In somewhat of a surprise announcement, last week the SEC proposed rules to implement the requirement under the Dodd-Frank Act that companies disclose their policies with respect to hedging by employees and directors.
This Has Nothing to Do With Yard Work
Hedging is a means by which investors protect themselves against downside risk—think “hedging your bets.” This is all well and good for the average investor, but when the investor in question is an officer or director of the company who has received compensatory awards of stock and/or options, hedging can be problematic. Companies grant equity awards to align their officers and directors with shareholders and to motivate them to increase the value of the company’s stock. If the officers and directors can use hedging instruments to protect themselves from downside risk, they might be less motivated by their equity awards.
Likewise, where a company has implemented ownership guidelines, if officers and directors can hedge against the stock they own to comply with the guidelines, then the guidelines aren’t terribly effective because officers and directors haven’t really assumed the risk of ownership.
More Controversial Than You Might Think
The proposal was issued via written consents of the Commissioners, rather than an open meeting, which is why it caught many of us by surprise. An open meeting would have been announced in advance and people that follow the SEC’s meeting schedule would have known it was happening.
I thought that this ought to be relatively simple—essentially, “disclose your hedging policy”—especially since companies are already doing this for their NEOs in the CD&A. But I guess nothing that the SEC does is very simple; the proposing release is 103 pages long. That is, however, shorter than the CEO pay ratio disclosure proposal, which clocked in at 162 pages.
Part of the complexity is that there are virtually an infinite number of possible types of arrangements and instruments that can be used to hedge a financial position. Complicated strategies like equity swaps, variable prepaid forward contracts, and collars (in case you are wondering, I have no idea what any of these things are, except that I do know that an equity swap is not the same thing as a swap exercise) and more straightforward transactions such as a short sale (I know what that is: a short sale is selling stock you don’t own yet—you are hoping the stock price will decline before you have to buy the stock to close out your position).
The SEC requests comments on a number of matters related to the rules, including:
- Should the disclosure apply to all employees (the language included in Dodd-Frank) or just officers and directors (the individuals investors are probably most concerned about when it comes to hedging)?
- Should the rules be part of corp governance disclosures under Reg S-K Item 407 or part of the Say-on-Pay disclosures under Item 402? The proposal includes them under Item 407, which means that shareholders technically aren’t voting on them as part of Say-on-Pay.
- Types of equity securities that should be subject to the disclosure.
- Should companies be required to disclose hedging activities that employees, officers, and directors have engaged in?
- Should smaller reporting companies or emerging growth companies be exempted from making the disclosure or subject to a delayed implementation schedule?
Comments should be submitted to the SEC by April 20, 2015.
Cooley’s blog has a nice summary of the proposal, if you don’t want to read all 103 pages.
– Barbara
Tags: Dodd-Frank Act, hedging policies, Reg S-K, SEC rulemaking
Just when you thought you were finally getting a handle on the executive compensation disclosures, the SEC is considering changing them. According to an alert by McGuireWoods, the SEC staff has reviewed the disclosure requirements of Reg S-K (all of them, not just the disclosures relating to executive compensation) and issued a report that includes recommendations for further review. The JOBS Act of 2012 (not to be confused with the Jobs Creation Act of 2004) required the study with respect to disclosures by emerging growth companies, but the SEC expanded it to cover all companies.
The staff’s recommendations with respect to the executive compensation disclosures are fairly vague; they point out that these disclosures can be quite lengthy and technical and further review might be warranted on this basis, as well as to confirm that the information disclosed is useful to investors. The staff also suggests that the disclosures be reviewed to determine if they need to be made simpler for smaller companies.
So maybe the disclosures will change and maybe they won’t. According to the report, there weren’t any comments submitted to the SEC’s JOBS Act website on the executive compensation disclosures. Interestingly, there were two comments suggesting that the table disclosing the number of shares outstanding and available for grant under stock plans approved by shareholders and not approved by shareholders could be eliminated (and one comment that this table shouldn’t be eliminated, proving once again that you can’t please all the people, all the time).
According to McGuireWoods, at this time, the SEC is still formulating an action plan with respect to the study; a time frame hasn’t been specified for completing any further reviews called for under the study, much less promulgating and transitioning to any new rules.
Did You Know?
I did learn a couple of interesting tidbits when reading the section of the SEC’s report that covered the executive compensation disclosures. I thought you might be interested to know that:
- The executive compensation disclosure rules have been amended more often than any other rules for disclosures required under Reg S-K.
- The executive compensation disclosures, albeit in a very different format, have been around since the very first registration statement (Form A-1) implemented in 1933.
- Back in 1933, the disclosure was required for any directors, officers, or other persons earning in excess of $25,000. This seems like a pretty low threshold, but then I ran the amount through the Bureau of Labor Statistic’s inflation calculator. In today’s dollars, that’s around $450,000.
- In 1972, the threshold for disclosure was increased to compensation in excess of $40,000. According to the inflation calculator, that’s around $223,000 in today’s dollars.
- It wasn’t until 1992 that the threshold was increased to $100,000. In today’s dollars, that’s about $166,000. $40,000 in 1972 was the equivalent of about $134,000 in 1992, so my guess is that we have a ways to go until the SEC decides to increase the threshold again.
– Barbara
Tags: disclosures, executive compensation disclosures, Item 201(d), Item 402, proxy, Reg S-K, SEC, stock plan disclosures
On January 16, the SEC approved the new NYSE and NASDAQ listing standards relating to compensation committee independence. As noted in the NASPP’s alert on the original proposals (“Exchanges Issue New Standards for Compensation Committee Independence“), the new standards include three primary requirements:
- The compensation committee must be comprised of independent directors, based on a number of “bright line” tests (many of which were already applicable to independent directors under each exchange’s prior listing standards) as well as additional factors that the SEC suggested should be considered in determining a director’s independence. Also, NASDAQ will now require a separate compensation committee (the NYSE already required this).
- The compensation committee must have authority and funding to retain compensation advisors and must be directly responsible for appointment, compensation, and oversight of any advisors to the committee.
- The committee must evaluate the independence of any advisors (compensation consultants, legal advisors, etc.).
The final rules make only a few minor changes to the original proposals, including clarifying that the compensation committee will not be required to conduct the required independence assessment as to a compensation adviser that acts in a role limited to:
- consulting on a broad-based plan that does not discriminate in favor of executive officers or directors of the company, and that is available generally to all salaried employees; or
- providing information (such as survey data) that is not customized for a particular company or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.
See the NASPP alert “SEC Approves Exchange Standards for Compensation Committee Independence” for more information.
Disclosures
Public companies now need to assess whether the compensation consultants and other advisors engaged by their compensation committee raise any conflicts of interest and disclose any identified conflicts in their proxy statement (for annual meetings after January 1, 2013 at which directors will be elected). Although not required, where no conflict of interest is found, we expect that many companies will include a disclosure to indicate this.
In his Proxy Disclosure Blog on CompensationStandards.com, Mark Borges of Compensia highlights a recent disclosure on this topic in Viacom’s proxy statement, which might be useful to review as you draft your own disclosure (if this isn’t your gig, perhaps you can score some points by forwarding it on to the person that will be drafting this disclosure).
– Barbara
Tags: compensation committee, compensation consultant, conflict of interest, corporate governance, Dodd-Frank, Dodd-Frank Act, independent directors, listing standards, NASDAQ, nonemployee directors, NYSE, outside directors, Reg S-K