8486 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

1 17 CFR 229.402. 

2 17 CFR 229.10 et seq. 

3 17 CFR 229.407. 

4 17 CFR 14a–101. 

5Public Law 111–203, 124 Stat. 1900 (July 21, 

2010). 

6 15 U.S.C. 78a et seq. 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Parts 229 and 240 

[Release No. 33–9723; 34–74232; IC–31450; 

File No. S7–01–15] 

RIN 3235–AL49 

Disclosure of Hedging by Employees, 

Officers and Directors 

AGENCY: Securities and Exchange 

Commission. 

ACTION: Proposed rule. 

SUMMARY: We are proposing 

amendments to our rules to implement 

Section 955 of the Dodd-Frank Wall 

Street Reform and Consumer Protection 

Act, which requires annual meeting 

proxy statement disclosure of whether 

employees or members of the board of 

directors are permitted to engage in 

transactions to hedge or offset any 

decrease in the market value of equity 

securities granted to the employee or 

board member as compensation, or held 

directly or indirectly by the employee or 

board member. The proposed disclosure 

would be required in a proxy statement 

or information statement relating to an 

election of directors, whether by vote of 

security holders at a meeting or an 

action authorized by written consent. 

DATES: Comments should be received on 

or before April 20, 2015. 

ADDRESSES: Comments may be 

submitted by any of the following 

methods: 

Electronic Comments 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/

rules/proposed.shtml); 

• Send an email to rule-comments@

sec.gov. Please include File Number S7– 

01–15 on the subject line; or 

• Use the Federal Rulemaking Portal 

(http://www.regulations.gov). Follow the 

instructions for submitting comments. 

Paper Comments 

• Send paper comments in triplicate 

to Brent J. Fields, Secretary, U. S. 

Securities and Exchange Commission, 

100 F Street NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number S7–01–15. This file number 

should be included on the subject line 

if email is used. To help us process and 

review your comments more efficiently, 

please use only one method. The 

Commission will post all comments on 

the Commission’s Internet Web site 

(http://www.sec.gov/rules/

proposed.shtml). Comments are also 

available for Web site viewing and 

printing in the Commission’s Public 

Reference Room, 100 F Street NE., 

Washington, DC 20549, on official 

business days between the hours of 

10:00 a.m. and 3:00 p.m. All comments 

received will be posted without change; 

we do not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly. 

Studies, memoranda or other 

substantive items may be added by the 

Commission or staff to the comment file 

during this rulemaking. A notification of 

the inclusion in the comment file of any 

such materials will be made available 

on the SEC’s Web site. To ensure direct 

electronic receipt of such notifications, 

sign up through the ‘‘Stay Connected’’ 

option at www.sec.gov to receive 

notifications by email. 

FOR FURTHER INFORMATION CONTACT: 

Carolyn Sherman, Special Counsel, or 

Anne Krauskopf, Senior Special 

Counsel, at (202) 551–3500, in the 

Office of Chief Counsel, Division of 

Corporation Finance, and Nicholas 

Panos, Senior Special Counsel, at (202) 

551–3440, in the Office of Mergers and 

Acquisitions, Division of Corporation 

Finance; or, with respect to investment 

companies, Michael Pawluk, Branch 

Chief, at (202) 551–6792, Division of 

Investment Management, U.S. Securities 

and Exchange Commission, 100 F Street 

NE., Washington, DC 20549. 

SUPPLEMENTARY INFORMATION: We 

propose to amend Item 402 1 of 

Regulation S–K 2 by revising paragraph 

(b) to add Instruction 6; to amend Item 

407 3 of Regulation S–K to add new 

paragraph (i); and to amend Schedule 

14A 4 to revise Items 7 and 22. 

Table of Contents 

I. Introduction 

II. Background 

III. Discussion of the Proposed Amendments 

A. Transactions Subject to the Disclosure 

Requirement 

B. Specifying the Term ‘‘Equity Securities’’ 

C. Employees and Directors Subject to the 

Proposed Disclosure Requirement 

D. Implementation 

1. Manner and Location of Disclosure 

2. Disclosure on Schedule 14C 

3. Relationship to Existing CD&A 

Obligations 

4. Issuers Subject to the Proposed 

Amendments 

a. Registered Investment Companies 

b. Emerging Growth Companies and 

Smaller Reporting Companies 

c. Foreign Private Issuers 

IV. Economic Analysis 

A. Background 

B. Baseline 

C. Discussion of Benefits and Costs, and 

Anticipated Effects on Efficiency, 

Competition and Capital Formation 

1. Introduction 

2. New Disclosure Requirements Across 

Covered Companies 

3. Benefits and Costs 

4. Anticipated Effects on Efficiency, 

Competition and Capital Formation 

D. Alternatives 

1. Changing the Scope of Disclosure 

Obligations 

2. Issuers Subject to the Proposed 

Amendments 

E. Request for Comments 

V. Paperwork Reduction Act 

A. Background 

B. Summary of the Proposed Amendments 

C. Burden and Cost Estimates Related to 

the Proposed Amendments 

D. Request for Comment 

VI. Small Business Regulatory Enforcement 

Fairness Act 

VII. Initial Regulatory Flexibility Act 

Analysis 

A. Reasons for, and Objectives of, the 

Proposed Action 

B. Legal Basis 

C. Small Entities Subject to the Proposed 

Amendments 

D. Reporting, Recordkeeping and other 

Compliance Requirements 

E. Duplicative, Overlapping or Conflicting 

Federal Rules 

F. Significant Alternatives 

G. Solicitation of Comments 

VIII. Statutory Authority and Text of the 

Proposed Amendments 

I. Introduction 

We are proposing rule amendments to 

implement Section 955 of the DoddFrank Wall Street Reform and Consumer 

Protection Act (the ‘‘Act’’),5 which adds 

new Section 14(j) to the Securities 

Exchange Act of 1934 (the ‘‘Exchange 

Act’’).6 Section 14(j) directs the 

Commission to require, by rule, each 

issuer to disclose in any proxy or 

consent solicitation material for an 

annual meeting of the shareholders of 

the issuer whether any employee or 

member of the board of directors of the 

issuer, or any designee of such 

employee or director, is permitted to 

purchase financial instruments 

(including prepaid variable forward 

contracts, equity swaps, collars, and 

exchange funds) that are designed to 

hedge or offset any decrease in the 

market value of equity securities either 

(1) granted to the employee or director 

by the issuer as part of the 

compensation of the employee or 

director; or (2) held, directly or 

indirectly, by the employee or director. 

A report issued by the Senate 

Committee on Banking, Housing, and 


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Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 8487 

7See Report of the Senate Committee on Banking, 

Housing, and Urban Affairs, S. 3217, Report No. 

111–176 (Apr. 30, 2010) (‘‘Senate Report 111–176’’). 

8As defined in Item 402(a)(3) of Regulation S–K, 

‘‘named executive officers’’ are all individuals 

serving as the company’s principal executive officer 

during the last completed fiscal year, all individuals 

serving as the company’s principal financial officer 

during that fiscal year, the company’s three other 

most highly compensated executive officers who 

were serving as executive officers at the end of that 

year, and up to two additional individuals who 

would have been among the three most highly 

compensated but for not serving as executive 

officers at the end of that year. 

9As defined in Exchange Act Rule 12b–2 [17 CFR 

240.12b–2]. 

10Section 101 of the Jumpstart Our Business 

Start-Ups Act (the ‘‘JOBS Act’’) [Pub. L. 112–106, 

126 Stat. 306 (2012)] codified the definition of 

‘‘emerging growth company’’ in Section 3(a)(80) of 

the Exchange Act and Section 2(a)(19) of the 

Securities Act. 

11Registered investment companies are 

investment companies registered under Section 8 of 

the Investment Company Act of 1940 (‘‘Investment 

Company Act’’). 15 U.S.C. 80a et seq. 

12As defined in Rule 3b–4 [17 CFR 240.3b–4]. 

13 15 U.S.C. 78l. 

14 15 U.S.C. 78p(a). For Section 16 purposes, the 

term ‘‘derivative securities’’ is defined in Exchange 

Act Rule 16a–1(c), which excludes rights with an 

exercise or conversion privilege at a price that is not 

fixed. Exchange Act Rule 16a–1(d) defines ‘‘equity 

security of the issuer’’ as any equity security or 

derivative security relating to the issuer, whether or 

not issued by that issuer. See also Exchange Act 

Rule 16a–4, which provides that for Section 16 

purposes, both derivative securities and the 

underlying securities to which they relate shall be 

deemed to be the same class of equity securities. 

The Commission has clarified that Section 16 

applies to equity swap and similar transactions that 

a Section 16 insider may use to hedge, and has 

addressed how these derivative securities 

transactions should be reported, including 

specifically identifying them through the use of 

transaction code K. See Ownership Reports and 

Trading by Officers, Directors and Principal 

Security Holders, Release No. 34–34514 (Aug. 10, 

1994) [59 FR 42449] at Section III.G; and Ownership 

Reports and Trading by Officers, Directors and 

Principal Security Holders, Release No. 34–37260 

(May 31, 1996) [61 FR 30376] at Sections III.H and 

III.I. The Commission also has clarified how 

transactions in securities futures should be 

reported. Commission Guidance on the Application 

of Certain Provisions of the Securities Act of 1933, 

the Securities Exchange Act of 1934, and Rules 

thereunder to Trading in Security Futures Products, 

Release No. 33–8107 (June 21, 2002) [67 FR 43234] 

at Q. 13. 

15A prepaid variable forward contract obligates 

the seller to sell, and the counterparty to purchase, 

a variable number of shares at a specified future 

maturity date. The number of shares deliverable 

will depend on the per share market price of the 

shares close to the maturity date. The contract 

specifies maximum and minimum numbers of 

shares subject to delivery, and at the time the 

contract is entered into, the seller will pledge to the 

counterparty the maximum number of shares. The 

Commission has indicated that forward sales 

contracts are derivative securities transactions 

subject to Section 16(a) reporting. Mandated 

Electronic Filing and Web site Posting for Forms 3, 

4 and 5, Release No. 33–8230 (May 7, 2003) [68 FR 

25788], text at n. 42. 

16 Item 403(b) of Regulation S–K [17 CFR 

229.403(b)]. Disclosure is required on an individual 

basis as to each director, nominee, and named 

executive officer, and on an aggregate basis as to 

executive officers of the issuer as a group and must 

be provided in proxy statements, annual reports on 

Form 10–K [referenced in 17 CFR 240.310], and 

registration statements under the Securities Act and 

under the Exchange Act on Form 10. 

17The Commission’s rationale for requiring the 

disclosure of the amount of shares pledged as 

security was as follows: ‘‘To the extent that shares 

owned by named executive officers, directors and 

director nominees are used as collateral, these 

shares may be subject to material risk or 

contingencies that do not apply to other shares 

beneficially owned by these persons.’’ Executive 

Compensation and Related Person Disclosure, 

Release No. 33–8732A (Aug. 29, 2006) [71 FR 

53158] (the ‘‘2006 Executive Compensation 

Disclosure Release’’) at Section IV. 

Urban Affairs stated that Section 14(j) is 

intended to ‘‘allow shareholders to 

know if executives are allowed to 

purchase financial instruments to 

effectively avoid compensation 

restrictions that they hold stock longterm, so that they will receive their 

compensation even in the case that their 

firm does not perform.’’ 7 In this regard, 

we infer that the statutory purpose of 

Section 14(j) is to provide transparency 

to shareholders, if action is to be taken 

with respect to the election of directors, 

about whether employees or directors 

are permitted to engage in transactions 

that mitigate or avoid the incentive 

alignment associated with equity 

ownership. 

We propose to implement Section 

14(j) as described in detail below. 

Neither Section 14(j) nor the proposed 

amendments would require a company 

to prohibit hedging transactions or to 

otherwise adopt practices or a policy 

addressing hedging by any category of 

individuals. 

II. Background 

The current disclosure obligations 

relating to company hedging policies are 

provided by Item 402(b) of Regulation 

S–K, which sets forth the disclosure 

required in the company’s 

Compensation Discussion and Analysis 

(‘‘CD&A’’). CD&A requires disclosure of 

material information necessary to an 

understanding of a company’s 

compensation policies and decisions 

regarding the named executive officers.8

Item 402(b)(2)(xiii) includes, as an 

example of the kind of information that 

should be provided, if material, the 

company’s equity or other security 

ownership requirements or guidelines 

(specifying applicable amounts and 

forms of ownership) and any company 

policies regarding hedging the economic 

risk of such ownership. This CD&A 

disclosure item requirement, which 

does not apply to smaller reporting 

companies,9 emerging growth 

companies,10 registered investment 

companies 11 or foreign private 

issuers,12 by its terms addresses only 

hedging by the named executive 

officers. In providing their CD&A 

disclosure, however, some companies 

describe policies that address hedging 

by employees and directors, as well as 

the named executive officers. 

In addition, disclosures pursuant to 

other requirements may reveal when 

company equity securities have been 

hedged: 

• For companies with a class of 

equity securities registered pursuant to 

Section 12 of the Exchange Act,13

hedging transactions by officers and 

directors in transactions involving one 

or more derivative securities—such as 

options, warrants, convertible securities, 

security futures products, equity swaps, 

stock appreciation rights and other 

securities that have an exercise or 

conversion price related to a company 

equity security or derive their value 

from a company equity security—are 

subject to reporting within two business 

days on Form 4, pursuant to Exchange 

Act Section 16(a).14

• Some hedging transactions, such as 

prepaid variable forward contracts,15

may involve pledges of the underlying 

company equity securities as collateral. 

Item 403(b) of Regulation S–K requires 

disclosure of the amount of company 

equity securities beneficially owned by 

directors, director nominees and named 

executive officers,16 including the 

amount of shares that are pledged as 

security.17

III. Discussion of the Proposed 

Amendments 

We propose to implement Section 

14(j) by adding new paragraph (i) to 

Item 407 of Regulation S–K to require 

companies to disclose whether they 

permit employees and directors to 

hedge their company’s securities. We 

believe that the disclosure called for by 

Section 14(j) is primarily corporate 

governance-related because it requires a 

company to provide in its proxy 

statement information giving 

shareholders 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. 

Because Section 14(j) calls for 

disclosure about employees and 

directors, we believe that this 

information raises broader issues with 

respect to the alignment of shareholders’ 

interests with those of employees’ and 

directors’, and is more closely related to 

the Item 407 corporate governance 

disclosure requirements than to Item 

402 of Regulation S–K, which focuses 

only on the compensation of named 


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8488 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

18As a result, the proposed disclosure would not 

be subject to shareholder advisory votes to approve 

the compensation of named executive officers, as 

disclosed pursuant to Item 402, that are required 

pursuant to Section 14A(a)(1) of the Exchange Act 

and Rule 14a–21(a) [17 CFR 240.14a–21(a)]. We 

recognize, however, that there is an executive 

compensation component of the proposed 

disclosure as it relates to existing CD&A obligations. 

See Section III.D.3, below. 

19 15 U.S.C. 78l. 

20 17 CFR 240.14c–101. 

21By covering ‘‘exchange funds,’’ we believe that 

Section 14(j) can be interpreted to cover 

transactions involving dispositions or sales of 

securities. This is because an employee or director 

can acquire an interest in an exchange fund only 

in exchange for a disposition to the exchange fund 

of equity securities held by the employee or 

director. Whether the disposition to the exchange 

fund is a hedging transaction will depend on the 

terms of the fund. 

22See Senate Report 111–176. 

23Section 14(j) refers to financial instruments that 

are designed to hedge or offset any decrease in 

market value. The proposed amendments do not 

define the term ‘‘hedge,’’ as we believe the meaning 

of hedge is generally understood and should be 

applied as a broad principle. 

24A pledge or loan of equity securities that does 

not involve a prepaid variable forward or similar 

transaction, would not be considered a hedging 

transaction covered by the proposed disclosure rule 

even though such a pledge or loan may be viewed 

as an ‘‘offer or sale’’ of a security under Securities 

Act Section 17(a) [15 U.S.C. 77q(a)]. See Rubin v. 

United States, 449 U.S. 424 (1981). This is because 

such stand-alone pledges and loans generally 

contemplate the return of the pledged or borrowed 

securities to the employee, with no consequent 

change in the employee’s economic risk in 

ownership of the securities. 

25 Item 402(b)(2)(xiii) of Regulation S–K, 

discussed in Section II.D, below. 26Proposed Instruction 3 to Item 407(i). 

executive officers and directors. We 

propose to amend Item 407 in this 

manner to keep disclosure requirements 

relating to corporate governance matters 

together in a single item in Regulation 

S–K.18

The proposed amendments 

implement Section 14(j) in the following 

ways: 

• Include within the scope of the 

proposed disclosure requirement other 

transactions with economic 

consequences comparable to the 

financial instruments specified in 

Section 14(j); 

• specify that the equity securities for 

which disclosure is required are only 

equity securities of the company, any 

parent of the company, any subsidiary 

of the company or any subsidiary of any 

parent of the company that are 

registered under Section 12 of the 

Exchange Act; 19

• require the disclosure in any proxy 

statement on Schedule 14A or 

information statement on Schedule 

14C20 with respect to the election of 

directors because the information seems 

most relevant for shareholders voting or 

receiving information about the election 

of directors; and 

• clarify that the term ‘‘employee’’ 

includes officers of the company. 

A. Transactions Subject to the 

Disclosure Requirement 

Section 14(j) requires disclosure of 

whether any employee or director of the 

issuer, or any designee of such 

employee or director, is permitted to 

purchase financial instruments 

(including prepaid variable forward 

contracts, equity swaps, collars, and 

exchange funds 21) that are designed to 

hedge or offset any decrease in the 

market value of equity securities. Our 

proposal would implement this 

requirement and would also require 

disclosure of transactions with 

economic consequences comparable to 

the purchase of the specified financial 

instruments. 

As noted above, a Senate report 

indicated that Section 14(j) was added 

so that shareholders would know 

whether executive officers are able ‘‘to 

effectively avoid compensation 

restrictions that they hold stock longterm, so that they will receive their 

compensation even in the case that their 

firm does not perform.’’ 22 Although 

Section 14(j) expressly refers only to the 

purchase of financial instruments 

designed to hedge or offset any decrease 

in the market value of equity securities, 

there are other transactions that could 

have the same economic effects, the 

disclosure of which would be consistent 

with the purpose of Section 14(j).23 For 

example, a short sale can hedge the 

economic risk of ownership. Similarly, 

selling a security future establishes a 

position that increases in value as the 

value of the underlying equity security 

decreases, thereby establishing the 

downside price protection that is the 

essence of the transactions 

contemplated by Section 14(j). 

We are concerned that if the proposed 

disclosure requirement is not 

sufficiently principles-based, the result 

would be incomplete disclosure as to 

the scope of hedging transactions that 

an issuer permits. If, for example, a 

company discloses that it prohibits the 

purchase of the types of financial 

instruments specifically listed in the 

statute, and does not otherwise disclose 

whether it permits other types of 

hedging transactions that may have the 

same economic effects as the purchase 

of the listed financial instruments, a 

shareholder might assume that the 

company does not permit any hedging 

transactions at all, even though that may 

not be the case. Similarly, failing to 

cover transactions with the same 

economic effects as purchase of the 

listed financial instruments might cause 

employees and directors to use those 

transactions that are not covered by the 

disclosure requirement. In order for the 

disclosure to be complete and to avoid 

discouraging or promoting the use of 

particular hedging transactions, our 

proposed amendment would require 

disclosure of whether an issuer permits 

other types of transactions that have the 

same hedging effect as the purchase of 

those instruments specifically identified 

in Section 14(j). Proposed Item 407(i) 

would require disclosure of whether an 

employee, officer or director, or any of 

their designees, is permitted to purchase 

financial instruments (including 

prepaid variable forward contracts, 

equity swaps, collars, and exchange 

funds) or otherwise engage in 

transactions that are designed to or have 

the effect of hedging or offsetting any 

decrease in the market value of equity 

securities. The proposed amendment 

would therefore cover all transactions 

that establish downside price 

protection—whether by purchasing or 

selling a security or derivative security 

or otherwise,24 consistent with the 

statutory purpose and providing more 

complete disclosure. Like the existing 

CD&A disclosure item, which applies to 

company policies regarding hedging the 

economic risk of named executive 

officers’ ownership of the company’s 

securities,25 the scope of the proposed 

amendment is not limited to any 

particular types of hedging transactions. 

A proposed instruction would clarify 

that the company must disclose which 

categories of transactions it permits and 

which categories of transactions it 

prohibits.26 Disclosure of both the 

categories prohibited and those 

permitted conveys a complete 

understanding of the scope of hedging at 

the company. However, we recognize 

that where, for example, a company 

only prohibits specified hedging 

transactions, potentially limitless 

disclosure of each specific category 

otherwise permitted may not be 

meaningful. Accordingly, if a company 

specifically prohibits certain hedging 

transactions, it would disclose the 

categories of transactions it specifically 

prohibits, and could, if true, disclose 

that it permits all other hedging 

transactions in lieu of listing all of the 

specific categories that are permitted. 

For example, a company could disclose 

that it prohibits prepaid variable 

forward contracts, but permits all other 

hedging transactions. Conversely, where 

a company specifies only the hedging 

transactions that it permits, in addition 

to disclosing the particular categories of 

transactions permitted, it may, if true, 

disclose that it prohibits all other 


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27Proposed Instruction 4 to Item 407(i). 

