Document ID: SEC-2019-0074-0001
Agency: sec
Document Type: Rule
Title: Disclosure of Hedging by Employees, Officers and Directors
Posted Date: 2019-02-06T05:00Z

[Federal Register Volume 84, Number 25 (Wednesday, February 6, 2019)]
[Rules and Regulations]
[Pages 2402-2426]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-28123]

[[Page 2401]]

Vol. 84

Wednesday,

No. 25

February 6, 2019

Part IV

Securities and Exchange Commission

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17 CFR Parts 229 and 240

Disclosure of Hedging by Employees, Officers and Directors; Final Rule

  Federal Register / Vol. 84 , No. 25 / Wednesday, February 6, 2019 / 
Rules and Regulations  

[[Page 2402]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229 and 240

[Release No. 33-10593; 34-84883; IC-33333; File No. S7-01-15]
RIN 3235-AL49

Disclosure of Hedging by Employees, Officers and Directors

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are adopting a rule to implement a provision of the Dodd-
Frank Wall Street Reform and Consumer Protection Act. The new rule 
requires a company to describe any practices or policies it has adopted 
regarding the ability of its employees (including officers) or 
directors to purchase financial instruments, or otherwise engage in 
transactions, that hedge or offset, or are designed to hedge or offset, 
any decrease in the market value of equity securities granted as 
compensation, or held directly or indirectly by the employee or 
director. The new rule requires a company to describe the practices or 
policies and the categories of persons they affect. If a company does 
not have any such practices or policies, the company must disclose that 
fact or state that hedging transactions are generally permitted. The 
new disclosure is required in a proxy statement or information 
statement relating to an election of directors.

DATES: 
    Effective date: March 8, 2019.
    Compliance dates: Companies that do not qualify as ``smaller 
reporting companies'' or ``emerging growth companies'' (each as defined 
in 17 CFR 240.12b-2) must comply with these disclosure requirements for 
proxy and information statements with respect to the election of 
directors during fiscal years beginning on or after July 1, 2019.
    Companies that qualify as ``smaller reporting companies'' or 
``emerging growth companies'' must comply with these disclosure 
requirements for proxy and information statements with respect to the 
election of directors during fiscal years beginning on or after July 1, 
2020.

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, U.S. 
Securities and Exchange Commission, 100 F Street NE, Washington, DC 
20549.

SUPPLEMENTARY INFORMATION: We are amending 17 CFR 229.402 (``Item 402'' 
of Regulation S-K \1\) by revising paragraph (b) to add Instruction 6; 
17 CFR 229.407 (``Item 407'' of Regulation S-K) to add new paragraph 
(i); and 17 CFR 14a-101 (``Schedule 14A'') to revise Item 7.
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    \1\ 17 CFR 229.10 et seq.
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Table of Contents

I. Introduction
II. Background
III. Discussion of the Amendments
    A. Scope of the Disclosure Requirement
    1. Proposed Amendments
    2. Comments on the Proposed Amendments
    3. Final Amendments
    B. Defining the Term ``Equity Securities''
    1. Proposed Amendments
    2. Comments on the Proposed Amendments
    3. Final Amendments
    C. Employees and Directors Subject to the Disclosure Requirement
    1. Proposed Amendments
    2. Comments on the Proposed Amendments
    3. Final Amendments
    D. Implementation
    1. Manner and Location of Disclosure
    a. Proposed Amendments
    b. Comments on Proposed Amendments
    c. Final Amendments
    2. Disclosure on Schedule 14C
    a. Proposed Amendments
    b. Comments on Proposed Amendments
    c. Final Amendments
    3. Relationship to Existing CD&A Obligations
    a. Proposed Amendments
    b. Comments on Proposed Amendments
    c. Final Amendments
    4. Issuers Subject to the Amendments
    a. Proposed Amendments
    b. Comments on Proposed Amendments
    c. Final Amendments
    i. Investment Companies
    ii. Emerging Growth Companies and Smaller Reporting Companies
    iii. Foreign Private Issuers
IV. Other Matters
V. Compliance Dates
VI. Economic Analysis
    A. Background
    B. Baseline and Affected Parties
    C. Discussion of Economic Effects
    1. Effects of the Item 407(i) Disclosure Requirements
    a. Benefits
    b. Costs
    c. Exclusion of Listed Closed-End Funds
    d. Disclosure in Schedule 14C
    e. Compliance Dates
    2. Efficiency, Competition, and Capital Formation
    3. Reasonable Alternatives
VII. Paperwork Reduction Act
    A. Background
    B. Summary of Information Collections
    C. Burden and Cost Estimates Related to the Amendments
VIII. Final Regulatory Flexibility Act Analysis
    A. Need for, and Objectives of, the Amendments
    B. Significant Issues Raised by Public Comments
    C. Small Entities Subject to the Amendments
    D. Reporting, Recordkeeping and Other Compliance Requirements
    E. Agency Action To Minimize Effect on Small Entities
Statutory Authority and Text of Amendments

I. Introduction

    On February 9, 2015, the Commission proposed rule amendments \2\ to 
implement Section 955 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (the ``Act'').\3\ Section 955 added Section 14(j) to the 
Securities Exchange Act of 1934 (the ``Exchange Act'').\4\ 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 shareholders whether any of its employees or members of its 
board of directors, 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.
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    \2\ See Rel. No. 33-9723 (Feb. 9, 2015) [80 FR 8485 (Feb. 17, 
2015)] (the ``Proposing Release''), available at: http://www.sec.gov/rules/proposed/2015/33-9723.pdf.
    \3\ Public Law 111-203, 124 Stat. 1900 (July 21, 2010).
    \4\ 15 U.S.C. 78a et seq.
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    The Senate Committee on Banking, Housing, and Urban Affairs stated 
in its report on the Act 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 long-term, so that they will receive their compensation even 
in the case that their firm does not perform.'' \5\ In this regard, we 
infer that the statutory purpose of Section 14(j) is to provide 
transparency to shareholders at the time of an annual meeting, which is 
when directors are elected, about whether a company's employees or 
directors may engage in transactions that reduce or avoid the incentive 
alignment associated with equity ownership related to their employment 
or board service.
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    \5\ See Report of the Senate Committee on Banking, Housing, and 
Urban Affairs, S. 3217, Report No. 111-176 (Apr. 30, 2010) (``Senate 
Report 111-176'').

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[[Page 2403]]

    Twenty-two commenters, including individuals, professional and 
trade associations, law firms, consulting firms, pension funds, and 
institutional investor associations, submitted comment letters in 
response to the Proposing Release. We have reviewed and considered all 
of the comments that we received on the Proposing Release. In general, 
commenters supported the proposed amendments and their objectives,\6\ 
although several commenters provided suggestions for clarifying the 
proposed amendments' disclosure standard.\7\
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    \6\ See, e.g., letters from Chris Barnard, Council of 
Institutional Investors dated Apr. 16, 2015 and Sept. 7, 2017 
(collectively ``CII''), Taylor Dove, Susie E. Hawthorne, Michael Nau 
and Public Citizen expressing general support for the proposed 
rules.
    \7\ See, e.g., letters from American Bar Association Section of 
Business Law Committee on Federal Regulation of Securities dated 
Jul. 8, 2015 and Oct. 13, 2015 (collectively ``ABA'' unless 
specified by date), Keith P. Bishop, Business Roundtable, and Davis 
Polk suggesting modifications.
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    As discussed below, we are adopting new Item 407(i) of Regulation 
S-K, along the lines proposed, but with certain modifications, 
consistent with commenters' suggestions. We believe the adopted 
amendments will fulfill the statutory purpose of Section 14(j), while 
providing a clearer and more straightforward standard of disclosure 
that should benefit both registrants and investors.

II. Background

    The Commission's rules currently require some disclosure about 
company hedging policies and practices. Item 402(b) of Regulation S-K 
requires a Compensation Discussion and Analysis (``CD&A'') that 
discloses material information necessary to an understanding of a 
company's compensation policies and decisions regarding the ``named 
executive officers.'' \8\ Under Item 402(b)(2)(xiii), an example of the 
kind of information that should be provided, if material, includes a 
description of 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 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. CD&A does not apply to smaller reporting companies 
(``SRCs''),\9\ emerging growth companies (``EGCs''),\10\ registered 
investment companies \11\ or foreign private issuers (``FPIs'').\12\
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    \8\ As 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.
    \9\ As defined in Exchange Act Rule 12b-2 [17 CFR 240.12b-2]. 
The Commission recently amended the definition of ``smaller 
reporting company'' to include registrants with a public float of 
less than $250 million, as well as registrants with annual revenues 
of less than $100 million for the previous year and either no public 
float or a public float of less than $700 million. See Smaller 
Reporting Company Definition, Release No. 33-10513 (Jun. 28, 2018) 
[83 FR 31992 (Jul. 10, 2018)].
    \10\ Section 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. See 
also Exchange Act Rule 12b-2 [17 CFR 240.12b-2], which reflects 
inflation adjustments to the definition of ``emerging growth 
company.''
    \11\ Registered 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.
    \12\ As defined in Rule 3b-4 [17 CFR 240.3b-4].
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    Other disclosure requirements also 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\
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    \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) 
[17 CFR 240.16a-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 (Aug. 17, 1994)] 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 (Jun. 14, 1996)] 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 
(Jun. 27, 2002)] at Q. 13.
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     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, which 
requires disclosure of the amount of company equity securities 
beneficially owned by directors, director nominees and named executive 
officers,\16\ also requires disclosure of the amount of shares that are 
pledged as security.\17\
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    \15\ A 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 
Website Posting for Forms 3, 4 and 5, Release No. 33-8230 (May 7, 
2003) [68 FR 25788 (May 18, 2003)], 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.
    \17\ See Executive Compensation and Related Person Disclosure, 
Release No. 33-8732A (Aug. 29, 2006) [71 FR 53158 (Sept. 8, 2006)] 
(the ``2006 Executive Compensation Disclosure Release'') at Section 
IV.

The rule amendments we are adopting today will require additional 
disclosure about an issuer's hedging practices or policies, but will 
not affect these existing requirements.

III. Discussion of the Amendments

    The Commission proposed to implement Section 14(j) by amending Item 
407 of Regulation S-K, to add new paragraph (i), which would require 
companies to disclose whether they permit employees and directors to 
hedge their company's equity securities. The disclosure called for by 
Section 14(j) is primarily corporate governance-related because it 
requires a company to provide information in its proxy statement about 
whether the company's employees and directors may engage in

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transactions that could reduce the extent to which their equity 
holdings and equity compensation are aligned with shareholders' 
interests. Because Section 14(j) calls for disclosure about employees 
and directors and their alignment with shareholders' interests, it 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 executive officers and directors. Two 
commenters expressed general support for locating the new disclosure 
requirement in the Commission's corporate governance-related disclosure 
rules.\18\ Accordingly, we are implementing Section 14(j) by amending 
Item 407 to keep the disclosure requirements relating to corporate 
governance matters together in a single item of Regulation S-K.\19\
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    \18\ See letters from Business Roundtable and CFA Institute.
    \19\ As a result, the new 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 new disclosure as it 
relates to existing CD&A obligations. See Section III.D.3, below.
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    The final amendments will:
     Require the company to describe any practices or policies 
regarding the ability of employees, directors or their designees to 
purchase financial instruments, or otherwise engage in transactions, 
that hedge or offset, or are designed to hedge or offset, any decrease 
in the market value of company equity securities. A company will be 
required either to provide a fair and accurate summary of any practices 
or policies that apply, including the categories of persons covered and 
any categories of hedging transactions that are specifically permitted 
and any categories that are specifically disallowed, or to disclose the 
practices or policies in full;
     if the company does not have any such practices or 
policies, require the company to disclose that fact or state that 
hedging transactions are generally permitted;
     specify that the equity securities for which disclosure is 
required are only equity securities of the company or of any parent or 
subsidiary of the company or any subsidiary of any parent of the 
company;
     require the disclosure in any proxy statement on Schedule 
14A or information statement on Schedule 14C \20\ with respect to the 
election of directors; and
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    \20\ 17 CFR 240.14c-101.
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     clarify that the term ``employee'' includes officers of 
the company.
    Nothing in these amendments or this release should be construed as 
suggesting companies need to have a practice or policy regarding 
hedging, or a particular type of practice or policy. These amendments 
relate only to disclosure of hedging practices or policies.

A. Scope of the Disclosure Requirement

1. Proposed Amendments
    Section 14(j) was enacted to require 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) that are designed to hedge or offset any decrease in the market 
value of equity securities. While Section 14(j) specifically refers to 
particular transactions,\21\ it also requires disclosure more generally 
of whether any employee or director of the issuer, or any designee of 
such employee or director, is permitted to purchase financial 
instruments that are designed to hedge or offset any decrease in the 
market value of equity securities.
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    \21\ By covering ``exchange funds,'' we believe that Section 
14(j) should 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.
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    The proposed amendments would have implemented Section 14(j) by 
requiring disclosure of ``whether the registrant permits'' any 
employees (including officers) or directors, or any of their designees, 
to purchase these specific types of financial instruments, and also 
would have required the same disclosure with respect to other 
transactions that could have the same economic effects as those 
specified in the statute, consistent with the purpose of Section 14(j). 
The proposed amendments were intended to cover all transactions that 
establish downside price protection--whether by purchasing or selling a 
security, derivative security or otherwise.
    Consistent with the statute, the proposed amendments applied to 
hedging transactions relating to equity securities that are held, 
directly or indirectly, by employees or directors. The proposal did not 
define the circumstances in which securities would be considered held, 
directly or indirectly.
    Establishing downside price protection is the essence of the 
transactions contemplated by Section 14(j). While this principle guided 
the Commission's consideration of the transactions subject to 
disclosure, the Commission did not propose to define the term 
``hedge.'' \22\ Under the proposed amendments, a company would disclose 
the categories of transactions it permits and the categories of 
transactions it prohibits.\23\ The proposed amendments would have 
required a company that permits hedging transactions to disclose 
sufficient detail to explain the scope of the permitted transactions. 
Additionally, the proposed amendments would have required a registrant 
that permits hedging by some, but not all, of the categories of covered 
persons to disclose the categories of persons who are permitted to 
engage in hedging transactions and those who are not.
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    \22\ In the context of Section 16, the Commission has stated 
that ``[t]he term `hedging' means lessening the risk of loss by 
offsetting the risk of a securities position with an opposite 
position in a related security.'' See Release No. 34-26333 (Dec. 2, 
1988) [53 FR 49997 (Dec. 13, 1988)] at n. 137.
    \23\ Proposed Instructions 3 and 4 to Item 407(i).
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2. Comments on the Proposed Amendments
    Commenters expressed a variety of views on the scope of the 
proposed amendments. One commenter expressed general support for 
requiring disclosure of the types of hedging transactions that a 
company permits as well as those that it prohibits, and the categories 
of persons that it allows and does not allow to hedge.\24\ Similarly, 
another commenter stated that the rule, as proposed, would provide 
investors with a more complete understanding regarding the persons 
permitted to engage in hedging transactions and the types of hedging 
transactions allowed.\25\ Another commenter stated that mandating 
disclosure of whether a company ``permits'' hedging would imply that 
affirmative company permission is required for these transactions and 
suggested that the relevant disclosure requirement instead should be 
whether the company prohibits hedging by employees.\26\ Several other 
commenters similarly indicated that requiring disclosure of the 
categories of hedging transactions that a registrant permits as well as 
prohibits could result in a disclosure standard that is confusing, 
overly broad and onerous for registrants to satisfy without accurately 
reflecting the policy decisions that a company has made with

