Document ID: SEC-2015-0270-0001
Agency: sec
Document Type: Proposed Rule
Title: Disclosure of Hedging by Employees, Officers and Directors
Posted Date: 2015-02-17T05:00Z

[Federal Register Volume 80, Number 31 (Tuesday, February 17, 2015)]
[Proposed Rules]
[Pages 8485-8510]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2015-02948]

[[Page 8485]]

Vol. 80

Tuesday,

No. 31

February 17, 2015

Part IV

Securities and Exchange Commission

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17 CFR Parts 229 and 240

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

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

[[Page 8486]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229 and 240

[Release No. 33-9723; 34-74232; IC-31450; File No. S7-01-15]
RIN 3235-AL49

Disclosure of Hedging by Employees, Officers and Directors

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: We are proposing amendments to our rules to implement Section 
955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 
which requires annual meeting proxy statement disclosure of whether 
employees or members of the board of directors are permitted to engage 
in transactions to hedge or offset any decrease in the market value of 
equity securities granted to the employee or board member as 
compensation, or held directly or indirectly by the employee or board 
member. The proposed disclosure would be required in a proxy statement 
or information statement relating to an election of directors, whether 
by vote of security holders at a meeting or an action authorized by 
written consent.

DATES: Comments should be received on or before April 20, 2015.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
     Send an email to rule-comments@sec.gov. Please include 
File Number S7-01-15 on the subject line; or
     Use the Federal Rulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Brent J. Fields, 
Secretary, U. S. Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-01-15. This file number 
should be included on the subject line if email is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE., Washington, DC 
20549, on official business days between the hours of 10:00 a.m. and 
3:00 p.m. All comments received will be posted without change; we do 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.
    Studies, memoranda or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on the SEC's Web site. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Carolyn Sherman, Special Counsel, or 
Anne Krauskopf, Senior Special Counsel, at (202) 551-3500, in the 
Office of Chief Counsel, Division of Corporation Finance, and Nicholas 
Panos, Senior Special Counsel, at (202) 551-3440, in the Office of 
Mergers and Acquisitions, Division of Corporation Finance; or, with 
respect to investment companies, Michael Pawluk, Branch Chief, at (202) 
551-6792, Division of Investment Management, U.S. Securities and 
Exchange Commission, 100 F Street NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: We propose to amend Item 402 \1\ of 
Regulation S-K \2\ by revising paragraph (b) to add Instruction 6; to 
amend Item 407 \3\ of Regulation S-K to add new paragraph (i); and to 
amend Schedule 14A \4\ to revise Items 7 and 22.
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    \1\ 17 CFR 229.402.
    \2\ 17 CFR 229.10 et seq.
    \3\ 17 CFR 229.407.
    \4\ 17 CFR 14a-101.
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Table of Contents

I. Introduction
II. Background
III. Discussion of the Proposed Amendments
    A. Transactions Subject to the Disclosure Requirement
    B. Specifying the Term ``Equity Securities''
    C. Employees and Directors Subject to the Proposed Disclosure 
Requirement
    D. Implementation
    1. Manner and Location of Disclosure
    2. Disclosure on Schedule 14C
    3. Relationship to Existing CD&A Obligations
    4. Issuers Subject to the Proposed Amendments
    a. Registered Investment Companies
    b. Emerging Growth Companies and Smaller Reporting Companies
    c. Foreign Private Issuers
IV. Economic Analysis
    A. Background
    B. Baseline
    C. Discussion of Benefits and Costs, and Anticipated Effects on 
Efficiency, Competition and Capital Formation
    1. Introduction
    2. New Disclosure Requirements Across Covered Companies
    3. Benefits and Costs
    4. Anticipated Effects on Efficiency, Competition and Capital 
Formation
    D. Alternatives
    1. Changing the Scope of Disclosure Obligations
    2. Issuers Subject to the Proposed Amendments
    E. Request for Comments
V. Paperwork Reduction Act
    A. Background
    B. Summary of the Proposed Amendments
    C. Burden and Cost Estimates Related to the Proposed Amendments
    D. Request for Comment
VI. Small Business Regulatory Enforcement Fairness Act
VII. Initial Regulatory Flexibility Act Analysis
    A. Reasons for, and Objectives of, the Proposed Action
    B. Legal Basis
    C. Small Entities Subject to the Proposed Amendments
    D. Reporting, Recordkeeping and other Compliance Requirements
    E. Duplicative, Overlapping or Conflicting Federal Rules
    F. Significant Alternatives
    G. Solicitation of Comments
VIII. Statutory Authority and Text of the Proposed Amendments