28Proposed Instruction 2 to Item 407(i). 

29 15 U.S.C. 78c(a)(11). Exchange Act Section 

3(a)(11) defines ‘‘equity security’’ as any stock or 

similar security; or any security future on any such 

security; or any security convertible, with or 

without consideration, into such a security, or 

carrying any warrant or right to subscribe to or 

purchase such a security; or any such warrant or 

right; or any other security which the Commission 

shall deem to be of similar nature and consider 

necessary or appropriate, by such rules and 

regulations as it may prescribe in the public interest 

or for the protection of investors, to treat as an 

equity security. 

30 17 CFR 240.3a11–1. Exchange Act Rule 3a11– 

1 defines ‘‘equity security’’ to include any stock or 

similar security, certificate of interest or 

participation in any profit sharing agreement, 

preorganization certificate or subscription, 

transferable share, voting trust certificate or 

certificate of deposit for an equity security, limited 

partnership interest, interest in a joint venture, or 

certificate of interest in a business trust; any 

security future on any such security; or any security 

convertible, with or without consideration into 

such a security, or carrying any warrant or right to 

subscribe to or purchase such a security; or any 

such warrant or right; or any put, call, straddle, or 

other option or privilege of buying such a security 

from or selling such a security to another without 

being bound to do so. 

31 15 U.S.C. 78l; Proposed Instruction 1 to Item 

407(i). 

32 15 U.S.C. 78l(b). 

33 15 U.S.C. 78l(g). 

34Examples may include, but are not limited to, 

where a company reorganizes to create a publiclytraded subsidiary. 

35See Senate Report 111–176. 

36The parenthetical ‘‘(including officers)’’ in 

proposed Item 407(i) is intended to include officers 

employed by an issuer and avoid possible 

confusion with Exchange Act Rule 12b–2 [17 CFR 

240.12b–2], which states that the term ‘‘employee’’ 

does not include a director, trustee, or officer. 

37Section 14(j) refers to ‘‘designee[s]’’ of 

employees and directors. Under the proposed 

disclosure requirement, whether someone is a 

‘‘designee’’ would be determined by a company 

based on the particular facts and circumstances. 

hedging transactions in lieu of listing all 

of the specific categories that are 

prohibited. For example, a company 

could disclose that it permits exchange 

fund transactions, but prohibits all other 

hedging transactions. If a company does 

not permit any hedging transactions, or 

permits all hedging transactions, it 

should so state and would not need to 

describe them by category. An 

additional instruction would require a 

company that permits hedging 

transactions to disclose sufficient detail 

to explain the scope of such permitted 

transactions.27 For example, a company 

that permits hedging of equity securities 

that have been held for a specified 

period of time would need to disclose 

the period of time the securities must 

have been held. 

If a company permits some, but not 

all, of the categories of persons covered 

by the proposed amendment to engage 

in hedging transactions, the company 

would disclose both the categories of 

persons who are permitted to hedge and 

those who are not.28 For example, a 

company might disclose that it prohibits 

all hedging transactions by executive 

officers and directors, but does not 

restrict hedging transactions by other 

employees. Disclosing both categories of 

transactions and persons would provide 

investors a more complete 

understanding of the persons permitted 

to engage in hedging transactions, if 

any, and the types of hedging 

transactions permitted by the company. 

B. Specifying the Term ‘‘Equity 

Securities’’ 

We are proposing an instruction to 

specify that the term ‘‘equity securities,’’ 

as used in proposed Item 407(i), would 

mean any equity securities (as defined 

in Exchange Act Section 3(a)(11) 29 and 

Exchange Act Rule 3a11–1) 30 issued by 

the company, any parent of the 

company, any subsidiary of the 

company or any subsidiary of any 

parent of the company that are 

registered under Section 12 of the 

Exchange Act.31 As proposed, the 

disclosure requirement would apply to 

the equity securities issued by the 

company and its parents, subsidiaries or 

subsidiaries of the company’s parents 

that are registered on a national 

securities exchange 32 or registered 

under Exchange Act Section 12(g).33 We 

believe that the equity securities 

registered under Exchange Act Section 

12 encompass the securities that are 

more likely to be readily traded, and 

more easily hedged. Because the 

Exchange Act and Exchanges Act Rules 

definitions of ‘‘equity security’’ do not 

specify the issuer, and Section 14(j) 

does not itself do so, without an 

instruction that narrows the scope, the 

term ‘‘equity securities’’ could be 

interpreted to include the equity 

securities of any company that are held 

directly or indirectly by an employee or 

director. 

The proposed instruction would 

specify the scope of covered equity 

securities for both paragraphs (1) 

(compensatory equity securities grants) 

and (2) (other equity securities holdings) 

of proposed Item 407(i). Disclosure of 

whether a director or employee is 

permitted to hedge equity securities 

granted as compensation or otherwise 

held from whatever source acquired will 

more fully inform shareholders whether 

employees and directors are able to 

engage in transactions that reduce the 

alignment of their interests with the 

economic interests of other shareholders 

of the company and any affiliated 

company in which the employees or 

directors might have an interest. 

Shareholders would receive the Item 

407(i) disclosure because they hold 

equity securities of the company and 

action is to be taken with respect to the 

election of directors for that company. 

The disclosure would provide 

additional information on whether the 

company has policies affecting the 

alignment of incentives for employees 

and directors of the company whose 

securities they hold. We therefore 

believe that disclosure about whether 

employees and directors are permitted 

to hedge equity securities issued by the 

company, its parents, subsidiaries or 

subsidiaries of the company’s parents 

that are registered under Exchange Act 

Section 12 would be most relevant 

when providing information about the 

election of directors. We believe that, in 

certain instances,34 companies may 

grant equity securities of affiliated 

companies to their employees or 

directors that are intended to achieve 

similar incentive alignment as grants in 

the company’s equity securities. In these 

instances, we believe it would be 

relevant for shareholders to know 

whether such persons are permitted to 

mitigate or avoid the risks associated 

with long-term ownership of these 

securities. 

C. Employees and Directors Subject to 

the Proposed Disclosure Requirement 

Section 14(j) covers hedging 

transactions conducted by any 

employee or member of the board of 

directors or any of their designees. 

Consistent with that mandate, we 

believe the term ‘‘employee’’ should be 

interpreted to include everyone 

employed by an issuer, including its 

officers. We believe it is just as relevant 

for shareholders to know if officers are 

allowed to effectively avoid restrictions 

on long-term compensation as it is for 

directors and other employees of the 

company.35 Accordingly, we propose to 

implement Section 14(j) by adding the 

parenthetical ‘‘(including officers)’’ after 

the term ‘‘employees’’ in the language of 

the proposed disclosure requirement.36

In sum, the proposed amendment uses 

the language ‘‘any employees (including 

officers) or directors of the registrant, or 

any of their designees’’ in describing the 

persons covered by the disclosure 

requirement.37

Request for Comment 

1. Should the disclosure required by 

Section 14(j) be implemented by 

amending the corporate governance 

disclosures required by Item 407, as 

proposed? Alternatively, should it be 

implemented by amending the Item 402 


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38Exchange Act Rule 12b-2 [17 CFR 240.12b–2]. 39Exchange Act Rule 12b-2 [17 CFR 240.12b–2]. 40See Letter from Compensia, Inc. (Oct. 4, 2010). 

To facilitate public input on the Act, the 

Commission has provided a series of email links, 

organized by topic, on its Web site at http://

www.sec.gov/spotlight/regreformcomments.shtml. 

The public comments we have received on Section 

955 of the Act are available on our Web site at 

http://www.sec.gov/comments/df-title-ix/executivecompensation/executive-compensation.shtml. 

41See Section IV.C.1. 

executive compensation disclosure 

requirements? Are there advantages or 

disadvantages to requiring these 

disclosures under Item 402? If so, please 

explain why. 

2. Should the scope of the proposed 

Item 407(i) disclosure requirement cover 

transactions that are not expressly listed 

in Exchange Act Section 14(j) but have 

economic consequences comparable to 

the purchase of the financial 

instruments specifically identified in 

Section 14(j), as proposed? If not, why 

not? 

3. Should the scope of transactions 

covered by proposed Item 407(i) be 

clarified? We are of the view that there 

is a meaningful distinction between an 

index that includes a broad range of 

equity securities, one component of 

which is company equity securities, and 

a financial instrument, even one 

nominally based on a broad index, 

designed to or having the effect of 

hedging the economic exposure to 

company equity securities. Should we 

clarify the application of Item 407(i) to 

account for this situation? If so, how? 

For example, if an issuer prohibited 

hedging generally, but permitted the 

purchase of broad-based indices, should 

we specify that the issuer could 

nonetheless disclose that it prohibits all 

hedging transactions? Should the rule 

explicitly distinguish between 

instruments that provide exposure to a 

broad range of issuers or securities and 

those that are designed to hedge 

particular securities or have that effect? 

Would a principles-based or numerical 

threshold approach be most helpful in 

this regard? If not, what other 

clarification should be provided? 

4. If a company prohibits some, but 

not all, of the categories of transactions 

described in the proposed amendment, 

in order to fully describe what hedging 

transactions are permitted and by 

whom, is it necessary to require 

disclosure, as proposed, of both the 

categories of transactions that are 

permitted and the categories of 

transactions that are prohibited? If not, 

please explain why not. Does proposed 

Instruction 3 to Item 407(i) provide a 

way for companies that permit or 

prohibit only certain covered 

transactions to disclose this information 

in a clear and effective manner? 

Alternatively, should the company 

simply be required to describe its 

policy, if any, without further 

elaboration? 

5. A company that permits hedging 

transactions would be required to 

disclose sufficient detail to explain the 

scope of such permitted transactions. 

For example, a company may permit 

hedging transactions only if preapproved, or only after the company’s 

stock ownership guidelines have been 

met. Should proposed Instruction 4 be 

more specific about the types of details, 

such as a pre-approval requirement, that 

the company must disclose? 

6. Does our proposal to define the 

term ‘‘equity securities’’ as equity 

securities of the company or any of its 

parents, subsidiaries or subsidiaries of 

its parents that are registered under 

Exchange Act Section 12 appropriately 

capture the disclosure that shareholders 

would find useful? Should the 

Commission limit the term ‘‘equity 

securities’’ to only equity securities of 

the company? If so, please explain why 

and the costs and benefits that would 

result. How often are directors and 

employees compensated through equity 

securities of an affiliated company that 

are not registered under Section 12(b) of 

the Exchange Act? If the definition of 

equity securities includes only equity 

securities registered under Section 12(b) 

of the Exchange Act, would that affect 

either compensation structure or 

corporate structure? Do companies 

typically have policies addressing 

hedging of equity securities of their 

parents, subsidiaries or subsidiaries of 

their parents? What would be the costs 

and benefits of disclosing whether 

hedging the equity securities of these 

affiliates is permitted or prohibited? 

Would any on-going compliance efforts 

be different? If so, please explain why 

and the costs and benefits that would 

result. 

7. Should the proposed definition be 

broadened to include equity securities 

that are not registered under Exchange 

Act Section 12 or narrowed to only 

include equity securities registered 

under Section 12(b) of the Exchange 

Act? If so, explain why and the costs 

and benefits that would result. 

Alternatively, should the proposed 

definition be revised to exclude equity 

securities that do not trade in an 

established public market? If so, how 

would ‘‘established public market’’ be 

defined? To the extent the amendment 

applies to equity securities that do not 

trade on an established public market, 

should we provide guidance about how 

to interpret ‘‘market value’’ for purposes 

of the proposed amendment? In either 

case, please explain why, and what 

costs and benefits would result from the 

recommended change. 

8. Should we define ‘‘parent’’ and 

‘‘subsidiary’’ specifically for purposes of 

this disclosure requirement? The 

definition of ‘‘parent’’ of a person in the 

Exchange Act Rules is an affiliate 

controlling such person directly, or 

indirectly through one or more 

intermediaries.38 Similarly, the 

Exchange Act Rules definition of 

‘‘subsidiary’’ of a person is an affiliate 

controlled by such person directly, or 

indirectly through one or more 

intermediaries.39 Will these definitions, 

in the context of hedging disclosure, 

present any implementation challenges 

in determining what needs to be 

disclosed? Should we consider an 

alternative term, or alternative 

definition of ‘‘parent’’ for this disclosure 

requirement, such as an affiliate that 

owns a majority of the voting securities 

in the company? Similarly, with respect 

to subsidiaries, should we consider an 

alternative term, or alternative 

definition of ‘‘subsidiary’’ for this 

disclosure requirement, such as a 

majority-owned subsidiary, whollyowned subsidiary, consolidated 

subsidiary or significant subsidiary? In 

each case, please explain why, and what 

costs and benefits would result from the 

recommended change. 

9. Section 14(j) does not define the 

circumstances in which equity 

securities are ‘‘held, directly or 

indirectly’’ by an employee or director. 

Is the concept of ‘‘held, directly or 

indirectly’’ unclear, such that we should 

provide more certainty about what is 

meant by the phrase? If so, how should 

we clarify it? Section 14(j) also does not 

define who is a ‘‘designee,’’ nor is this 

term otherwise defined in the rules 

under the Securities Act or the 

Exchange Act. One commenter has 

recommended that the Commission 

define the term ‘‘designee.’’40 Should 

the proposed amendment include an 

instruction clarifying who is a 

‘‘designee’’? If so, please explain how 

this term should be defined, and the 

costs and benefits that would result. 

10. Section 14(j) is directed to ‘‘any 

employee’’ and we interpret that to 

mean anyone employed by the issuer. 

Should we limit the definition of 

‘‘employee’’ to the subset of employees 

that participate in making or shaping 

key operating or strategic decisions that 

influence the company’s stock price? 41

Why or why not? If so, how would that 

distinction be defined for practical 

purposes? Alternatively, should we add 

an express materiality condition to the 

definition, as is the case under CD&A, 


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42See letter from Brian Foley & Company, Inc. 

(Sept. 22, 2010). 

43The Commission has previously recognized 

that directors ordinarily are elected at annual 

meetings. See, e.g., Rule 14a–6(a) [17 CFR 240.14a– 

6(a)], which acknowledges that registrants soliciting 

proxies in the context of an election of directors at 

an annual meeting may be eligible to rely on the 

exclusion from the requirement to file a proxy 

statement in preliminary form. Rule 14a–3(b) [17 

CFR 240.14a–3(b)] requires proxy statements used 

in connection with the election of directors at an 

annual meeting to be preceded or accompanied by 

an annual report containing audited financial 

statements. The requirement for registrants to hold 

an annual meeting at which directors are to be 

elected, however, is imposed by a source of legal 

authority other than the federal securities laws. In 

Delaware, for example, where more than 50% of the 

publicly traded issuers are incorporated according 

to the State of Delaware’s official Web site, 

Delaware General Corporation Law, Section 211(b) 

is viewed as requiring an annual meeting for the 

election of directors. See Delaware Law of 

Corporations & Business Organizations, Third 

Edition by R. Franklin Balotti, Jesse A. Finkelstein 

at § 7.1, Folk on the Delaware General Corporate 

Law, 2013 Edition by Edward P. Welch, Andrew J. 

Turezyn, and Robert S. Saunders at § 211.2, and the 

text of DGCL Section 211(b), which reads in 

relevant part, ‘‘unless directors are elected by 

written consent in lieu of an annual meeting as 

permitted by this subsection, an annual meeting of 

stockholders shall be held for the election of 

directors on a date and at a time designated by or 

in the manner provided in the bylaws.’’ See also 

Corporations and Other Business Associations, 

Seventh Edition by Charles R.T. O’Kelley and 

Robert B. Thompson at page 167 (explaining that 

the ‘‘paramount shareholder function is the election 

of directors’’ and that ‘‘[m]ost corporation codes 

protect this right by specifying immutably that 

directors shall be elected at an annually held 

meeting of shareholders.’’), California Corporations 

Code, Section 600(b), and 1984 Model Business 

Corporation Act (as amended through 2006), 

Section 7.01(a) (each requiring an annual meeting 

of shareholders for the election of directors). 

44Rule 14a–1(f) [17 CFR 240.14a–1(f)] defines the 

term ‘‘proxy’’ to include every proxy, consent or 

authorization within the meaning of Section 14(a) 

of the Exchange Act. A solicitation of consents 

therefore constitutes a solicitation of proxies subject 

to Section 14(a) and Regulation 14A. 

45See Items 7(b)–(d) and 8(a) of Schedule 14A. 

46We note that an annual meeting, the meeting 

at which companies generally provide for the 

election of directors, could theoretically not include 

an election of directors. For reasons explained 

above, an annual meeting ordinarily involves an 

election of directors. In the unlikely event that a 

company is not conducting a solicitation for the 

election of directors but is otherwise soliciting 

proxies at an annual meeting, the proposed 

amendment would not require the proposed 

disclosure in the proxy statement. 

47Proposed amended Item 7(b) and Instruction to 

Item 7 of Schedule 14A. 

48This approach is consistent with the disclosure 

requirements for registration statements under the 

Securities Act and for annual reports on Form 10– 

K, which include only selected provisions of Item 

407. See Item 11(l) and 11(o) on Form S–1 and 

Items 10, 11 and 13 of Form 10–K. 

49As permitted by General Instruction G to Form 

10–K. Proposed Instruction 5 to Item 407(i) would 

provide that information disclosed pursuant to Item 

407(i) would not be deemed incorporated by 

reference into any filing under the Securities Act, 

the Exchange Act or the Investment Company Act. 

As proposed, the disclosure also would not be 

subject to forward incorporation by reference under 

Item 12(b) of Securities Act Form S–3 [17 CFR 

239.13]. 

50As stated above, Exchange Act Rule 14a–1(f) 

[17 CFR 240.14a–1(f)] defines the term ‘‘proxy’’ to 

include every proxy, consent or authorization 

within the meaning of section 14(a) of the 

[Exchange] Act. Exchange Act Rule 14a–3(a) [17 

CFR 240.14a–3(a)] prohibits any proxy solicitation 

unless each person solicited is currently or has been 

previously furnished with a publicly-filed 

preliminary or definitive proxy statement 

containing the information specified in Schedule 

14A [17 CFR 240.14a–101], and Exchange Act Rule 

14a–6(m) [17 CFR 240.14a–6(m) requires proxy 

materials to be filed under cover of Schedule 14A. 

51Specifically, Item 1 of Schedule 14C permits 

the exclusion of information called for by Schedule 

14A Items 1(c) (Rule 14a–5(e) information re 

shareholder proposals), 2 (revocability of proxy), 4 

(persons making the solicitation), and 5 (interest of 

certain persons in matters to be acted upon). Other 

Items of Schedule 14C prescribe the information to 

Continued 

to permit each issuer to determine 

whether disclosure about all its 

employees would be material 

information for its investors? Why or 

why not? 

11. Should the amendment define 

‘‘hedge’’? If so, what concepts other than 

the statutory reference to ‘‘offset[ting] 

any decrease in the market value of 

equity securities’’ would be necessary to 

define this term? 

12. One commenter has recommended 

that the Commission ‘‘should not only 

require disclosure of whether hedging is 

permitted, but should also require 

disclosure of any hedging that has 

occurred—both in promptly filed Form 

4 filings and in the annual proxy 

statement.’’ 42 Should the Commission 

require such disclosure in the final rule 

for those already subject to Form 4 

reporting requirements? 

D. Implementation 

1. Manner and Location of Disclosure 

Section 14(j) calls for disclosure in 

any proxy or consent solicitation 

material for an annual meeting of the 

shareholders. Shareholder annual 

meetings are typically the venue in 

which directors are elected.43 Although 

the language of Section 14(j) refers to 

disclosure in any proxy or consent 

solicitation material for an annual 

meeting of the shareholders, this 

language, construed strictly, would 

result in the disclosure appearing in 

different instances than we currently 

require other corporate governance 

related disclosure. In particular, under 

our current rules, if a company solicits 

proxies 44 with respect to the election of 

directors, its proxy statement must 

include specified corporate governance 

information required by Item 407 of 

Regulation S–K, whether or not the 

election takes place at an annual 

meeting.45 We believe that Item 407(i) 

disclosure would be relevant 

information for shareholders evaluating 

the governance practices of the 

company and the election of directors. 