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respect to hedging.\27\ Instead, these commenters recommended that the 
Commission adopt a more focused disclosure standard. For example, two 
of these commenters recommended an approach that would require 
companies to describe the material aspects of their policies regarding 
hedging.\28\
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    \24\ See letter from CFA Institute.
    \25\ See letter from CII.
    \26\ See letter from Keith P. Bishop.
    \27\ See letters from ABA, Business Roundtable and Davis Polk.
    \28\ See letters from Business Roundtable and Davis Polk.
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    In response to a specific request for comment on the scope of 
transactions covered by the proposed amendments, commenters made 
varying recommendations. Some supported a principles-based approach to 
defining the scope of covered hedging transactions.\29\ One stated that 
covering all transactions with comparable economic consequences to the 
specified financial instruments would provide more complete disclosure 
and would be in line with legislative intent.\30\ Another said that the 
proposed approach is preferable to defining the term ``hedge,'' because 
any definition of that term would encourage circumvention and may 
require constant updating as new financial instruments are 
developed.\31\
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    \29\ See letters from ABA, Business Roundtable, CFA Institute 
and Chris Barnard.
    \30\ See letter from Chris Barnard.
    \31\ See letter from ABA.
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    In contrast, two commenters specifically recommended defining the 
term ``hedge.'' One commenter suggested including common examples of 
derivative instruments and any instrument that produces the effect of 
limiting the insider's equity risk in the company without engaging in 
an outright sale, while explicitly excluding exchange funds from the 
definition.\32\ The other commenter suggested limiting the definition 
to financial instruments that are substantially similar to those listed 
in Section 14(j) and providing objective criteria for determining what 
is, and is not, a financial instrument subject to the new disclosure 
requirement.\33\ This commenter recommended excluding any financial 
instrument that is not a ``derivative security'' \34\ with respect to 
the company's equity securities that is designed to hedge or offset 
decreases in the market value of a company's equity securities.\35\
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    \32\ See letter from Clinton Carlisle.
    \33\ See letter from McDermott Will & Emery (``McDermott''). See 
also letter from ABA (recommending that we consider this approach).
    \34\ As defined in Exchange Act Rule 16a-l(c) [17 CFR 240.16a-
1(c)].
    \35\ See letter from McDermott.
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    In addition, some commenters recommended that the proposed 
amendments be modified to clarify that the new disclosure requirement 
will not apply to portfolio diversification transactions.\36\ For 
example, these commenters noted that the purchase of equity securities 
of one or more unrelated companies as an investment strategy could be 
considered a hedging transaction subject to the proposed disclosure if 
those securities ``are negatively correlated at any level as compared 
to the company's equity securities,'' \37\ or if they are 
diversification transactions in securities of market sectors that are 
counter-cyclical to the company's equity securities.\38\ One commenter 
recommended specific language to clarify that portfolio diversification 
is not within the scope of the new disclosure requirement.\39\ Two 
commenters also recommended that all long and short positions relating 
to equity securities other than the company's own equity securities be 
excluded from the scope of the new disclosure requirement.\40\
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    \36\ See letters from ABA, McDermott and Society of Corporate 
Secretaries & Governance Professionals (``SCSGP'').
    \37\ See letter from McDermott.
    \38\ See letter from ABA.
    \39\ See letter from SCSGP, recommending that it cover ``. . . 
transactions that are designed to or and have the direct effect of 
hedging or offsetting any decrease in the market value of equity 
securities. . .,'' and to add a new instruction stating that ``[t]he 
disclosure mandated here is limited to instruments that are tied to 
and principally designed to perform opposite of the [company's] 
equity securities. It does not include investments that provide 
general portfolio diversification.''
    \40\ See letters from ABA and McDermott.
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    The Commission solicited comment on whether it is necessary to 
clarify the application of the proposed amendments to account for 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. Commenters 
generally agreed that there is a meaningful distinction between such a 
broad-based index and a financial instrument designed to, or having the 
effect of, hedging the economic exposure to company equity 
securities.\41\ In this regard, several commenters recommended that the 
new disclosure requirement not apply to certain categories of 
transactions.\42\ For example, commenters suggested that a company be 
able to disclose that it prohibits all hedging transactions even if it 
permits: (1) Transactions in a broad-based index that includes company 
equity securities; \43\ (2) the purchase and sale of mutual funds, 
index funds and other diversified investment vehicles; \44\ or (3) the 
purchase of broad-based indexes, exchange traded funds, indexes and 
baskets.\45\
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    \41\ See e.g., letters from Business Roundtable, Davis Polk & 
Wardwell LLP (``Davis Polk''), McDermott and SCSGP. In contrast, one 
commenter did not agree that the new disclosure requirement should 
explicitly distinguish between instruments that provide exposure to 
a broad range of companies or securities and those that are designed 
to hedge particular securities or have that effect, and that all 
should be covered by the disclosure requirement. See letter from 
Joyce Dillard.
    \42\ See letters from ABA, Business Roundtable, Clearly 
Gottlieb, Davis Polk, McDermott and SCSGP.
    \43\ See letters from ABA, Business Roundtable, Cleary Gottlieb 
Steen & Hamilton LLP (``Cleary Gottlieb'') and McDermott.
    \44\ See letter from Davis Polk.
    \45\ See letter from SCSGP.
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    Some commenters recommended that we provide guidance on the meaning 
of the concept of ``held, directly or indirectly'' as used in the new 
disclosure requirement,\46\ for example by reference to the term 
``beneficial ownership'' as defined in Exchange Act Rule 13d-
3(d)(1).\47\
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    \46\ See letters from ABA, Davis Polk and Joyce Dillard.
    \47\ 17 CFR 240.13d-3(d)(1). See letters from ABA and Davis 
Polk.
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    Finally, the Commission requested comment on whether to require 
disclosure of any hedging transactions that have occurred--in the 
annual proxy statement as well as in promptly filed Form 4 filings. 
Comments on whether to require new annual proxy statement disclosure of 
hedging transactions were mixed, with some commenters generally 
supporting requiring such disclosure,\48\ and others stating that it is 
unnecessary due to the existing Section 16 reporting requirements.\49\
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    \48\ See letters from Clinton Carlisle and Joyce Dillard.
    \49\ See letters from ABA and Business Roundtable.
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3. Final Amendments
    The scope of the disclosure requirement we are adopting is in line 
with the proposed amendments but with certain modifications to address 
commenters' concerns about potential implementation challenges. As 
adopted, Item 407(i) requires the company to describe any practices or 
policies it has adopted (whether written or not) \50\ regarding the 
ability of employees (including officers) or directors of the

[[Page 2406]]

company, 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 hedge or 
offset, or are designed to hedge or offset, any decrease in the market 
value of company equity securities granted to the employee or director 
by the company as part of the compensation of the employee or director, 
or held, directly or indirectly, by the employee or director. The 
company will be required to provide a fair and accurate summary of the 
practices or policies that apply, including the categories of persons 
covered and any categories of hedging transactions that are 
specifically permitted and any categories that are specifically 
disallowed. Alternatively, the company will be required to disclose the 
practices or policies in full. The rule does not direct companies to 
have practices or policies regarding hedging, or dictate the content of 
any such practice or policy. If the company does not have any such 
practices or policies, the company must disclose that fact or state 
that hedging transactions are generally permitted.\51\
---------------------------------------------------------------------------

    \50\ For example, a company that does not have a written hedging 
policy might have a practice of reviewing, and perhaps restricting, 
hedging transactions as part of its program for reviewing employee 
trading in company securities. Similarly, a company might have a 
practice of including anti-hedging provisions in employment 
agreements or equity award documentation.
    \51\ Item 407(i) of Regulation S-K. For example, if a company 
does not have any such practices or policies, it could state: ``Our 
company does not have any practices or policies regarding hedging or 
offsetting any decrease in the market value of registrant equity 
securities.''
---------------------------------------------------------------------------

    Although Section 14(j) refers to whether certain categories of 
persons are ``permitted'' to engage in covered transactions, we 
recognize, as one commenter observed, that the statute's use of 
``permitted'' is potentially confusing, as companies generally do not 
affirmatively permit hedging transactions, and could result in 
uncertainty in making the required disclosure.\52\ We also are mindful 
of concerns that requiring disclosure of categories of hedging 
transactions that are permitted could result in lengthy disclosures 
that do not accurately reflect the policy decisions that a company has 
made with respect to hedging.\53\
---------------------------------------------------------------------------

    \52\ See letter from Keith P. Bishop.
    \53\ See letters from ABA, Business Roundtable and Davis Polk.
---------------------------------------------------------------------------

    In implementing Section 14(j), we have sought to fulfill the 
statutory purpose of informing shareholders whether the covered persons 
can avoid downside price risk with respect to company equity securities 
with a clear and simple disclosure requirement. In doing so, we have 
construed the statute's use of the term ``permit'' as calling for 
disclosure as to whether the company has a practice or policy regarding 
the ability of covered persons to engage in such transactions. 
Therefore, as adopted, Item 407(i) requires disclosure about whether 
the company has adopted any practices or policies regarding the ability 
of covered persons to engage in transactions that hedge or offset any 
decrease in the market value of these securities. If the company does 
not have any such practices or policies, Item 407(i) requires it to 
disclose that fact or state that hedging transactions are generally 
permitted.
    In the Proposing Release, the Commission solicited comment on 
whether, as an alternative to the proposed disclosure, the company 
should be required to describe its applicable hedging policies.\54\ As 
noted above, some commenters recommended such an approach, with one 
such commenter stating that it would focus the required disclosures on 
material information.\55\ After considering the comments received, we 
are persuaded that the approach we are adopting is a better means of 
achieving Section 14(j)'s statutory purpose. By requiring the company 
to describe any practice or policy it has adopted and the categories of 
persons covered, we believe investors will be informed with greater 
clarity as to the scope of the company's practices or policies 
regarding hedging transactions, and the compliance challenges 
associated with the proposed approach will be addressed. One commenter 
expressed concern that the proposed rules would discourage the use of 
hedging.\56\ Neither Section 14(j) nor the rule amendments would 
require a company to prohibit hedging transactions or to otherwise 
adopt practices or policies addressing hedging by any category of 
individuals.
---------------------------------------------------------------------------

    \54\ Proposing Release at 8490.
    \55\ See letter from Business Roundtable.
    \56\ See letter from John A. Olagues.
---------------------------------------------------------------------------

    As in the proposal, Item 407(i) as adopted does not define the term 
``hedge'' because we believe the language of Section 14(j), which 
refers to financial instruments ``that are designed to hedge or offset 
any decrease in the market value'' is clear and indicates that 
``hedge'' should be applied as a broad principle. Like the proposed 
rule, the rule as adopted applies to transactions with the same 
economic effects--to hedge or offset any decrease in the market value 
of company equity securities--as the transactions specified by the 
statute, the disclosure of which is consistent with the purpose of 
Section 14(j).\57\ While we recognize commenters' observations that the 
language of the proposal could be far reaching,\58\ potentially scoping 
in transactions that may not necessarily raise the same concerns as the 
financial instruments specified by Section 14(j), such as portfolio 
diversification transactions, we believe the adopted approach will 
alleviate these concerns by requiring disclosure of any practice or 
policy the company has adopted regarding these types of transactions. 
In this regard, a company would only need to describe portfolio 
diversification transactions, broad-based index transactions, or other 
types of transactions, if its hedging practice or policy addresses 
them.
---------------------------------------------------------------------------

    \57\ For example, a short sale can hedge the economic risk of 
ownership, as can entering into a borrowing or other arrangement 
involving a non-recourse pledge of securities. Similarly, selling a 
security future that establishes a position that increases in value 
as the value of the underlying equity security decreases can provide 
the downside price protection that is the essence of the 
transactions contemplated by Section 14(j).
    \58\ See letters from ABA, McDermott and SCSGP.
---------------------------------------------------------------------------

    As in 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,\59\ the scope of the 
new disclosure requirement is not limited to any particular types of 
hedging transactions. Moreover, by focusing on the company's practices 
or policies, the rule avoids adopting a definition that could prove 
either over- or under-inclusive, and allows for flexibility to address 
new downside price protection techniques as they develop. Based on 
their CD&A disclosures, it appears that many companies already have, 
and presumably enforce, practices or policies that rely on an undefined 
concept of ``hedging.'' Under the final amendments, each company will 
continue to make its own judgments in determining what activities, if 
any, should be covered by a practice or policy. Further, to the extent 
a company currently discloses its practices or policies regarding 
hedging transactions in the CD&A, (either in full or in a summary that 
would meet the requirements of Item 407(i)), the amendments will not 
require the company to revise its practices or policies--or its 
disclosure. A company that has disclosed a policy that covers only a 
subset of employees or directors would not be required to further 
disclose that it did not have a policy with regard to the company's 
other employees or directors.
---------------------------------------------------------------------------

    \59\ Item 402(b)(2)(xiii) of Regulation S-K, discussed in 
Section II.D, below.
---------------------------------------------------------------------------

    Consistent with the statutory language, Item 407(i) as adopted 
applies to hedging transactions relating to

[[Page 2407]]

company equity securities that are ``held, directly or indirectly,'' by 
employees (including officers) or directors. This terminology covers a 
broad variety of means by which equity securities can be held. As 
adopted, the new disclosure requirement does not define the term 
``held, directly or indirectly.'' \60\ Rather, under the amendments as 
adopted, companies will describe the scope of their hedging practices 
or policies, which may include whether and how they apply to securities 
that are ``indirectly'' held. Because companies can address this issue 
in describing the scope of their practices or policies, we do not 
believe that further guidance on this topic is necessary.
---------------------------------------------------------------------------

    \60\ Further, the final amendments do not reference the term 
``beneficial ownership,'' as determined under Exchange Act Rule 13d-
3(d)(1), as suggested by some commenters, because the voting power 
and investment power standards articulated in that rule do not 
necessarily correlate to whether a person has the risk of loss in an 
equity security that would be mitigated by a hedge.
---------------------------------------------------------------------------

    As noted above, while comments were mixed on whether to require 
disclosure in the annual proxy statement of any hedging transactions 
that have occurred, the final amendments will not require annual 
meeting proxy statement disclosure about such hedging transactions. We 
believe that such disclosure would be largely duplicative of 
disclosures required by the existing Section 16 reporting requirements, 
which shareholders can review to determine if officers and directors 
are in fact hedging, and take into consideration in their voting 
decisions. In addition, while disclosing information about hedging 
transactions of employees other than officers and directors may 
potentially provide some benefits to investors, collecting such 
information and preparing the disclosure would likely impose 
significant additional costs on companies.\61\
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    \61\ See letter from Clinton Carlisle.
---------------------------------------------------------------------------

B. Defining the Term ``Equity Securities''

1. Proposed Amendments
    Section 14(j) uses the term ``equity securities,'' but does not by 
its terms limit disclosure to equity securities of the reporting 
company.\62\ As such, the term ``equity securities'' could be 
interpreted to include the equity securities of any company that an 
employee or director holds. A proposed instruction specified that the 
term ``equity securities,'' as used in the proposed rule, would mean 
any equity securities (as defined in Exchange Act Section 3(a)(11) \63\ 
and Exchange Act Rule 3a11-1 \64\) issued by the company, or of any 
parent or subsidiary of the company or any subsidiary of any parent of 
the company, which equity securities are registered under Section 12 of 
the Exchange Act.\65\
---------------------------------------------------------------------------

    \62\ In addition, the Exchange Act's and Exchange Act Rules' 
definitions of ``equity security'' do not limit the scope of this 
term to equity securities of a particular company.
    \63\ 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.
    \64\ 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.
    \65\ Proposed Instruction 1 to Item 407(i).
---------------------------------------------------------------------------

2. Comments on the Proposed Amendments
    Commenters recommended various approaches to defining the scope of 
``equity securities'' for purposes of the new disclosure requirement. 
Some commenters agreed with the proposal,\66\ with one expressing the 
view that the level of complexity of disclosure due to including equity 
securities of affiliated companies would reflect the level of 
complexity of the hedging policy of the company in question.\67\ Others 
suggested using a broader definition, for example by including ``equity 
securities'' of additional categories of affiliated entities.\68\ Two 
commenters stated that the new disclosure requirement should not be 
limited to transactions relating to equity securities that are 
registered under Exchange Act Section 12 or traded in an established 
public market.\69\ Some commenters recommended including only ``equity 
securities'' of the company,\70\ or otherwise narrowing the definition, 
for example by including equity securities of certain other entities if 
they are reported as compensation under Item 402, or if the company 
allows them to count towards an executive's equity retention 
requirements.\71\
---------------------------------------------------------------------------

    \66\ See, e.g., letters from CFA Institute, CII and Florida 
State Board of Administration.
    \67\ See letter from Florida State Board of Administration.
    \68\ See letter from Joyce Dillard.
    \69\ See letters from Joyce Dillard and Michael Nau.
    \70\ See letters from ABA and SCSGP.
    \71\ See letter from SCSGP.
---------------------------------------------------------------------------

3. Final Amendments
    As was proposed, the Item 407(i) disclosure requirement will apply 
to equity securities issued by the company and its parents, 
subsidiaries or subsidiaries of the company's parents.\72\ We have 
included these other entities within the scope of ``registrant equity 
securities'' because we understand that these equity securities can be 
relevant to the compensation practices of some issuers. Further, in a 
change from the proposal, Item 407(i) uses the term ``registrant equity 
securities,'' rather than ``equity securities,'' to indicate the scope 
of the rule is narrower than potentially any equity security, but 
broader than only the equity security of the particular company that is 
the employer or on whose board the director sits.\73\ The relevant 
instruction specifies the scope of covered equity securities for both 
compensatory equity securities grants \74\ and other equity securities 
holdings.\75\
---------------------------------------------------------------------------

    \72\ Instruction 1 to Item 407(i).
    \73\ This term also avoids confusion with the broader 
definitions of ``equity security'' in Exchange Act Section 3(a)(11) 
[15 U.S.C. 78c(a)(11)] and Rule 3a11-1 [17 CFR 240.3a11-1].
    \74\ Item 407(i)(1)(i).
    \75\ Item 407(i)(1)(ii).
---------------------------------------------------------------------------

    Disclosure of whether a company has adopted practices or policies 
regarding a director's or employee's ability to hedge such 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. For example, 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, or have ownership 
requirements or guidelines regarding such equity securities.\76\ In 
instances such as these, the rule would require disclosure regarding 
whatever practice or policy regarding hedging applies.
---------------------------------------------------------------------------

    \76\ An example is where a company creates a publicly-traded 
subsidiary.
---------------------------------------------------------------------------

    Consistent with Item 407(i)'s focus on the company's hedging 
practices or policies, the final amendments do not limit coverage to 
company equity

[[Page 2408]]

securities that are registered under Exchange Act Section 12. Instead, 
the company's practices or policies will determine which, if any, 
classes of securities are covered. For example, to the extent a company 
has a different hedging practice or policy with respect to different 
classes of equity securities, the company's disclosure should reflect 
that fact.