I. Introduction

    We are proposing rule amendments to implement Section 955 of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (the 
``Act''),\5\ which adds new Section 14(j) to the Securities Exchange 
Act of 1934 (the ``Exchange Act'').\6\ Section 14(j) directs the 
Commission to require, by rule, each issuer to disclose in any proxy or 
consent solicitation material for an annual meeting of the shareholders 
of the issuer whether any employee or member of the board of directors 
of the issuer, or any designee of such employee or director, is 
permitted to purchase financial instruments (including prepaid variable 
forward contracts, equity swaps, collars, and exchange funds) that are 
designed to hedge or offset any decrease in the market value of equity 
securities either (1) granted to the employee or director by the issuer 
as part of the compensation of the employee or director; or (2) held, 
directly or indirectly, by the employee or director.
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    \5\ Public Law 111-203, 124 Stat. 1900 (July 21, 2010).
    \6\ 15 U.S.C. 78a et seq.
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    A report issued by the Senate Committee on Banking, Housing, and

[[Page 8487]]

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.'' \7\ In this regard, we 
infer that the statutory purpose of Section 14(j) is to provide 
transparency to shareholders, if action is to be taken with respect to 
the election of directors, about whether employees or directors are 
permitted to engage in transactions that mitigate or avoid the 
incentive alignment associated with equity ownership.
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    \7\ 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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    We propose to implement Section 14(j) as described in detail below. 
Neither Section 14(j) nor the proposed amendments would require a 
company to prohibit hedging transactions or to otherwise adopt 
practices or a policy addressing hedging by any category of 
individuals.

II. Background

    The current disclosure obligations relating to company hedging 
policies are provided by Item 402(b) of Regulation S-K, which sets 
forth the disclosure required in the company's Compensation Discussion 
and Analysis (``CD&A''). CD&A requires disclosure of material 
information necessary to an understanding of a company's compensation 
policies and decisions regarding the named executive officers.\8\ Item 
402(b)(2)(xiii) includes, as an example of the kind of information that 
should be provided, if material, the company's equity or other security 
ownership requirements or guidelines (specifying applicable amounts and 
forms of ownership) and any company policies regarding hedging the 
economic risk of such ownership. This CD&A disclosure item requirement, 
which does not apply to smaller reporting companies,\9\ emerging growth 
companies,\10\ registered investment companies \11\ or foreign private 
issuers,\12\ by its terms addresses only hedging by the named executive 
officers. In providing their CD&A disclosure, however, some companies 
describe policies that address hedging by employees and directors, as 
well as the named executive officers.
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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].
    \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.
    \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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    In addition, disclosures pursuant to other requirements may reveal 
when company equity securities have been hedged:
     For companies with a class of equity securities registered 
pursuant to Section 12 of the Exchange Act,\13\ hedging transactions by 
officers and directors in transactions involving one or more derivative 
securities--such as options, warrants, convertible securities, security 
futures products, equity swaps, stock appreciation rights and other 
securities that have an exercise or conversion price related to a 
company equity security or derive their value from a company equity 
security--are subject to reporting within two business days on Form 4, 
pursuant to Exchange Act Section 16(a).\14\
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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), 
which excludes rights with an exercise or conversion privilege at a 
price that is not fixed. Exchange Act Rule 16a-1(d) defines ``equity 
security of the issuer'' as any equity security or derivative 
security relating to the issuer, whether or not issued by that 
issuer. See also Exchange Act Rule 16a-4, which provides that for 
Section 16 purposes, both derivative securities and the underlying 
securities to which they relate shall be deemed to be the same class 
of equity securities.
    The Commission has clarified that Section 16 applies to equity 
swap and similar transactions that a Section 16 insider may use to 
hedge, and has addressed how these derivative securities 
transactions should be reported, including specifically identifying 
them through the use of transaction code K. See Ownership Reports 
and Trading by Officers, Directors and Principal Security Holders, 
Release No. 34-34514 (Aug. 10, 1994) [59 FR 42449] at Section III.G; 
and Ownership Reports and Trading by Officers, Directors and 
Principal Security Holders, Release No. 34-37260 (May 31, 1996) [61 
FR 30376] at Sections III.H and III.I. The Commission also has 
clarified how transactions in securities futures should be reported. 
Commission Guidance on the Application of Certain Provisions of the 
Securities Act of 1933, the Securities Exchange Act of 1934, and 
Rules thereunder to Trading in Security Futures Products, Release 
No. 33-8107 (June 21, 2002) [67 FR 43234] at Q. 13.
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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 requires 
disclosure of the amount of company equity securities beneficially 
owned by directors, director nominees and named executive officers,\16\ 
including the amount of shares that are pledged as security.\17\
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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 
Web site Posting for Forms 3, 4 and 5, Release No. 33-8230 (May 7, 
2003) [68 FR 25788], text at n. 42.
    \16\ Item 403(b) of Regulation S-K [17 CFR 229.403(b)]. 
Disclosure is required on an individual basis as to each director, 
nominee, and named executive officer, and on an aggregate basis as 
to executive officers of the issuer as a group and must be provided 
in proxy statements, annual reports on Form 10-K [referenced in 17 
CFR 240.310], and registration statements under the Securities Act 
and under the Exchange Act on Form 10.
    \17\ The Commission's rationale for requiring the disclosure of 
the amount of shares pledged as security was as follows: ``To the 
extent that shares owned by named executive officers, directors and 
director nominees are used as collateral, these shares may be 
subject to material risk or contingencies that do not apply to other 
shares beneficially owned by these persons.'' Executive Compensation 
and Related Person Disclosure, Release No. 33-8732A (Aug. 29, 2006) 
[71 FR 53158] (the ``2006 Executive Compensation Disclosure 
Release'') at Section IV.
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III. Discussion of the Proposed Amendments