By providing the disclosure in a proxy 

statement if action is to be taken with 

respect to the election of directors, 

shareholders will be able to consider the 

proposed disclosure at the same time as 

they are considering the company’s 

other corporate governance disclosures 

and voting for the election of directors, 

without regard to whether at an annual 

or special meeting of shareholders or in 

connection with an action authorized by 

written consent.46 We therefore propose 

to implement Section 14(j) by amending 

Items 7 and 22 of Schedule 14A to call 

for new Item 407(i) information to be 

provided if action is to be taken with 

respect to the election of directors. In 

addition to including the new 

disclosure requirement, the proposal 

would amend Item 7 of Schedule 14A 

to streamline its current provisions by 

more succinctly cross-referencing 

disclosure Items.47

The information required under 

proposed Item 407(i) would need to be 

included in proxy or consent 

solicitation materials and information 

statements with respect to the election 

of directors. Section 14(j) specifically 

calls for the disclosure to be made in the 

proxy solicitation materials, and we 

believe the information would be most 

relevant to shareholders if action is to be 

taken with respect to the election of 

directors. We therefore do not propose 

to require Item 407(i) disclosure in 

Securities Act or Exchange Act 

registration statements or in the Form 

10–K Part III Item 407 disclosure,48 even 

if that disclosure is incorporated by 

reference from the company’s definitive 

proxy statement or information 

statement filed with the Commission 

not later than 120 days after the end of 

the fiscal year covered by the Form 10– 

K.49

2. Disclosure on Schedule 14C 

The statutory language of Section 14(j) 

expressly calls for proxy or consent 

solicitation materials for an annual 

meeting of the shareholders of the issuer 

to include the disclosure contemplated 

by the proposed amendments. These 

solicitation materials are required by 

our proxy rules to be filed under cover 

of Schedule 14A.50 As provided in Item 

1 of Schedule 14C, however, an 

information statement filed on Schedule 

14C must include the information called 

for by all of the items of Schedule 14A 

to the extent each item would be 

applicable to any matter to be acted 

upon at a meeting if proxies were to be 

solicited, with only limited 

exceptions.51 An information statement 


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be provided with regard to such of these topics that 

are relevant to information statements. Specifically, 

Item 3 addresses the interest of certain persons in 

or opposition to matters to be acted upon, and Item 

4 addresses proposals by security holders. In 

addition, Notes A, C, D and E to Schedule 14A are 

applicable to Schedule 14C [17 CFR 240.14c–101]. 

52Because our proposal would not add a new 

exclusion for information called for by the proposed 

amendment to Item 7 of Schedule 14A, the effect 

of the proposal will be to require Item 407(i) 

disclosure in Schedule 14C. 

53Section 14(c) of the Exchange Act was enacted 

to ‘‘reinforce [ ] fundamental disclosure principles 

[for companies] subject to the proxy rules which 

did not solicit proxies . . .’’ By enacting Section 

14(c), Congress was advised that these companies 

‘‘would be required to furnish shareholders with 

information equivalent to that contained in a proxy 

statement . . . [and that such legislation was 

needed] [b]ecause evasion of the disclosures 

required by the proxy rules is made possible by the 

simple device of not soliciting proxies . . .’’ 

Statement of William L. Cary, Chairman, Securities 

and Exchange Commission, Part I. K. Other 

Amendments Proposed by S. 1642, Hearings before 

a Subcommittee of the Committee on Banking and 

Currency for the U.S. Senate, Eighty-Eighth 

Congress, First Session on S. 1642, June 18–21 and 

24–25, 1963. 

54A controlled company is generally understood 

to be a company in which more than 50% of the 

voting power is held by an individual, a group or 

another issuer. See e.g., Exchange Act Section 

10C(g)(2) [15 U.S.C. 78jC(g)(2)]. 

55At the time Section 14(c) was being considered 

by Congress as an amendment to the Exchange Act, 

the Securities and Exchange Commission provided 

an official statement that reported findings 

associated with a study that examined the proxy 

solicitation practices of 556 industrial and other 

companies. ‘‘Twenty-nine percent of these 

companies did not solicit proxies and 24 percent 

did not even send shareholders a notice of 

meeting.’’ Statement of the Securities and Exchange 

Commission with respect to Proposed Amendments 

to Sections 12, 13, 14, 15, 16, 20(c), and 32(b) of 

the Securities Exchange Act of 1934 and Section 

4(1) of the Securities Act of 1933, at 2. Existing 

Disclosures by Over-the-Counter Companies, 

Hearings before a Subcommittee of the Committee 

on Banking and Currency for the U.S. Senate, 

Eighty-Eighth Congress, First Session on S. 1642, 

June 18–21 and 24–25, 1963. Simply extending the 

coverage of the proxy rules to reach over-thecounter issuers was not viewed as a solution, and 

was believed to have been a decision that would 

have accentuated the problem of non-solicitation 

‘‘because of management’s relatively larger 

holdings.’’ Statement of William L. Cary, Chairman, 

U.S. Securities and Exchange Commission, cited in 

n. [51] above. 

56Of the approximately 6845 operating 

companies with at least one class of securities 

registered under Section 12 of the Exchange Act, 

4018 have a class of securities listed on an 

exchange. Based on our review of and experience 

with NASDAQ, the New York Stock Exchange or 

NYSE Market, collectively referred to here as 

primary market exchanges, companies with a class 

of common or voting preferred stock (or their 

equivalents) listed on these exchanges are generally 

required to solicit proxies from shareholders for all 

meetings of shareholders, including those to elect 

directors. See, e.g., NYSE Listed Company Manual 

Section 402.04, and NASDAQ Rule IM–5620— 

Meetings of Shareholders or Partners. Operating 

companies with a class of voting stock listed on a 

primary exchange that comply with the listing 

exchange’s requirements, therefore, will be 

providing the proposed disclosure in proposed 

amended Item 7 of Schedule 14A and proposed 

Item 407(i) of Regulation S–K for each election of 

directors. By contrast, the approximately 2827 nonexchange listed companies with a class of securities 

registered under Section 12 may not be subject to 

compulsory requirements analogous to the primary 

market exchange rules that impose an affirmative 

obligation to solicit shareholders. Consequently, 

these non-exchange listed companies, if not subject 

to a compulsory requirement to solicit proxies, 

could avoid the proposed disclosures if the new 

requirement were limited to only companies 

soliciting proxies or consents pursuant to Section 

14(a), especially given that companies with a class 

of securities registered only under Exchange Act 

Section 12(g) may be able to effectuate a corporate 

action (as referenced in Exchange Act Rule 14c–2) 

without soliciting security holder approval and thus 

would need only comply with Section 14(c) and 

Regulation 14C. 

57 Item 402(b)(2)(xiii) of Regulation S–K. 

58As required by Item 8 of Schedule 14A. 

59See Section III, above. 

60Proposed Instruction 6 to Item 402(b). 

filed on Schedule 14C in connection 

with an election of directors therefore 

already is required to include the 

information required by Item 7 of 

Schedule 14A. Absent an amendment to 

Schedule 14C to exclude proposed Item 

407(i) from the requirements for the 

information statement, the disclosure 

contemplated by the amendments 

would be required in Schedule 14C 

pursuant to existing Item 1 of Schedule 

14C. 

We are not proposing to exclude Item 

407(i) disclosure from Schedule 14C.52

Applying the proposed disclosure 

obligation to Schedule 14C filings 

would have the effect of expanding the 

requirement to comply with Item 407(i) 

to companies that do not solicit proxies 

from any or all security holders but are 

otherwise authorized by security 

holders to take an action with respect to 

the election of directors. 

We believe that doing so would retain 

consistency in the corporate governance 

disclosure provided in proxy statements 

and information statements with respect 

to the election of directors. Exchange 

Act Section 14(c) was enacted to apply 

to companies not soliciting proxies or 

consents from some or all holders of a 

class of securities registered under 

Section 12 of the Exchange Act entitled 

to vote at a meeting or authorize a 

corporate action by execution of a 

written consent.53 It creates disclosure 

obligations for a company that chooses 

not to, or otherwise does not, solicit 

proxies, consents, or other 

authorizations from some or all of its 

security holders entitled to vote. An 

example of when such a situation could 

occur is in the case of a controlled 

company 54 not listed on the New York 

Stock Exchange, NYSE Market or 

NASDAQ. In instances where 

management and/or a shareholder 

affiliate may control sufficient shares to 

assure a quorum and a favorable voting 

outcome, as in the case of a majorityowned subsidiary, or where a 

solicitation of proxies, consents or 

authorization is made of only certain 

security holders in connection with an 

election of directors, Section 14(c) 

would operate to ensure that security 

holders not solicited would receive 

disclosure substantially equivalent to 

that which would have been included in 

a proxy statement had a solicitation of 

all security holders been made.55 In 

light of this purpose, we believe 

requiring Item 407(i) disclosure in 

information statements filed pursuant to 

Section 14(c) furthers the regulatory 

objective of Section 14(j) of the 

Exchange Act and would mitigate the 

regulatory disparity that otherwise 

might result.56

3. Relationship to Existing CD&A 

Obligations 

One of the non-exclusive examples 

currently listed in the Item 402(b) 

requirement for CD&A calls, in part, for 

disclosure of any registrant policies 

regarding hedging the economic risk of 

company securities ownership,57 to the 

extent material. CD&A applies only to 

named executive officers and is part of 

the Item 402 executive compensation 

disclosure that is required in Securities 

Act and Exchange Act registration 

statements, and Exchange Act annual 

reports on Form 10–K, as well as proxy 

and information statements relating to 

the election of directors.58 Smaller 

reporting companies, emerging growth 

companies, registered investment 

companies and foreign private issuers, 

however, are not required to provide 

CD&A disclosure. 

By requiring proxy statement 

disclosure of whether employees 

generally are permitted to hedge equity 

securities that they receive as 

compensation or otherwise hold, the 

disclosure mandated by Section 14(j) 

includes within its scope hedging 

policies applicable to named executive 

officers.59 To reduce potentially 

duplicative disclosure in proxy and 

information statements, we propose to 

amend Item 402(b) of Regulation S–K to 

add an instruction providing that a 

company may satisfy its CD&A 

obligation to disclose material policies 

on hedging by named executive officers 

by cross referencing the information 

disclosed pursuant to proposed Item 

407(i) to the extent that the information 

disclosed there satisfies this CD&A 

disclosure requirement.60 This 

instruction, like the Item 407(i) 

disclosure requirement, would apply to 

a company’s proxy statement or 

information statement with respect to 

the election of directors. We believe that 


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61Exchange Act Rule 14a–21(a) [17 CFR 240.14a– 

21(a)] provides that shareholder advisory say-onpay votes apply to executive compensation 

disclosure pursuant to Item 402 of Regulation S–K, 

which includes CD&A. Because Item 407(i) 

disclosure will not be subject to these votes except 

to the extent made part of CD&A pursuant to the 

proposed cross-reference instruction, the proposal 

will not effect any change in the scope of disclosure 

currently subject to say-on-pay votes. We also note 

that the cross-reference is optional and issuers may, 

if they prefer, avoid making the Item 407(i) 

disclosure part of CD&A by not cross-referencing 

the disclosure. 

62Section 36(a) of the Exchange Act permits the 

Commission, by rule, regulation, or order, to 

conditionally or unconditionally exempt any 

person security, or transaction, or any class or 

classes of persons, securities, or transactions, from 

any provision or provisions of this title or of any 

rule or regulation thereunder, to the extent that 

such exemption is necessary or appropriate in the 

public interest, and is consistent with the 

protection of investors. 

63Business development companies are a 

category of closed-end investment company that are 

not registered under the Investment Company Act 

[15 U.S.C. 80a–2(a)(48) and 80a–53–64]. As 

proposed, business development companies would 

be treated in the same manner as all issuers (other 

than certain funds as discussed in this section) and 

therefore would be subject to the requirements of 

proposed Item 407(i). We believe that this would be 

consistent with the Commission’s treatment of 

business development companies regarding other 

disclosure requirements. See the 2006 Executive 

Compensation Disclosure Release, at Section II.D.3. 

64Some funds do have employees, who might 

also hold fund shares. See also footnote 36 and 

accompanying text (explaining that the 

parenthetical ‘‘(including officers)’’ in proposed 

Item 407(i) is intended to include officers employed 

by an issuer). 

65Funds also typically will contract with other 

service providers in addition to the investment 

adviser. 

66See Saitz, Greg, ‘‘Here Are Two Choices: Buy 

Fund Shares or Buy Fund Shares,’’ July 30, 2013, 

available at http://www.boardiq.com/c/556021/

60971/here_choices_fund_shares_fund_shares. 

67Registered open-end and closed-end 

investment companies are generally prohibited 

from issuing their securities for services. See 

Sections 22(g) (open-end funds) and 23(a) (closedend funds) of the Investment Company Act. 

Recognizing that ‘‘effective fund governance can be 

enhanced when funds align the interests of their 

directors with the interests of their shareholders,’’ 

our staff has provided guidance concerning the 

circumstances under which funds may compensate 

fund directors with fund shares consistent with 

sections 22(g) and 23(a). See Interpretive Matters 

Concerning Independent Directors of Investment 

Companies, Investment Company Act Release No. 

24083 (Oct. 14, 1999). With respect to registered 

closed-end funds, some of which would be subject 

to the proposed amendments, our staff stated that 

‘‘[c]losed-end funds also may wish to institute 

policies that encourage or require their directors to 

use the compensation that they receive from the 

funds to purchase fund shares in the secondary 

market on the same basis as other fund 

shareholders.’’ See id. at n.73. The staff also stated 

that it ‘‘would not recommend enforcement action 

to the Commission under Section 23(a) if closedend funds directly compensate their directors with 

fund shares, provided that the directors’ services 

are assigned a fixed dollar value prior to the time 

that the compensation is payable,’’ while noting 

that ‘‘any closed-end fund that compensates its 

directors by issuing fund shares would generally be 

required to issue those shares at net asset value, 

even if the shares are trading at a discount to their 

net asset value.’’ See id. at n.74. 

68The requirement to hold an annual meeting of 

shareholders at which directors are to be elected 

generally is imposed by a source of authority other 

than the federal securities laws. See footnote 43 

above. Funds are typically organized under state 

law as a form of trust or corporation that is not 

required to hold an annual meeting. See Robert A. 

Robertson, Fund Governance: Legal Duties of 

Investment Company Directors § 2.–6[5]. Funds 

may, however, hold shareholder meetings from time 

to time under certain circumstances, including 

where less than a majority of the directors of the 

fund were elected by the holders of the fund’s 

outstanding voting securities. See Section 16(a) of 

the Investment Company Act. See also footnote 73 

and accompanying text. 

69ETFs are organized either as open-end funds or 

unit investment trusts (‘‘UITs’’). A UIT does not 

have a board of directors, corporate officers, or an 

investment adviser to render advice during the life 

of the trust, and does not actively trade its 

investment portfolio. See Section 4(2) of the 

Investment Company Act (‘‘Unit investment trust’’ 

means an investment company which (A) is 

organized under a trust indenture, contract of 

custodianship or agency, or similar instrument, (B) 

does not have a board of directors, and (C) issues 

only redeemable securities, each of which 

represents an undivided interest in a unit of 

specified securities, but does not include a voting 

trust.’’). 

70The term ‘‘redeemable,’’ as used with respect 

to fund shares, refers to shares that are redeemable 

at the discretion of the investor holding the shares. 

See Section 2(a)(32) of the Investment Company Act 

(defining the term ‘‘redeemable security’’). Closedend fund shares, in contrast, generally are not 

redeemable, and these shares trade at negotiated 

market prices, including on national securities 

exchanges. 

amending Item 402(b) to add this 

instruction will, in certain 

circumstances, make it easier for 

companies that are subject to both Item 

407(i) and Item 402(b) to prepare their 

proxy and information statements by 

avoiding the potential for duplicative 

disclosure.61 In addition, we believe 

that locating all the responsive 

disclosure in one place in the proxy or 

information statement will make it 

easier for investors to find. 

4. Issuers Subject to the Proposed 

Amendments 

In proposing amendments to 

implement Section 14(j), we have 

considered whether certain categories of 

issuers should be exempted from the 

proposed Item 407(i) disclosure 

requirements, or, alternatively, whether 

they should be subject to a delayed 

implementation schedule.62 In making 

these determinations, we have been 

guided by what we understand to be the 

statutory purpose behind Section 14(j), 

namely, to provide transparency to 

shareholders, if action is to be taken 

with respect to the election of directors, 

about whether employees or directors 

are permitted to engage in transactions 

that mitigate or avoid the incentive 

alignment associated with equity 

ownership. 

a. Registered Investment Companies 

We are proposing to require closedend investment companies that have 

shares that are listed and registered on 

a national securities exchange (‘‘listed 

closed-end funds’’) to provide the 

proposed disclosure. Investment 

companies registered under the 

Investment Company Act of 1940 

(‘‘funds’’ or ‘‘registered investment 

companies’’) that are not listed closedend funds would be excluded from 

these requirements, as discussed in 

more detail below.63

Funds generally have a management 

structure and regulatory regime that 

differs in various respects from issuers 

that are operating companies, which we 

believe makes the proposed disclosure 

less useful for investors in funds that are 

not listed closed-end funds. Nearly all 

funds, unlike other issuers, are 

externally managed and have few, if 

any, employees who are compensated 

by the fund.64 Rather, personnel who 

operate the fund and manage its 

portfolio generally are employed and 

compensated by the fund’s investment 

adviser.65 Although fund directors may 

hold shares of the funds they serve,66

fund compensation practices can be 

distinguished from those of operating 

companies. We believe that the granting 

of shares as a component of incentivebased compensation is uncommon (and 

in some cases is prohibited) 67 for funds. 

Concerns about avoiding restrictions on 

long-term compensation, which we 

understand to be one of the reasons 

Congress mandated this disclosure, may 

therefore be less likely to be raised with 

respect to funds. 

In addition, most funds, other than 

listed closed-end funds as discussed 

below, also are generally not required to 

hold annual meetings of shareholders.68

Exchange-traded funds (‘‘ETFs’’), 

although traded on an exchange, also do 

not generally hold annual meetings of 

shareholders, and some ETFs do not 

have boards of directors.69

Open-end funds differ from operating 

companies in the way that their shares 

are purchased and sold. For example, 

mutual funds sell shares that are 

redeemable, meaning generally that 

shareholders are able to present the 

shares to the fund at the shareholder’s 

discretion and receive the net asset 

value (‘‘NAV’’) per share determined at 

the end of each day.70 For funds like 

mutual funds whose shares do not trade 

on an exchange, it may be less efficient 

or not possible to engage in certain 

hedging transactions with respect to the 

fund’s shares. And although ETF shares 


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71Based on staff review of information available 

from Morningstar Direct and filings with the 

Commission. 

72Based on staff review of market data available 

from the Bloomberg Professional service. 

73See, e.g., Section 302.00 of the New York Stock 

Exchange’s Corporate Governance Standards 

(‘‘Listed companies are required to hold an annual 

shareholders’ meeting during each fiscal year.’’). 

74Listed closed-end funds also are similar to 

operating company issuers in other respects. For 

example, listed closed-end funds, like operating 

companies, do not issue redeemable securities (i.e., 

at the option of the holder); rather, they issue 

securities in traditional underwritings, which are 

subsequently listed on an exchange or traded in the 

over-the-counter markets. In addition, listed closedend funds and operating companies each may be 

able to issue preferred shares and are not restricted 

in the amount of illiquid assets they may hold, 

although the assets of an operating company are 

generally more illiquid than the securities held by 

a listed closed-end fund. 

75See Section 30(h) of the Investment Company 

Act (‘‘Every person who is . . . an officer, director, 

member of an advisory board, investment adviser, 

or affiliated person of an investment adviser of [a 

registered closed-end fund] shall in respect of his 

transactions in any securities of such company 

(other than short-term paper) be subject to the same 

duties and liabilities as those imposed by section 

16 of the Securities Exchange Act of 1934 upon 

certain beneficial owners, directors, and officers in 

respect of their transactions in certain equity 

securities.’’). 

76Section 102 of the JOBS Act exempts emerging 

growth companies from: the say-on-pay, say-onfrequency, and say-on-golden parachutes advisory 

votes required by Exchange Act Sections 14A(a) and 

(b), enacted in Section 951 of the Act; the ‘‘pay 

versus performance’’ proxy disclosure requirements 

of Exchange Act Section 14(i), enacted in Section 

953(a) of the Act; and the pay ratio disclosure 

requirements of Section 953(b) of the Act. 

77See Section 102(c) of the JOBS Act and Item 

402(l) of Regulation S–K. 

78See Item 407(a), (b), (c), (d), (e)(1)–(3), (f) and 

(h) of Regulation S–K; but see Item 407(g) of 

Regulation S–K that provides a phase-in period for 

smaller reporting companies from the disclosure 

required by Item 407(d)(5) of Regulation S–K and 

does not require smaller reporting companies to 

provide the disclosures required by Item 407(e)(4) 

and (5) of Regulation S–K. In addition, as noted 

above, officers and directors at smaller reporting 

companies and emerging growth companies are 

subject to the obligation under Exchange Act 

Section 16(a) to report transactions involving 

derivative securities. 

trade on exchanges, they often trade on 

the secondary market at prices close to 

the NAV of the shares, rather than at 

discounts or premiums to NAV. 

Based on these considerations, the 

proposed amendments would not 

require funds, other than listed closedend funds, to provide the proposed 

disclosure. 

We are, however, proposing to require 

listed closed-end funds to provide Item 

407(i) disclosure. Although listed 

closed-end funds are similar to other 

funds in certain respects, including with 

respect to their management structure 

and regulatory regime, there are several 

features of listed closed-end funds that 

may make requiring the Item 407(i) 

disclosure appropriate. Shares of listed 

closed-end funds, unlike mutual fund 

shares, trade at negotiated market prices 

on a national securities exchange and 

are not redeemable from the funds. The 

shares thus may, and often do, trade at 

a ‘‘discount,’’ or a price below the NAV 

per share.71 Requiring listed closed-end 

funds to provide the proposed 

disclosure would allow shareholders to 

know if a listed closed-end fund permits 

its directors and employees (if any) to 

hedge the value of the fund’s securities 

held by these persons and thus whether 

they, like the fund’s other shareholders, 

would receive that discounted price 

upon a sale of the shares without an 

offset from any hedging transactions. 