C. Employees and Directors Subject to the Disclosure Requirement

1. Proposed Amendments
    Section 14(j) covers hedging transactions conducted by any employee 
or member of the board of directors or any of their designees. The 
Commission proposed to apply the term ``employee'' to anyone employed 
by an issuer, including its officers. Further, under the proposed rule, 
whether someone is a ``designee'' would be determined based on the 
particular facts and circumstances.
2. Comments on the Proposed Amendments
    Some commenters supported the proposed Item 407(i) disclosure 
requirement covering all employees of the company.\77\ These commenters 
expressed the view that shareholders should have information about 
whether employees can dilute the original intention of company-provided 
compensation incentives,\78\ and that all employees have an ability to 
affect share price and contribute to the prosperity of a company.\79\ 
Another commenter recommended expanding the scope to include 
consultants.\80\ Two commenters specifically supported the inclusion of 
``officers'' in the group of employees, which the proposed disclosure 
requirement would cover.\81\
---------------------------------------------------------------------------

    \77\ See letters from CII, Florida State Board of Administration 
and Public Citizen.
    \78\ See letters from CII and Florida State Board of 
Administration.
    \79\ See letters from CII and Public Citizen.
    \80\ See letter from Joyce Dillard.
    \81\ See letters from CFA Institute and Florida State Board of 
Administration.
---------------------------------------------------------------------------

    The Commission requested comment on whether to 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, or to add an express materiality qualifier to 
the definition to permit each issuer to determine whether disclosure 
about all of its employees would be material information for its 
investors. Some commenters suggested narrowing the scope of the new 
disclosure requirement to cover a more limited group of employees,\82\ 
such as directors and executive officers,\83\ or only requiring 
disclosure about a policy that governs non-executive employees if a 
company determines the information is material to its investors.\84\ 
Some of these commenters stated that including only ``executive 
officers'' as defined by Exchange Act Rule 3b-7 \85\ or ``officers'' as 
defined in Exchange Act Rule 16a-1(f) \86\ would result in disclosure 
of the information that is material to shareholders, and that limiting 
the scope of covered ``employees'' would reduce company costs.\87\
---------------------------------------------------------------------------

    \82\ See letters from ABA, Business Roundtable, Cleary Gottlieb, 
Davis Polk, McDermott and SCSGP.
    \83\ See, e.g., letters from Business Roundtable, Cleary 
Gottlieb and SCSGP.
    \84\ See letter from Davis Polk.
    \85\ See, e.g., letters from Cleary Gottlieb and SCSGP. Exchange 
Act Rule 3b-7 [17 CFR 240.3b-7] defines ``executive officer'' as a 
company's ``. . . president, any vice president of the [company] in 
charge of a principal business unit, division or function (such as 
sales, administration or finance), any other officer who performs a 
policy making function or any other person who performs similar 
policy making functions for the [company],'' and includes executive 
officers of subsidiaries of the company if they perform such policy 
making functions for the company.
    \86\ See letters from ABA and Davis Polk. Exchange Act Rule 16a-
1(f) defines ``officer'' as ``. . . an issuer's president, principal 
financial officer, principal accounting officer (or, if there is no 
such accounting officer, the controller), any vice-president of the 
issuer in charge of a principal business unit, division or function 
(such as sales, administration or finance), any other officer who 
performs a policy-making function, or any other person who performs 
similar policy-making functions for the issuer,'' and if they 
perform policy-making functions for the issuer, includes officers of 
a company's parent(s) or subsidiaries and officers or employees of 
the general partner(s) or of the trustee(s), respectively, of an 
issuer that is a limited partnership or a trust.
    \87\ See, e.g., letters from ABA, Davis Polk and SCSGP.
---------------------------------------------------------------------------

    The Commission also requested comment about whether to include an 
instruction clarifying who is a ``designee.'' Some commenters expressed 
the view that it is not clear who the term ``designee'' is intended to 
cover, and recommended that the Commission provide guidance as to its 
meaning.\88\ One of these commenters recommended defining ``designee'' 
as someone specifically appointed to make decisions that the 
authorizing person would reasonably believe could result in the hedging 
of equity securities the person beneficially owns.\89\ Another 
recommended defining ``designee'' to include immediate family members 
and family or affiliated investment vehicles.\90\
---------------------------------------------------------------------------

    \88\ See letters from ABA, Davis Polk and Keith P. Bishop.
    \89\ See letter from Davis Polk.
    \90\ See letter from ABA.
---------------------------------------------------------------------------

3. Final Amendments
    The final amendments require disclosure of practices or policies 
that apply to employees, including officers, as well as directors. We 
believe the inclusion of officers is consistent with Congress' 
intent.\91\ Accordingly, as was proposed, Item 407(i) adds the 
parenthetical ``(including officers)'' after the term ``employees'' in 
the language of the new disclosure requirement.\92\
---------------------------------------------------------------------------

    \91\ For example, the Senate Report 111-176 contemplates 
disclosure under Section 14(j) regarding ``executives.''
    \92\ This clarification is needed because Exchange Act Rule 12b-
2 defines ``employees'' as not including a ``director, trustee or 
officer,'' unless the context otherwise requires.
---------------------------------------------------------------------------

    Describing the persons covered by the new disclosure requirement as 
``any employees (including officers) or directors of the registrant, or 
any of their designees'' is consistent with the mandate in Section 
14(j). Although some commenters suggested that we limit the persons 
covered by Item 407(i), in light of the statutory mandate, we have not 
narrowed the scope of the requirement to address only policies directed 
at directors and executive officers or to add a materiality qualifier. 
We also note that the change in the final rules to focus Item 407(i)'s 
disclosure on the company's practices or policies should help to 
alleviate concerns about the rule's compliance costs. Companies of 
different sizes, industries and workforces may have different kinds of 
practices or policies with respect to hedging, and each company will 
make its own judgments in determining the categories of persons to 
which they apply. The rule as adopted will require companies to provide 
disclosure reflecting their particular policy choices with respect to 
hedging.\93\
---------------------------------------------------------------------------

    \93\ We have not, however, specified that ``employees'' includes 
consultants, because we have not heard concerns about the alignment 
of their interests with those of shareholders and they may be more 
likely to monetize their equity compensation.
---------------------------------------------------------------------------

    The amendments as adopted require disclosure of any company 
practices or policies regarding ``designees.'' While we continue to 
believe that whether someone is a ``designee'' depends on the 
particular facts and circumstances involved, the focus of Item 407(i), 
as adopted, is on disclosure of a company's particular practices or 
policies. Because companies with hedging practices or policies will 
determine who is covered by the scope of the practice or policy, we do 
not believe that further guidance on this topic is necessary.

[[Page 2409]]

D. Implementation

1. Manner and Location of Disclosure
1. Proposed Amendments
    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.\94\ We proposed to implement Section 14(j) by amending 
Items 7 and 22 of Schedule 14A to require the new Item 407(i) 
information if action is to be taken with respect to the election of 
directors. Although the language of Section 14(j) refers to disclosure 
in any proxy or consent solicitation material for an annual meeting of 
the company's shareholders, this language, construed strictly, could 
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 \95\ 
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.\96\ The proposal reflected the view that Item 407(i) 
disclosure similarly would be relevant information for shareholders 
evaluating a company's corporate governance practices in the context of 
director elections.
---------------------------------------------------------------------------

    \94\ The 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, such as state corporate law. See, e.g, Delaware 
General Corporate Law, Section 211(b).
    \95\ 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. A solicitation of 
consents therefore constitutes a solicitation of proxies subject to 
Section 14(a) and Regulation 14A.
    \96\ See Items 7(b)-(d) and 8(a) of Schedule 14A.
---------------------------------------------------------------------------

    The proposal did not call for Item 407(i) disclosure to be included 
in Securities Act or Exchange Act registration statements or in the 
Form 10-K Part III disclosure,\97\ even if that disclosure is 
incorporated by reference from the company's definitive proxy statement 
or information statement.\98\
---------------------------------------------------------------------------

    \97\ This 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 in Part III of Form 10-K.
    \98\ As permitted by General Instruction G to Form 10-K.
---------------------------------------------------------------------------

    In addition to including the new disclosure requirement, the 
Commission proposed to amend Item 7 of Schedule 14A to streamline its 
current provisions by more succinctly cross-referencing disclosure 
Items.
2. Comments on Proposed Amendments
    Most commenters supported requiring the new Item 407(i) disclosure 
only in proxy or consent solicitation material and information 
statements with respect to the election of directors.\99\ Two of these 
commenters stated that the new Item 407(i) disclosure would not be 
relevant to investors in Securities Act or Exchange Act registration 
statements or annual reports.\100\ In contrast, one commenter stated 
that the new Item 407(i) disclosure also should be required in annual 
reports to capture companies that are not holding annual meetings.\101\
---------------------------------------------------------------------------

    \99\ See letters from ABA, Business Roundtable, CII and Davis 
Polk.
    \100\ See letters from ABA and Davis Polk.
    \101\ See letter from Clinton Carlisle.
---------------------------------------------------------------------------

    One commenter expressed support for the proposal to streamline Item 
7, and stated that it would facilitate compliance with the new 
item.\102\
---------------------------------------------------------------------------

    \102\ See letter from ABA.
---------------------------------------------------------------------------

3. Final Amendments
    We are adopting the amendments to Item 7 of Schedule 14A as 
proposed. By providing the disclosure in a proxy statement when action 
is to be taken with respect to the election of directors, shareholders 
will be able to consider the new disclosure at the same time they are 
considering the company's other corporate governance disclosures and 
voting for directors.\103\ The disclosure will provide additional 
information on whether the company has practices or policies affecting 
the alignment of incentives for employees and directors of the company 
whose securities they hold. We believe that this disclosure is most 
relevant when providing information about the election of directors. 
This will be the case whether shareholders are voting for directors at 
an annual or special meeting of shareholders, or in connection with an 
action authorized by written consent.\104\
---------------------------------------------------------------------------

    \103\ We are not adopting the proposed amendment to Item 22 of 
Schedule 14A because, as discussed in Section III.D.3.c.i., below, 
we are excluding listed closed-end funds from the new disclosure 
requirement.
    \104\ We 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 amendments do not 
require Item 407(i) disclosure in the proxy statement.
---------------------------------------------------------------------------

    As adopted, the amendments provide that the new Item 407(i) 
information will not be required in Form 10-K Part III disclosure even 
if that disclosure is incorporated by reference from the company's 
definitive proxy statement or information statement.\105\
---------------------------------------------------------------------------

    \105\ Instruction 2 to Item 407(i), providing that information 
disclosed pursuant to Item 407(i) is not deemed incorporated by 
reference into any filing under the Securities Act or the Exchange 
Act, except to the extent the company specifically incorporates that 
information by reference. The disclosure also is not subject to 
forward incorporation by reference under Item 12(b) of Securities 
Act Form S-3 [17 CFR 239.13] or Item 12 of Securities Act Form S-1 
[17 CFR 239.11].
---------------------------------------------------------------------------

    In addition, we are amending Item 7 of Schedule 14A to streamline 
its current provisions in the manner proposed.\106\
---------------------------------------------------------------------------

    \106\ Amended Item 7(b) and Instruction to Item 7 of Schedule 
14A.
---------------------------------------------------------------------------

2. Disclosure on Schedule 14C
1. Proposed Amendments
    Exchange Act Section 14(c) applies to companies not soliciting 
proxies or consents from some or all holders of a class of securities 
registered under Exchange Act Section 12 entitled to vote at a meeting 
or authorize a corporate action by execution of a written consent.\107\ 
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. Section 
14(j) expressly calls for proxy or consent solicitation materials for 
an annual meeting of the shareholders of the issuer to include the 
required disclosure. Our proxy rules require these solicitation

[[Page 2410]]

materials to be filed under cover of Schedule 14A.\108\ 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.\109\ An information statement 
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.
---------------------------------------------------------------------------

    \107\ Section 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.
    \108\ As noted 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.
    \109\ Specifically, 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 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].
---------------------------------------------------------------------------

    The Commission did not propose to exclude the new Item 407(i) 
disclosure from Schedule 14C.\110\
---------------------------------------------------------------------------

    \110\ Because the proposed amendments did not add a new 
exclusion for information called for by the amendment to Item 7 of 
Schedule 14A, the effect of the proposal was to require Item 407(i) 
disclosure in Schedule 14C.
---------------------------------------------------------------------------

2. Comments on Proposed Amendments
    One commenter supported the inclusion of new Item 407(i) disclosure 
in Schedule 14C, noting that the Item 407(i) disclosure differs in type 
and nature from the disclosures currently excludable.\111\ The 
commenter indicated that the proposed approach was appropriate because 
it would maintain consistency in the corporate governance disclosure 
provided in proxy statements and information statements with respect to 
the election of directors. No commenters opposed the proposed approach.
---------------------------------------------------------------------------

    \111\ See letter from ABA dated Oct. 13, 2015.
---------------------------------------------------------------------------

3. Final Amendments
    As proposed, the final amendments do not exclude Item 407(i) 
disclosure from Schedule 14C. Applying the disclosure obligation to 
Schedule 14C filings will have the effect of applying the new Item 
407(i) requirement 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. Consistent 
with the views of one commenter, we believe that doing so is 
appropriate to retain consistency in the corporate governance 
disclosure provided in proxy statements and information statements with 
respect to the election of directors.
3. Relationship to Existing CD&A Obligations
a. Proposed Amendments
    As noted above, one of the non-exclusive examples currently listed 
in the Item 402(b) requirement for CD&A calls, in part, for disclosure 
of any company policies regarding hedging the economic risk of company 
securities ownership,\112\ to the extent material. CD&A requires 
information about named executive officers.
---------------------------------------------------------------------------

    \112\ Item 402(b)(2)(xiii) of Regulation S-K.
---------------------------------------------------------------------------

    The Commission proposed amending 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 new 
Item 407(i) to the extent that the information disclosed there 
satisfies this CD&A disclosure requirement.\113\
---------------------------------------------------------------------------

    \113\ Proposed Instruction 6 to Item 402(b).
---------------------------------------------------------------------------

b. Comments on Proposed Amendments
    Comments on this proposed instruction were mixed. Two commenters 
supported permitting cross-referencing, stating that this may reduce 
potentially duplicative disclosure in proxy and information 
statements.\114\ One of these commenters suggested also permitting 
companies to include the new Item 407(i) disclosure in their CD&A,\115\ 
expressing the view that companies should have the flexibility to 
locate the disclosure where it best fulfills their communication 
objectives. Another commenter expressed concern about permitting cross-
referencing the new Item 407(i) disclosure in CD&A, noting the 
importance of hedging policy disclosure and its direct relevance to the 
CD&A.\116\ In contrast, a different commenter recommended eliminating 
the Item 402(b) hedging disclosure requirement as unnecessary and 
redundant in light of the new Item 407(i) disclosure.\117\
---------------------------------------------------------------------------

    \114\ See letters from ABA and Chris Barnard.
    \115\ See letter from ABA.
    \116\ See letter from Florida State Board of Administration.
    \117\ See letter from Davis Polk.
---------------------------------------------------------------------------

c. Final Amendments
    We are amending Item 402(b) of Regulation S-K to add the 
instruction as proposed. We believe this new instruction to Item 402(b) 
will allow companies that are subject to both Item 407(i) and Item 
402(b) to avoid the potential for duplicative disclosure in their proxy 
or information statements with respect to the election of 
directors.\118\ We are not eliminating Item 402(b), as one commenter 
suggested, as it applies to Item 402 disclosure in registration 
statements and annual reports, as well as proxy statements.
---------------------------------------------------------------------------

    \118\ We have modified the text of new Instruction 6 to clarify 
that this new instruction applies to CD&A disclosure in these proxy 
or information statements.
---------------------------------------------------------------------------

    In response to comments, we note that companies have flexibility in 
where they present the new Item 407(i) disclosure. A company could 
choose to include its Item 407(i) disclosure outside of CD&A and 
provide a separate Item 402(b) disclosure as part of CD&A without a 
cross reference. Alternatively, it could incorporate the Item 407(i) 
disclosure into CD&A, either by directly including the information or 
by providing the Item 407(i) information outside of CD&A and adding a 
cross-reference within CD&A.\119\
---------------------------------------------------------------------------

    \119\ Exchange Act Rule 14a-21(a) [17 CFR 240.14a-21(a)] 
provides that shareholder advisory say-on-pay 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 a company chooses to 
make it part of CD&A either directly or pursuant to the new cross-
reference instruction, the final rule will not effect any change in 
the scope of disclosure currently subject to say-on-pay votes. We 
note that issuers may, if they prefer, avoid making the Item 407(i) 
disclosure part of CD&A by not cross-referencing or directly 
including that disclosure in their Item 402 disclosure.
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4. Issuers Subject to the Amendments
a. Proposed Amendments
    The Proposing Release discussed whether certain categories of 
issuers should be exempted from the new Item 407(i) disclosure 
requirement, or, alternatively, whether they should be subject to a 
delayed implementation schedule. Under the proposal, the new disclosure 
requirement would apply to EGCs and SRCs. Securities registered by an 
FPI are not subject to the proxy statement requirements of Exchange Act 
Section 14,\120\ and therefore FPIs are not

[[Page 2411]]

subject to Section 14(j) and hence would not be required to provide 
Item 407(i) disclosure.
---------------------------------------------------------------------------

    \120\ Exchange Act Rule 3a12-3(b) [17 CFR 240.3a12-3(b)] 
specifically exempts securities registered by a FPI from Exchange 
Act Sections 14(a) and 14(c).
---------------------------------------------------------------------------

    The Commission proposed to apply the disclosure requirements to 
closed-end investment companies with shares listed on a national 
securities exchange and registered under Exchange Act Section 12(b) 
\121\ (``listed closed-end funds'') as well as business development 
companies (``BDCs'').\122\ The Commission also requested comment on 
whether to require the proposed disclosure for other investment 
companies registered under the Investment Company Act (``funds'' or 
``registered investment companies'') that do not hold annual meetings, 
including exchange-traded funds (``ETFs'') \123\ and other open-end 
funds.
---------------------------------------------------------------------------

    \121\ 15 U.S.C. 78l(b).
    \122\ BDCs 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, BDCs would be treated in the 
same manner as non-investment company issuers.
    \123\ ETFs 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.
---------------------------------------------------------------------------

b. Comments on Proposed Amendments
    Comments on whether EGCs or SRCs should be subject to the proposed 
disclosure requirement were mixed. Four commenters supported requiring 
the new Item 407(i) disclosure for EGCs and SRCs.\124\ One commenter 
opposed an ``early stage exemption'' for EGCs or SRCs, stating that it 
could allow for poor hedging policies at early growth stages that would 
eventually need to be corrected.\125\ Two commenters indicated that the 
Item 407(i) disclosure would be useful, and might be of greater value, 
to investors in these companies than to investors in other public 
companies because: (1) EGCs and SRCs are not subject to the CD&A 
requirement to disclose policies about hedging by named executive 
officers; (2) EGCs and SRCs are generally subject to greater market 
risk than other public companies; and (3) the breadth of usage of 
hedging transactions at those companies supports requiring 
disclosure.\126\ Three commenters indicated that they did not expect 
the new disclosure requirement to impose a significant compliance 
burden on EGCs and SRCs.\127\
---------------------------------------------------------------------------

    \124\ See letters from CFA Institute, CII, Florida State Board 
of Administration and Public Citizen.
    \125\ See letter from Florida State Board of Administration.
    \126\ See letters from CII and Florida State Board of 
Administration.
    \127\ See letters from CFA Institute, CII and Public Citizen.
---------------------------------------------------------------------------

    In contrast, two commenters recommended exempting EGCs and SRCs 
from the new disclosure requirement,\128\ stating that requiring the 
new Item 407(i) disclosure for these companies could lead to 
misalignment of the interests of employees and directors with their 
shareholders. These commenters indicated that, since EGCs and SRCs are 
not required to provide CD&A disclosure, they are less likely to have 
hedging policies in place, and that rather than disclosing they do not 
have such a policy, these companies may feel compelled to adopt one. In 
their view, such an action may not be in the best interests of 
shareholders if it results in company executives, who are more likely 
than those of larger companies to be heavily invested in the company: 
(1) Refraining from undertaking risks that could be in the best 
interests of the company's shareholders; \129\ or (2) reducing their 
company stock holdings so their interests are less aligned with 
shareholders.\130\ In addition, these commenters believed that applying 
the new disclosure requirement to EGCs and SRCs would impose costs that 
are disproportionate to the benefits to be obtained.
---------------------------------------------------------------------------