    We propose to implement Section 14(j) by adding new paragraph (i) 
to Item 407 of Regulation S-K to require companies to disclose whether 
they permit employees and directors to hedge their company's 
securities. We believe that the disclosure called for by Section 14(j) 
is primarily corporate governance-related because it requires a company 
to provide in its proxy statement information giving shareholders 
insight into whether the company has policies affecting how the equity 
holdings and equity compensation of all of a company's employees and 
directors may or may not align with shareholders' interests. Because 
Section 14(j) calls for disclosure about employees and directors, we 
believe that this information raises broader issues with respect to the 
alignment of shareholders' interests with those of employees' and 
directors', and is more closely related to the Item 407 corporate 
governance disclosure requirements than to Item 402 of Regulation S-K, 
which focuses only on the compensation of named

[[Page 8488]]

executive officers and directors. We propose to amend Item 407 in this 
manner to keep disclosure requirements relating to corporate governance 
matters together in a single item in Regulation S-K.\18\
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    \18\ As a result, the proposed disclosure would not be subject 
to shareholder advisory votes to approve the compensation of named 
executive officers, as disclosed pursuant to Item 402, that are 
required pursuant to Section 14A(a)(1) of the Exchange Act and Rule 
14a-21(a) [17 CFR 240.14a-21(a)]. We recognize, however, that there 
is an executive compensation component of the proposed disclosure as 
it relates to existing CD&A obligations. See Section III.D.3, below.
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    The proposed amendments implement Section 14(j) in the following 
ways:
     Include within the scope of the proposed disclosure 
requirement other transactions with economic consequences comparable to 
the financial instruments specified in Section 14(j);
     specify that the equity securities for which disclosure is 
required are only equity securities of the company, any parent of the 
company, any subsidiary of the company or any subsidiary of any parent 
of the company that are registered under Section 12 of the Exchange 
Act; \19\
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    \19\ 15 U.S.C. 78l.
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     require the disclosure in any proxy statement on Schedule 
14A or information statement on Schedule 14C \20\ with respect to the 
election of directors because the information seems most relevant for 
shareholders voting or receiving information about the election of 
directors; and
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    \20\ 17 CFR 240.14c-101.
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     clarify that the term ``employee'' includes officers of 
the company.