This information may be important to 

the voting decision of an investor when 

evaluating the extent to which a fund 

director or employee’s interest is 

aligned with that of the fund’s other 

shareholders, including in considering 

whether the director or employee may 

be more or less incentivized as a result 

of holding shares in the fund to seek to 

decrease the discount. It also may be 

more efficient to engage in certain 

hedging transactions with respect to 

shares of a listed closed-end fund as 

compared to certain other types of 

funds. Market participants can and do 

sell these types of fund shares short, for 

example.72 Hedging transactions might 

thus be more likely with respect to 

shares of listed closed-end funds, and 

thus potentially of greater interest to 

those funds’ shareholders. 

Finally, unlike other types of funds as 

discussed above, listed closed-end 

funds generally are required to hold 

annual meetings of shareholders.73

Listed closed-end funds thus more 

closely resemble operating companies 

that would be subject to the proposed 

disclosure requirements in this 

respect.74 We also note that officers and 

directors of listed closed-end funds, like 

officers and directors of emerging 

growth companies and smaller reporting 

companies which would be subject to 

the proposed disclosure requirements as 

discussed below, are subject to the 

requirement in Section 16(a) of the 

Exchange Act to report hedging 

transactions.75

For all of these reasons and those 

discussed in Section IV below, we 

propose to require listed closed-end 

funds to provide Item 407(i) disclosure 

and to exclude all other registered 

investment companies from these 

requirements. We request comment 

below on this proposed approach and, 

more generally, on the application of the 

proposed disclosure requirements to 

funds, including whether these 

requirements should apply to additional 

specific types of funds, such as ETFs. 

We seek input and data on the 

prevalence of hedging by employees and 

directors for all registered investment 

companies. 

b. Emerging Growth Companies and 

Smaller Reporting Companies 

We do not propose to exempt smaller 

reporting companies or emerging growth 

companies from Item 407(i) disclosure. 

We are not aware of any reason why 

information about whether a company 

has policies affecting the alignment of 

shareholder interests with those of 

employees and directors would be less 

relevant to shareholders of an emerging 

growth company or a smaller reporting 

company than to shareholders of any 

other company. In this regard, we 

believe it is consistent with the statutory 

purpose of Section 14(j) to require these 

companies to provide disclosure about 

their hedging policies. Moreover, given 

its narrow focus, the proposed 

disclosure is not expected to impose a 

significant compliance burden on 

companies. For these reasons, the 

proposed disclosure would apply to 

smaller reporting companies and 

emerging growth companies to the same 

extent as other companies subject to the 

federal proxy rules. 

We acknowledge that the JOBS Act 

excludes emerging growth companies 

from some, but not all, of the provisions 

of Title IX of the Act, of which Section 

955 is a part,76 and that emerging 

growth companies and smaller reporting 

companies are in many instances 

subject to scaled disclosure 

requirements, including with respect to 

executive compensation.77 We believe 

that it would be more consistent with 

our historical approach to corporate 

governance related disclosures,78 as 

well as the statutory objectives of 

Section 14(j), not to exempt these 

companies from the proposed disclosure 

requirement. We recognize that, since 

emerging growth companies and smaller 

reporting companies are not required to 

provide CD&A disclosure required by 

Item 402(b) and therefore may not have 

had the occasion to consider a hedging 

policy, these companies may have a 

greater initial cost than companies that 

already have a policy or already disclose 

one. Further, these companies would 

also have on-going costs implementing 

and administering their policies. On 

balance, however, we believe the 

proposed rule would not constitute a 

substantial, incremental burden for 

smaller reporting companies or 

emerging growth companies. 


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79Exchange Act Rule 3a12–3(b) [17 CFR 

240.3a12–3(b)] specifically exempts securities 

registered by a foreign private issuer from Exchange 

Act Sections 14(a) and 14(c). 

In light of what we believe to be the 

minimal burden imposed by proposed 

Item 407(i) in terms of additional 

disclosure and the time necessary to 

prepare it, we are not proposing a 

delayed implementation schedule for 

smaller reporting companies and 

emerging growth companies. We are 

requesting comment, however, on the 

need for either an exemption for smaller 

reporting companies or emerging growth 

companies or a delayed implementation 

schedule for these companies. 

c. Foreign Private Issuers 

As noted above, Section 14(j) calls for 

disclosure in any proxy or consent 

solicitation material for an annual 

meeting of the shareholders of the 

issuer. Because securities registered by 

a foreign private issuer are not subject 

to the proxy statement requirements of 

Exchange Act Section 14,79 foreign 

private issuers would not be required to 

provide Item 407(i) disclosure. 

Request for Comment 

13. Should Item 407(i) disclosure be 

required whenever action is taken with 

respect to the election of directors, as 

proposed? Instead, should we require 

disclosure in any proxy or information 

statement relating to an annual meeting 

of shareholders, irrespective of whether 

directors are to be elected at that 

meeting? Should the disclosure be 

limited only to annual meetings, and 

not special meetings, even if directors 

are to be elected at a special meeting? 

14. Should proposed Item 407(i) 

disclosure also be required in Securities 

Act and Exchange Act registration 

statements? Should it be required in 

Exchange Act annual reports on Form 

10–K? Would such information be 

material to investors in any of those 

contexts? 

15. To retain consistency in the 

corporate governance disclosure 

provided in proxy statements and 

information statements with respect to 

the election of directors, Item 407(i) 

disclosure as proposed would apply to 

Schedule 14C as well as Schedule 14A. 

Is there any reason that the proposed 

Item 407(i) disclosure should be limited 

to issuers that are soliciting proxies? 

Why or why not? 

16. In addition to including the new 

disclosure requirement, the proposed 

amendment to Item 7 of Schedule 14A 

would amend this Item to more 

succinctly organize its current 

provisions without changing the 

substance. As so revised, would the 

requirements of Item 7 be easier to 

understand? Alternatively, should we 

retain the current structure of Item 7, 

with the addition of the Item 407(i) 

disclosure? 

17. We propose to amend the CD&A 

requirement of Item 402(b) of Regulation 

S–K to add an instruction providing that 

the obligation under that item 

requirement to disclose material 

policies on hedging by named executive 

officers in a proxy or information 

statement with respect to the election of 

directors may be satisfied by a cross 

reference to the Item 407(i) disclosure in 

that document to the extent that the 

information disclosed there satisfies this 

CD&A disclosure requirement. Is there 

an alternative way to avoid possibly 

duplicative hedging disclosure in these 

proxy and information statements? 

18. Is there a better way to align the 

requirements of Item 402(b) of 

Regulation S–K and proposed Item 

407(i) of Regulation S–K? Are there 

circumstances in which the current 

CD&A requirement in Item 402(b) of 

Regulation S–K would result in more 

complete disclosure about the 

company’s hedging policies than what 

would be required under proposed Item 

407(i)? For example, although Section 

14(j) addresses only hedging of equity 

securities, would disclosure of 

employees’ and directors’ ability to 

hedge other securities further the 

statutory purpose? In this regard, should 

we expand the proposed disclosure in 

Item 407(i) to include debt securities? 

19. We request comment on all 

aspects of the proposed disclosure 

requirements as applied to funds, 

including whether all funds or 

additional types of funds other than 

listed closed-end funds should be 

required to provide the proposed 

disclosure. Should we require all funds, 

including mutual funds and ETFs, to 

provide the proposed disclosure? 

Should we, instead, require different 

specific types of funds to provide the 

proposed disclosure? For example, 

should we require ETFs to provide the 

proposed disclosure? Would 

shareholders in mutual funds, ETFs, or 

other types of funds benefit from the 

information provided by the proposed 

disclosure? 

20. If we were to require additional 

types of funds to provide the proposed 

disclosure, why and how, if at all, 

should we modify the disclosure 

requirements for such funds? As noted 

above, some ETFs are organized as UITs, 

which do not have boards of directors, 

and ETFs generally do not hold annual 

meetings of shareholders. How should 

any disclosure under Section 14(j) 

accommodate these or other 

characteristics of ETFs if we were to 

require ETFs to provide the proposed 

disclosure? 

21. Are there additional 

characteristics of funds that we should 

consider in determining which funds 

should be required to provide the 

proposed disclosure or whether the 

disclosure requirements should be 

modified for funds or particular types of 

funds? If we were to require some or all 

funds to provide the proposed 

disclosure, including listed closed-end 

funds as proposed, what are the benefits 

and costs expected to result? 

22. Should we modify the Item 407(i) 

disclosure requirements for listed 

closed-end funds? Would this 

information be material to an investor in 

contexts other than those relating to 

voting decisions, such as an investment 

decision? Should we also require the 

disclosure in listed closed-end funds’ 

other disclosure documents, such as an 

annual report or shareholder report next 

following a meeting of shareholders, for 

example? If we were to require all funds 

or a broader group of funds to provide 

Item 407(i) disclosure, should we also 

require the disclosure in other 

disclosure documents, such as the 

funds’ Statements of Additional 

Information? 

23. As proposed, listed closed-end 

funds would be required to provide 

proposed Item 407(i) disclosure. Should 

we not require listed closed-end funds 

to provide this disclosure? If so, please 

explain why, and the benefits and costs 

that would result. 

24. Do funds generally have policies 

concerning their employees and 

directors engaging in hedging 

transactions of securities issued by their 

respective funds, or policies that 

prohibit such hedging transactions? To 

what extent do employees or directors 

of listed closed-end funds receive shares 

of such funds as a form of 

compensation? Do employees or 

directors of listed closed-end funds 

currently effect hedging transactions 

with respect to the shares of those funds 

and, if so, what kinds of transactions do 

they effect? 

25. How could employees or directors 

effect hedging transactions with respect 

to shares of funds other than listedclosed end funds, in particular mutual 

funds? How prevalent are these hedging 

transactions? 

26. As proposed, listed closed-end 

funds, like the other issuers covered by 

the proposed amendments, would be 

required to provide disclosure 

concerning hedging of the equity 

securities issued by the fund or any of 

the fund’s parents, subsidiaries or 

subsidiaries of the fund’s parents that 


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8496 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

80 Item 22 of Schedule 14A defines terms used in 

that Item, including the terms parent and 

subsidiary. Item 22(a)(1)(ix) defines the term 

‘‘parent’’ to mean ‘‘the affiliated person of a 

specified person who controls the specified person 

directly or indirectly through one or more 

intermediaries.’’ Item 22(a)(1)(xii) defines the term 

‘‘subsidiary’’ to mean ‘‘an affiliated person of a 

specified person who is controlled by the specified 

person directly, or indirectly through one or more 

intermediaries.’’ 

81We estimate the number of operating 

companies subject to the proposed amendments by 

analyzing companies that filed annual reports on 

Form 10–K in calendar year 2012 with the 

Commission. This set excludes ABS issuers (SIC 

6189), registered investment companies, issuers that 

have filed registration statements but have yet to 

file Forms 10–K with the Commission, and foreign 

issuers filing on Forms 20–F and 40–F. We identify 

are registered under Section 12 of the 

Exchange Act.80 Should we instead 

require listed closed-end funds to 

provide disclosure only about hedging 

transactions concerning the funds’ 

shares? Would investors in listed 

closed-end funds benefit from receiving 

information about the funds’ directors’ 

and employees’ holdings of the funds’ 

parents, subsidiaries or subsidiaries of 

the fund’s parents? 

27. As proposed, business 

development companies would be 

required to provide proposed Item 

407(i) disclosure. Should we modify the 

disclosure requirements for business 

development companies? Should we not 

require business development 

companies to provide this disclosure? If 

so, please explain why, and the benefits 

and costs that would result. Should we 

only require a business development 

company to provide the proposed 

disclosure if the business development 

company’s shares are listed on a 

national securities exchange? 

28. Should smaller reporting 

companies or emerging growth 

companies be exempted from proposed 

Item 407(i) or subject to a delayed 

implementation schedule? If so, please 

explain why and the benefits and costs 

that would result. As discussed below, 

a component of the disclosure costs 

(especially initial costs) may be fixed, 

which may have a greater impact on 

smaller reporting companies and 

emerging growth companies. Do the 

proposed disclosure requirements also 

impose other potential costs on smaller 

reporting companies or emerging growth 

companies that are different in kind or 

degree from those imposed on other 

companies?) Would the proposed 

disclosure requirements be as 

meaningful for investors in smaller 

reporting companies and emerging 

growth companies as for those in other 

companies? Do investors in smaller 

reporting companies and emerging 

growth companies place more, less, or 

the same value on corporate governance 

disclosures of the type proposed here 

than do investors in larger, more 

established companies, either alone or 

in relation to other disclosures? 

29. Should foreign private issuers be 

required to provide the disclosure? If so, 

please explain why and specify the 

filing(s) in which the disclosure should 

be required? 

30. Are there any other categories of 

issuers that should be exempt from the 

requirement to provide Item 407(i) 

disclosure? If so, please explain why, 

and the benefits and costs that would 

result. 

General Request for Comment 

We request and encourage any 

interested person to submit comments 

on any aspect of our proposals, other 

matters that might have an impact on 

the proposed amendments, and any 

suggestion for additional changes. With 

respect to any comments, we note that 

they are of greatest assistance to our 

rulemaking initiative if accompanied by 

supporting data and analysis of the 

issues addressed in those comments and 

by alternatives to our proposals where 

appropriate. 

IV. Economic Analysis 

A. Background 

Section 955 of the Act added Section 

14(j) to the Exchange Act, which directs 

the Commission to adopt rules requiring 

an issuer to disclose in any proxy or 

consent solicitation material for an 

annual meeting of its shareholders 

whether any employee or director of the 

issuer, or any designee of an employee 

or director, is permitted to engage in 

transactions to hedge or offset any 

decrease in the market value of equity 

securities granted to the employee or 

director as compensation, or held 

directly or indirectly by the employee or 

director. 

To implement the mandate of Section 

14(j), we are proposing new paragraph 

(i) of Item 407 of Regulation S–K and 

amendments to Schedule 14A under the 

Exchange Act. Further, to reduce 

potentially duplicative disclosure, we 

propose to allow a company to satisfy 

its obligation to disclose material 

policies on hedging by named executive 

officers in the CD&A by cross reference 

to the information disclosed under 

proposed Item 407(i) to the extent that 

the information disclosed there satisfies 

this CD&A disclosure requirement. 

We are mindful that our proposed 

amendments can both impose costs and 

confer benefits. Exchange Act Section 

3(f) requires us, when engaging in 

rulemaking that requires us to consider 

or determine whether an action is 

necessary or appropriate in the public 

interest, to consider, in addition to the 

protection of investors, whether the 

action will promote efficiency, 

competition and capital formation. 

Exchange Act Section 23(a)(2) requires 

us, when adopting rules under the 

Exchange Act, to consider the impact 

that any new rule would have on 

competition and not to adopt any rule 

that would impose a burden on 

competition that is not necessary or 

appropriate in furtherance of the 

purposes of the Exchange Act. 

The discussion below addresses the 

economic effects of the proposed 

amendments, including likely benefits 

and costs, as well as the likely effect of 

the proposal on efficiency, competition 

and capital formation. We request 

comment throughout this release on 

alternative means of meeting the 

statutory mandate of Section 14(j) and 

on all aspects of the costs and benefits 

of our proposals and possible 

alternatives. We also request comment 

on any effect the proposed disclosure 

requirements may have on efficiency, 

competition and capital formation. We 

appreciate comments on costs and 

benefits that are attributed to the statute 

itself and, to the extent that they are 

separable, the costs and benefits that are 

a result of policy choices made by the 

Commission in implementing the 

statutory requirements, as well as any 

data or analysis that helps quantify the 

potential costs and the benefits 

identified. 

B. Baseline 

The proposed amendments affect all 

issuers registered under Section 12 of 

the Exchange Act, including smaller 

reporting companies (‘‘SRCs’’), emerging 

growth companies (‘‘EGCs’’), and listed 

closed-end funds, but excluding foreign 

private issuers (‘‘FPIs’’), and other types 

of registered investment companies, 

including non-listed closed-end funds, 

open-end funds, and unit investment 

trusts. We estimate that approximately 

7,447 companies would be subject to the 

proposed amendments, including 4,620 

listed Exchange Act Section 12(b) 

registrants and 2,827 non-listed 

Exchange Act Section 12(g) registrants. 

Among the Section 12(b) registrants 

subject to the proposed amendments, 

we estimate that 602 are listed closedend funds, 916 are SRCs or EGCs, and 

the remaining 3,102 are other operating 

companies. Among the Section 12(g) 

registrants subject to the proposed 

amendments, 2,220 are SRCs or EGCs, 

and the remaining 607 are operating 

companies that are not SRCs or EGCs.81


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the companies that have securities registered under 

Section 12(b) or Section 12(g) from Form 10–K. We 

also determine from Form 10–K whether a company 

is a SRC. We determine whether a company is an 

EGC by reviewing both its Form 10–K and any 

registration statement. We estimate the number of 

listed closed-end funds based upon data from the 

2014 Investment Company Fact Book, page 170 

(available at http://www.ici.org/pdf/2014_

factbook.pdf). 

82Among the approximately 602 listed closedend funds in 2012, Commission staff has identified 

only 4 internally-managed closed-end funds from a 

review of filings with the Commission. 

83 In some instances, equity of a company’s 

subsidiary may be granted as compensation for that 

company’s officers (He et al. 2009). Stock holdings 

in a company’s subsidiary provide officers with an 

incentive to make decisions to improve the 

subsidiary’s performance, which in turn may 

positively affect the economic prospects of the 

parent company. As discussed later, it is important 

for shareholders (of both the company and its 

subsidiary) to better understand whether incentives 

can be reduced by hedging. See He W., M. K. Tarun, 

and P. Wei, 2009, ‘‘Agency Problems in Tracking 

Stock and Minority Carve-out Decisions: Explaining 

the Discrepancy in Short- and Long-term 

Performances’’ Journal of Economics and Finance 

33(1): 27–42. 

84As proposed, companies would be required to 

make disclosure under proposed Item 407(i) when 

they file proxy or information statements with 

respect to the election of directors. Proxy statement 

disclosure obligations only arise under Section 

14(a), however, when an issuer with a class of 

securities registered under Section 12 chooses to 

solicit proxies (including consents). Since the 

federal securities laws do not require the 

solicitation of proxies, the application of Section 

14(a) is not automatic. Whether or not an issuer has 

to solicit therefore depends upon any requirement 

under its charter and/or bylaws, or otherwise 

imposed by law in the state of incorporation and/ 

or by the relevant stock exchange (if listed). For 

example, NYSE, NYSE Market, and NASDAQ 

generally require solicitation of proxies for all 

meetings of shareholders. If a listed company then 

chooses to hold a meeting at which directors are to 

be elected and solicit proxies, Section 14(a) would 

then apply and compel the disclosure identified in 

Item 407(i). Section 12(g)-registered companies also 

can make the decision to solicit proxies and thus 

similarly will have to comply with Section 14(a), 

to the same extent Section 12(b)-registered 

companies. When Section 12 registrants that do not 

solicit proxies from any or all security holders are 

nevertheless authorized by security holders to take 

an action with respect to the election of directors, 

disclosure obligations also arise under proposed 

Item 407(i) due to the requirement to file and 

disseminate an information statement under 

Section 14(c). 

Other affected parties include these 

issuers’ employees (including officers) 

and directors who hold equity securities 

of these issuers, and investors in 

general. Because almost all listed 

closed-end funds are externally 

managed by investment advisers and 

only a small number of listed closedend funds are internally managed where 

the portfolio managers are employees of 

the closed-end funds, the proposed 

amendments will generally affect the 

funds’ employees and directors; 

employees of the funds’ investment 

advisers (e.g., portfolio managers) will 

not be affected by the amendments.82

Equity securities covered by the 

proposed amendments include equity 

securities issued by the company, any 

parent of the company, any subsidiary 

of the company or any subsidiary of any 

parent of the company that are 

registered under Section 12 of the 

Exchange Act.83

To assess the economic impact of the 

proposed amendments, we use as our 

baseline the state of the market as it 

exists at the time of this release. For 

Section 12 registrants (other than SRCs, 

EGCs, and listed closed-end funds) that 

are subject to the proposed 

amendments, the regulatory baseline is 

the current CD&A disclosure 

requirement in Item 402(b)(2)(xiii) of 

Regulation S–K. Item 402(b)(2)(xiii) 

calls for disclosure of ‘‘any registrant 

policies regarding hedging the economic 

risk’’ of security ownership by named 

executive officers as one of the ‘‘nonexclusive’’ examples of information 

includable in CD&A, if material. To the 

extent that a registrant does not have a 

policy regarding hedging by named 

executive officers, there is no obligation 

to disclose. For SRCs, EGCs, and listed 

closed-end funds, CD&A disclosure 

pursuant to Item 402(b)(2)(xiii) is not 

currently required. 

Additionally, officers and directors of 

companies with a class of equity 

securities registered under Section 12, 

including SRCs and EGCs, are currently 

required to report their hedging 

transactions involving the company’s 

equity securities pursuant to Exchange 

Act Section 16(a). Further, Section 30(h) 

of Investment Company Act specifies 

that officers and directors of closed-end 

funds are subject to the same duties and 

liabilities as those imposed by Section 

16 of the Exchange Act. 