    \128\ See letters from ABA and SCSGP.
    \129\ See letters from ABA and SCSGP.
    \130\ See letter from SCSGP.
---------------------------------------------------------------------------

    Two commenters agreed with the proposed treatment of FPIs.\131\ 
Both noted that securities registered by FPIs are not subject to the 
proxy statement requirements of Exchange Act Section 14 and do not need 
to make other governance disclosures under existing Item 407.
---------------------------------------------------------------------------

    \131\ See letters from ABA and Davis Polk.
---------------------------------------------------------------------------

    A few commenters addressed registered investment companies and none 
specifically addressed BDCs. Three commenters agreed with the 
Commission's approach in the Proposing Release not to subject open-end 
investment companies and ETFs to the proposed disclosure 
requirement.\132\ No commenter explicitly supported the application of 
the proposed disclosure requirement to listed closed-end funds and 
three commenters opposed making listed closed-end funds subject to the 
proposed requirement.\133\ Two commenters asserted that it is difficult 
to hedge shares of closed-end funds, either by selling short or 
entering into derivative positions.\134\ One commenter agreed with the 
Commission's observation that closed-end funds typically are externally 
managed and do not employ executives or have employees like operating 
companies.\135\ Two commenters suggested that since closed-end funds 
share many similar characteristics regarding corporate governance with 
open-end funds, they should be treated similarly for purposes of the 
proposed disclosure.\136\ Finally, one commenter stated that the 
Commission had not demonstrated that closed-end fund executives had 
engaged in problematic hedging practices similar to those used by 
operating company executives and that because most closed-end funds did 
not have specific hedging policies already in place, they would need to 
develop, revise, and maintain such policies.\137\
---------------------------------------------------------------------------

    \132\ See letters from ABA, ICI and MFDF.
    \133\ Id.
    \134\ See Letters from ABA and MFDF.
    \135\ See Letter from ICI.
    \136\ See Letters from ICI and MFDF.
    \137\ See Letter from ICI.
---------------------------------------------------------------------------

c. Final Amendments
    The amendments will apply to the categories of issuers proposed, 
except with respect to listed closed-end funds, which we are exempting 
from the Item 407(i) disclosure requirement. 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 a company's employees or directors may 
engage in transactions that mitigate or avoid the incentive alignment 
associated with equity ownership.
i. Investment Companies
    In a change from the proposal, after considering the comments 
received, we have determined not to apply the new Item 407(i) 
disclosure requirement to listed closed-end funds,\138\ but it will 
apply to BDCs. We believe that this approach is consistent with the 
Commission's treatment of BDCs regarding executive compensation 
disclosure requirements,\139\ and no commenter suggested that BDCs 
should be excluded.
---------------------------------------------------------------------------

    \138\ Section 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.
    \139\ See 2006 Executive Compensation Disclosure Release, at 
Section II.D.3.
---------------------------------------------------------------------------

    Registered investment companies have a management structure, 
regulatory regime, and disclosure obligations that

[[Page 2412]]

differ in various respects from operating companies, which we believe 
makes the proposed disclosure less useful for investors in funds. 
Nearly all funds, unlike other issuers, are externally managed and have 
few, if any, employees who are compensated by the fund. Rather, 
personnel who operate the fund and manage its portfolio generally are 
employed and compensated by the fund's investment adviser.\140\
---------------------------------------------------------------------------

    \140\ In 2017, staff identified 5 (1%) internally managed listed 
closed-end funds based on a review of filings with the Commission. 
Funds also typically will contract with other service providers in 
addition to the investment adviser.
---------------------------------------------------------------------------

    Although fund directors, including directors of listed closed-end 
funds, may hold shares of the funds they serve, fund compensation 
practices can be distinguished from those of operating companies.\141\ 
We believe that the granting of shares as a component of incentive-
based compensation is uncommon, and in some cases is prohibited, for 
both open-end and closed-end funds.\142\ From a practical standpoint, 
even if fund directors were to acquire shares of listed closed-end 
funds, commenters indicated that it is difficult to hedge such shares 
by selling short or trading in derivatives.\143\ 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 open-end and closed-end 
funds.\144\
---------------------------------------------------------------------------

    \141\ See 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.
    \142\ Registered investment companies are generally prohibited 
from issuing their securities for services. See Sections 22(g) 
(open-end funds) and 23(a) (closed-end 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,'' the Commission staff has 
suggested 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) (discussing, among other matters, the staff's views on 
application of Section 23(a) to the compensation of directors in 
closed-end funds using fund shares).
    \143\ See note 132 above and accompanying text.
    \144\ See note 5 above and accompanying text.
---------------------------------------------------------------------------

    Section 14(j) of the Exchange Act directs the Commission to require 
certain disclosures in connection with any proxy or consent 
solicitation material for an annual meeting of shareholders. Most 
funds, other than listed closed-end funds, are not required to hold 
annual meetings of shareholders.\145\ ETFs, although traded on an 
exchange, do not generally hold annual meetings of shareholders, and 
ETFs organized as UITs do not have boards of directors. Listed closed-
end funds, on the other hand, generally are required to hold annual 
meetings of shareholders.\146\
---------------------------------------------------------------------------

    \145\ The requirement to hold an annual meeting of shareholders 
at which directors are to be elected is imposed by a source of 
authority other than the federal securities laws. See note 94 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 Sec.  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.
    \146\ See, e.g., Section 302.00 of the New York Stock Exchange's 
Corporate Governance Standards.
---------------------------------------------------------------------------

    The Commission has considered, in the context of compensation and 
corporate governance, whether listed closed-end funds are more like 
operating companies or more like ETFs and open-end funds. As recognized 
in the Proposing Release, shares of listed closed-end funds trade at 
negotiated market prices on a national securities exchange and often 
trade at a ``discount'' to the fund's net asset value per share.\147\ 
While the Commission suggested in the Proposing Release that 
information as to whether a listed closed-end fund's directors and 
employees, if any, would receive the discounted price upon a sale of 
the shares without an offset from a hedging transaction may be 
important to the voting decision of an investor, we received no public 
comment in support of this premise. On the contrary, a number of 
commenters opposed the inclusion of listed closed-end funds for a 
variety of reasons.\148\
---------------------------------------------------------------------------

    \147\ Proposing Release at 8494.
    \148\ See notes 134-137 above and accompanying text.
---------------------------------------------------------------------------

    We are persuaded by commenters that listed closed-end funds are 
more similar to open-end funds in this context and it is not necessary 
to apply the hedging disclosure requirements to listed closed-end 
funds. Accordingly, we find it is in the public interest and consistent 
with the protection of investors to exclude listed closed-end funds 
from the Item 407(i) disclosure requirements.
ii. Emerging Growth Companies and Smaller Reporting Companies
    As adopted, the amendments do not exempt EGCs or SRCs from the new 
disclosure requirement. We believe that information about potential 
alignment of shareholder interests with those of employees and 
directors would be relevant to shareholders of an EGC or an SRC. 
Moreover, given the change in the disclosure requirement to focus on a 
company's existing practices or policies, we do not expect the new 
disclosure to impose a significant compliance burden on companies.
    We are mindful that that the JOBS Act excludes EGCs from some, but 
not all, of the provisions of Title IX of the Act, of which Section 955 
is a part,\149\ and that EGCs and SRCs are in many instances subject to 
scaled disclosure requirements, including with respect to executive 
compensation.\150\ We believe that it would be more consistent with our 
historical approach to corporate governance related disclosures,\151\ 
as well as the statutory objectives of Section 14(j), not to exempt 
these companies from the new disclosure requirement. EGCs and SRCs are 
not required to provide CD&A disclosure required by Item 402(b) and 
therefore may be less likely to have hedging practices or policies. 
Item 407(i) as adopted, however, does not direct them to adopt such 
practices or policies, or dictate the content of any such practices or 
policies. We believe the amendments would not impose a substantial 
direct cost on companies as they would simply require the company to 
disclose what, if any, practices or policies it has adopted and to whom 
they apply, or in the absence of any such practices or policies, 
disclose that none exists or state that hedging transactions are 
generally permitted. Accordingly, a company that does not believe a 
hedging policy would be in the best interests of its shareholders would 
be able to comply with the disclosure requirement without creating a 
practice or policy. As with any company, the complexity of the 
disclosure would reflect mainly the level of complexity of the hedging 
practices or policies of the individual company.
---------------------------------------------------------------------------

    \149\ Section 102 of the JOBS Act exempts EGCs from: The say-on-
pay, say-on-frequency, 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.
    \150\ See Section 102(c) of the JOBS Act and Item 402(l) of 
Regulation S-K.
    \151\ See 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, which 
provides a phase-in period for SRCs from the disclosure required by 
Item 407(d)(5) of Regulation S-K and does not require SRCs 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 EGCs and SRCs are subject to the obligation under Exchange Act 
Section 16(a) to report transactions involving derivative 
securities.
---------------------------------------------------------------------------

    As discussed in Section VI below, in addition to direct costs, 
companies subject to the disclosure requirement

[[Page 2413]]

may also incur indirect costs associated with the disclosure, which may 
be larger for companies without practices or policies regarding hedging 
in place. We thus recognize that EGCs and SRCs may incur greater costs 
as a result of the disclosure requirement. Accordingly, we are adopting 
a delayed compliance date for EGCs and SRCs.
    As noted below,\152\ in order to give companies adequate time to 
implement the new disclosures, we are providing a transition period. 
Companies that are not SRCs or EGCs are required to comply with Item 
407(i) in proxy and information statements with respect to the election 
of directors during fiscal years beginning on or after July 1, 2019. We 
believe that providing a delayed compliance date for SRCs and EGCs will 
benefit those companies by allowing them to observe how other larger 
and more established companies implement Item 407(i). Accordingly, to 
assist SRCs and EGCs in preparing to implement Item 407(i), we are 
requiring them to comply with Item 407(i) in proxy and information 
statements with respect to the election of directors during fiscal 
years beginning on or after July 1, 2020.
---------------------------------------------------------------------------

    \152\ See Section V, below.
---------------------------------------------------------------------------

iii. 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 FPI are not subject 
to the proxy statement requirements of Exchange Act Section 14,\153\ 
under the amendments, FPIs are not required to provide the new Item 
407(i) disclosure.
---------------------------------------------------------------------------

    \153\ Exchange Act Rule 3a12-3(b) [17 CFR 240.3a12-3(b)] 
specifically exempts securities registered by a FPI from Exchange 
Act Sections 14(a) and 14(c).
---------------------------------------------------------------------------

IV. Other Matters

    If any of the provisions of these rules, or the application thereof 
to any person or circumstance, is held to be invalid, such invalidity 
shall not affect other provisions or application of such provisions to 
other persons or circumstances that can be given effect without the 
invalid provision or application.

V. Compliance Dates

    In order to give companies adequate time to implement these 
disclosures, we are requiring companies that are not SRCs or EGCs to 
begin complying with Item 407(i) in proxy and information statements 
with respect to the election of directors during fiscal years beginning 
on or after July 1, 2019. We are delaying the required compliance for 
SRCs and EGCs until fiscal years beginning on or after July 1, 2020.

VI. Economic Analysis

A. Background

    We are adopting amendments to implement Section 955 of the Act, 
which added Section 14(j) to the Exchange Act concerning disclosure 
about a company's hedging policies in proxy or consent solicitation 
materials.\154\ We are mindful of the costs imposed by and the benefits 
obtained from our rules. Exchange Act Section 3(f) \155\ 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 also consider, in addition to the protection of investors, whether 
the action will promote efficiency, competition, and capital formation. 
Additionally, Exchange Act Section 23(a)(2) \156\ requires us, when 
adopting rules under the Exchange Act, to consider the impact that any 
new rule will have on competition and not to adopt any rule that will 
impose a burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \154\ See Section I, above.
    \155\ 15 U.S.C. 78c(f).
    \156\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The discussion below addresses the expected economic effects of the 
final amendments, including the likely benefits and costs, as well as 
the likely effects of the final amendments on efficiency, competition, 
and capital formation. The Commission has, where possible, quantified 
the economic effects expected to result from the final amendments in 
the analysis below. However, we are unable to quantify some of the 
potential effects discussed below. Notably, the benefits of the final 
amendments are difficult to quantify because we lack data on the extent 
to which shareholders currently factor information on hedging practices 
or policies into their decisions and the extent to which the 
availability of the new disclosure under the final amendments will 
inform shareholder decisions. Further, we are unable to quantify the 
indirect costs of the final amendments because we lack information to 
predict the extent of changes to hedging policies that companies may 
undertake following the amendments and the incremental costs companies 
may incur as a result of implementing such changes, including costs to 
develop and administer new or revised hedging policies and costs 
associated with potential changes to incentives of directors and 
employees. Therefore, much of the discussion below is qualitative in 
nature, although the Commission describes, where possible, the 
direction of these effects. Finally, for purposes of this economic 
analysis, we address the benefits and costs resulting from the 
statutory mandate and our exercise of discretion together because the 
two types of benefits and costs are not readily separable.

B. Baseline and Affected Parties

    The final amendments will affect all companies with a class of 
securities registered under Section 12 of the Exchange Act, including 
SRCs, EGCs, and BDCs. The final amendments do not apply to FPIs and 
investment companies registered under the Investment Company Act. In a 
change from the proposal, listed closed-end funds will not be subject 
to the final amendments.\157\ We estimate that approximately 5,795 
companies will be subject to the final amendments.\158\ Among the 
companies subject to the final amendments, we estimate approximately 
2,086 to be SRCs; \159\

[[Page 2414]]

1,224 to be EGCs; \160\ and 80 to be BDCs.\161\ Besides companies, 
affected parties include employees (including officers) and directors 
of the affected companies, as well as investors in these companies. 
Equity securities covered by the final amendments include equity 
securities issued by the company and its parents, subsidiaries or 
subsidiaries of the company's parents.
---------------------------------------------------------------------------

    \157\ Based on data from Morningstar, we identify approximately 
512 closed-end funds that were listed on an exchange as of December 
31, 2017.
    \158\ We estimate the number of unique operating companies 
subject to the final amendments by analyzing companies that filed 
annual reports on Form 10-K in calendar year 2017 with the 
Commission. This estimate excludes ABS issuers (identified based on 
prior ABS-related filings), registered investment companies, issuers 
that have not filed Form 10-K, and foreign issuers filing Forms 20-F 
and 40-F. We identify companies that have securities registered 
under Section 12(b) or Section 12(g) from Form 10-K. Companies not 
identified as having a class registered either under Section 12(b) 
or Section 12(g) are excluded. We determine whether a company 
identifies itself as a SRC from Form 10-K. We determine whether a 
company identifies itself as an EGC based on Ives Group's 
AuditAnalytics data. This estimate is an upper bound on the number 
of affected filers to the extent that not all of these filers file a 
proxy statement or an information statement in a given year (for 
example, some filers may not hold a director election).
    \159\ See note 9, above. These estimates are based on calendar 
year 2017 data, the last full year of data available to us. 
Following the amendments to the SRC definition, which expanded the 
range of companies that qualify for SRC status, effective September 
10, 2018, we expect the proportion of SRCs among companies subject 
to the final amendments to be higher than estimated based on 2017 
data. Among companies subject to the final amendments based on 2017 
data, approximately 814 additional companies, including 567 
companies that are not EGCs, would have qualified as SRCs under the 
expanded definition.
    Those non-EGCs that were in existence prior to the recent 
expansion of the SRC definition and that newly qualify for SRC 
status under the expanded definition would have been subject to Item 
402(b) in prior years.
    \160\ The estimate is based on Ives Group's AuditAnalytics data 
on filers that identified themselves as EGCs during 2017.
    \161\ The EGC, SRC, and BDC filer categories partly overlap. The 
estimate of the number of BDCs is based on September 2017 data at 
https://www.sec.gov/open/datasets-bdc.html.
---------------------------------------------------------------------------

    We assess the economic effects of the final amendments relative to 
the baseline, which includes the existing state of disclosure 
requirements and practices. As discussed in Section II above, among the 
registrants subject to the final amendments, Section 12 registrants 
other than SRCs and EGCs are currently subject to the CD&A disclosure 
requirement in Item 402(b) of Regulation S-K. Under Item 
402(b)(2)(xiii), an example of the kind of information that should be 
provided, if material, includes a description of 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. Although Item 
402(b)(2)(xiii) addresses only hedging by the named executive officers, 
some companies describe policies that address hedging by employees and 
directors, as well as named executive officers, in providing their CD&A 
disclosure.\162\
---------------------------------------------------------------------------

    \162\ Listed closed-end funds, which are not subject to the 
final amendments, are not subject to the CD&A disclosure 
requirement.
---------------------------------------------------------------------------

    Additionally, Section 16(a) of the Exchange Act requires officers 
and directors of Section 12 registrants, including SRCs and EGCs, to 
report their hedging transactions involving the company's equity 
securities.\163\ However, unless a company discloses a policy regarding 
hedging by officers and directors, it is not possible for investors to 
obtain full information about whether a company has a hedging policy or 
how one may apply. For example, investors may not be able to discern 
from current disclosure whether the disclosure of hedging transactions 
by officers and directors indicates that the company does not have a 
hedging policy; the company has a policy regarding hedging, but that 
the particular types of transactions are not restricted by the policy; 
or a company's hedging policy was violated, but the transaction was 
reported in accordance with Section 16(a). Similarly, it is not 
possible to discern from current disclosure whether the absence of 
reported hedging transactions indicates that the company prohibits 
hedging; the company does not prohibit hedging, but that officers and 
directors did not engage in hedging transactions; or officers and 
directors engaged in hedging transactions but did not comply with 
Section 16(a).
---------------------------------------------------------------------------

    \163\ Section 30(h) of the Investment Company Act subjects 
officers and directors of listed closed-end funds to the same duties 
and liabilities as those imposed by Section 16(a) of the Exchange 
Act.
---------------------------------------------------------------------------