A. Transactions Subject to the Disclosure Requirement

    Section 14(j) requires disclosure of whether any employee or 
director of the issuer, or any designee of such employee or director, 
is permitted to purchase financial instruments (including prepaid 
variable forward contracts, equity swaps, collars, and exchange funds 
\21\) that are designed to hedge or offset any decrease in the market 
value of equity securities. Our proposal would implement this 
requirement and would also require disclosure of transactions with 
economic consequences comparable to the purchase of the specified 
financial instruments.
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    \21\ By covering ``exchange funds,'' we believe that Section 
14(j) can be interpreted to cover transactions involving 
dispositions or sales of securities. This is because an employee or 
director can acquire an interest in an exchange fund only in 
exchange for a disposition to the exchange fund of equity securities 
held by the employee or director. Whether the disposition to the 
exchange fund is a hedging transaction will depend on the terms of 
the fund.
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    As noted above, a Senate report indicated that Section 14(j) was 
added so that shareholders would know whether executive officers are 
able ``to effectively avoid compensation restrictions that they hold 
stock long-term, so that they will receive their compensation even in 
the case that their firm does not perform.'' \22\ Although Section 
14(j) expressly refers only to the purchase of financial instruments 
designed to hedge or offset any decrease in the market value of equity 
securities, there are other transactions that could have the same 
economic effects, the disclosure of which would be consistent with the 
purpose of Section 14(j).\23\ For example, a short sale can hedge the 
economic risk of ownership. Similarly, selling a security future 
establishes a position that increases in value as the value of the 
underlying equity security decreases, thereby establishing the downside 
price protection that is the essence of the transactions contemplated 
by Section 14(j).
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    \22\ See Senate Report 111-176.
    \23\ Section 14(j) refers to financial instruments that are 
designed to hedge or offset any decrease in market value. The 
proposed amendments do not define the term ``hedge,'' as we believe 
the meaning of hedge is generally understood and should be applied 
as a broad principle.
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    We are concerned that if the proposed disclosure requirement is not 
sufficiently principles-based, the result would be incomplete 
disclosure as to the scope of hedging transactions that an issuer 
permits. If, for example, a company discloses that it prohibits the 
purchase of the types of financial instruments specifically listed in 
the statute, and does not otherwise disclose whether it permits other 
types of hedging transactions that may have the same economic effects 
as the purchase of the listed financial instruments, a shareholder 
might assume that the company does not permit any hedging transactions 
at all, even though that may not be the case. Similarly, failing to 
cover transactions with the same economic effects as purchase of the 
listed financial instruments might cause employees and directors to use 
those transactions that are not covered by the disclosure requirement. 
In order for the disclosure to be complete and to avoid discouraging or 
promoting the use of particular hedging transactions, our proposed 
amendment would require disclosure of whether an issuer permits other 
types of transactions that have the same hedging effect as the purchase 
of those instruments specifically identified in Section 14(j). Proposed 
Item 407(i) would require disclosure of whether an employee, officer or 
director, or any of their designees, is permitted to purchase financial 
instruments (including prepaid variable forward contracts, equity 
swaps, collars, and exchange funds) or otherwise engage in transactions 
that are designed to or have the effect of hedging or offsetting any 
decrease in the market value of equity securities. The proposed 
amendment would therefore cover all transactions that establish 
downside price protection--whether by purchasing or selling a security 
or derivative security or otherwise,\24\ consistent with the statutory 
purpose and providing more complete disclosure. Like the existing CD&A 
disclosure item, which applies to company policies regarding hedging 
the economic risk of named executive officers' ownership of the 
company's securities,\25\ the scope of the proposed amendment is not 
limited to any particular types of hedging transactions.
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    \24\ A pledge or loan of equity securities that does not involve 
a prepaid variable forward or similar transaction, would not be 
considered a hedging transaction covered by the proposed disclosure 
rule even though such a pledge or loan may be viewed as an ``offer 
or sale'' of a security under Securities Act Section 17(a) [15 
U.S.C. 77q(a)]. See Rubin v. United States, 449 U.S. 424 (1981). 
This is because such stand-alone pledges and loans generally 
contemplate the return of the pledged or borrowed securities to the 
employee, with no consequent change in the employee's economic risk 
in ownership of the securities.
    \25\ Item 402(b)(2)(xiii) of Regulation S-K, discussed in 
Section II.D, below.
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    A proposed instruction would clarify that the company must disclose 
which categories of transactions it permits and which categories of 
transactions it prohibits.\26\ Disclosure of both the categories 
prohibited and those permitted conveys a complete understanding of the 
scope of hedging at the company. However, we recognize that where, for 
example, a company only prohibits specified hedging transactions, 
potentially limitless disclosure of each specific category otherwise 
permitted may not be meaningful. Accordingly, if a company specifically 
prohibits certain hedging transactions, it would disclose the 
categories of transactions it specifically prohibits, and could, if 
true, disclose that it permits all other hedging transactions in lieu 
of listing all of the specific categories that are permitted. For 
example, a company could disclose that it prohibits prepaid variable 
forward contracts, but permits all other hedging transactions. 
Conversely, where a company specifies only the hedging transactions 
that it permits, in addition to disclosing the particular categories of 
transactions permitted, it may, if true, disclose that it prohibits all 
other