Table 1 below draws a comparison 

between the current requirements for 

CD&A disclosure and Section 16 

reporting, where applicable, and the 

proposed disclosure requirement for the 

registrants that would be affected by the 

proposed amendments. 

TABLE 1—COMPARISON OF DISCLOSURE REQUIREMENTS

Covered company Covered persons Current company reporting 

requirement 

Current officer & director 

reporting requirement 

Company 

reporting 

requirement 

under the 

proposed 

amendments 

(1) (2) (3) (4) (5) 

12(b) companies other than 

SRCs, EGCs, and listed 

closed-end funds [Number 

= 3,102].

NEOs ..................................... Item 402(b) ............................ Section 16(a).

Other employees ................... None ...................................... Section 16(a), if an officer.

Directors ................................ None ...................................... Section 16(a).

12(g) companies other than 

SRCs and EGCs [Number 

= 607].

NEOs ..................................... Item 402(b) ............................ Section 16(a).

Other employees ................... None ...................................... Section 16(a), if an officer ..... Item 407(i).84

Directors ................................ None ...................................... Section 16(a).

SRCs & EGCs under 12(b) 

[Number = 916].

Employees (including NEOs) 

& Directors.

None ...................................... Section 16(a), if an officer or 

director.

SRCs & EGCs under 12(g) 

[Number = 2,220].

Employees (including NEOs) 

& Directors.

None ...................................... Section 16(a), if an officer or 

director.

Listed closed-end funds 

[Number = 602].

Employees & Directors .......... None ...................................... Section 30(h) of the Investment Company Act.


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8498 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

85To be included in the S&P 500 index, the 

companies must be publicly listed on either the 

NYSE (NYSE Arca or NYSE MKT) or NASDAQ 

(NASDAQ Global Select Market, NASDAQ Select 

Market or the NASDAQ Capital Market). Because 

this index includes foreign companies, there were 

fewer than 500 proxy statements filed. 

86The literature in economics and finance 

typically refers to a principal-agent model to 

describe the employment relationship between 

shareholders and executive officers (managers) at a 

company. The principal (shareholders) hires an 

agent (manager) to operate the company. However, 

because shareholders cannot perfectly observe 

managerial actions, this information asymmetry 

gives rise to a moral hazard problem: managers may 

act in their own self-interest and not always in the 

interest of shareholders. This potential 

misalignment of incentives is ameliorated when 

managers are also owners of the company, and thus 

must internalize the cost of any actions that harm 

shareholders or do not otherwise maximize the 

value of the company. See, e.g., Jensen, M. C. and 

W. H. Meckling, 1976. ‘‘Theory of The Firm: 

Managerial Behavior, Agency Costs and Ownership 

Structure’’ Journal of Financial Economics 3: 305– 

360; Holmstrom, B., 1979. ‘‘Moral Hazard and 

Observability’’ Bell Journal of Economics 10: 324– 

340; Holmstrom, B. and Ricart I Costa, J., 1986 

‘‘Managerial Incentives and Capital Management’’, 

Quarterly Journal of Economics 101, 835–860. 

87See, e.g., Institutional Shareholder Services 

Inc., ‘‘2013 Corporate Governance Policy Updates 

and Process: Executive Summary’’, Nov. 16, 2012 at 

http://www.issgovernance.com/file/files/

2013ExecutiveSummary.pdf. 

88Meulbroek (2005) points out that employees 

may be even more undiversified than their equity 

holdings suggest: ‘‘their continued employment and 

its relation to the fortunes of the firm, outstanding 

deferred compensation owed to the employee, and 

any firm specific human capital exacerbate 

employees’ firm-specific risk exposure.’’ See 

Meulbroek, L. 2005, ‘‘Company Stock in Pension 

Plans: How Costly Is It?’’ Journal of Law and 

Economics, vol. XLVIII: 443–474; Hall, B., and K. 

Murphy. 2002. ‘‘Stock options for undiversified 

executives’’ Journal of Accounting and Economics 

33: 3–42. Moral hazard and adverse selection issues 

cause boards of directors to compel executive 

officers to maintain large personal investment in 

their companies. Executive officers may not be able 

to diversify this exposure because of explicit stock 

ownership guidelines for executives and directors, 

contractual restrictions on trading equity grants 

within the vesting periods, and retention plans that 

prohibit the sale of unrestricted stock for some time 

after vesting. 

89This underinvestment concern has been 

studied in a long strand of academic literature. See 

e.g., Rappaport, A. 1978, ‘‘Executive Incentives vs. 

Corporate Growth’’ Harvard Business Review 57: 

81–88; Smith, C., and R. Stulz. 1985. ‘‘The 

Determinants of Firms’ Hedging Policies’’, Journal 

of Financial and Quantitative Analysis 20: 391–405; 

Kaplan, R., 1982, ‘‘Advanced Management 

Accounting’’ Englewood Cliffs, N. J.: Prentice-Hall; 

and Lambert, R., 1986, ‘‘Executive Effort and the 

As illustrated in Table 1, disclosure 

requirements will increase for all 

companies subject to the proposed 

amendments, although the extent of the 

increase may vary for different 

categories of registrants. 

To establish the baseline practices for 

Section 12 companies subject to Item 

402(b)(2)(xiii), we reviewed the 

disclosures of ‘‘policies regarding 

hedging’’ by named executive officers 

from two samples of exchange-listed 

companies. The first sample included 

all S&P 500 companies that filed proxy 

statements during the calendar year 

2012, totaling 484 companies.85 Our 

analysis revealed that disclosures are 

not uniform across companies. Out of 

the 484 proxy statements, 158 

companies (33%) did not disclose 

hedging policies for named executive 

officers, six companies (1%) disclosed 

that the company did not have a policy 

regarding hedging by named executive 

officers, 284 companies (59%) disclosed 

that named executive officers were 

prohibited from hedging, and 36 

companies (7%) disclosed that they 

permitted hedging by named executive 

officers under certain circumstances. 

The second sample included 100 

randomly selected companies from the 

494 S&P Smallcap 600 index companies 

that filed proxy statements during the 

calendar year 2012. These companies 

are significantly smaller and less widely 

followed than S&P 500 companies, and, 

as a result, may have significantly 

different disclosure practices. These 

companies are all exchange-listed, and 

none are SRCs or EGCs. We found that 

71 companies (71%) did not disclose 

hedging policies for named executive 

officers, four companies (4%) disclosed 

that the company did not have a policy 

regarding hedging by named executive 

officers, 23 companies (23%) disclosed 

that named executive officers were 

prohibited from hedging, and two 

companies (2%) disclosed that they 

permitted hedging by named executive 

officers under certain circumstances. 

Our analysis of the two samples 

revealed that a significant percentage 

(34%) of S&P 500 companies, and an 

even larger percentage of the subset of 

S&P Smallcap 600 companies (75%) 

either did not make a disclosure or 

reported that they did not have a policy 

for named executive officers. This 

baseline analysis suggests that smaller 

companies will likely have a greater 

initial disclosure burden under the 

proposed amendments than larger 

companies. 

As mentioned above, SRCs, EGCs, and 

listed closed-end funds are not required 

to make Item 402(b) disclosure and, 

consequently, are not currently required 

to disclose any policies regarding 

hedging by named executive officers. 

However, officers and directors at SRCs 

and EGCs with a class of equity 

securities registered under Section 12 

are currently required to report their 

hedging transactions involving the 

companies’ equity securities pursuant to 

Section 16(a), and officers and directors 

of registered closed-end funds are 

required to make similar reports by 

Section 30(h) of the Investment 

Company Act. Notwithstanding these 

reports, investors’ ability to use reported 

insider hedging transactions, if any, to 

infer these companies’ policies 

regarding hedging by officers and 

directors is imperfect at best. First, an 

investor must track all the accumulated 

insider trades reported to assess 

whether there is hedging. Disclosures of 

particular hedging transactions by 

officers and directors could indicate that 

the company permits that particular 

type of transaction, that the company 

has no hedging policy, or that a 

company policy was violated but the 

transaction was reported in accordance 

with current rules. The absence of 

reported hedging transactions could 

indicate that the company prohibits 

hedging, that the company permits 

hedging but the officers and directors do 

not engage in hedging transactions, or 

that officers and directors engage in 

hedging transactions but are not 

complying with Section 16(a) reporting 

requirements. 

C. Discussion of Benefits and Costs, and 

Anticipated Effects on Efficiency, 

Competition and Capital Formation 

1. Introduction 

From an economic theory perspective, 

an executive officer’s ownership in the 

employer company ties his or her 

financial wealth to shareholder wealth, 

and hence can provide the executive 

officer with an incentive to improve the 

company’s performance, as measured by 

stock price.86 Permitting executive 

officers to hedge can be perceived by 

shareholders as a problematic practice 87

because hedging can have the economic 

effect of taking a short position on the 

employer’s stock, which is counter to 

the interests of other shareholders. 

Alternatively, permitting executive 

officers to hedge, under certain 

circumstances, could align officers’ and 

shareholders’ preferences more closely 

and thereby promote more efficient 

corporate investment. Compared with 

well-diversified shareholders, executive 

officers are likely to be 

disproportionately invested in their 

company and thus inherently 

undiversified.88 The concentrated 

financial exposure, together with 

executive officers’ concerns about job 

security in the event of a stock price 

decline, could lead them to take on 

fewer risky projects (i.e., projects with 

uncertain future cash flows) that are 

potentially value enhancing than would 

be in the interest of well-diversified 

shareholders, resulting in 

underinvestment.89 This 


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Selection of Risky Projects’’ Rand Journal of 

Economics 17, 77–88. 

90See Hemmer, T., O., Kim, and R. Verrecchia, 

1999, ‘‘Introducing Convexity into Optimal 

Compensation Contracts’’ Journal of Accounting 

and Economics 28: 307–327. 

91For example, requiring executive officers to 

hold stock options can also provide them with 

incentives to take on risky but value-enhancing 

investment projects. Such risk-taking incentives 

depend on option moneyness: the incentives are the 

strongest when options are near the money, but 

quickly diminish when options go deep in the 

money. If a company experiences a sharp stock 

price increase, which causes executive officers’ 

option holdings to become deep in-the-money, such 

holdings likely would not provide effective risktaking incentives. In this situation, permitting 

executives to hedge may be a better solution to the 

underinvestment concern than for the company to 

grant new at-the-money options, because the latter 

may cause the company to overpay the executives. 

Hedging of corporate operations, as opposed to 

personal hedging by executive officers, could also 

increase the executives’ incentives to take higher 

risk but value-enhancing corporate projects, but 

corporate hedging can be costly. See Smith C. and 

R. Stulz, 1985, ‘‘The Determinants of Firms’ 

Hedging Policies’’ Journal of Financial and 

Quantitative Analysis 20(4): 392–405). 

92For S&P 1500 companies, median total 

compensation per outside director rose from 

$57,514 in 1998 to $112,745 in 2004 (a 51% 

increase), far greater than the rate of increase of 

24% in CEO compensation over the same period. 

The proportion of director pay provided by equity 

increased from around 45% in 1998 to over 60% 

in 2004. Yermack (2004) show that, in Fortune 500 

companies, some directors near the top of the 

distribution receive very significant equity awards 

that can provide ex-post performance rewards 

exceeding those of some CEOs. Altogether, equity 

holdings, turnover, and opportunities to obtain new 

board seats provide outside directors serving in 

their fifth year with wealth increases of 

approximately 11 cents per $1,000 rise in firm 

value. Although typically smaller than incentives 

for CEOs, director incentives can be significant 

given that many directors serve on multiple boards. 

See Yermack, D. 2004, ‘‘Remuneration, Retention, 

and Reputation Incentives for Outside Directors’’, 

The Journal of Finance LIX: 2281–2308; Farrell K., 

G. Friesen, and P. Hersch, 2008, ‘‘How Do Firms 

Adjust Director Compensation?’’, Journal of 

Corporate Finance 14: 153–162; J. Linck, J. Netter, 

and T. Yang, 2009, ‘‘The Effects and Unintended 

Consequences of the Sarbanes-Oxley Act on the 

Supply and Demand for Directors’’, The Review of 

Financial Studies 22: 3287–3328; and Fedaseyeu V., 

J. Linck, and H. Wagner, 2014, ‘‘The Determinants 

of Director Compensation’’ Bocconi University and 

Southern Methodist University working paper 

(available at http://papers.ssrn.com/sol3/

papers.cfm?abstract_id= 2335584). Note that these 

studies used samples prior to 2011; however, we 

have no reason to believe that director incentives 

and compensation have declined significantly in 

more recent years. 

93See Oyer, P. 2002, ‘‘Stock Options—It’s Not Just 

About Motivation’’, Stanford Institute for Economic 

Policy Research (available at http://

web.stanford.edu/group/siepr/cgi-bin/siepr/

?q=system/files/shared/pubs/papers/briefs/

policybrief_oct02.pdf); Oyer, P. and S. Schaefer, 

2005, ‘‘Why Do Some Firms Give Stock Options to 

All Employees?: An Empirical Examination of 

Alternative Theories’’, Journal of Financial 

Economics 76 (1): 99–133. 

94We have previously published the Commission 

staff’s view that ‘‘[f]und directors who own shares 

in the funds that they oversee have a clear 

economic incentive to protect the interests of fund 

shareholders,’’ and that fund policies that 

encourage or require independent directors to 

invest the compensation that they receive from the 

funds in shares of the funds ‘‘gives the independent 

directors a direct and tangible stake in the financial 

performance of the funds that they oversee, and can 

help more closely align the interests of independent 

directors and fund shareholders.’’ See Interpretive 

Matters Concerning Independent Directors of 

Investment Companies, Investment Company Act 

Release No. 24083 (Oct. 14, 1999). 

95Zhao (2007) studies 316 closed-end funds in 

2002. She finds that 200, or 62.3%, report positive 

director ownership. The average (median) director 

ownership is at $105,493 ($30,001). See Zhao, L., 

2007, ‘‘Director Ownership and Fund Value: 

Evidence from Open-End and Closed-End Funds’’, 

Columbia University working paper (available at 

http://papers.ssrn.com/sol3/papers.cfm?abstract_

id=963047). 

96See Wu, Y., R. Wermers, and J. Zechner, 2013, 

‘‘Managerial Rents vs. Shareholder Value in 

Delegated Portfolio Management: The Case of 

Closed-End Funds’’ working paper. Available at 

http://papers.ssrn.com/sol3/papers.cfm?abstract_

id=2179125&download=yes. 

underinvestment concern can be 

addressed by providing downside price 

protection to executive officers’ equity 

holdings, in case high-risk projects— 

that are in the interest of shareholders 

at the time of the investment decision— 

do not turn out to be successful and 

thereby cause a decline in the stock 

price.90 One way to do so is to permit 

executive officers to seek downside 

price protection by hedging their equity 

holdings. However, the value of hedging 

to address potential underinvestment 

depends on the availability and costeffectiveness of other solutions to the 

underinvestment concern.91

The theories of equity incentives 

described above for executive officers 

may also apply to critical employees 

(e.g., key research scientists), because 

these individuals’ actions and decisions 

can also impact company stock price. 

These theories can also apply to 

directors, who typically receive equitybased compensation to align their 

interests with those of the shareholders 

they represent. However, directors may 

have less incentive to hedge because 

their financial wealth is typically better 

diversified than executive officers’, and 

is therefore less sensitive to company 

stock price. Nevertheless, directors’ 

compensation, particularly in the form 

of equity compensation, grew 

significantly during the 2000s, 

contributing to a significant increase in 

directors’ equity incentives.92 The 

increased level of directors’ equity 

incentives suggests that equity 

incentives could be playing an 

increasingly important role in 

influencing directors’ actions on 

corporate decisions. 

These theories of equity incentives 

may not apply to employees who do not 

participate in making and shaping key 

operating or strategic decisions that 

influence stock price. While some of 

these employees may also receive equity 

grants as part of the companies’ broadbased equity plans, their equity 

ownership on average is much lower 

than that of executive officers. Equity 

ownership for these employees mainly 

serves the purpose of recruitment and 

job retention, and on an individual 

employee basis, is unlikely to have a 

notable impact on the company’s equity 

market value.93 In other words, for 

employees below the executive level 

who typically do not make decisions 

that influence stock price, information 

about their equity incentives and 

hedging of their equity holdings may be 

less relevant for investors. 

Like operating companies, listed 

closed-end funds also confront a 

principal-agent relationship between 

shareholders and the fund’s directors 

and employees, if any. The connection 

between managerial incentives and firm 

performance is, however, less direct in 

listed closed-end funds than it is in 

operating companies because almost all 

of these funds are externally managed 

by investment advisers. 

Fund directors oversee the many 

service providers that will typically 

serve a listed closed-end fund, 

including the investment adviser. 

Holding equity shares in the fund can 

align directors’ interests with those of 

the shareholders.94 Some listed closedend funds do require or encourage 

directors to hold fund shares.95 The 

proposed disclosure thus would allow 

the shareholders of a listed closed-end 

fund whose shares, for example, are 

trading at a discount to know if the 

listed closed-end fund permits its 

directors to hedge the value of the 

fund’s equity securities. The proposed 

disclosure would thereby show whether 

the fund’s directors, like the fund’s 

other shareholders, would receive that 

discounted price upon a sale of the 

shares without an offset from any 

hedging transactions. 

In an operating company, 

shareholdings also affect the incentives 

of employees, including managers who 

are making the company’s decisions. In 

contrast, almost all listed closed-end 

funds have few (if any) employees. 

Fund portfolios are almost always 

managed by portfolio managers who are 

employed by external investment 

advisers. Because listed closed-end fund 

shares are not redeemable and often 

trade at a discount to NAV, shareholders 

of those funds may place importance on 

the degree of incentive alignment 

between funds’ key decision makers and 

shareholders when making voting 

decisions.96


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8500 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

97For example, as discussed above, we collected 

data on the baseline practice of some Section 12(b) 

registrants other than SRCs and EGCs. The proxy 

statements filed during calendar year 2012 

indicated that most of the S&P 500 companies 

disclosed their hedging policies for named 

executive officers: 59% of companies prohibited 

hedging, while 7% permitted hedging. The rest 

either made no disclosure of hedging policy (33% 

of companies) or disclosed that they did not have 

a policy regarding hedging by named executive 

officers (1% of companies); we include such 

companies in category 2. The incidence of no 

disclosure tended to be higher among smaller 

companies. 

98See, e.g., Institutional Shareholder Services 

Inc., ‘‘2013 Corporate Governance Policy Updates 

and Process: Executive Summary’’, Nov. 16, 2012 at 

http://www.issgovernance.com/file/files/

2013ExecutiveSummary.pdf (‘‘Stock-based 

compensation or open market purchases of 

company stock are intended to align executives’ or 

directors’ interests with those of shareholders. 

Therefore, hedging of company stock through 

covered call, collar, or other derivative transactions 

severs the ultimate alignment with shareholders’ 

interests. Any amount hedged will be considered a 

problematic practice warranting a negative voting 

recommendation on the election of directors.’’). 

The proposed amendments apply 

only to employees and directors of the 

fund itself, however. As a result, these 

amendments would not directly affect 

outside portfolio managers’ asset 

choices. However, fund directors may 

influence the investment adviser’s 

management of the fund’s portfolio 

indirectly, through the directors’ 

oversight of the investment adviser, 

which is responsible for managing the 

fund’s portfolio consistent with the 

fund’s disclosed strategy and 

investment objectives. 

In summary, information on the 

company’s policies regarding hedging 

by employees and directors may help 

investors better understand the 

employees’ and directors’ incentives in 

creating shareholder wealth. For 

example, in operating companies, 

because executive officers’ and 

directors’ reported equity holdings in 

proxy statements may not reflect their 

actual economic exposure to the 

company’s performance, there may in 

certain cases exist an information 

asymmetry between insiders and other 

investors regarding the executive 

officers’ and directors’ equity 

incentives. The mandated disclosures 

can help mitigate this information 

asymmetry. 

2. New Disclosure Requirements Across 

Covered Companies 

Before considering the economic 

effects from proposed Item 407(i), we 

first discuss the new disclosures that 

would be required for different covered 

companies, and the new information 

from these disclosures. The potential 

economic effects would likely vary 

across companies depending on the 

nature and amount of new information 

from the disclosures, the degree of 

investment opportunities available to 

the company, and the likelihood that 

employees and directors engage in 

hedging transactions (discussed in 

detail later). 

Section 12 registrants, with the 

exception of SRCs, EGCs, and registered 

investment companies (which include 

listed closed-end funds), are currently 

required under Item 402(b) to disclose 

their hedging policies for named 

executive officers, if material. 

Companies are not otherwise currently 

required to provide information about 

whether they have a policy on hedging. 

They may not be providing such 

disclosures, possibly because their 

hedging policies are not material, or 

because they do not have a policy. Table 

2 divides covered companies, which 

includes both operating companies and 

listed closed-end funds, into four 

categories. The first three categories 

include operating companies. The last 

category includes listed closed-end 

funds. 

TABLE 2—FOUR CATEGORIES OF COVERED COMPANIES

Section 12 Companies Subject to the Proposed Amendments 

(1) Companies that are subject to Item 402(b) and make disclosures for named executive officers. 