    The extent to which there will be a change in the hedging policy 
disclosures under the final amendments will vary for different 
categories of registrants subject to the amendments. While a number of 
reporting companies already make hedging policy disclosures, others 
will need to do so for the first time. To establish the baseline of 
existing practices related to disclosure of hedging policies, we 
analyzed information from comment letters and industry surveys of large 
companies' hedging policy disclosure practices \164\ and reviewed proxy 
statements for information on disclosures of hedging policies for four 
samples of companies.\165\ The first sample includes a randomly chosen 
subset of 100 S&P 500 companies that filed proxy statements during the 
calendar year 2017.\166\ The second sample includes 100 randomly 
selected companies from the S&P SmallCap 600 that filed proxy 
statements during the calendar year 2017.\167\ These companies are 
smaller than S&P 500 companies; however, all of them are exchange-
listed, and none are SRCs (based on the pre-2018 definition).\168\ In 
addition, we have examined hedging policy disclosure practices for 
random samples of 100 SRCs and 100 non-SRC EGCs (using the pre-2018 SRC 
definition).\169\
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    \164\ See notes 171-175, below.
    \165\ We did not receive comment on the methodological approach 
used in this baseline analysis in the Proposing Release. Our 
baseline analysis in this release is generally consistent with the 
baseline analysis in the Proposing Release; however, we are 
considering data from proxy statements filed in 2017, which is the 
most recent full calendar year of filings available to us. We also 
are making some modifications in light of the availability of 
information in other sources about the prevalence of hedging policy 
disclosure among large companies. Specifically, we are considering a 
random sample of 100, rather than the set of all, S&P 500 companies, 
in light of other information on hedging policies of large companies 
that has become available from commenters and industry surveys. See 
notes 171-175, below. In light of comments regarding the potentially 
greater effects of the disclosure requirement on SRCs and EGCs, in a 
change from the baseline analysis in the Proposing Release, we are 
adding an analysis of samples of 100 SRCs and 100 non-SRC EGCs. 
Similar to the analysis in the Proposing Release, we also examine a 
sample of 100 S&P SmallCap 600 companies.
    We note that the estimated rate of hedging policy disclosure 
obtained based on a sample of companies, rather than the entire set 
of companies, can differ from the actual rate of hedging policy 
disclosure for the full set of companies. However, such differences 
should not be systematic in light of our use of random sampling.
    \166\ A total of 489 S&P 500 companies filed proxy statements 
during the calendar year 2017.
    \167\ A total of 586 S&P SmallCap 600 companies filed proxy 
statements during the calendar year 2017.
    \168\ See note 159, above. SRC status is based on status 
reported in filings in calendar year 2017. Twenty-one EGCs were 
included in the S&P SmallCap 600 index during the calendar year 
2017.
    \169\ See note 159, above. SRC status is based on status 
reported in filings in calendar year 2017. The SRC sample therefore 
does not include companies that would become newly eligible for SRC 
status under the expanded SRC definition following the 2018 
amendments, while the non-SRC EGC sample may include such companies. 
Because companies newly eligible for SRC status under the 2018 
amendments would tend to be larger than the companies eligible for 
SRC status prior to the 2018 amendments, to the extent that larger 
companies are more likely to disclose hedging, the prevalence of 
hedging disclosure in the analyzed sample of SRCs from 2017 may be 
lower than the prevalence of hedging disclosure among SRCs under the 
amended definition.
---------------------------------------------------------------------------

    In general, the sampled S&P 500 companies disclosed hedging 
policies more frequently than the other categories of sampled 
companies.

                              Table 1--Current Hedging Policy Disclosure Practices
----------------------------------------------------------------------------------------------------------------
                                           Size of the
           Covered companies                examined         Covered persons         Disclosed     No disclosed
                                             sample                               hedging policy      policy
----------------------------------------------------------------------------------------------------------------
Companies in the S&P 500 index.........             100  NEOs...................        97 (97%)          3 (3%)
                                         ..............  Directors..............        77 (77%)        23 (23%)
                                         ..............  Employees..............        51 (51%)        49 (49%)
Companies in the S&P SmallCap 600 index             100  NEOs...................        71 (71%)        29 (29%)
                                         ..............  Directors..............        60 (60%)        40 (40%)

[[Page 2415]]

 
                                         ..............  Employees..............        33 (33%)        67 (67%)
SRCs (pre-2018 definition).............             100  NEOs...................          7 (7%)        93 (93%)
                                         ..............  Directors..............          6 (6%)        94 (94%)
                                         ..............  Employees..............          1 (1%)        99 (99%)
EGCs that are not SRCs (pre-2018                    100  NEOs...................        15 (15%)        85 (85%)
 definition).
                                         ..............  Directors..............        13 (13%)        87 (87%)
                                         ..............  Employees..............        11 (11%)        89 (89%)
----------------------------------------------------------------------------------------------------------------

    Table 1 shows that disclosures and hedging policies are not uniform 
across covered categories of companies. Almost all of the S&P 500 
companies sampled (97%) disclosed policies regarding hedging by named 
executive officers. A large majority of the S&P 500 companies sampled 
(77%) also disclosed their policy about hedging by directors, but only 
51% disclosed hedging policies for non-executive employees. These 
percentages are smaller for smaller companies. Of the 100 S&P SmallCap 
600 companies sampled, only 71% disclosed hedging policies for named 
executive officers, 60% disclosed such policies for directors, and 33% 
disclosed hedging policies for non-executive employees. An even smaller 
proportion of the sampled SRCs and non-SRC EGCs (based on the pre-2018 
definition) \170\ disclosed hedging policies: 7% of SRCs and 15% of 
non-SRC EGCs disclosed policies regarding hedging by named executive 
officers; 6% of SRCs and 13% of non-SRC EGCs disclosed policies 
regarding hedging by directors; and 1% of SRCs and 11% of non-SRC EGCs 
disclosed policies regarding hedging by non-executive employees. Among 
the different categories of the sampled companies that disclosed 
hedging policies, all or almost all such companies disclosed policies 
that either prohibited or restricted hedging.
---------------------------------------------------------------------------

    \170\ Id.
---------------------------------------------------------------------------

    These results are broadly in line with those reported by commenters 
and industry reports. One commenter stated that 49% of Russell 3000 
companies and 84% of S&P 500 companies have hedging policies governing 
their officers and directors.\171\ Another commenter indicated that 
approximately 54% of Russell 3000 Companies and 84% of S&P 500 
companies have prohibited employees from hedging company shares.\172\ A 
different commenter indicated that a survey of 100 companies among the 
Fortune 500 found that 95% of companies disclosed hedging policies 
during the 2014 proxy season, and the vast majority of these policies 
involved a ban.\173\ Another commenter reviewed company disclosures in 
Commission filings and corporate governance documents available on 
company websites, and found that: (1) 95% of a cross-section of 60 
publicly traded companies whose CEOs are members of Business Roundtable 
prohibit hedging of company securities by executive officers, and (2) 
85% prohibit hedging by directors.\174\ More recent industry studies of 
large companies have reported that the majority of the surveyed 
companies disallow executive hedging.\175\
---------------------------------------------------------------------------

    \171\ See letter from Davis Polk.
    \172\ See letter from CII.
    \173\ See letter from Public Citizen.
    \174\ See letter from Business Roundtable.
    \175\ A 2015 report found that among the 250 largest market 
capitalization S&P 500 companies, the prevalence of policies 
prohibiting hedging by executives is 92%. See Frederic W. Cook & 
Co., Inc., Corporate Governance Study 1 (December 2015), available 
at https://www.fwcook.com/content/Documents/Publications/FWC_2015_Corp_Gov_Study_Final.pdf.
    Another recent report found hedging policies to be present in 
96% of large publicly traded companies and attributed that 
percentage to the influence of legislation, proxy advisory firms, 
and shareholder scrutiny. The report considered ``110 companies from 
10 industries, selected to provide a broad representation of market 
practice among large U.S. public companies.'' See Compensation 
Advisory Partnerts (CAP), CAP 100 Company Research Industry Report 
2017-2018 13, https://www.capartners.com/cap-thinking/cap-100-company-research-17-18/.
    In another report, 93 of the largest 100 companies (93%) that 
have equity securities listed on the NYSE or Nasdaq were found to 
prohibit hedging. See 2018 Shearman & Sterling LLP Corporate 
Governance survey, at 103.
    An analysis of 2017 data indicated that 98% of a random subset 
of S&P 500 companies and 71% of a random subset of S&P SmallCap 600 
companies disclosed hedging policies for named executive officers. 
In the Proposing Release, an analysis of 2012 data indicated that 
67% of S&P 500 companies and 29% of a random subset of S&P SmallCap 
600 companies disclosed hedging policies for named executive 
officers. See Proposing Release, at 8498. We cannot identify the 
causes of increased incidence of hedging policy disclosure among 
large companies with certainty and note that estimates based on 
samples of companies may contain noise, although differences in 
estimates are not likely to be biased because samples are drawn 
randomly. The increase in the rate of hedging policy disclosure over 
this time period may be partly due to the anticipation of a future 
requirement to provide hedging disclosures as a result of the Dodd-
Frank Act and the Proposing Release, as well as due to demand from 
shareholders and other market participants. See also Section VI.B 
below, analyzing the prevalence of disclosure of hedging practices 
and policies in a randomly drawn sample of companies.
---------------------------------------------------------------------------

Discussion of Economic Effects

    To help inform our analysis of the potential benefits and costs of 
disclosure of practices or policies regarding hedging to shareholders, 
we consider the potential ways in which hedging by employees and 
directors may affect shareholder value. However, as discussed in 
Section III above, these amendments relate only to disclosure of 
hedging practices or policies and should not be construed as suggesting 
that companies should have a practice or policy regarding hedging, or a 
particular type of practice or policy.
    Generally, by linking employees' and directors' wealth to 
shareholder wealth, an ownership stake in the company can provide 
employees and directors with an incentive to improve shareholder 
value.\176\ Permitting employees and directors to hedge their exposure 
to the company's stock price can reduce the alignment of their 
incentives with the interests of shareholders, potentially resulting in 
less optimal corporate investment decisions and lower shareholder 
value. Alternatively, permitting hedging could, in some circumstances, 
more closely align the risk preferences of employees and directors with 
those of shareholders, potentially resulting in more efficient 
corporate investment decisions and higher shareholder value. Compared 
to shareholders, employees and directors are more likely to have 
undiversified

[[Page 2416]]

exposure to their company, which could lead them to avoid making risky 
corporate investments, even if such actions would enhance shareholder 
value.\177\ Allowing employees and directors to hedge equity holdings 
could in some circumstances partly ameliorate the imperfect alignment 
of risk-taking incentives created by undiversified exposure.\178\ The 
net effect of hedging by employees on the efficiency of corporate 
investment decisions would depend on the relative impact of these 
tradeoffs; the availability and cost-effectiveness of other tools to 
address these concerns;\179\ and the extent and types of hedging used 
by employees and directors. In particular, the impact of hedging on the 
incentives of employees and directors may depend on the amount of 
hedging as well as on the type of hedging transactions used and payoffs 
provided by the particular instrument.
---------------------------------------------------------------------------

    \176\ See Proposing Release, at 8498, n. 86. See, e.g., Michael 
C. Jensen & William H. Meckling, Theory of The Firm: Managerial 
Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305-
360 (1976); Bengt Holmstrom, Moral Hazard and Observability, 10 Bell 
J. Econ. 324-340 (1979); Bengt Holmstrom & Joan Ricart I. Costa, 
Managerial Incentives and Capital Management, 101 Q. J. Econ. 835-
860 (1986). Terms of employee and director compensation contracts, 
including holding and vesting periods, may also affect the alignment 
of incentives with shareholder value over time.
    \177\ See Proposing Release, at 8498-99, nn. 88-89. See, e.g., 
Lisa Meulbroek, Company Stock in Pension Plans: How Costly Is It?, 
48 J. L. & Econ. 443, (2005); Brian J. Hall &Kevin J. Murphy, Stock 
Options for Undiversified Executives 33 J. Acct. & Econ.no. 1, 3-42 
(2002) (stating that a large literature has studied the resulting 
underinvestment concern).
    See, e.g., Alfred Rappaport, Executive Incentives vs. Corporate 
Growth, 57 Harv. Bus. Rev. 81-88 (1978); Clifford Smith & Rene 
Stulz, The Determinants of Firms' Hedging Policies, 20 J. Fin. and 
Quantitative Analysis 391-405 (1985); Robert Kaplan, Advanced 
Management Accounting, (Prentice-Hall, 1982); and Richard Lambert, 
Executive Effort and the Selection of Risky Projects, 17 RAND J. 
Econ. 77-88 (1986).
    \178\ Besides concentrated financial wealth exposure, employees 
and directors have human capital exposure to the company. Hedging by 
employees and directors affects the former.
    \179\ For example, corporate hedging of cash flow risk, or a 
requirement that executive officers hold stock options, also can 
strengthen executives' incentives to take on risky but value-
enhancing investment projects; however, both can involve costs. See 
Proposing Release, at 8499, n. 91.
---------------------------------------------------------------------------

    There is limited research on hedging transactions by corporate 
insiders. In an effort to understand these incentives, one academic 
study concludes that there is significant variation in the motivations 
for the use of derivative transactions for hedging by corporate 
insiders.\180\ However, the study does not find evidence that the use 
of hedging instruments is associated with significant changes in 
earnings management, investment policy, including R&D, or company risk, 
and concludes that the evidence is mixed as to whether these 
instruments are a contractual response to agency problems, or 
suboptimal contracts.\181\
---------------------------------------------------------------------------

    \180\ See J. Carr Bettis, John Bizjak & Swaminathan Kalpathy, 
Why Do Insiders Hedge Their Ownership? An Empirical Examination, 44 
Financial Management, 655 (2015). The study also finds that insider 
derivative transactions are more likely among companies with 
overvalued equity, higher CEO pay-for-performance sensitivity, and 
higher insider equity ownership. Given the sample period used in the 
study (1996-2006), it is not clear if their findings reflect the 
current situation.
    \181\ Id. We also note that the likelihood of employees and 
directors using hedging at a particular firm may also be affected by 
other factors, including firm characteristics, risk preferences and 
tax circumstances of individual employees and directors, and the 
specific features of a firm's hedging policy.
---------------------------------------------------------------------------

1. Effects of the Item 407(i) Disclosure Requirements

    Item 407(i) is being adopted to require a company to describe any 
practices or policies it has adopted regarding the ability of employees 
or directors of the company to purchase financial instruments 
(including prepaid variable forward contracts, equity swaps, collars, 
and exchange funds), or otherwise engage in transactions that hedge or 
offset, or are designed to hedge or offset, any decrease in the market 
value of company equity securities granted to the employee or director 
by the company as part of the compensation of the employee or director, 
or held, directly or indirectly, by the employee or director.\182\ If 
the company does not have any such practices or policies, the company 
must disclose that fact or state that hedging transactions are 
generally permitted. The rule does not direct companies to have such 
practices or policies, or dictate the content of any such practices or 
policies.
---------------------------------------------------------------------------

    \182\ See Section III, above.
---------------------------------------------------------------------------

    Similar to the proposal, and similar to the existing Item 
402(b)(2)(xiii), the final amendments do not define the term ``hedge.'' 
Instead, the final amendments use the term as a broad principle for 
transactions that hedge or offset, or are designed to hedge or offset, 
any decrease in the market value of registrant equity securities. Not 
limiting the disclosure requirement to specific transaction types will 
enable it to comprehensively capture policies related to those hedging 
transactions that companies view as relevant in light of their specific 
circumstances and incentive structures. The final amendments allow for 
flexibility to address new downside price protection techniques as they 
develop, providing relevant information to investors, and avoid 
adopting a definition that could prove either over- or under-inclusive. 
However, we acknowledge that the principles-based approach could lead 
to less comparability in the required disclosures across companies.
    Generally, information about hedging practices or policies may be 
relevant for shareholders seeking to assess the equity incentives of 
employees and directors and the extent of alignment of those incentives 
with shareholder interests. As is shown in Table 1, such information is 
not always available to shareholders, particularly for companies not 
presently subject to Item 402(b)(2)(xiii). Providing this information 
could help mitigate the information asymmetry between companies and 
shareholders about the strength of employees' and directors' equity 
incentives, thus potentially enhancing the ability of shareholders to 
make fully informed voting and, potentially, investment decisions.
    As discussed below, the potential economic effects of the final 
amendments are expected to vary across companies, depending on the 
nature and amount of new information contained in the disclosures, 
whether a company decides to implement or revise hedging policies, the 
nature of investment opportunities available to the company, and 
whether employees and directors currently engage in hedging.
    The economic effects of the final amendments will likely be smaller 
for companies that are subject to Item 402(b)(2)(xiii), which requires 
disclosure of policies regarding hedging by named executive officers, 
if material.\183\ If such companies currently disclose practices or 
policies regarding hedging by named executive officers, their existing 
disclosure may satisfy Item 407(i) requirements as to those officers. 
Companies subject to Item 402(b)(2)(xiii) that do not currently 
disclose practices or policies regarding hedging by named executive 
officers (either because they do not have such policies or because 
their disclosure would not be material), will need to provide new 
disclosure under Item 407(i). Because investors may already draw 
inferences about a company's hedging practices or policies regarding 
named executive officers from the absence of an Item 402(b)(2)(xiii) 
disclosure, the incremental effects of the Item 407(i) disclosure for 
investor understanding of hedging practices or policies of such 
companies as to those

[[Page 2417]]

officers may be small. Further, irrespective of whether companies 
subject to Item 402(b)(2)(xiii) currently disclose practices or 
policies regarding hedging by named executive officers, if such 
companies have practices or policies regarding hedging by other 
employees or directors, they will be required to disclose such 
practices or policies under Item 407(i), which will provide additional 
information to investors. Companies without any practices or policies 
regarding hedging will be required to disclose that fact or state that 
hedging transactions are generally permitted.
---------------------------------------------------------------------------

    \183\ SRCs and EGCs are not subject to Item 402(b). The 
incremental effects of the final amendments on BDCs depend on 
whether the BDC currently qualifies as an SRC or EGC and thus 
whether it is subject to Item 402(b)(2)(xiii). Further, the 
incremental effects of the amendments are expected to be greater for 
internally managed BDCs than for BDCs that are externally managed by 
an investment adviser's portfolio manager because employees of the 
investment adviser are outside the scope of Item 407(i). Based on 
staff estimates, among BDCs with a class of securities registered 
under Section 12, approximately 87.5% are externally managed. 
However, directors of externally managed BDCs play a role in 
overseeing the BDC's investment adviser, and policies regarding 
director hedging are within the scope of Item 407(i).
---------------------------------------------------------------------------