[[Page 8489]]

hedging transactions in lieu of listing all of the specific categories 
that are prohibited. For example, a company could disclose that it 
permits exchange fund transactions, but prohibits all other hedging 
transactions. If a company does not permit any hedging transactions, or 
permits all hedging transactions, it should so state and would not need 
to describe them by category. An additional instruction would require a 
company that permits hedging transactions to disclose sufficient detail 
to explain the scope of such permitted transactions.\27\ For example, a 
company that permits hedging of equity securities that have been held 
for a specified period of time would need to disclose the period of 
time the securities must have been held.
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    \26\ Proposed Instruction 3 to Item 407(i).
    \27\ Proposed Instruction 4 to Item 407(i).
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    If a company permits some, but not all, of the categories of 
persons covered by the proposed amendment to engage in hedging 
transactions, the company would disclose both the categories of persons 
who are permitted to hedge and those who are not.\28\ For example, a 
company might disclose that it prohibits all hedging transactions by 
executive officers and directors, but does not restrict hedging 
transactions by other employees. Disclosing both categories of 
transactions and persons would provide investors a more complete 
understanding of the persons permitted to engage in hedging 
transactions, if any, and the types of hedging transactions permitted 
by the company.
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    \28\ Proposed Instruction 2 to Item 407(i).
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B. Specifying the Term ``Equity Securities''

