “Increasing transparency into hedging policies will help investors better understand the alignment of the interests of employees and directors with their own.”
The hedging activities covered under the rule include the purchase of financial instruments such as prepaid variable forward contracts, equity swaps, collars, and exchange funds.
As CFO wrote in 2012, governance experts have called hedging of company stock a problematic pay practice.
According to the proxy governance firm Institutional Shareholder Services, “Stock-based compensation or open market purchases of company stock should serve to align executives’ or directors’ interests with shareholders” and “hedging of company stock through . . . derivative transactions severs the ultimate alignment with shareholders’ interests.”
The ISS and apparently takes this view even if the hedged stock is in addition to stock owned by the executive or director that meets stock-ownership requirements imposed by the issuer to enhance alignment of management’s interest with stockholders’ interest.
Congress directed the SEC as part of the Dodd-Frank Act to issue rules requiring disclosure of hedging activities. There are no readily available, up-to-date data on what percentage of public companies allow directors and officers to hedge their company shareholdings.
The SEC will seek public comment on the proposed rule amendments for 60 days following their publication in the Federal Register.
Featured image: Thinkstock