(2) Companies that are subject to Item 402(b) but make no disclosures. 

(3) SRCs and EGCs that are not currently required to make Item 402(b) disclosures but must disclose under Item 407(i). 

(4) Listed closed-end funds that are not currently required to make Item 402(b) disclosures but must disclose under Item 407(i). 

Category 1 refers to the subset of 

companies subject to Item 402(b) that 

currently provide disclosure about 

hedging policies for named executive 

officers. These companies may be 

unlikely to change such policies as a 

result of the proposed amendments. For 

these companies, the new disclosures 

required under proposed Item 407(i) are 

whether employees (other than named 

executive officers) and directors are 

permitted to hedge. 

Category 2 refers to companies subject 

to Item 402(b) that do not currently 

disclose information about whether 

hedging by their named executive 

officers is permitted.97 New disclosures 

under the proposed amendments would 

confirm for shareholders whether 

hedging is permitted. Given that 

shareholders are likely to view a policy 

prohibiting hedging by named executive 

officers as shareholder friendly,98 the 

requirement to disclose may prompt 

some of these companies to adopt new 

policies or change their current policies 

or practices. In light of the required sayon-pay vote on executive compensation, 

we believe that companies prohibiting 

hedging by named executive officers 

would already have an incentive to 

disclose such a policy. Some 

shareholders may believe it is 

reasonable to infer that a company that 

is subject to Item 402(b) but does not 

disclose a hedging policy in effect may 

permit named executive officers to 

hedge. As a result, because shareholders 

either know through affirmative 

disclosure under Item 402(b)(2)(xiii) or 

may believe it is reasonable to infer 

from the absence of disclosure that 

named executive officers are permitted 

to hedge, the proposed amendments 

may not have much effect in reducing 

uncertainty as it relates to named 

executive officers. For Section 12 

registrants other than SRCs, EGCs and 

listed closed-end funds, the new 

information provided by disclosures 

under the proposed amendments relates 

primarily to whether employees (other 

than named executive officers) and 

directors are permitted to hedge. 

Category 3 refers to SRCs and EGCs, 

which are currently exempt from Item 

402(b). The new information available 

to investors under proposed Item 407(i) 

would require disclosure, for the first 

time, about whether employees 

(including named executive officers) 

and directors are permitted to hedge. 

Category 4 refers to listed closed-end 

funds. Since these funds are not 

currently subject to Item 402(b), the new 

information that would be available to 

shareholders is comparable in type to 

that of SRCs and EGCs. However, the 

new information about listed closed-end 

funds may in fact be less substantial 

than that of SRCs and EGCs for most 

funds because almost all listed closedend funds are externally managed, as 

discussed above. Only a small number 

of internally-managed listed closed-end 

funds have employees, which include 

funds’ portfolio managers. 


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99Our discussion focuses on officers and nonofficer critical employees, not on employees who do 

not participate in making and shaping key operating 

or strategic decisions that influence stock price. As 

discussed earlier, information about these other 

employees’ equity incentives and hedging of their 

equity holdings is less relevant for investors. 

100Between 1996 and 2006, in firms where 

insiders hedged their equity ownership, insiders on 

average used collars, forwards or swaps to cover 

about 30% of their ownership and placed about 9% 

of their ownership into the exchange funds. See 

Bettis, C., J. Bizjak, and S. Kalpathy, 2013, ‘‘Why 

Do Insiders Hedge Their Ownership? An Empirical 

Examination’’ working paper (available at http://

papers.ssrn.com/sol3/papers.cfm?abstract_

id=1364810). There is limited research on hedging 

transactions by corporate insiders. Hedging 

transactions studied in this paper included those by 

10% owners. In addition, the sample period was 

1996–2006, and thus the findings may not reflect 

the current situation. 

101Alternatively, as discussed later, if the change 

in hedging policies reduces incentive alignment, 

such change can reduce shareholder wealth. 

102Such companies include any company that 

currently does not disclose a hedging policy for any 

category of employees (including named executive 

officers) and directors, so could fall under any of 

the last three categories of companies in Table 2. 

103See Larcker D. and B. Tayan, 2010,’’Pledge 

(and Hedge) Allegiance to the Company’’, Stanford 

Closer Look Series, available at http://ssrn.com/

abstract=1690746. 

104Because listed closed-end funds exhibit salient 

differences in organizational structure, and hence 

incentive compensation mechanisms, from 

operating companies, we do not compare the 

economic effects of the proposed amendments 

between listed closed-end funds and operating 

companies. 

105See Lane, S., Schary, M.,1991,’’Understanding 

the Business Failure Rate’’, Contemporary 

Economic Policy 9: 93–105; Kapadia, N. 2011. 

‘‘Tracking Down Distress Risk,’’ Journal of Financial 

Economics 102: 167–182 

106Though no study to our knowledge directly 

examines whether insiders of smaller firms tend to 

hedge more, indirect evidence suggests that this is 

likely the case. For example, Bettis et al. (2001) find 

a total of 87 zero-cost collar transactions by 

searching Forms 3, 4 and 5 filed between January 

1996 and December 1998. Firms in this sample have 

total assets with a mean (median) value of $3.4 

billion ($401 million). These firms are much 

smaller than S&P 500 companies over the same time 

period, whose total assets have mean (median) of 

$16.15 billion ($3.84 billion) based on our 

calculation. This comparison indicates that hedging 

by zero-cost collars is disproportionally more 

frequent in smaller firms. See Bettis, J., J. Bizjak, 

and M. Lemmon. 2001. ‘‘Managerial Ownership, 

Incentive Contracting, and the Use of Zero-cost 

Collars and Equity Swaps by Corporate Insiders’’ 

Journal of Financial and Quantitative Analysis 36 

(3): 345–370. 

3. Benefits and Costs 

Investors can benefit from the 

disclosures under the proposed 

amendments in the following ways.99

First, as discussed above, officers’, 

directors’, and non-officer critical 

employees’ equity incentives tend to 

align their interests with those of the 

shareholders. Under the proposed 

amendments, investors would benefit 

from new disclosures that provide more 

clarity and transparency about these 

incentives, thereby reducing the 

information asymmetry between 

corporate insiders and shareholders 

regarding such incentives. Better 

information about equity incentives 

could be useful for investors’ evaluation 

of companies, enabling investors to 

make more informed investment and 

voting decisions, thereby encouraging 

more efficient capital allocation 

decisions. 

Second, the proposed amendments 

may reduce the costs for investors in 

researching and analyzing equity-based 

incentives. Knowledge that employees 

and directors are not permitted to hedge 

could confirm for investors that the 

reported equity holdings of officers and 

directors in proxy statements and 

annual reports on Form 10–K represent 

their actual incentives.100 While Section 

16(a) reports provide transaction-level 

information on officer and director 

hedging activity, Forms 3, 4, and 5 may 

be costly to search; investors also may 

incur costs in analyzing whether a 

reported transaction is indeed a hedge. 

Moreover, hedging activity disclosed on 

a Form 3, 4, or 5 does not indicate 

whether a transaction was conducted in 

accordance with the company’s hedging 

policy, and therefore may lead to 

improper inferences about the 

company’s hedging policy. 

Third, the proposed amendments 

could also benefit investors if the public 

nature of the required disclosures 

results in changes in hedging policies 

that improve incentive alignment 

between shareholders and executive 

officers or directors.101 Companies that 

currently already disclose whether 

named executive officers are permitted 

to hedge may be unlikely to 

substantially change their policies as a 

result of the proposed amendments. 

However, this could be different for 

companies that do not currently make 

disclosures on hedging policies for all 

employees or directors.102 Without 

disclosed hedging policies, these 

companies may in fact implicitly permit 

hedging. However, permitting hedging 

may not necessarily promote efficient 

investment decisions. Employees and 

directors often demand a premium for 

receiving equity compensation in lieu of 

cash. However, through hedging they 

may be able to convert the value of that 

premium into cash. This causes the 

company to overpay relative to its 

opportunity cost.103 If, in light of the 

disclosure requirement under Item 

407(i), the company later chooses to 

prohibit hedging, this change could 

increase shareholder wealth to the 

extent that the change better aligns 

incentives and hence induces officers 

and directors to make corporate 

decisions that are more beneficial to all 

shareholders. However, to the extent 

that changes in hedging policies reduce 

incentive alignment between 

shareholders and officers or directors, 

and results in underinvesting in 

potentially value-enhancing projects, 

the opposite effect could result. 

The benefits discussed above are 

relevant for investors of all companies 

affected by proposed Item 407(i), 

including listed closed-end funds.104

Among operating companies (the first 

three categories in Table 2), the new 

information elicited from the required 

disclosures increases, so we expect the 

benefits from the new disclosures also 

to increase similarly. Further, we expect 

the potential benefits to be higher for 

EGCs and SRCs (category 3) than for 

non-EGCs and non-SRCs (categories 1 

and 2), because EGCs and SRCs 

potentially face greater risk of a stock 

price decline than non-EGCs and nonSRCs. EGCs are typically younger firms 

with high growth options but fewer 

financial resources and are more likely 

to face financial distress since firm age 

is among the most important 

determinants of probability of failure.105

Because employees and directors of 

EGCs and SRCs potentially face greater 

downside price risk than those of nonEGCs and non-SRCs, the former have 

likely stronger incentives to hedge, thus 

making information about permissible 

hedging activities more relevant for 

shareholders of these companies.106

The benefits to investors also depend 

on the likelihood that officers and 

directors engage in hedging 

transactions. Officers and directors can 

hedge by, for example, entering into 

exchange-traded or over-the-counter 

derivative contracts. In either case, 

however, when the underlying stock is 

illiquid, the price of the derivatives 

contracts likely reflects the higher risk 

and cost that would be required to 

dynamically replicate the exposure of 

the derivatives contracts by trading in 

the underlying stock. As a result, it is 

likely more costly to hedge the risk of 

more illiquid stock. Though 

undiversified officers and directors have 

strong incentives to diversify (e.g., 

through hedging), they may not engage 

in hedging transactions if the cost is too 

high. In companies whose officers and 

directors are less likely to hedge due to 

high hedging cost, the potential benefits 

to investors from the required 

disclosures under the proposed 

amendments might be more limited. In 

the first three categories of companies, 

each category includes both exchangelisted and non-exchange-listed 


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107See Section V of the release. 

108Such costs are only incremental to the extent 

that the company does not already have procedures 

in place to administer and make such determination 

for named executive officers. 

109As discussed above, hedging by officers and 

directors is one of the solutions to the 

underinvestment concern, and the significance of 

such a problem depends on the availability and 

cost-effectiveness of other solutions. 

companies. Since stocks of exchangelisted companies are typically more 

liquid than stocks of non-exchangelisted companies, the potential benefits 

of the new disclosure to investors of 

non-exchange-listed companies may be 

lower than for exchange-listed ones. It is 

possible that stocks of smaller 

companies are less liquid, and hence 

these companies may be subject to the 

same effect. 

The expected potential benefits from 

proposed Item 407(i) would not be 

achieved without costs. All covered 

companies would incur costs to comply 

with the proposed amendments. Such 

costs include both disclosure costs, 

which stem directly from complying 

with the proposed amendments, and 

potential costs incurred to implement, 

administer, or revise a hedging policy. 

We first focus on disclosure costs, 

which should increase with the amount 

of new disclosures required under 

proposed Item 407(i). As discussed 

above, for operating companies (i.e., the 

three first categories in Table 2), the 

new required disclosures are higher in 

categories 2 and 3 than in category 1, so 

disclosure costs should also be higher in 

categories 2 and 3. Specifically, category 

1 companies would incur costs to 

determine whether employees (other 

than named executive officers) and 

directors are permitted to engage in 

hedging transactions, and incur costs to 

provide the required disclosure. 

Category 2 companies are subject to 

Item 402(b) but do not currently 

disclose any information about whether 

hedging by their named executive 

officers is permitted. To the extent that 

these companies permit hedging and 

that required disclosures under the 

proposed amendments do not change 

this practice, this category of companies 

would incur small additional costs to 

disclose their hedging policies for 

named executive officers. If these 

companies instead decide to prohibit 

hedging by named executive officers, 

they would incur a small additional cost 

to disclose the revised hedging policies, 

but they could incur other costs that 

could be more significant, which we 

discuss separately below. Similar to 

category 1, these companies would also 

incur costs to determine and disclose 

whether directors and employees other 

than named executive officers are 

permitted to hedge. 

Category 3 companies, i.e., SRCs and 

EGCs, are not currently subject to Item 

402(b). They may be less likely than 

companies subject to Item 402(b) to 

have policies, or to have articulated 

their practices, on whether hedging is 

permitted for employees (including 

named executive officers) and directors. 

Some SRCs and EGCs may incur costs 

in formulating policies for the first time, 

which will likely involve obtaining the 

advice of legal counsel and may also 

involve retaining compensation 

consultants. These companies would 

also incur costs in presenting the 

required disclosures in proxy or 

information statements. 

In Category 4, listed closed-end funds, 

similar to SRCs and EGCs, would incur 

costs to disclose, and possibly to 

formulate, policies regarding hedging by 

employees and directors. As noted 

above, the vast majority of listed closedend funds is externally-managed and 

thus would incur costs to disclose 

whether hedging by employees (if any) 

and directors is permitted. The limited 

number of listed closed-end funds that 

are internally managed also would incur 

costs to disclose if employees and 

directors are permitted to hedge with 

the difference, relative to externallymanaged listed closed-end funds, that 

these funds will have portfolio 

managers and others as employees. 

We expect the above disclosure costs 

to be minimal for these four categories 

of companies. A component of these 

costs (especially initial costs) may be 

fixed, which may have a greater impact 

on the smaller companies in category 3. 

While we cannot quantify these 

disclosure costs with precision, many of 

the costs reflect the burden associated 

with collection and reporting of 

information that we estimate for 

purposes of the Paperwork Reduction 

Act (‘‘PRA’’). For purposes of the PRA, 

we estimate the total annual increase in 

paperwork burden for all covered 

companies to be approximately 19,283 

hours of in-house personnel time and 

approximately $2,571,200 for the 

services of outside professionals.107

These disclosure costs, however, do 

not include costs incurred to 

implement, administer, or revise a 

hedging policy. For example, under the 

proposed amendments, a company that 

prohibits hedging by directors may 

incur additional costs to implement this 

policy, e.g., by analyzing whether 

transactions by a director have the effect 

of hedging.108 If a company revises its 

hedging policy as a result of the 

proposed amendments, additional costs 

may also arise. Such costs could involve 

obtaining the advice of compensation 

consultants and legal counsel. 

Perhaps most importantly, disclosing 

whether employees and directors are 

permitted to hedge might lead to 

changes in hedging policies that reduce 

incentive alignment between 

shareholders and officers or directors, if 

the current compensation arrangement 

is already in shareholders’ interest. 

Specifically, a company may currently 

permit hedging by executive officers to 

promote efficient investments in risky 

projects. As discussed above, companies 

in category 1 currently disclose hedging 

policy for named executive officers, and 

may be unlikely to substantially change 

their policies under proposed Item 

407(i). However, companies in 

categories 2 and 3, which do not 

disclose their hedging policies for 

named executive officers, may currently 

permit hedging by named executive 

officers but could switch to prohibiting 

hedging as a result of public disclosure 

under proposed Item 407(i). Such a 

change in policy, in certain instances, 

could limit executives’ ability to arrive 

at optimal levels of economic exposure 

to the company—i.e., one that leads 

executives to undertake the optimal 

level of risk in corporate investment 

decisions for the company’s 

shareholders.109 To the extent that 

compensation incentives materially 

affect a firm’s value, such changes could 

result in a reduction in shareholder 

wealth. 

We expect this cost from distorted 

investment incentives to be greater for 

companies in categories 2 and 3 than 

those in 1, as the latter may be unlikely 

to substantially change their hedging 

policies. However, between categories 2 

and 3, it is not clear whether category 

3 (EGCs and SRCs) would incur a higher 

cost than category 2. On one hand, EGCs 

and SRCs likely have higher growth 

options than non-EGCs and non-SRCs. 

Since the use of equity incentives to 

induce officers and directors to make 

proper corporate investment decisions 

is more important for companies with 

higher growth options, the cost from 

distorting investment incentives could 

be higher for EGCs and SRCs. On the 

other hand, as discussed above, such 

cost is limited by the availability of 

other cost-effective solutions to the 

underinvestment concern, e.g., requiring 

an officer to hold stock options. Without 

adequate data, it is difficult to 

determine whether and when hedging 

would be more prevalent than stock 

options in providing incentives for 

officers at EGCs and SRCs as compared 

to non-EGCs and non-SRCs. Evidence 


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110See Guay, W., 1999, ‘‘The Sensitivity of CEO 

Wealth to Equity Risk: An Analysis of the 

Magnitude and Determinants’’, Journal of Financial 

Economics 53, 43–71. 

111Such loss does not necessarily need to be 

compensated through other forms of compensation. 

Consider the following three alternative scenarios. 

First, under efficient contracting where hedging by 

officers promotes efficient investment decisions, 

officers are paid their opportunity wage to the 

extent that their labor market is competitive. If 

hedging is later prohibited as a result of public 

disclosure under the proposed amendments, these 

companies would resort to other, possibly more 

costly, compensation mechanisms to promote 

efficient investment decisions. While this change 

represents a cost to the company, officers still 

would receive their opportunity wage, so they are 

not better or worse off than before. Note that the 

dollar amount of the compensation may vary due 

to a potential change in riskiness of compensation. 

Prohibiting hedging may affect the riskiness of 

officers’ compensation, but the riskiness also 

depends on the use of new types of compensation 

mechanism to promote efficient investments 

decisions, so the direction of the net change is not 

clear. The change in the dollar amount of 

compensation, if any, reflects the change in the 

riskiness of the compensation, and is not a 

compensation for a loss in hedging opportunity. 

Second, if the labor market is not competitive, 

officers may be paid above their opportunity wage. 

If hedging is used to promote efficient investment 

decisions, prohibiting it as a result of public 

disclosure under the proposed amendments may 

shift the balance of power between the board and 

officers. While the loss of hedging opportunity is a 

cost to the officers, they may not be compensated 

for it as long as their compensation is still above 

their opportunity wage. Third, if hedging by officers 

is not in shareholders’ interests, a change from 

permitting to prohibiting hedging better aligns 

incentives. Officers may incur a cost from the loss 

of ability to hedge, but such cost merely represents 

the loss in the rents extracted by officers, and the 

officers should not be compensated for it. 

from academic studies shows that 

reported hedging transactions by 

officers and directors are infrequent; 

however, officers’ option holdings are 

much more prevalent, and the 

magnitude of CEO options holdings is 

greater in higher-growth firms to 

provide risk-taking incentives.110 Taken 

together, it is not clear whether costs to 

EGCs and SRCs are higher than to 

companies in category 2. 

The extent of the cost resulting from 

distorted investment incentives not only 

depends on a company’ growth 

opportunities, but also depends on the 

likelihood that officers and directors 

engage in hedging transactions. As 

discussed above, we expect officers and 

directors are less likely to hedge when 

the equity security is more illiquid, 

because hedging cost is higher. As a 

result, in these companies, hedging by 

officers and directors is less likely to be 

used as a way to address the 

underinvestment concern in the first 

place. Thus, the cost to these companies 

from prohibiting hedging when it would 

otherwise be economically beneficial 

would also likely to be more limited. In 

company categories 1, 2, and 3, each 

category includes both exchange-listed 

and non-exchange-listed companies; we 

expect such cost to be lower for nonexchange-listed companies than 

exchange-listed companies, because 

equity securities of the former typically 

are more liquid than equity securities of 

non-exchange-listed companies. Finally, 

to the extent that equity securities of 

smaller companies are less liquid, these 

companies may be subject to the same 

effect. 

The effects resulting from distorted 

incentives are likely to be different 

between externally-managed listed 

closed-end funds and internallymanaged listed closed-end funds. As 

discussed above, portfolio managers for 

these externally managed funds are 

employees of the funds’ investment 

advisers and thus are not covered by 

proposed Item 407(i). Policies on 

whether portfolio managers are 

permitted to hedge, if any, therefore are 

unlikely to change as a result of listed 

closed-end funds complying with 

proposed Item 407(i). Since these 

portfolio managers directly make 

investment decisions, their incentives to 

make portfolio selections are unlikely to 

be changed by the proposed 

amendments. Directors of listed closedend funds are covered by proposed 

407(i), however, and so directors’ equity 

incentives could be affected. To the 

extent that directors do not influence 

portfolio managers’ investment 

decisions, we do not expect listed 

closed-end funds to incur any cost from 

possible distortion of director incentives 

by the required disclosure under Item 

407(i). However, directors oversee the 

fund’s investment adviser (and other 

service providers), which employs the 

portfolio managers for the funds. If 

directors exert some influence over 

portfolio managers’ investment 

decisions through their oversight of the 

investment adviser, closed-end funds 

may incur cost from distorted director 

incentives. Out of all listed closed-end 

funds, we estimate only 4 are internally 

managed, so their portfolio managers are 

covered by proposed 407(i). These four 

closed-end funds may incur cost 

resulting from distortion to both 

portfolio managers’ and directors’ 

incentives by the required disclosure 

under Item 407(i). 