    On the other hand, the incremental economic effects of the final 
amendments are expected to be larger for Section 12 registrants that 
have been reporting as SRCs or EGCs. As discussed in Section VI.B 
above, a relatively smaller proportion of companies that are not 
subject to Item 402(b)(2)(xiii) presently discloses information about 
hedging practices or policies. Under the final amendments, such 
registrants will be required to provide new disclosure about whether 
they have practices or policies regarding hedging by employees 
(including officers) and directors.
a. Benefits
    Investors may benefit from the disclosures required by the final 
amendments in several ways.
    First, new disclosures provide more clarity and transparency about 
incentives of employees and directors, thereby potentially reducing the 
information asymmetry between corporate insiders and shareholders 
regarding such incentives and promoting more informed voting and, 
potentially, investment decisions. Although shareholders currently have 
access to officers' and directors' historical hedging transactions 
through Section 16(a) reports, those shareholders may not have 
information about whether officers and directors can engage in hedging 
in the future.
    Several commenters agreed that the required disclosure will enhance 
transparency and investor understanding of hedging practices.\184\ For 
example, one commenter indicated that the new disclosures will help 
investors to better understand the incentives of employees (including 
officers) and directors to improve shareholder value.\185\ Another 
commenter stated that the disclosure of a company's hedging policy may 
be considered by investors in the course of voting on proposals 
prohibiting hedging, advisory votes on executive compensation, and 
director elections.\186\
---------------------------------------------------------------------------

    \184\ See, e.g., letters from Chris Barnard, CII and Taylor 
Dove.
    \185\ See, e.g., letter from Chris Barnard, who also stated that 
hedged equity exposures do not reflect the economic exposure to 
actual equity performance.
    \186\ See letter from CII.
---------------------------------------------------------------------------

    Second, the final amendments may reduce the costs for investors of 
researching and analyzing equity-based incentives. While Section 16(a) 
reports provide transaction-specific information about officer and 
director hedging, investors may incur costs to search and aggregate 
information from Forms 3, 4, and 5 and to determine whether a reported 
transaction constitutes hedging. Information about whether employees 
and directors are subject to a practice or policy regarding hedging 
could confirm for investors whether the reported equity holdings of 
officers and directors represent their actual incentives.
    Third, the final amendments may potentially yield indirect benefits 
for investors if the public nature of the required disclosures leads 
companies subject to Item 407(i) to adopt changes in hedging practices 
or policies. If such changes better align the incentives of employees 
and directors with those of shareholders, such companies may experience 
an increase in shareholder value. Alternatively, as discussed in 
Section VI.C.1.b below, if the change in hedging practices or policies 
reduces incentive alignment, such changes could reduce shareholder 
wealth. We do not have data by which to be able to assess whether 
companies will adopt changes in hedging practices or policies, and if 
so, whether such changes will result in net benefits or costs.
    The three types of benefits described above are likely to be most 
significant with respect to the disclosure practices or policies for 
executive officers. Some of these types of benefits may also apply to 
disclosure about practices or policies for directors and non-executive 
employees, although as discussed below, the benefits may be less 
pronounced.
    Directors may receive equity-based compensation to better align 
their interests with those of the shareholders they represent.\187\ The 
benefits of disclosure about hedging policies for non-officer directors 
may be smaller than for officers because non-officer directors 
generally are less involved in corporate investment decisions than 
officers. Also, because their exposure to the company as a proportion 
to their overall wealth is likely to be lower, non-officer directors 
may be less likely to engage in hedging than officers.\188\
---------------------------------------------------------------------------

    \187\ For 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. However, director incentives are typically smaller than 
incentives for CEOs. See David Yermack, Remuneration, Retention, and 
Reputation Incentives for Outside Directors, 59 J. Fin. 2281-
2308(2004); Kathleen Farrell, Geoffrey Friesen & Philip Hersch, How 
Do Firms Adjust Director Compensation?, 14 J. Corp. Fin. 153 (2008); 
James Linck, Jeffry Netter & Tina Yang, The Effects and Unintended 
Consequences of the Sarbanes-Oxley Act on the Supply and Demand for 
Directors, Review of Financial Studies 22(8): 3287-3328 (2009); and 
Viktar Fedaseyeu, James Linck, & Hannes Wagner, The Determinants of 
Director Compensation (J. Corp. Fin. 2014) working paper available 
at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2335584.
    Although these studies used samples prior to 2011, we have no 
reason to believe that director incentives and compensation have 
declined significantly in more recent years. For example, according 
to a 2017 industry study of ``non-employee director compensation at 
300 companies of various sizes and industries,'' equity represented 
58% of total director pay across all companies. The share of equity 
in director compensation was higher at large-cap companies (market 
cap above $5 billion) (62%) than at mid-cap (market cap of $1-5 
billion) (58%) or small-cap (market cap below $1 billion) (54%). 
Median total director pay in the survey was $150,000 for small-cap, 
$201,667 for mid-cap, and $274,000 for large-cap companies. See 
Frederic W. Cook & Co., Inc., Director Compensation Report, 1, 6 
(November 2017) available at https://www.fwcook.com/content/documents/publications/11-21-17_FWC_2017_Director_Comp_Final.pdf.
    However, directors of listed closed-end funds generally do not 
receive equity-based compensation. See notes 141-142, above.
    \188\ Average levels of equity pay awarded to non-officer 
directors are lower than for executives. Id.
    In addition, most non-officer directors have other sources of 
income and wealth (e.g., seats on other boards or an officer 
position at a different company) not tied to the company on whose 
board they sit. See, e.g., Ronald Masulis & Shawn Mobbs, Independent 
Director Incentives: Where Do Talented Directors Spend their Limited 
Time and Energy? 111 J. Fin. Econ. 406, 410, Table 1 (2013).
---------------------------------------------------------------------------

    Disclosure of hedging policies regarding employees generally may 
also benefit investors to the extent that they contribute, individually 
or as a group, to shareholder value. This potential benefit can be 
greater in the case of critical non-executive employees (e.g., key 
research scientists and founding employees), who may have equity stakes 
or option holdings and whose actions and decisions can also affect the 
company's stock price, than in the case of those employees who do not 
participate in making and shaping key operating or strategic decisions 
to the same extent. While some non-executive employees may receive 
equity grants as part of the companies' broad-based equity plans, their 
equity ownership and compensation levels on average are much lower 
compared to executive

[[Page 2418]]

officers.\189\ Further, individual rank-and-file employees are unlikely 
to have a notable impact on the company's equity market value.
---------------------------------------------------------------------------

    \189\ See, e.g., Paul Oyer & Scott Schaefer, Why Do Some Firms 
Give Stock Options to All Employees? An Empirical Examination of 
Alternative Theories, 76 J. Fin. Econ. 99-133 (2005); Serdar 
Aldatmaz, Paige Ouimet, & Edward D. Van Wesep, The Option to Quit: 
The Effect of Employee Stock Options on Turnover, 127 J. Fin. Econ. 
136-151 (2018); Ehan Kim & Paige Ouimet, Broad-Based Employee Stock 
Ownership: Motives and Outcomes, 69 J. Fin. Econ. 1273-1319 (2014).
---------------------------------------------------------------------------

    Nevertheless, while a decision by a single non-executive employee 
is unlikely to affect the stock price, the combined actions of non-
executive employees motivated by equity incentives may have a 
significant effect on the company.\190\ Several commenters stated that 
it is important to require disclosure of hedging policies for all 
employees, asserting that such information is useful, whether or not 
the employees are officers of the company.\191\ However, several other 
commenters stated that information about hedging below the executive 
level is not material to shareholders since non-executive employees do 
not make or shape key operating and strategic decisions that influence 
the company's stock price.\192\ Importantly, the rule requires 
disclosure of a company's hedging practices or policies but does not 
require the practices or policies to be the same for officers as for 
other employees or to cover any category of employees.
---------------------------------------------------------------------------

    \190\ See, e.g., Kim and Ouimet (showing that small employee 
stock ownership plans, comprising less than 5% of shares, granted by 
companies with moderate employee size, increase productivity and 
benefit both employees and shareholders but that the effects are 
weaker when there are too many employees to mitigate 
free[hyphen]riding or for large employee stock ownership plans); Xin 
Chang., Kangkang Fu, Angie Low & Wenrui Zhang, Non-Executive 
Employee Stock Options and Corporate Innovation, 115 J. Fin. Econ. 
168 (2015) (showing a positive effect of non-executive employee 
stock options on corporate innovation, mainly through the risk-
taking incentive, rather than the performance-based incentive); 
Francesco Bova, Kalin Kolev, Jacob Thomas & X. Frank Zhang, Non-
Executive Employee Ownership and Corporate Risk, 90 Acct. Rev. 115 
(2015) (showing a positive effect of non-executive stock options and 
a negative effect of stock holdings on corporate risk taking).
    \191\ See letters from CII, Florida State Board of 
Administration and Public Citizen.
    \192\ See letters from ABA, Business Roundtable, Cleary Gottlieb 
and McDermott.
---------------------------------------------------------------------------

    While the potential benefits discussed above may apply to investors 
in all companies subject to the final amendments, the magnitude of the 
benefits may vary across companies. The potential benefits of the new 
disclosure could be higher for shareholders of EGCs and SRCs, which are 
not presently subject to Item 402(b)(2)(xiii) with respect to named 
executive officer hedging policies and a relatively smaller proportion 
of such companies presently discloses hedging practices or policies. In 
turn, investors in companies that currently disclose hedging policies 
may be unlikely to realize significant additional benefits from the 
prescribed disclosure or changes in hedging policies as a result of the 
final amendments.
    The potential benefits to investors also will depend on the 
likelihood that officers and directors engage in hedging transactions. 
Information about hedging policies may be more relevant to investors in 
companies for which there are stronger incentives for employees and 
directors to hedge. The evidence on which types of companies are likely 
to have stronger incentives to hedge is inconclusive. For example, we 
expect the benefits of the new disclosure to be higher for shareholders 
of companies with volatile stock prices and a higher risk of stock 
price decline because such companies' employees and directors may have 
relatively stronger incentives to hedge.\193\ This category of 
companies is likely to include EGCs and SRCs because smaller companies 
have generally been linked to greater distress risk.\194\ Additionally, 
since company age is among the most important predictors of failure, 
younger companies such as EGCs are more likely to have a higher risk of 
financial distress.\195\ EGCs also tend to have more growth 
opportunities,\196\ riskier cash flows, and fewer financial resources. 
Some commenters stated that SRCs and EGCs have greater exposure to 
market risk and that, as a result, officers and directors of these 
companies may use hedging transactions more often, and therefore the 
value of hedging policy disclosure to investors in these companies may 
be greater.\197\ However, because it is costlier to hedge the risk of 
illiquid stocks,\198\ officers and directors of these companies may 
instead be less likely to engage in hedging. Thus, the potential 
benefits of the new disclosure could instead be lower for investors in 
smaller companies or those companies not listed on a national 
securities exchange. Overall, the effects of greater risk and lower 
liquidity associated with small cap stocks on hedging practices may 
partly offset one another.\199\
---------------------------------------------------------------------------

    \193\ For example, Bettis, Bizjak, and Kalpathy, find in two out 
of three specifications in Table 4 of their study a significant 
positive effect of volatility on the probability of executives using 
derivatives in the 1996-2006 sample.
    \194\ See, e.g., Nishad Kapadia, Tracking Down Distress Risk, 
102 J. Fin. Econ. 167 (2011).
    \195\ See, e.g., Sarah Lane & Martha Schary, Understanding the 
Business Failure Rate, 9 Contemp. Econ. Pol'y 93 (1991); See id.
    \196\ While EGCs may have higher company-specific risk, be 
smaller on average, and have more exposure to market risk, as 
Kapadia notes, growth companies have less exposure to aggregate 
distress risk than more mature companies, holding constant the 
effects of size and exposure to market risk.
    \197\ See letters from CII and Florida State Board of 
Administration.
    \198\ Officers and directors can hedge by, for example, entering 
into exchange-traded or over-the-counter derivative contracts. When 
the underlying stock is illiquid, the price of the derivative 
contract 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.
    \199\ To our knowledge, studies have not conclusively determined 
whether insiders of smaller companies tend to hedge more often. For 
example, Bettis, Bizjak, and Lemmon (2001) find a total of 87 zero-
cost collar transactions, one method of executive hedging, by 
searching Forms 3, 4 and 5 filed between January 1996 and December 
1998. Companies in this sample have total assets with a mean 
(median) value of $3.4 billion ($401 million). These companies 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 more frequent in smaller companies. See J. Carr 
Bettis, John Bizjak & Michael Lemmon, Managerial Ownership, 
Incentive Contracting, and the Use of Zero-Cost Collars and Equity 
Swaps by Corporate Insiders, 36 J. Fin. & Quantitative Analysis No. 
3, 345 (2001). At the same time, liquidity may also affect the 
ability to hedge.
    Bettis, Bizjak, and Kalpathy (2015) state that ``smaller firms 
may not have enough market liquidity for investment banks to either 
structure these instruments or hedge their own risk exposure.'' 
Table 4 of their study reports a statistically significant positive 
relation between larger company size and the probability of 
executives using derivatives, but the effect becomes either 
statistically insignificant or only significant at the 10% level in 
specifications incorporating additional covariates.
---------------------------------------------------------------------------

b. Costs
    The costs of complying with the final amendments include direct 
costs of preparing the disclosures they require as well as potential 
indirect costs.
    The costs are expected to be lower for companies that already 
disclose some of the information that will be required by Item 407(i), 
most notably for companies subject to Item 402(b)(2)(xiii). As part of 
the final amendments, we are adding an instruction to Item 402(b) 
providing that a company may, in certain circumstances, satisfy its 
CD&A obligation to disclose any material policies on hedging by named 
executive officers by cross-referencing the information disclosed 
pursuant to Item 407(i), if the disclosure would satisfy the Item 
402(b) requirement. This approach could reduce potentially duplicative 
disclosure under the existing Item 402(b) requirements and the new Item 
407(i) requirements, thereby reducing issuers' cost of compliance with 
the final amendments.
    As discussed above, companies that do not currently provide any 
hedging

[[Page 2419]]

policy disclosure will incur relatively higher costs of complying with 
Item 407(i). The costs are expected to be highest for EGCs and SRCs, 
which are not subject to Item 402(b)(2)(xiii).\200\ These companies 
will incur costs of disclosing the information required by Item 407(i) 
in proxy or information statements. Some commenters stated that, since 
EGCs and SRCs are not required to provide CD&A disclosure, they are 
less likely to have hedging policies in place, and implementation for 
these companies would impose costs that are disproportionate to the 
benefits to be obtained.\201\ These commenters also stated that the 
EGCs and SRCs may not have the resources to develop hedging policies or 
implement compliance programs, which may involve compensation for 
consultants and legal counsel.\202\ We recognize that direct, as well 
as indirect, costs of the disclosure requirement, which are discussed 
in detail below, are likely to be greater for EGCs and SRCs. We note, 
however, that under the final amendments, companies are not required to 
develop hedging practices or policies and can instead disclose the fact 
that they do not have practices or policies regarding hedging or state 
the hedging transactions are generally permitted, which may enable such 
companies to decrease some of these potential costs (although companies 
disclosing that they have no practices or policies regarding hedging 
may still incur some costs).
---------------------------------------------------------------------------

    \200\ Some SRCs would incur relatively lower costs of complying 
with the Item 407(i) disclosure. In particular, those non-EGCs that 
were subject to Item 402(b) prior to the 2018 SRC amendments but 
that newly qualified for SRC status under the amended definition 
might already have incurred the cost of complying with named 
executive officer hedging disclosure, if material, in prior years 
and thus may have systems in place for making such disclosures as to 
named executive officers, resulting in lower ongoing costs of 
complying with Item 407(i). See also note 159, above.
    \201\ See letters from ABA and SCSGP.
    \202\ Id.
---------------------------------------------------------------------------

    On average, we expect the direct costs of the final amendments to 
be relatively modest, and potentially lower than the costs would have 
been under the proposed amendments, especially because it should be 
less burdensome to provide clarity as to the scope of the company's 
practices or policies regarding hedging transactions. As discussed in 
Section III.A.3 above, in recognition of commenters' concerns about 
implementation challenges, the final amendments require filers to 
disclose their practices or policies regarding hedging transactions. To 
satisfy this obligation, the company will be required either to provide 
a fair and accurate summary of the practices or policies that apply, 
including the categories of persons to which they apply and any 
categories of transactions that are specifically permitted or 
specifically disallowed, or to disclose the practices or policies in 
full. If the company does not have any such practices or policies, the 
company must disclose that fact or state that hedging transactions are 
generally permitted. By reducing the complexity of the disclosure, this 
change from the proposal is expected to potentially reduce filer costs 
of preparing disclosures and investor costs of interpreting these 
disclosures.
    While we cannot quantify these disclosure costs with precision, 
many of the direct 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, the 
Commission estimated in the Proposing Release that the amendments would 
result in an average incremental paperwork burden of three hours per 
filing of a proxy or information statement in the first three years of 
the amendments.\203\ We did not receive comment on these estimates. 
However, because the final amendments focus on the disclosure of a 
company's particular practices or policies regarding hedging, we 
anticipate that compliance with the final amendments will be easier and 
more straightforward, resulting in potentially lower compliance 
burdens. If the company does not have any such practices or policies, 
the company must disclose that fact or state that hedging transactions 
are generally permitted. Thus, for purposes of the PRA, the final 
amendments are expected to result in an average incremental paperwork 
burden of two hours per proxy or information statement filing in the 
first year that a filer is subject to the amendments and one hour per 
filing in subsequent years. This estimate is less than the estimated 
burdens of the approach in the Proposing Release, which we estimated 
would have been five hours per filing in the first year that a filer is 
subject to the amendments and two hours per filing in subsequent years 
that a filer is subject to the amendments.\204\
---------------------------------------------------------------------------

