Ideally, a company’s executives and directors have incentives that align their interests with those of shareholders. Equity ownership, of course, is one of the primary vehicles. But what about when executives and directors can hedge against possible declines in their holdings of the company’s equity?
Many U.S. issuers allow such hedging, and, until recently didn’t have to disclose much about it to investors. On Tuesday, however, the Securities and Exchange Commission approved a final rule requiring companies to disclose the fact that executives and directors are permitted to engage in transactions that mitigate or avoid the incentive alignment associated with equity ownership.
Under the rule, which takes effect for some companies in mid-2019, issuers will have to describe any practices or policies they have regarding the ability of their employees (including officers) or directors to “offset any decrease in the market value of equity securities granted as compensation or held directly or indirectly.” They will have to detail these policies if individuals are allowed to purchase securities or other financial instruments or engage in other transactions that are designed to be a hedge.
The disclosures have to be provided in proxy or information statements relating to the election of directors.
The SEC said a company could satisfy the requirement by providing a fair and accurate summary of the practices or policies that apply to such hedging. That would include the categories of persons the policies affect and any categories of hedging transactions that are specifically permitted or specifically disallowed. Practices and policies can also be disclosed 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.
The proposed amendments would not require a company to prohibit hedging transactions or otherwise to adopt practices or policies addressing hedging, the SEC emphasized.
The SEC added that companies that prohibit hedging may include that information in their securities trading policies or corporate governance guidelines.
The new disclosures must be provided for fiscal years beginning on or after July 1, 2019. However, companies that qualify as “smaller reporting companies” or “emerging growth companies” have until a year later, July 1, 2020, to comply.
Listed closed-end funds and foreign private issuers are exempt.
In commenting on the rule when it was first proposed in 2015, John Hayes, chairman of Ball, said nearly all (95%) of a cross‐section of 60 publicly traded companies whose CEOs are members of Business Roundtable prohibited hedging of company securities by executive officers, and 85% prohibited hedging by directors.
A representative of the Council of Institutional Investors favored the disclosure, saying it would put members and other investors “in a better position to make more informed investment and voting decisions, including voting decisions on proposals to adopt hedging policies, advisory votes on executive compensation, and voting decisions in connection with the election of directors.”
The hedging disclosure rule implements a mandate from the Dodd-Frank Wall Street Reform and Consumer Protection Act.