A revision in hedging policy also 

could impose costs on employees and 

directors. For example, if the company 

currently allows hedging for named 

executive officers but decides to 

prohibit all hedging transactions as a 

result of the new proposed disclosure 

requirements, named executive officers 

may incur costs stemming from the loss 

of their ability to hedge their current 

and future equity compensation awards 

or holdings.111

These costs incurred to implement a 

hedging policy or to revise a hedging 

policy are difficult to quantify. For 

example, in the absence of data on a 

company’s investment opportunities, 

the magnitude of the inefficiency in 

choosing investment projects as a result 

of a change in hedging policy is difficult 

to estimate. 

The proposed amendments would 

also require Item 407(i) disclosure in 

Schedule 14C, in addition to Schedule 

14A. This would extend the disclosure 

requirements and potential benefits 

described above to the Section 12(g) 

companies that do not file proxy 

statements with respect to the election 

of directors, thereby facilitating better 

understanding of companies’ corporate 

governance policies and practices, 

without regard to whether proxies or 

consents are solicited or otherwise 

obtained for such an action. At the same 

time, requiring the disclosure specified 

in proposed Item 407(i) to be included 

in information statements on Schedule 

14C would impose costs on companies 

that file Schedule 14C. However, 

consistency of the disclosure 

requirements applicable to both 

Schedules 14A and 14C in the context 

of an action with respect to the election 

of directors would facilitate better 

understanding of how companies 

address hedging, without regard to 

whether proxies or consents are 

solicited or otherwise obtained in 

connection with such action. 

The proposed amendment to Item 

402(b) would add an instruction 

providing that a company may satisfy its 

CD&A obligation to disclose any 

material policies on hedging by named 

executive officers under that 

requirement by cross referencing to the 

information disclosed pursuant to 

proposed Item 407(i) to the extent that 

the information disclosed there would 

satisfy this CD&A disclosure 

requirement. This approach would 

reduce potentially duplicative 

disclosure in complying with the 

existing CD&A requirements under Item 

402(b) and the proposed requirements of 

Item 407(i), thereby reducing issuers’ 

cost of compliance. Locating all the 

responsive disclosure in one place also 

would make it easier for investors to 

find it. 

4. Anticipated Effects on Efficiency, 

Competition, and Capital Formation 

As discussed above, the proposed 

amendments may improve capital 


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112See footnote 91. 

113The scope for hedging may be even more 

limited for mutual funds, as investors purchase 

mutual fund shares from or sell them to the fund 

daily at NAV. 

114See Pontiff, J., 1997, ‘‘Excess Volatility and 

Closed-End Funds’’ American Economic Review 87 

(1): 155–169. Day et al. (2011) find similar evidence 

in a much more recent sample. See Day T., G. Li, 

and Y. Xu, 2011, ‘‘Dividend Distributions and 

Closed-end Fund Discounts’’ Journal of Financial 

Economics 100: 579–593. 

115 Id. 

allocation efficiency by enabling 

investors to make more informed voting 

decisions. The disclosure costs incurred 

by Section 12 registrants to comply with 

the proposed amendments would be 

minimal, and hence unlikely to put any 

company at a competitive disadvantage. 

However, as discussed above, additional 

costs could arise if companies revise 

their hedging policies from permitting 

hedging to prohibiting hedging by 

officers and directors. Such a change 

could aggravate the underinvestment 

concern and result in shareholder 

wealth reduction. However, such costs 

would be limited by the availability and 

cost-effectiveness of other means to 

promote investments in high risk but 

value-enhancing projects.112 The 

proposed amendments are unlikely to 

have a notable impact on the 

competition either among U.S. 

companies or between U.S. companies 

and FPIs. We also do not expect the 

proposed amendments to affect the 

attractiveness of employment 

opportunities at the company to 

employees and directors, and hence 

impact the competitiveness of the labor 

market of employees and directors. The 

proposed amendments would impose 

new costs on companies seeking to 

become public, but such costs, taken 

alone, are unlikely to be a significant 

hurdle to companies seeking to become 

public. 

D. Alternatives 

1. Changing the Scope of Disclosure 

Obligations 

The proposed amendments would 

extend reporting requirements to 

information statements on Schedule 

14C. This extension primarily affects 

those Section 12(g) registrants that do 

not file proxy statements given that 

Section 12(b) registrants are generally 

required to solicit proxies. We have 

considered alternatives to this 

extension. One alternative would be to 

require proposed Item 407(i) disclosure 

in proxy statements only, i.e., not in 

information statements. This would 

reduce the disclosure burden on 

companies that do not solicit proxies 

from any or all security holders but are 

otherwise authorized by security 

holders to take an action with respect to 

the election of directors. However, 

providing Item 407(i) disclosure in 

information statements provides 

consistency in disclosures in proxy 

statements and information statements, 

so that the disclosure could be made to 

all shareholders when a company does 

not solicit proxies from any or all 

security holders but are otherwise 

authorized by security holders to take a 

corporate action with respect to the 

election of directors. Excluding the Item 

407(i) disclosure from information 

statements, as under this alternative, 

would reduce such benefits. 

We also considered extending the 

proposed disclosure requirement to 

Form 10–K filings of Section 12 

companies in order to impose consistent 

disclosure obligations upon all 

registrants with a class of securities 

registered under Section 12. This 

extension would have increased the 

proposed disclosure obligations 

especially for Section 12(g) companies 

that did not solicit proxies as they then 

would be required to provide the 

required disclosure in annual Form 10– 

K filings. Moreover, extending the 

disclosure requirement to all Section 

12(g) companies may provide limited 

benefits to shareholders, as nonexchange listed companies can have 

infrequently traded stock, making it 

more costly and thus less likely that 

employees and directors would pursue 

hedging opportunities. 

2. Issuers Subject to the Proposed 

Amendments 

The proposed amendments apply to 

all Section 12 registrants, including 

EGCs, SRCs, and listed closed-end 

funds. We have considered the 

following alternatives about the scope of 

the proposed amendments. 

The first alternative would be to 

either exempt or delay the application 

of the proposed amendments to EGCs 

and SRCs. Doing so would reduce costs 

for these entities, but the potential 

benefits would be eliminated or delayed 

as well. As discussed above, we expect 

the potential benefits from the required 

disclosures under proposed Item 407(i) 

to be higher for shareholders of EGCs 

and SRCs (i.e., category 3 in Table 2) 

than for shareholders of other operating 

companies (i.e., categories 1 and 2). 

While EGCs and SRCs likely also incur 

a higher cost from distorted incentives 

than companies in category 1, it is not 

clear whether such cost is higher than 

that for companies in category 2. 

Not exempting EGCs and SRCs from 

the proposed amendment is also 

consistent with officers and directors at 

these companies not being exempt from 

the obligation under Exchange Act 

Section 16(a) to disclose hedging 

transactions involving derivative 

securities. 

The second alternative is to include 

all funds, including mutual funds and 

ETFs, or a broader group of funds than 

listed closed-end funds, as proposed. 

Requiring all funds to provide the 

proposed disclosure would impose costs 

on the funds. The disclosure also could 

provide benefits, however, although the 

benefits to investors in funds other than 

listed closed-end funds may not be as 

significant where fund shares do not 

trade on an exchange. As discussed 

above, exchange-listed fund shares 

likely are more liquid than nonexchange-listed fund shares. Due to 

increased cost to hedge less liquid 

shares, directors and employees of nonexchange-listed funds may be less likely 

to engage in hedging transactions than 

those at exchange-listed funds.113

Further, the benefits that would result 

from applying the proposed 

amendments to ETFs are likely lower 

than the benefits from applying the 

proposed amendments to listed closedend funds as proposed. Employees (if 

any) and directors of ETFs may not have 

as strong an incentive to hedge their 

personal fund shareholdings as those at 

listed closed-end funds. First, listed 

closed-end funds likely are more 

volatile than ETFs. While the shares of 

many ETFs often trade on the secondary 

market at prices close to NAV of the 

shares, one study finds that closed-end 

funds’ monthly return on average is 

64% more volatile than that of the 

underlying NAV.114 The difference in 

volatility between ETF and closed-end 

fund returns is not driven by the 

difference in NAV between the two 

types of funds, and the listed closed-end 

funds’ ‘‘excess’’ volatility is largely 

idiosyncratic, and cannot be explained 

by market risk or risks that affect other 

closed-end funds.115 Employees and 

directors of listed closed-end funds may 

therefore have more incentive to hedge 

their fund shareholdings due to the 

‘‘excess’’ volatility. Second, the nonredeemability of listed closed-end fund 

shares allows the funds to take more 

illiquid positions, or positions that may 

not be possible to sell quickly and at 

short notice without incurring a 

substantial loss in value. Due to the 

potentially heightened liquidity risk in 

the funds’ portfolios, fund directors and 

employees may prefer not to expose 

their personal portfolios to the volatility 

resulting from liquidity risk and thus 

may hedge their personal fund share 

holdings. To the extent that listed 


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closed-end funds have greater ability 

than ETFs to invest in illiquid assets, it 

is possible that employees and directors 

of listed closed-end funds would have 

more incentives to hedge their personal 

holdings. 

Another alternative is not to require 

any funds to provide the proposed 

disclosure. Doing so would not impose 

costs related to the proposed rule on the 

funds. However, fund investors, 

including investors in listed closed-end 

funds, also would not derive any 

benefits, including a better 

understanding of policies that may 

affect incentives provided by fund 

shareholdings of employees and 

directors. 

E. Request for Comments 

1. We request information including 

data that would help quantify the costs 

and the value of the benefits of the 

proposed amendments described above. 

We seek estimates of these costs and 

benefits, as well as any costs and 

benefits not already defined, that may 

result from the adoption of the proposed 

amendment. We also request qualitative 

feedback on the nature of the benefits 

and costs described above and any 

benefits and costs we may have 

overlooked. 

2. We are interested in any studies or 

analysis on the number and 

characteristics of companies that have 

made disclosures of their ‘‘policies 

regarding hedging’’ under the existing 

requirement of Item 402(b)(2)(xiii) or 

otherwise. In particular, among the 

companies subject to the reporting 

requirement of Item 402(b)(2)(xiii), how 

many have hedging policies that they do 

not disclose because they do not deem 

them material? Among companies that 

disclose hedging policies, what are the 

types of the ‘‘policies’’ disclosed? 

3. Among companies currently subject 

to Item 402(b), some make no disclosure 

of a hedging policy for named executive 

officers. We believe that it may be 

reasonable to construe the absence of a 

disclosure of hedging policy to mean 

that the company does not prevent 

named executive officers from hedging. 

Is there evidence to the contrary? Are 

we correct in thinking that investors 

may draw the same inference? 

4. To our knowledge, hedging 

transactions typically involve derivative 

contracts, and fixed price derivative 

contracts are subject to reporting under 

Section 16(a). Are there any types of 

hedging transactions that are not 

currently subject to reporting by officers 

and directors under Section 16(a)? If 

yes, please provide details. 

5. Would the proposed disclosure 

increase the transparency to investors 

about the incentives provided by 

employees’ and directors’ equity 

holdings? Are there alternative ways to 

make the disclosures that would be 

more useful to investors in evaluating 

employees’ and directors’ incentive 

alignment with shareholders while still 

satisfying the mandate of Section 14(j)? 

6. What impact would the proposed 

amendments have on the incentives of 

employees and directors? Would the 

proposed amendments likely change the 

behavior of issuers, investors, or other 

market participants? 

7. Would the proposed disclosure 

requirements be likely to cause 

companies to change their policies on 

whether hedging is permitted for 

employees and directors? Why and 

how? If so, what costs would be 

incurred? What effect, if any, may the 

proxy voting policies of institutional 

investors and proxy advisory firms have 

on a company’s decision to change its 

policy? Have institutional investors and 

proxy advisory firms already established 

hedging policy positions that have been 

guiding voting decisions and vote 

recommendations? Have institutional 

investors and proxy advisory firm 

recommendations regarding such 

policies encouraged companies to 

provide transparency into hedging 

transactions that are permitted at the 

companies? How would the 

transparency into hedging transactions 

as a result of this disclosure impact 

investor communication with 

companies about such policies? What 

effect will this proposed disclosure 

requirement have on voting decisions? 

Would the proposed disclosure 

requirements be likely to cause 

companies to change their 

compensation policies for employees 

(including officers) or directors? Why or 

why not, and if so, how? 

8. If a company revises its hedging 

policy, would this revision influence 

other corporate decisions, for example, 

by encouraging or discouraging more 

risky but value-enhancing corporate 

investments? Please explain and 

provide data. 

9. Relative to other operating 

companies, would the proposed 

amendments have differential economic 

effects on EGCs and SRCs that we do not 

currently discuss in the release? If so, 

what are these differential economic 

effects? Would the impact of the proxy 

voting policies of institutional investors 

and proxy advisory firms, if any, be 

different for EGCs and SRCs than for 

other operating companies? In the 

absence of disclosure of hedging 

policies by EGCs and SRCs, to what 

extent have hedging policy positions of 

institutional investors and proxy 

advisory firms already been guiding 

voting decisions and vote 

recommendations for EGCs and SRCs? 

10. Are the costs and benefits of 

disclosing information about whether 

non-officer employees are permitted or 

prohibited to hedge different from the 

costs and benefits of disclosing 

information about officers and 

directors? If so, should the rule be 

modified to take those differences into 

account? 

11. What impact would the proposed 

amendments have on competition? 

Would the proposed amendments put 

registrants subject to the new disclosure 

requirements, or particular types of 

registrants subject to the new disclosure 

requirements, at a competitive 

advantage or disadvantage? 

12. What impact would the proposed 

amendments have on efficiency? Have 

we overlooked any positive or negative 

effects on efficiency? 

13. What impact would the proposed 

amendments have on capital formation? 

Would there be any positive or negative 

effects on capital formation that we may 

have overlooked? 

14. Are listed closed-end funds 

subject to an incentive alignment 

concern due to shareholders’ inability to 

redeem their shares from the fund (or 

often to sell them in secondary 

transactions at or close to the funds’ 

NAV per share) that would relate to 

hedging considerations? What are the 

characteristics of listed closed-end 

funds’ incentive structure with respect 

to employees and directors that would 

inform this consideration? 

15. We note above that shares of listed 

closed-end funds are not redeemable, 

and they may trade at a discount to 

NAV. Will this create heightened 

incentives for these funds’ employees 

and directors to hedge personal 

holdings in listed closed-end funds as 

compared to employees and directors of 

other types of funds? Are there features 

of ETFs that would make the disclosures 

under the proposed amendments 

particularly useful for their investors 

even though ETF shares often trade on 

the secondary market at prices close to 

NAV of the shares? Are there features of 

mutual funds or other types of funds 

that would make the disclosures under 

the proposed amendments particularly 

useful for their investors? 

16. The potential cost to companies 

from distorting investment incentives as 

a result of required disclosures under 

proposed Item 407(i) is lower for 

companies with fewer investment 

choices. How, if at all, does the range of 

available investment choices for listed 

closed-end funds differ from that for 

operating companies? 


tkelley on DSK3SPTVN1PROD with PROPOSALS4
8506 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

116 44 U.S.C. 3507(d) and 5 CFR 1320.11. 

117The paperwork burden from Regulation S–K is 

imposed through the forms that are subject to the 

disclosure requirements in Regulation S–K and is 

reflected in the analysis of these forms. To avoid a 

Paperwork Reduction Act inventory reflecting 

duplicative burdens, for administrative 

convenience we estimate the burden imposed by 

Regulation S–K to be a total of one hour. 

118Proposed Instruction 6 to Item 402(b). 

119Our estimates represent the average burden for 

all companies, both large and small. 

120See the 2006 Executive Compensation 

Disclosure Release. 

121For convenience, the estimated hour and cost 

burdens in the table have been rounded to the 

nearest whole number. 

V. Paperwork Reduction Act 

A. Background 

The proposed amendments contain 

‘‘collection of information’’ 

requirements within the meaning of the 

Paperwork Reduction Act of 1995 

(‘‘PRA’’). We are submitting the 

proposed amendments to the Office of 

Management and Budget (‘‘OMB’’) for 

review in accordance with the PRA.116

The titles for the collection of 

information are: 

(1) ‘‘Regulation 14A and Schedule 

14A’’ (OMB Control No. 3235–0059); 

(2) ‘‘Regulation 14C and Schedule 

14C’’ (OMB Control No. 3235–0057); 

(3) ‘‘Regulation S–K’’ (OMB Control 

No. 3235–0071); 117 and 

(4) ‘‘Rule 20a–1 under the Investment 

Company Act of 1940, Solicitation of 

Proxies, Consents, and Authorizations’’ 

(OMB Control No. 3235–0158). 

Regulation S–K was adopted under 

the Securities Act and Exchange Act; 

Regulations 14A and 14C and the 

related schedules were adopted under 

the Exchange Act; and Rule 20a–1 was 

adopted under the Investment Company 

Act. The regulations and schedule set 

forth the disclosure requirements for 

proxy and information statements filed 

by companies to help investors make 

informed investment and voting 

decisions. The hours and costs 

associated with preparing, filing and 

sending the schedule constitute 

reporting and cost burdens imposed by 

each collection of information. An 

agency may not conduct or sponsor, and 

a person is not required to respond to, 

a collection of information unless it 

displays a currently valid OMB control 

number. Compliance with the proposed 

amendment would be mandatory. 

Responses to the information collection 

would not be kept confidential, and 

there would be no mandatory retention 

period for the information disclosed. 

B. Summary of the Proposed 

Amendments 

We are proposing to add new 

paragraph (i) to Item 407 of Regulation 

S–K that would implement Section 14(j) 

of the Exchange Act, as added by 

Section 955 of the Act. As discussed in 

more detail above, proposed Item 407(i) 

would require disclosure of whether 

employees and directors of the 

company, or their designees, are 

permitted to hedge or offset any 

decrease in the market value of equity 

securities that are granted to them by 

the company as part of their 

compensation, or that are held, directly 

or indirectly, by them. Pursuant to the 

proposed amendment to Item 7 of 

Schedule 14A, and for listed closed-end 

funds, the proposed amendment to Item 

22 of Schedule 14A, this new disclosure 

would be required in proxy or consent 

solicitation materials with respect to the 

election of directors, or an information 

statement in the case of such corporate 

action authorized by the written consent 

of security holders. 

In addition, to reduce potentially 

duplicative disclosure between 

proposed Item 407(i) and the existing 

requirement for CD&A under Item 

402(b) of Regulation S–K, we propose to 

amend Item 402(b) to add an instruction 

providing that a company may satisfy its 

obligation to disclose material policies 

on hedging by named executive officers 

in the CD&A by cross referencing the 

information disclosed pursuant to 

proposed Item 407(i) to the extent that 

the information disclosed there satisfies 

this CD&A disclosure requirement.118

This instruction, like the Item 407(i) 

disclosure requirement, would apply to 

the company’s proxy or information 

statement with respect to the election of 

directors. 

C. Burden and Cost Estimates Related to 

the Proposed Amendments 

If adopted, proposed Item 407(i) 

would require additional disclosure in 

proxy statements filed on Schedule 14A 

with respect to the election of directors 

and information statements filed on 

Schedule 14C where such corporate 

action is taken by the written consents 

or authorizations of security holders, 

and would thus increase the burden 

hour and cost estimates for each of those 

forms. For purposes of the PRA, we 

estimate the total annual increase in the 

paperwork burden for all affected 

issuers to comply with our proposed 

collection of information requirements, 

averaged over the first three years, to be 

approximately 19,238 hours of in-house 

personnel time and approximately 

$2,565,200 for the services of outside 

professionals (see Table 3).119 These 

estimates include the time and cost of 

collecting and analyzing the 

information, preparing and reviewing 

disclosure, and filing the documents. 

In deriving our estimates, we assumed 

that the information that proposed Item 

407(i) would require to be disclosed 

would be readily available to the 

management of a company because it 

only requires disclosure of policies they 

already have but does not direct them to 

have a policy or dictate the content of 

the policy. Nevertheless, we used 

burden estimates similar to those used 

in the 2006 Executive Compensation 

Disclosure Release for updating 

Schedules 14A and 14C, which we 

believe were more extensive.120 Since 

the first year of compliance with the 

proposed amendment is likely to be the 

most burdensome because companies 

are not likely to have compiled this 

information in this manner previously, 

we assumed it would take five total 

hours per form the first year and two 

total hours per form in all subsequent 

years. 

Based on our assumptions, we 

estimated that the proposed 

amendments would increase the burden 

hour and cost estimates per company by 

an average of three total hours per year 

over the first three years the 

amendments are in effect for each 

Schedule 14A or Schedule 14C with 

respect to the election of directors. 

We recognize that the burdens may 

vary among individual companies based 

on a number of factors, including the 

size and complexity of their 

organizations, and whether or not they 

prohibit or restrict hedging transactions 

by employees, directors and their 

designees and if they do, the specificity 

and complexity of such restrictions. 