    \203\ See Section VII, below.
    \204\ See Section VII, below.
---------------------------------------------------------------------------

    Indirect costs may also be incurred by some companies to the extent 
that companies adopt new, or revise existing, hedging policies in 
anticipation of complying with the amendments, given the public nature 
of the disclosure required by Item 407(i). As discussed above, these 
indirect costs may be greater for companies that do not presently 
disclose practices or policies regarding hedging. These indirect costs 
could include potential costs associated with retaining compensation 
consultants and legal counsel, administering a hedging policy, and 
changes to the incentive structure within the company that may result 
from changes to the hedging policy. Several commenters suggested that 
companies may feel compelled to adopt or modify hedging policies in 
light of the new disclosure requirement.\205\ Such costs will be 
affected by the scope of hedging policies that companies choose to 
adopt and by company characteristics. One commenter asserted that 
limiting the covered persons to executive officers would lower costs 
and that costs for compliance and enforcement mechanisms for policies 
that cover all employees would vary based on the size of a company's 
employee base, the geographic dispersion of employees, and the nature 
of the company's efforts toward ensuring compliance.\206\ Some 
commenters also indicated that excluding non-executive employees from 
the scope of the final amendments would lower the burden on 
companies.\207\
---------------------------------------------------------------------------

    \205\ See, e.g., letters from ABA, Cleary Gottlieb, Davis Polk, 
McDermott, and SCSGP.
    \206\ See letter from Davis Polk.
    \207\ See letters from ABA, Cleary Gottlieb, Davis Polk, and 
SCSGP.
---------------------------------------------------------------------------

    Indirect costs may also be incurred by companies that already have 
optimal compensation arrangements but that make changes to compensation 
policies that reduce incentive alignment between shareholders and 
officers or directors after the final amendments. If changes in hedging 
policies reduce incentive alignment between shareholders and officers 
or directors, resulting in underinvestment in potentially value-
enhancing projects, they could lead to a reduction in shareholder 
wealth.
    The likelihood that adopting or changing hedging policies will 
distort the company's investment decisions may depend on the company's 
growth opportunities. The incentives of officers and directors to make 
efficient corporate investment decisions may be more important for 
shareholder value at companies with more growth opportunities, such as 
EGCs and potentially SRCs. However, the expected effect of hedging 
restrictions on shareholder value at such companies is unclear. On the 
one hand, the problem of underinvestment in risky, value-enhancing 
projects as a result of

[[Page 2420]]

excess risk aversion of executives may have a relatively greater impact 
on firm value at such companies. For instance, one commenter argued 
that executives of many EGCs and SRCs have a large portion of their 
personal wealth exposed to their company and therefore will be more 
negatively affected if they are prohibited from mitigating the exposure 
of their holdings through hedging.\208\ On the other hand, restrictions 
on hedging could strengthen the alignment of managerial and shareholder 
incentives by tying executives' wealth more closely to share price. The 
extent of the potential cost resulting from the distortion of corporate 
investment incentives also may depend on the likelihood that officers 
and directors engage in hedging transactions. As discussed above, 
evidence on executive hedging at small companies is mixed.\209\ These 
factors make it difficult to predict whether small and growth 
companies, such as SRCs and EGCs, will incur a larger or a smaller 
indirect cost, should such companies implement hedging policies after 
the final amendments.
---------------------------------------------------------------------------

    \208\ See letter from ABA.
    \209\ See notes 193-199, above, and accompanying text.
---------------------------------------------------------------------------

    To the extent that the final amendments may lead some companies to 
implement or revise hedging policies, the rule also could impose costs 
on affected employees and directors by limiting their ability to 
achieve optimal portfolio allocations and potentially resulting in a 
lower risk-adjusted performance of their holdings. In turn, restrictive 
hedging practices and policies may affect employees' and directors' 
willingness to work for such companies, which may adversely affect the 
ability of some companies to attract and retain employees and 
directors, resulting in potential costs to such companies and their 
shareholders. The ability or inability to engage in hedging under a 
company's policy may be taken into account as part of the negotiation 
of the total level of compensation between companies and employees or 
directors. It is difficult to determine the relative magnitude of these 
effects and whether companies will offer higher (lower) compensation in 
consideration of a restrictive (permissive) hedging policy.\210\ This 
might depend, for instance, on the distribution of the bargaining power 
between the company and current and prospective employees and 
directors, as well as on the nature of labor market conditions in a 
specific industry and with regard to specific occupations and types of 
employees.
---------------------------------------------------------------------------

    \210\ See also Proposing Release, at 8501 (n. 103 and 
accompanying text) and 8503 (n. 111 and accompanying text).
---------------------------------------------------------------------------

c. Exclusion of Listed Closed-End Funds
    In a change from the proposal, after consideration of public 
comments,\211\ the final amendments do not apply to listed closed-end 
funds.\212\ While this change reduces the overall costs of the rule, it 
may also reduce the overall benefits of the rule due to the potential 
relevance of information about the alignment of incentives of 
shareholders and those of employees and directors of closed-end 
funds.\213\ However, we expect that the Item 407(i) disclosure would be 
less useful for investors in such funds compared to investors in 
operating companies because closed-end funds, like other registered 
investment companies, differ from operating companies with respect to 
management structure, regulatory regime, and disclosure obligations. In 
particular, almost all funds are externally managed, with portfolio 
managers generally employed and compensated by the fund's investment 
adviser. This attenuates the relation between incentives of fund 
employees and fund performance and makes the disclosure of employee 
hedging policies less useful for investors.
---------------------------------------------------------------------------

    \211\ See letters from ABA, ICI and MFDF.
    \212\ Similar to the proposal, other types of registered funds, 
including closed-end funds not listed on an exchange and open-end 
funds, will remain outside the scope of the Item 407(i) requirement.
    \213\ See Proposing Release, at 8499. See also Youchang Wu, Russ 
Wermers & Josef Zechner, Managerial Rents vs. Shareholder Value in 
Delegated Portfolio Management: The Case of Closed-End Funds, 29 
Rev. Fin. Stud. 3428-3470 (2016).
---------------------------------------------------------------------------

    While the disclosure of hedging policies applicable to directors of 
listed closed-end funds might potentially be informative, since 
directors oversee the fund's investment advisers and other service 
providers, based on evaluating input from commenters,\214\ we do not 
believe that such potential benefits are likely to be significant.
---------------------------------------------------------------------------

    \214\ See letters from ABA, ICI and MFDF.
---------------------------------------------------------------------------

d. Disclosure in Schedule 14C
    Similar to the proposal, the final amendments will require Item 
407(i) disclosure in Schedule 14C, in addition to Schedule 14A. This 
was supported by a commenter.\215\ Requiring Item 407(i) disclosure in 
Schedule 14C will extend the economic effects of the amendments to 
Section 12 registrants 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. While this 
provision will increase the overall costs of the rule, it also will 
provide additional information to investors and promote consistency of 
disclosure requirements in the context of an action authorized by 
shareholders with respect to the election of directors.
---------------------------------------------------------------------------

    \215\ See letter from ABA dated Oct. 13, 2015.
---------------------------------------------------------------------------

e. Compliance Dates
    As discussed above, SRCs and EGCs currently disclose less 
information about hedging practices or policies than other types of 
filers. Under the final amendments, registrants will be required to 
provide disclosure about whether they have practices or policies 
regarding hedging by employees (including officers) and directors. In a 
change from the proposal, after considering the concerns of some 
commenters about the burden of complying with the disclosure 
requirement for SRCs and EGCs,\216\ we are adopting a delayed 
compliance date for these companies. SRCs and EGCs will be required to 
comply with the rule for fiscal years beginning on or after July 1, 
2020, one year after the compliance date for the remaining filers 
subject to the final amendments.\217\ A delayed compliance date will 
defer the potential benefits of the final amendments for investors in 
SRCs and EGCs that choose to utilize the delayed compliance date. 
However, a delayed compliance date is also expected to defer the costs 
of the final amendments for such SRCs and EGCs. We expect that 
deferring the compliance date by one year will allow SRCs and EGCs to 
observe how Item 407(i) operates in practice for other, larger and more 
established companies, which may incrementally reduce the costs 
associated with initially preparing the required disclosure.
---------------------------------------------------------------------------

    \216\ See letters from ABA and SCSGP.
    \217\ Based on calendar year 2017 data, we estimate that 
approximately 5,795 companies will be subject to the amendments, of 
which 2,086 are SRCs under the pre-2018 definition (including 1,349 
companies that were not EGCs), 814 additional companies are newly 
eligible as SRCs under the amended SRC definition (including 567 
companies that were not EGCs), and 1,224 are EGCs. In the aggregate, 
EGCs and SRCs (including companies eligible under the amended 
definition) are estimated to comprise 54% of the companies subject 
to the amendments: (1,349 SRCs that are not also EGCs + 567 
companies estimated to be eligible as SRCs under the amended 
definition that are not also EGCs + 1,224 EGCs) = 3,140. 3,140/5,795 
= 54%. See notes 158-160, above.
---------------------------------------------------------------------------

2. Efficiency, Competition, and Capital Formation

[[Page 2421]]

    As discussed above, the final amendments may make it easier for 
investors to obtain information about hedging practices and policies. 
To the extent that the Item 407(i) disclosure yields new information, 
or makes it easier for investors to obtain information that is relevant 
for gauging the extent of incentive alignment of employees and 
directors with the interests of shareholders, the final amendments may 
facilitate better informed voting decisions. To the extent the 
disclosure has the ancillary effect of enabling investors to make more 
informed investment decisions, it may also potentially incrementally 
improve the efficiency of capital allocation.
    The direct disclosure costs incurred by Section 12 registrants to 
comply with the final amendments are expected to be relatively 
modest.\218\ While such costs may vary across companies and may have a 
relatively greater impact on smaller companies, after considering 
public comment, we continue to believe that these costs are unlikely to 
put any category of companies at a significant competitive 
disadvantage, as the Commission stated in the Proposing Release.\219\ 
In recognition of the fact that SRCs and EGCs may benefit from 
observing how Item 407(i) operates in practice for other, larger and 
more established companies, in a change from the proposal we are 
adopting a delayed compliance date that provides SRCs and EGCs with an 
additional year to comply. We expect this accommodation to facilitate 
compliance with the final amendments for EGCs and SRCs, which would 
include smaller filers.
---------------------------------------------------------------------------

    \218\ See Section VII, below.
    \219\ See Proposing Release, at 8504.
---------------------------------------------------------------------------

    However, as discussed above, the effects of the final amendments 
may vary from company to company. We further recognize that some 
companies may incur indirect costs if, as a result of the final rule, 
they choose to implement new, or revise existing, practices or policies 
regarding hedging by employees and directors, as discussed above. To 
the extent that any such new or revised practice or policy would 
restrict corporate insiders from hedging, those insiders could engage 
in less efficient corporate investment decisions resulting in lower 
shareholder value, and such changes could potentially lead to 
additional costs for some companies. However, these potential indirect 
costs may be limited for some companies that find other means of 
promoting investment in risky but value-enhancing projects to be cost-
effective.\220\ After considering commenter input, although we 
acknowledge that smaller companies may be incrementally more affected 
by the costs of the new disclosure requirement, we continue to believe, 
consistent with what the Commission stated in the Proposing 
Release,\221\ that the amendments should not have significant adverse 
effects on the overall competitiveness of the labor market for 
employees and directors, competition among U.S. companies or between 
U.S. companies and FPIs, or the ability of private companies to go 
public.
---------------------------------------------------------------------------

    \220\ See note 179, above.
    \221\ See Proposing Release, at 8504.
---------------------------------------------------------------------------

3. Reasonable Alternatives
    Consistent with the statutory mandate of Section 14(j), and as 
proposed, the final amendments will require disclosure of hedging 
practices and policies pertaining to ``any employees (including 
officers) or directors of the registrant, or any of their designees.'' 
As an alternative, we considered limiting the required disclosure to 
hedging practices and policies pertaining to executive officers and 
directors only. Compared to the final amendments, this alternative 
could reduce costs for registrants that do not presently disclose 
practices or policies regarding hedging by non-executive employees. 
Compared to the final amendments, this alternative could also reduce 
the amount of information available to shareholders about the 
incentives of non-executive employees, which may be valuable to some 
shareholders in gauging the extent of incentive alignment, as supported 
by several commenters.\222\
---------------------------------------------------------------------------

    \222\ See letters from CII, Florida State Board of 
Administration and Public Citizen.
---------------------------------------------------------------------------

    As an alternative to requiring Item 407(i) disclosure on Schedule 
14C information statements as well as Schedule 14A proxy statements, we 
considered requiring it only in proxy 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, 
requiring Item 407(i) disclosure in information statements provides 
consistency in hedging disclosures between 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 is 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 under 
this alternative would reduce the benefit of availability of 
information about hedging policies to shareholders in those cases.
    We also considered extending the disclosure requirement to all Form 
10-K filings in order to impose consistent disclosure obligations upon 
all registrants, irrespective of whether they file proxy or information 
statements. While extending the Item 407(i) requirement to companies 
that do not solicit proxies or information statements would not result 
in a more informed evaluation of corporate governance in the context of 
director elections, this alternative could result in potentially more 
informed investment decisions. However, this alternative also would 
increase the disclosure obligations for companies that do not solicit 
proxies or file information statements.
    As another alternative, we considered exempting EGCs and SRCs. As 
discussed in Section VI.B above, EGCs and SRCs currently are not 
subject to Item 402(b)(2)(xiii) and a relatively smaller proportion of 
such companies presently discloses hedging policies. Thus, EGCs and 
SRCs may incur higher costs of complying with Item 407(i). Providing 
such companies with an exemption from Item 407(i), as suggested by some 
commenters,\223\ may reduce or defer costs for these entities. However, 
this alternative would also eliminate the potential benefits to 
investors in such companies, as suggested by several commenters that 
did not support an exemption from the proposed requirement for EGCs and 
SRCs.\224\ Because currently a relatively smaller proportion of such 
companies discloses hedging policies, the potential incremental 
informational benefits from Item 407(i) are expected to be greater for 
shareholders of EGCs and SRCs than for shareholders of companies 
presently subject to Item 402(b).
---------------------------------------------------------------------------

    \223\ See letters from ABA and SCSGP.
    \224\ See letters from CFA Institute, CII, Florida State Board 
of Administration and Public Citizen.
---------------------------------------------------------------------------

    We have discussed above the tradeoffs associated with excluding 
listed closed-end funds from the scope of the final amendments, in a 
change from the proposal.\225\ As another alternative, we considered 
extending the Item 407(i) requirement to open-end registered investment 
companies. This alternative poses similar tradeoffs. Compared to the 
final amendments, it would impose costs on these companies. The 
disclosure also would yield minimal benefits to investors given the 
distinct regulatory and management structure of such funds. As 
discussed in the Proposing Release, the benefits are

[[Page 2422]]

expected to be attenuated in cases of mutual funds whose shares do not 
have a trading market and are redeemed at the NAV; ETFs that trade on 
the secondary market at prices closest to the NAV; or any open-end fund 
shares that have a secondary trading market with low liquidity, which 
increases hedging costs, deterring hedging by employees and 
directors.\226\
---------------------------------------------------------------------------

    \225\ See Section III.D.3.c.i., above.
    \226\ See Proposing Release, at 8504. See also letters from ABA, 
ICI and MFDF.
---------------------------------------------------------------------------

VII. Paperwork Reduction Act

A. Background

    Certain provisions of the final amendments contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (the ``PRA'').\227\ We published a notice 
requesting comment on the collection of information requirements in the 
Proposing Release for the rule amendments, and we submitted these 
collections of information requirements to the Office of Management and 
Budget (``OMB'') for review in accordance with the PRA.\228\ The titles 
for the collections of information are:
---------------------------------------------------------------------------

    \227\ 44 U.S.C. 3501 et seq.
    \228\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------

    (1) ``Regulation 14A and Schedule 14A'' (OMB Control No. 3235-
0059);
    (2) ``Regulation 14C and Schedule 14C'' (OMB Control No. 3235-
0057); and
    (3) ``Regulation S-K'' (OMB Control No. 3235-0071).\229\
---------------------------------------------------------------------------

    \229\ The 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.
---------------------------------------------------------------------------

    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. The regulations and schedules 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 final rule will be mandatory for affected companies. Responses 
to the information collection will not be kept confidential, and there 
will be no mandatory retention period for the information disclosed.

B. Summary of Information Collections

    We are adopting new paragraph (i) to Item 407 of Regulation S-K to 
implement Section 14(j) of the Exchange Act, as added by Section 955 of 
the Act. As discussed in more detail above, Item 407(i), as adopted, 
requires disclosure of the company's practices or policies regarding 
the ability of employees (including officers) or directors of the 
company, or their designees, to purchase financial instruments 
(including prepaid variable forward contracts, equity swaps, collars, 
and exchange funds) or otherwise engage in transactions that hedge or 
offset, or are designed to hedge or offset, any decrease in the market 
value of company equity securities that are granted to them as 
compensation, or that are held, directly or indirectly, by them. The 
company will be required either to provide a fair and accurate summary 
of the practices or policies that apply or to disclose the practices or 
policies in full. If the company does not have any such practices or 
policies, it must disclose that fact or state that hedging transactions 
are generally permitted. Pursuant to the amendments to Item 7 of 
Schedule 14A, this new disclosure is required in proxy or consent 
solicitation materials with respect to the election of directors, or 
information statements in the case of such corporate action authorized 
by the written consent of security holders.
    In addition, to reduce potentially duplicative disclosure between 
new Item 407(i) and the existing requirement for CD&A under Item 402(b) 
of Regulation S-K, we are amending 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 new Item 407(i) 
to the extent that the information disclosed there satisfies this CD&A 
disclosure requirement.\230\ This new instruction, like the new Item 
407(i) disclosure requirement, applies to the company's proxy or 
information statement with respect to the election of directors.
---------------------------------------------------------------------------

    \230\ Instruction 6 to Item 402(b).
---------------------------------------------------------------------------

C. Burden and Cost Estimates Related to the Amendments

    New Item 407(i) requires 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 thus increases the burden hour and cost estimates for each 
of those forms. For some filers, this may be mitigated to some extent 
by a minimal reduction in the burden to prepare their CD&A, as they 
would be permitted to instead cross reference the disclosure in Item 
407(i). The amendment to the CD&A requirement under Item 402(b) would 
not be applicable to SRCs or EGCs 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. We have taken this amendment into account in 
our estimates below.
    In the Proposing Release, for purposes of the PRA, we estimated 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.\231\ We did not receive substantive 
comments on the PRA that would affect this analysis. These estimates 
include the time and cost of collecting and analyzing the information, 
preparing and reviewing disclosure, and filing the documents.
---------------------------------------------------------------------------

    \231\ Our estimates represented the average burden for all 
companies, both large and small.
---------------------------------------------------------------------------

    In deriving our estimates, we assumed that the information that new 
Item 407(i) requires to be disclosed would be readily available to the 
management of a company because it only requires disclosure of 
practices or policies they already have but does not direct them to 
have a practice or policy or dictate the content of such a practice or 
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.\232\ Since 
the first year of compliance with the 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.
---------------------------------------------------------------------------

    \232\ See the 2006 Executive Compensation Disclosure Release.