The table below shows the three-year 

average annual compliance burden, in 

hours and in costs, of the collection of 

information pursuant to proposed Item 

407(i) of Regulation S–K.121 The burden 

estimates were calculated by 

multiplying the estimated number of 

responses by the estimated average 

amount of time it would take a company 

to prepare and review the proposed 

disclosure requirements. The portion of 

the burden carried by outside 

professionals is reflected as a cost, while 

the portion of the burden carried by the 

company internally is reflected in 

hours. For purposes of the PRA, we 

estimate that 75% of the burden of 

preparation of Schedules 14A and 14C 

is carried by the company internally and 

that 25% of the burden of preparation 

is carried by outside professionals 

retained by the company at an average 

cost of $400 per hour. There is no 

change to the estimated burden of the 


tkelley on DSK3SPTVN1PROD with PROPOSALS4
Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 8507 

122For Schedules 14A and 14C, the number of 

responses reflected in the table equals the threeyear average of the number of schedules filed with 

the Commission and currently reported by the 

Commission to OMB. For Rule 20a–1, the number 

of responses reflected in the table is based on an 

average of three years of data from 2012–2014 in the 

2014 ICI Fact book. 

123Public Law 104–121, Title II, 110 Stat. 857 

(1996). 124 5 U.S.C. 603. 

collections of information under 

Regulation S–K because the burdens 

that this regulation imposes are 

reflected in our burden estimates for 

Schedule 14A and 14C. 

TABLE 3—INCREMENTAL PAPERWORK BURDEN UNDER THE PROPOSED AMENDMENTS AFFECTING SCHEDULES 14A AND

14C—THREE-YEAR AVERAGE COSTS

Number of 

responses 

Incremental 

burden hours/ 

form 

Total 

incremental 

burden 

hours 

Internal 

company 

time 

External 

professional 

time 

External 

professional 

costs 

(A) 122 (B) (C)=(A)*(B) (D)=(C)*0.75 (E)=(C)*0.25 (F)=(E)*$400 

Sch. 14A .................................................. 7,300 3 21,900 16,425 5,475 $2,190,000 

Sch. 14C .................................................. 680 3 2,040 1,530 510 204,000 

Rule 20a–1 ............................................... 590 3 1,770 1,328 443 177,200 

Total .................................................. 8,570 ........................ 25,710 19,283 6,428 2,571,200 

The proposed amendment to the CD&A 

requirement under Item 402(b) would 

not be applicable to smaller reporting 

companies or emerging growth 

companies because under current CD&A 

reporting requirements these companies 

are not required to provide CD&A in 

their Commission filings. For all other 

issuers, we do not expect this 

amendment would materially affect the 

disclosure burden associated with their 

Commission filings. 

D. Request for Comment 

Pursuant to 44 U.S.C. 3506(c)(2)(B), 

we request comment in order to: 

• Evaluate whether the proposed 

collection of information is necessary 

for the proper performance of the 

functions of the Commission, including 

whether the information will have 

practical utility; 

• Evaluate the accuracy of our 

assumptions and estimates of the 

burden of the proposed collection of 

information; 

• Determine whether there are ways 

to enhance the quality, utility and 

clarity of the information to be 

collected; 

• Evaluate whether there are ways to 

minimize the burden of the collection of 

information on those who respond, 

including through the use of automated 

collection techniques or other forms of 

information technology; and 

• Evaluate whether the proposed 

amendments will have any effects on 

any other collection of information not 

previously identified in this section. 

Any member of the public may direct 

to us any comments concerning the 

accuracy of these burden estimates and 

any suggestions for reducing these 

burdens. Persons submitting comments 

on the collection of information 

requirements should direct their 

comments to the Office of Management 

and Budget, Attention: Desk Officer for 

the U.S. Securities and Exchange 

Commission, Office of Information and 

Regulatory Affairs, Washington, DC 

20503, and send a copy to, Brent J. 

Fields, Secretary, U.S. Securities and 

Exchange Commission, 100 F Street NE., 

Washington, DC 20549–1090, with 

reference to File No. S7–01–15. 

Requests for materials submitted to 

OMB by the Commission with regard to 

the collection of information should be 

in writing, refer to File No. S7–01–15 

and be submitted to the U.S. Securities 

and Exchange Commission, Office of 

FOIA Services, 100 F Street NE., 

Washington DC 20549–2736. OMB is 

required to make a decision concerning 

the collection of information between 30 

and 60 days after publication of this 

release. Consequently, a comment to 

OMB is best assured of having its full 

effect if the OMB receives it within 30 

days of publication. 

VI. Small Business Regulatory 

Enforcement Fairness Act 

For purposes of the Small Business 

Regulatory Enforcement Fairness Act of 

1996, or ‘‘SBREFA,’’ 123 we solicit data 

to determine whether the rule proposals 

constitute a ‘‘major’’ rule. Under 

SBREFA, a rule is considered ‘‘major’’ 

where, if adopted, it results or is likely 

to result in: 

• An annual effect on the economy of 

$100 million or more (either in the form 

of an increase or a decrease); 

• A major increase in costs or prices 

for consumers or individual industries; 

or 

• Significant adverse effects on 

competition, investment or innovation. 

Commentators should provide 

empirical data on: (1) The potential 

annual effect on the economy; (2) any 

increase in costs or prices for consumers 

or individual industries; and (3) any 

potential effect on competition, 

investment or innovation. 

VII. Initial Regulatory Flexibility Act 

Analysis 

This Initial Regulatory Flexibility 

Analysis has been prepared in 

accordance with the Regulatory 

Flexibility Act.124 This analysis 

involves a proposal to require, in proxy 

or consent solicitation materials, or in 

an information statement, with respect 

to the election of directors disclosure of 

whether employees (including officers), 

directors or their designees are 

permitted to engage in transactions to 

hedge or offset any decrease in the 

market value of equity securities granted 

to them as compensation, or directly or 

indirectly held by them. 

A. Reasons for, and Objectives of, the 

Proposed Action 

The proposed amendments are 

designed to implement Section 14(j), 

which was added to the Exchange Act 

by Section 955 of the Act. Specifically, 

the proposed amendments would 

require disclosure, in any proxy or 

information statement with respect to 

the election of directors, of whether any 

employee or director of the company or 

any designee of such employee or 

director, is permitted to purchase any 

financial instruments (including but not 

limited to prepaid variable forward 

contracts, equity swaps, collars, and 


tkelley on DSK3SPTVN1PROD with PROPOSALS4
8508 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

125 5 U.S.C. 601(6). 

126 17 CFR 240.0–10(a). 

127 17 CFR 270.0–10(a). 128Proposed Instruction 6 to Item 402(b). 129See Senate Report 111–176. 

exchange funds) or otherwise engage in 

transactions that are designed to or have 

the effect of hedging or offsetting any 

decrease in the market value of equity 

securities, that are granted to the 

employee or director by the company as 

compensation, or held, directly or 

indirectly, by the employee or director. 

The covered equity securities would be 

equity securities issued by the company, 

any parent of the company, any 

subsidiary of the company or any 

subsidiary of any parent of the company 

that are registered under Exchange Act 

Section 12. 

B. Legal Basis 

We are proposing the amendments 

pursuant to Section 955 of the Act, 

Sections 14, 23(a) and 36(a) of the 

Exchange Act, as amended, and 

Sections 6, 20(a) and 38 of the 

Investment Company Act, as amended. 

C. Small Entities Subject to the 

Proposed Amendments 

The proposed amendments would 

affect some companies that are small 

entities. The Regulatory Flexibility Act 

defines ‘‘small entity’’ to mean ‘‘small 

business,’’ ‘‘small organization,’’ or 

‘‘small governmental jurisdiction.’’ 125

The Commission’s rules define ‘‘small 

business’’ and ‘‘small organization’’ for 

purposes of the Regulatory Flexibility 

Act for each of the types of entities 

regulated by the Commission. Exchange 

Act Rule 0–10(a) 126 defines a company, 

other than an investment company, to 

be a ‘‘small business’’ or ‘‘small 

organization’’ if it had total assets of $5 

million or less on the last day of its most 

recent fiscal year. We estimate that there 

are approximately 428 issuers that may 

be considered small entities. The 

proposed amendments would affect 

small entities that have a class of 

securities that are registered under 

Section 12 of the Exchange Act. An 

investment company, including a 

business development company, is 

considered to be a ‘‘small business’’ if 

it, together with other investment 

companies in the same group of related 

investment companies, has net assets of 

$50 million or less as of the end of its 

most recent fiscal year.127 We believe 

that the proposal would affect some 

small entities that are investment 

companies. We estimate that there are 

approximately 29 investment companies 

that would be subject to the proposed 

rule that may be considered small 

entities. 

D. Reporting, Recordkeeping and Other 

Compliance Requirements 

The proposed amendments would 

add to the proxy disclosure 

requirements of companies, including 

small entities, that file proxy or 

information statements with respect to 

the election of directors, by requiring 

them to provide the disclosure called for 

by the proposed amendment. 

Specifically, proposed Item 407(i) 

would require disclosure of whether any 

employee or director of the company or 

any designee of such employee or 

director, is permitted to purchase any 

financial instruments (including but not 

limited to prepaid variable forward 

contracts, equity swaps, collars, and 

exchange funds) or otherwise engage in 

transactions that are designed to or have 

the effect of hedging or offsetting any 

decrease in the market value of equity 

securities, that are granted to the 

employee or director by the company as 

compensation, or held, directly or 

indirectly, by the employee or director. 

E. Duplicative, Overlapping or 

Conflicting Federal Rules 

We believe that the proposed 

amendments would not duplicate, 

overlap or conflict with other federal 

rules. The proposal would reduce 

potentially duplicative disclosure by 

adding an instruction permitting a 

company to satisfy any obligation under 

Item 402(b) of Regulation S–K to 

disclose in the CD&A material policies 

on hedging by named executive officers 

by cross referencing to the new 

disclosure required by proposed Item 

407(i) to the extent that the information 

disclosed there satisfies this CD&A 

disclosure requirement.128 However, as 

described above, the CD&A disclosure 

obligation does not apply to small 

entities that are emerging growth 

companies, smaller reporting companies 

or registered investment companies. 

F. Significant Alternatives 

The Regulatory Flexibility Act directs 

us to consider alternatives that would 

accomplish our stated objectives, while 

minimizing any significant adverse 

impact on small entities. In connection 

with the proposed amendments, we 

considered the following alternatives: 

• Establishing different compliance or 

reporting requirements or timetables 

that take into account the resources 

available to small entities; 

• clarifying, consolidating, or 

simplifying compliance and reporting 

requirements under the rules for small 

entities; 

• use of performance rather than 

design standards; and 

• exempting small entities from all or 

part of the proposed requirements. 

We believe that the proposed 

amendments would require clear and 

straightforward disclosure of whether 

employees or directors are permitted to 

engage in transactions to hedge or offset 

any decrease in the market value of 

equity securities granted to them as 

compensation, or directly or indirectly 

held by them. Given the straightforward 

nature of the proposed disclosure, we 

do not believe that it is necessary to 

simplify or consolidate the disclosure 

requirement for small entities. We have 

used performance standards in 

connection with the proposed 

amendments by proposing to use a 

principles-based approach to identify 

transactions that would hedge or offset 

any decrease in the market value of 

equity securities. Additionally, the 

amendments do not specify any specific 

procedures or arrangements a company 

must develop to comply with the 

standards, or require a company to have 

or develop a policy regarding employee 

and director hedging activities. 

We considered, but have not 

proposed, different compliance 

requirements or an exemption for small 

entities. We believe that mandating 

uniform and comparable disclosures 

across all issuers subject to our proxy 

rules will promote informed 

shareholder voting. The proposed rule 

amendments are intended to provide 

transparency regarding whether 

employees, directors, or their designees 

are allowed to engage in hedging 

transactions that will permit them to 

receive compensation without regard to 

company performance, or will permit 

them to mitigate or avoid the risks 

associated with long-term equity 

security ownership.129 We believe this 

transparency would be just as beneficial 

to shareholders of small companies as to 

shareholders of larger companies. By 

increasing transparency regarding these 

matters, the proposed amendments are 

designed to improve the quality of 

information available to all 

shareholders, thereby promoting 

informed voting decisions. Different 

compliance requirements or an 

exemption for small entities may 

interfere with the goal of enhancing the 

information provided by all issuers. We 

also note that the disclosure is expected 

to result in minimal additional 

compliance costs for issuers although 

there could be indirect costs for some 

small entities, depending on their 

current hedging policies. Thus, we 


tkelley on DSK3SPTVN1PROD with PROPOSALS4
Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 8509 

believe that our proposed amendments 

will promote consistent disclosure 

among all issuers, without creating a 

significant new burden for small 

entities. 

Although we preliminarily believe 

that an exemption for small entities 

from coverage of the proposed 

amendments would not be appropriate, 

we solicit comment on whether we 

should exempt small entities. At this 

time, we do not believe that different 

compliance methods or timetables for 

small entities would be necessary given 

the relatively straightforward nature of 

the disclosure involved. Nevertheless, 

we solicit comment on whether 

different compliance requirements or 

timetables for small entities would be 

appropriate and consistent with the 

purposes of Section 14(j). 

G. Solicitation of Comments 

We encourage the submission of 

comments with respect to any aspect of 

this Initial Regulatory Flexibility 

Analysis. In particular, we request 

comments regarding: 

• How the proposed amendments can 

achieve their objective while lowering 

the burden on small entities; 

• The number of small entities that 

may be affected by the proposed 

amendments; 

• Whether small entities should be 

exempt from the proposed amendments; 

• The existence or nature of the 

potential impact of the proposed 

amendments on small entities discussed 

in the analysis; and 

• How to quantify the impact of the 

proposed amendments. 

Respondents are asked to describe the 

nature of any impact of the proposed 

amendments on small entities and 

provide empirical data supporting the 

extent of the impact. Such comments 

will be considered in the preparation of 

the Final Regulatory Flexibility 

Analysis, if the proposed amendments 

are adopted, and will be placed in the 

same public file as comments on the 

proposed amendments themselves. 

VIII. Statutory Authority and Text of 

the Proposed Amendments 

The amendments contained in this 

release are being proposed under the 

authority set forth in Section 955 of the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Sections 14, 

23(a) and 36(a) of the Securities 

Exchange Act of 1934, as amended, and 

Sections 6, 20(a) and 38 of the 

Investment Company Act, as amended. 

List of Subjects in 17 CFR Parts 229 and 

240 

Reporting and recordkeeping 

requirements, Securities. 

Text of the Proposed Amendments 

For the reasons set out in the 

preamble, the Commission proposes to 

amend title 17, chapter II, of the Code 

of Federal Regulations as follows: 

PART 229—STANDARD 

INSTRUCTIONS FOR FILING FORMS 

UNDER SECURITIES ACT OF 1933, 

SECURITIES EXCHANGE ACT OF 1934 

AND ENERGY POLICY AND 

CONSERVATION ACT OF 1975— 

REGULATION S–K 

■ 1. The authority citation for part 229 

continues to read as follows: 

Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 

77k, 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), 

77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 

77nnn, 77sss, 78c, 78i, 78j, 78j–3, 78l, 78m, 

78n, 78n–1, 78o, 78u–5, 78w, 78ll, 78mm, 

80a–8, 80a–9, 80a–20, 80a–29, 80a–30, 80a– 

31(c), 80a–37, 80a–38(a), 80a–39, 80b–11, 

and 7201 et seq; and 18 U.S.C. 1350, unless 

otherwise noted. 

■ 2. Amend § 229.402 by adding 

Instruction 6 to Item 402(b), to read as 

follows: 

§ 229.402 (Item 402) Executive 

compensation. 

* * * * * 

(b) * * * 

Instructions to Item 402(b). * * * 

6. If the information disclosed 

pursuant to Item 407(i) would satisfy 

the registrant hedging policy disclosure 

requirements of paragraph (b)(2)(xiii) of 

this Item, a registrant may satisfy this 

Item in its proxy or information 

statement by referring to the information 

disclosed pursuant to Item 407(i). 

* * * * * 

■ 3. Amend § 229.407 by adding 

paragraph (i) before the Instructions to 

Item 407, to read as follows: 

§ 229.407 (Item 407) Corporate 

governance. 

* * * * * 

(i) Employee, officer and director 

hedging. In proxy or information 

statements with respect to the election 

of directors, disclose whether the 

registrant permits any employees 

(including officers) or directors of the 

registrant, or any of their designees, to 

purchase financial instruments 

(including prepaid variable forward 

contracts, equity swaps, collars, and 

exchange funds) or otherwise engage in 

transactions that are designed to or have 

the effect of hedging or offsetting any 

decrease in the market value of equity 

securities— 

(1) Granted to the employee or 

director by the registrant as part of the 

compensation of the employee or 

director; or 

(2) Held, directly or indirectly, by the 

employee or director. 

Instructions to Item 407(i). 

1. For purposes of this Item 407(i), 

‘‘equity securities’’ (as defined in 

section 3(a)(11) of the Exchange Act (15 

U.S.C. 78c(a)(11)) and § 240.3a11–1 of 

this chapter) shall mean only those 

equity securities issued by the registrant 

or any parent of the registrant, any 

subsidiary of the registrant or any 

subsidiary of any parent of the registrant 

that are registered under Section 12 of 

the Exchange Act (15 U.S.C. 78l). 

2. A registrant that permits hedging 

transactions by some, but not all, of the 

categories of persons covered by this 

Item 407(i) shall disclose the categories 

of persons who are permitted to engage 

in hedging transactions and those who 

are not. 

3. A registrant shall disclose the 

categories of hedging transactions it 

permits and those it prohibits. In 

disclosing these categories, a registrant 

may, if true, disclose that it prohibits or 

permits particular categories and 

permits or prohibits, respectively, all 

other hedging transactions. If a 

registrant does not permit any hedging 

transactions, or permits all hedging 

transactions, it shall so state and need 

not describe them by category. 

4. A registrant that permits hedging 

transactions shall disclose sufficient 

detail to explain the scope of such 

permitted transactions. 

5. The information required by this 

Item 407(i) will not be deemed to be 

incorporated by reference into any filing 

under the Securities Act, the Exchange 

Act or the Investment Company Act, 

except to the extent that the registrant 

specifically incorporates it by reference. 

* * * * * 

PART 240—GENERAL RULES AND 

REGULATIONS, SECURITIES 

EXCHANGE ACT OF 1934 

■ 4. The authority citation for Part 240 

continues to read, in part, as follows: 

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 

77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 

77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, 

78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m 78n, 

78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 

78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a–20, 

80a–23, 80a–29, 80a–37, 80b–3, 80b–4, 80b– 

11, 7210 et seq.; and 8302; 7 U.S.C. 2(c)(2)(E); 

12 U.S.C. 5521(e)(3); 18 U.S.C. 1350; and 

Pub. L. 111–203, 939A, 124 Stat. 1376, 

(2010), unless otherwise noted. 

* * * * * 

■ 5. Amend § 240.14a–101 by: 


tkelley on DSK3SPTVN1PROD with PROPOSALS4
8510 Federal Register / Vol. 80, No. 31 / Tuesday, February 17, 2015 / Proposed Rules 

■ a. Revising Item 7 paragraph (b); 

■ b. Removing Item 7 paragraphs (c) and 

(d); 

■ c. Redesignating Item 7 paragraph (e) 

as paragraph (c); 

■ d. Removing the Instruction to Item 7 

paragraph (e); 

■ e. Redesignating Item 7 paragraph (f) 

as paragraph (d); 

■ f. Redesignating Instruction to Item 7 

paragraph (f) as Instruction to Item 7 

and revising the newly redesignated 

Instruction to Item 7; 

■ g. Redesignating Item 7 paragraph (g) 

as paragraph (e); and 

■ h. Adding to Item 22(b) paragraph 

(20). 

The revisions and addition read as 

follows: 

§ 240.14a–101 Schedule 14A. Information 

required in proxy statement. 

SCHEDULE 14A INFORMATION 

* * * * * 

Item 7. Directors and Executive 

Officers. * * * 

(b) The information required by Items 

401, 404(a) and (b), 405 and 407 of 

Regulation S–K (§§ 229.401, 229.404(a) 

and (b), 229.405 and 229.407 of this 

chapter), other than the information 

required by: 

(i) Paragraph (c)(3) of Item 407 of 

Regulation S–K (§ 229.407(c)(3) of this 

chapter); and 

(ii) Paragraphs (e)(4) and (e)(5) of Item 

407 of Regulation S–K (§§ 229.407(e)(4) 

and 229.407(e)(5) of this chapter) 

(which are required by Item 8 of this 

Schedule 14A). 

* * * 

Instruction to Item 7. The information 

disclosed pursuant to paragraphs (c) and 

(d) of this Item 7 will not be deemed 

incorporated by reference into any filing 

under the Securities Act of 1933 (15 

U.S.C. 77a et seq.), the Securities 

Exchange Act of 1934 (15 U.S.C. 78a et 

seq.), or the Investment Company Act of 

1940 (15 U.S.C. 80a–1 et seq.), except to 

the extent that the registrant specifically 

incorporates that information by 

reference. 

* * * 

Item 22. Information required in 

investment company proxy statement. 

* * * * * 

(b) * * * 

(20) In the case of a Fund that is a 

closed-end investment company that is 

listed and registered on a national 

securities exchange, provide the 

information required by Item 407(i) of 

Regulation S–K (§ 229.407(i) of this 

chapter). 

* * * * * 

Dated: February 9, 2015. 

By the Commission. 

Brent J. Fields, 

Secretary. 

[FR Doc. 2015–02948 Filed 2–13–15; 8:45 am] 

BILLING CODE 8011–01–P 


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