---------------------------------------------------------------------------

[[Page 2423]]

    Accordingly, 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.
    The final amendments incorporate some changes from the proposal. In 
particular, the proposal would have required every company to disclose 
the categories of hedging transactions it permits and those it 
prohibits, and to specify those categories of persons who are permitted 
to engage in hedging transactions and those who are not. In contrast, 
the final amendments require disclosure of a company's practices or 
policies regarding hedging transactions, including the categories of 
persons covered and any categories of hedging transactions that are 
specifically permitted or specifically disallowed. A company will be 
required either to provide a fair and accurate summary, or to disclose 
the practices or policies in full. Because we anticipate that this 
change in emphasis may make compliance easier and more straightforward, 
we expect it to affect the burden hour and cost estimates per company. 
Accordingly, we estimate that the amendments will instead increase the 
burden hour and cost estimates per company by two hours per form in the 
first year and one hour per form in all subsequent years. As discussed 
in Section III.D.4.c.ii above, in a change from the proposal, we are 
providing SRCs and EGCs with an additional year to comply with the 
amendments. Therefore, we adjust the aggregate annual average burden 
during the first three years of the amendments to account for the 
phase-in. Companies eligible for an extended compliance date will incur 
no burden in the first year of the amendments, two burden hours to 
prepare each Schedule 14A or Schedule 14C filing in the second year, 
and one burden hour per filing in the third year, for an average of 1.0 
total hour per year over the first three years of the amendments for 
each Schedule 14A or 14C with respect to the election of 
directors.\233\ Companies that are not eligible for the extended 
compliance date will incur an average of 1.3 total hours per year over 
the first three years of the amendments for each Schedule 14A or 14C 
with respect to the election of directors.\234\
---------------------------------------------------------------------------

    \233\ (0 + 2 + 1)/3 = 1.0.
    \234\ (2 + 1 + 1)/3 = 1.3.
    \235\ Rounding affects totals.
    \236\ For Schedules 14A and 14C, the number of responses 
reflected in the table equals the three-year average of the number 
of schedules filed with the Commission and currently reported by the 
Commission to OMB.
    \237\ We estimate that 54% of the filers subject to the 
amendments will have an additional year to comply. See note 217 
above. We therefore assume that approximately 46% (100%-54%) of the 
filings will be subject to the amendments in the first year. We 
recognize that filers that receive an additional year to comply may 
account for a lower or higher proportion of filings than estimated, 
thus these estimates are approximate.
---------------------------------------------------------------------------

    In another change from the proposal, the final rules exclude listed 
closed-end funds. We anticipate that this change will reduce the number 
of affected companies from the proposal, and the numbers in the table 
below reflect that reduction, as well as more recent numbers of 
affected companies compared with the numbers in the Proposing Release.
    We recognize that the burdens may vary among individual companies 
based on a number of factors, including the size and complexity of 
their organizations, whether they have adopted practices or policies 
regarding hedging, and complexity of those practices or policies.
    The table below shows the average aggregate compliance burden, in 
hours and in costs, of the collection of information pursuant to new 
Item 407(i) of Regulation S-K, in the first three years of compliance 
with the amendments. 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 new 
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 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 2--Incremental Paperwork Burden Under the Amendments Affecting Schedules 14A and 14C--Three-Year Average Costs \235\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                            Incremental        Total                         External        External
                                                 Number of responses       burden hours/    incremental      Internal      professional    professional
                                                                               form        burden hours    company time        time            costs
                                            (A) \236\...................             (B)     (C) = (A) *     (D) = (C) *     (E) = (C) *     (F) = (E) *
                                                                                                     (B)            0.75            0.25            $400
--------------------------------------------------------------------------------------------------------------------------------------------------------
Sch. 14A..................................  5,586.......................  ..............  ..............  ..............  ..............  ..............
Filers eligible for an extended compliance  5,586 * 0.54 = 3,016........             1.0           3,016           2,262             754        $301,600
 date \237\.
Filers not eligible for an extended         5,586 * 0.46 = 2,570........             1.3           3,341        2,505.75          835.25         334,100
 compliance date.
                                           -------------------------------------------------------------------------------------------------------------
    Sch. 14A total........................  5,586.......................  ..............           6,357        4,767.75        1,589.25         635,700
                                           -------------------------------------------------------------------------------------------------------------
Sch. 14C..................................  569.........................  ..............  ..............  ..............  ..............  ..............
Filers eligible for an extended compliance  569 * 0.54 = 307............             1.0           307.0          230.25           76.75          30,700
 date.
Filers not eligible for an extended         569 * 0.46 = 262............             1.3           340.6          255.45           85.15          34,060
 compliance date.
                                           -------------------------------------------------------------------------------------------------------------
    Sch. 14C total........................  569.........................  ..............           647.6           485.7           161.9          64,760
                                           -------------------------------------------------------------------------------------------------------------
        Sch. 14A and Sch. 14C Total.......  6,155.......................  ..............         7,004.6        5,253.45        1,751.15         700,460
--------------------------------------------------------------------------------------------------------------------------------------------------------

[[Page 2424]]

VIII. Final Regulatory Flexibility Act Analysis

    The Commission has prepared the following Final Regulatory 
Flexibility Analysis in accordance with the Regulatory Flexibility 
Act.\238\ This analysis relates to the adoption of new Item 407(i) of 
Regulation S-K and related amendments. An Initial Regulatory 
Flexibility Analysis (``IRFA'') was prepared in accordance with the 
Regulatory Flexibility Act and included in the Proposing Release.
---------------------------------------------------------------------------

    \238\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Need for, and Objectives of, the Amendments

    The amendments are designed to implement Section 14(j), which was 
added to the Exchange Act by Section 955 of the Act. A report issued by 
the Senate Committee on Banking, Housing, and 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 long-term, so that they 
will receive their compensation even in the case that their firm does 
not perform.'' \239\ Consistent with the mandate in Section 14(j), the 
amendments will provide transparency to shareholders at the time of an 
annual meeting, which is when directors are elected, about whether 
employees or directors may engage in transactions that mitigate or 
avoid the incentive alignment associated with equity ownership. The 
need for, and objectives of, the final amendments are discussed in more 
detail in Sections I through III above.
---------------------------------------------------------------------------

    \239\ See Senate Report 111-176.
---------------------------------------------------------------------------

B. Significant Issues Raised by Public Comments

    In the Proposing Release, we requested comments on every aspect of 
the IRFA, including the number of small entities that would be affected 
by the proposed amendments, the existence or nature of the potential 
impact of the proposals on small entities discussed in the analysis, 
and how to quantify the impact of the proposed amendments. We did not 
receive any comments explicitly addressing the IRFA. As discussed more 
fully above in Section III.D.4.b., comments on whether EGCs or SRCs 
should be subject to the proposed amendments were mixed, with four 
commenters opposing an exemption from the disclosure obligation for 
EGCs and SRCs \240\ and two commenters recommending exempting them from 
the new disclosure requirement.\241\ While the latter commenters 
believed that applying the new disclosure requirement to EGCs and SRCs 
would impose costs that are disproportionate to the benefits to be 
obtained, other commenters did not expect the new disclosure 
requirement to impose a significant compliance burden on EGCs and 
SRCs.\242\
---------------------------------------------------------------------------

    \240\ See letters from CFA Institute, CII, Florida State Board 
of Administration and Public Citizen.
    \241\ See letters from ABA and SCSGP.
    \242\ See letters from CFA Institute, CII and Public Citizen.
---------------------------------------------------------------------------

C. Small Entities Subject to the Amendments

    The amendments affect some companies that are small entities. The 
Regulatory Flexibility Act defines ``small entity'' to mean ``small 
business,'' ``small organization,'' or ``small governmental 
jurisdiction.'' \243\ 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) \244\ 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 
currently 1,144 companies that qualify as ``small entities'' under the 
definitions set forth above.\245\ We estimate that 876 of these small 
entities have a class of securities registered under Section 12(b) or 
12(g) and therefore will be subject to the amendments. 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.\246\ We 
estimate that there are approximately 26 BDCs that will be subject to 
the amendments that may be considered small entities.\247\ We solicited 
comment in the Proposing Release on our estimates of the number of 
small entities affected by the proposed amendments and did not receive 
any comments on them. However, we have adjusted our estimates to 
reflect that, unlike the proposed amendments, the final amendments will 
not apply to listed closed-end funds.
---------------------------------------------------------------------------

    \243\ 5 U.S.C. 601(6).
    \244\ 17 CFR 240.0-10(a).
    \245\ This estimate is based on staff analysis of XBRL data 
submitted by filers, excluding co-registrants, with EDGAR filings of 
Forms 10-K filed during the calendar year of January 1, 2017 to 
December 31, 2017.
    \246\ 17 CFR 270.0-10(a).
    \247\ This estimate is based on staff analysis of Morningstar 
data and data submitted by filers on EDGAR that covered the period 
between April 1, 2018 and June 30, 2018.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping and Other Compliance Requirements

    The amendments 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 amendments. Specifically, 
new Item 407(i) requires disclosure of whether the company has adopted 
any practices or policies regarding the ability of any employee or 
director of the company or any designee of such employee or director, 
to purchase financial instruments (including prepaid variable forward 
contracts, equity swaps, collars, and exchange funds) or otherwise 
engage in transactions hedge or offset, or are designed to hedge or 
offset, 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 company 
will be required either to provide a fair and accurate summary of the 
practices or policies that apply, or to disclose the practices or 
policies in full. If the company does not have any such practices or 
policies, the company must disclose that fact or state that hedging 
transactions are generally permitted. The amendments do not impose any 
additional recordkeeping requirements on a company.
    The amendments will incrementally increase compliance costs for 
registrants, although we do not expect these additional costs to be 
significant. In addition, compliance with the amendments may require 
the use of professional skills, including legal skills. The amendments 
are discussed in detail in Section III above. We discuss the economic 
impact, including the estimated compliance costs and burdens, of the 
amendments in Sections VI and VII above.

E. Agency Action To Minimize Effect on Small Entities

    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 
amendments, we considered the following alternatives:
     Establishing different compliance or reporting 
requirements or timetables that take into account the resources 
available to small entities;

[[Page 2425]]

     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 
requirements.
    In a change from the proposal, the final amendments will require 
disclosure of any practices or policies adopted by a company regarding 
employees' or directors' ability to purchase financial instruments 
(including prepaid variable forward contracts, equity swaps, collars, 
and exchange funds), or otherwise engage in transactions that hedge or 
offset, or are designed 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. By focusing on a company's existing 
practices or policies, we believe that the final amendments will result 
in a clearer, more straightforward disclosure standard that will be 
easier for all companies, especially small entities, to apply. Given 
the straightforward nature of the new disclosure, we do not believe 
that it is necessary to further simplify or consolidate the disclosure 
requirement for small entities.
    We have used performance standards in connection with the 
amendments by requiring disclosure of the practices or policies that a 
company has adopted regarding hedging. The company will be required 
either to disclose a fair and accurate summary of the practices or 
policies or to disclose the practices or policies in full. 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 practice or policy regarding employee and director 
hedging activities. If the company does not have any such practices or 
policies, it must disclose that fact or state that hedging transactions 
are generally permitted.
    We considered, but have not adopted, an alternative approach of 
different compliance or reporting requirements that take into account 
the resources available to small entities. While we have not adopted 
different compliance or reporting requirements based on company size, 
we note that the change in the rule to provide for disclosure of a 
company's practices or policies should result in reporting that is more 
tailored to each company's particular circumstances and thus may have a 
similar effect to this alternative.
    Two commenters recommended exempting EGCs and SRCs from the new 
disclosure requirement, noting that these companies may not have 
hedging policies in place.\248\ We carefully considered these comments 
but are not exempting small entities from all or part of the 
amendments. The amendments are intended to provide transparency 
regarding whether the company has practices or policies regarding the 
ability of employees, directors, or their designees 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.\249\ We believe this transparency will be just as beneficial 
to shareholders of small companies as to shareholders of larger 
companies. By increasing transparency regarding these matters, the 
amendments are designed to improve the quality of information available 
to all shareholders, thereby promoting informed voting decisions. 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 modest additional compliance costs 
for issuers although there could be indirect costs for some small 
entities, depending on their current hedging policies. Overall, we 
believe that the amendments, as adopted, will elicit disclosure about 
relevant hedging practices and policies in a manner that is tailored to 
each company's particular circumstances, so as to avoid creating a 
significant new burden for small entities.
---------------------------------------------------------------------------

    \248\ See letters from ABA and SCSGP.
    \249\ See Senate Report 111-176.
---------------------------------------------------------------------------

    However, in another change from the proposal, after considering the 
concerns of some commenters about the burden of complying with the 
disclosure requirement for SRCs and EGCs,\250\ we are adopting a 
delayed compliance date for these companies. SRCs and EGCs will be 
required to comply with the rule for fiscal years beginning on or after 
July 1, 2020, one year after the compliance date for the remaining 
filers subject to the final amendments. A delayed compliance date will 
defer the costs of the final amendments for SRCs and EGCs. We expect 
that a delayed compliance date will allow SRCs and EGCs, which would 
include smaller filers, to observe how Item 407(i) operates in practice 
for other, larger and more established companies, which may 
incrementally reduce the costs associated with initially preparing the 
required disclosure.
---------------------------------------------------------------------------

    \250\ See letters from ABA and SCSGP.
---------------------------------------------------------------------------

Statutory Authority and Text of the Amendments

    The amendments contained in this release are being adopted under 
the authority set forth in Section 955 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, and Sections 14, 23(a) and 36(a) of 
the Securities Exchange Act of 1934, as amended.

List of Subjects in 17 CFR Parts 229 and 240

    Reporting and recordkeeping requirements, Securities.

Text of the Amendments

    For the reasons set out in the preamble, the Commission amends 
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

0
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, 78 mm, 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.; 18 U.S.C. 
1350; sec. 953(b), Pub. L. 111-203, 124 Stat. 1904 (2010); and sec. 
102(c), Pub. L. 112-106, 126 Stat. 310 (2012).

0
2. Section 229.402 is amended by adding Instruction 6 to Item 402(b) to 
read as follows:

Sec.  229.402   (Item 402) Executive compensation.

* * * * *
    (b) * * *
    Instructions to Item 402(b). * * *
    6. In proxy or information statements with respect to the election 
of directors, if the information disclosed pursuant to Item 407(i) 
would satisfy paragraph (b)(2)(xiii) of this Item, a registrant may 
refer to the information disclosed pursuant to Item 407(i).
* * * * *

0
3. Section 229.407 is amended by adding paragraph (i) before the 
Instructions to Item 407 to read as follows:

Sec.  229.407   (Item 407) Corporate governance.

* * * * *
    (i) Employee, officer and director hedging. In proxy or information 
statements with respect to the election of directors:

[[Page 2426]]

    (1) Describe any practices or policies that the registrant has 
adopted regarding the ability of 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 hedge or offset, or are designed to hedge or offset, 
any decrease in the market value of registrant equity securities--
    (i) Granted to the employee or director by the registrant as part 
of the compensation of the employee or director; or
    (ii) Held, directly or indirectly, by the employee or director.
    (2) A description provided pursuant to paragraph (1) shall provide 
a fair and accurate summary of the practices or policies that apply, 
including the categories of persons covered, or disclose the practices 
or policies in full.
    (3) A description provided pursuant to paragraph (1) shall also 
describe any categories of hedging transactions that are specifically 
permitted and any categories of such transactions specifically 
disallowed.
    (4) If the registrant does not have any such practices or policies 
regarding hedging, the registrant shall disclose that fact or state 
that the transactions described in paragraph (1) above are generally 
permitted.
    Instructions to Item 407(i).
    1. For purposes of this Item 407(i), ``registrant equity 
securities'' means those equity securities as defined in section 
3(a)(11) of the Exchange Act (15 U.S.C. 78c(a)(11)) and Sec.  240.3a11-
1 of this chapter) that are issued by the registrant or by any parent 
or subsidiary of the registrant or any subsidiary of any parent of the 
registrant.
    2. The information required by this Item 407(i) will not be deemed 
to be incorporated by reference into any filing under the Securities 
Act or the Exchange Act, except to the extent that the registrant 
specifically incorporates it by reference.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
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, 7201 et seq.; and 
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and 
Pub. L. 111-203, 939A, 124 Stat. 1887 (2010); and secs. 503 and 602, 
Pub. L. 112-106, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *

0
5. Section 240.14a-101 is amended by:
0
a. Revising paragraph (b) of Item 7;
0
b. Removing paragraphs (c) and (d) of Item 7;
0
c. Removing the Instruction to Item 7(e) of Item 7;
0
d. Redesignating paragraph (e) as paragraph (c) of Item 7;
0
e. Redesignating Instruction to Item 7(f) as Instruction to Item 7 and 
revising it;
0
f. Redesignating paragraph (f) as paragraph (d) of Item 7; and
0
g. Redesignating paragraph (g) as paragraph (e) of Item 7.
    The revisions read as follows:

Sec.  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 (Sec. Sec.  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 (Sec.  
229.407(c)(3) of this chapter); and
    (ii) Paragraphs (e)(4) and (e)(5) of Item 407 of Regulation S-K 
(Sec. Sec.  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.
* * * * *

    Dated: December 20, 2018.

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2018-28123 Filed 2-5-19; 8:45 am]
BILLING CODE 8011-01-P