    We are proposing an instruction to specify that the term ``equity 
securities,'' as used in proposed Item 407(i), would mean any equity 
securities (as defined in Exchange Act Section 3(a)(11) \29\ and 
Exchange Act Rule 3a11-1) \30\ issued by the company, any parent of the 
company, any subsidiary of the company or any subsidiary of any parent 
of the company that are registered under Section 12 of the Exchange 
Act.\31\ As proposed, the disclosure requirement would apply to the 
equity securities issued by the company and its parents, subsidiaries 
or subsidiaries of the company's parents that are registered on a 
national securities exchange \32\ or registered under Exchange Act 
Section 12(g).\33\ We believe that the equity securities registered 
under Exchange Act Section 12 encompass the securities that are more 
likely to be readily traded, and more easily hedged. Because the 
Exchange Act and Exchanges Act Rules definitions of ``equity security'' 
do not specify the issuer, and Section 14(j) does not itself do so, 
without an instruction that narrows the scope, the term ``equity 
securities'' could be interpreted to include the equity securities of 
any company that are held directly or indirectly by an employee or 
director.
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    \29\ 15 U.S.C. 78c(a)(11). Exchange Act Section 3(a)(11) defines 
``equity security'' as any stock or similar security; or any 
security future on any such security; or any security convertible, 
with or without consideration, into such a security, or carrying any 
warrant or right to subscribe to or purchase such a security; or any 
such warrant or right; or any other security which the Commission 
shall deem to be of similar nature and consider necessary or 
appropriate, by such rules and regulations as it may prescribe in 
the public interest or for the protection of investors, to treat as 
an equity security.
    \30\ 17 CFR 240.3a11-1. Exchange Act Rule 3a11-1 defines 
``equity security'' to include any stock or similar security, 
certificate of interest or participation in any profit sharing 
agreement, preorganization certificate or subscription, transferable 
share, voting trust certificate or certificate of deposit for an 
equity security, limited partnership interest, interest in a joint 
venture, or certificate of interest in a business trust; any 
security future on any such security; or any security convertible, 
with or without consideration into such a security, or carrying any 
warrant or right to subscribe to or purchase such a security; or any 
such warrant or right; or any put, call, straddle, or other option 
or privilege of buying such a security from or selling such a 
security to another without being bound to do so.
    \31\ 15 U.S.C. 78l; Proposed Instruction 1 to Item 407(i).
    \32\ 15 U.S.C. 78l(b).
    \33\ 15 U.S.C. 78l(g).
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    The proposed instruction would specify the scope of covered equity 
securities for both paragraphs (1) (compensatory equity securities 
grants) and (2) (other equity securities holdings) of proposed Item 
407(i). Disclosure of whether a director or employee is permitted to 
hedge equity securities granted as compensation or otherwise held from 
whatever source acquired will more fully inform shareholders whether 
employees and directors are able to engage in transactions that reduce 
the alignment of their interests with the economic interests of other 
shareholders of the company and any affiliated company in which the 
employees or directors might have an interest. Shareholders would 
receive the Item 407(i) disclosure because they hold equity securities 
of the company and action is to be taken with respect to the election 
of directors for that company. The disclosure would provide additional 
information on whether the company has policies affecting the alignment 
of incentives for employees and directors of the company whose 
securities they hold. We therefore believe that disclosure about 
whether employees and directors are permitted to hedge equity 
securities issued by the company, its parents, subsidiaries or 
subsidiaries of the company's parents that are registered under 
Exchange Act Section 12 would be most relevant when providing 
information about the election of directors. We believe that, in 
certain instances,\34\ companies may grant equity securities of 
affiliated companies to their employees or directors that are intended 
to achieve similar incentive alignment as grants in the company's 
equity securities. In these instances, we believe it would be relevant 
for shareholders to know whether such persons are permitted to mitigate 
or avoid the risks associated with long-term ownership of these 
securities.
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    \34\ Examples may include, but are not limited to, where a 
company reorganizes to create a publicly-traded subsidiary.
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C. Employees and Directors Subject to the Proposed Disclosure 
Requirement

    Section 14(j) covers hedging transactions conducted by any employee 
or member of the board of directors or any of their designees. 
Consistent with that mandate, we believe the term ``employee'' should 
be interpreted to include everyone employed by an issuer, including its 
officers. We believe it is just as relevant for shareholders to know if 
officers are allowed to effectively avoid restrictions on long-term 
compensation as it is for directors and other employees of the 
company.\35\ Accordingly, we propose to implement Section 14(j) by 
adding the parenthetical ``(including officers)'' after the term 
``employees'' in the language of the proposed disclosure 
requirement.\36\ In sum, the proposed amendment uses the language ``any 
employees (including officers) or directors of the registrant, or any 
of their designees'' in describing the persons covered by the 
disclosure requirement.\37\
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    \35\ See Senate Report 111-176.
    \36\ The parenthetical ``(including officers)'' in proposed Item 
407(i) is intended to include officers employed by an issuer and 
avoid possible confusion with Exchange Act Rule 12b-2 [17 CFR 
240.12b-2], which states that the term ``employee'' does not include 
a director, trustee, or officer.
    \37\ Section 14(j) refers to ``designee[s]'' of employees and 
directors. Under the proposed disclosure requirement, whether 
someone is a ``designee'' would be determined by a company based on 
the particular facts and circumstances.
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Request for Comment
    1. Should the disclosure required by Section 14(j) be implemented 
by amending the corporate governance disclosures required by Item 407, 
as proposed? Alternatively, should it be implemented by amending the 
Item 402

[[Page 8490]]

executive compensation disclosure requirements? Are there advantages or 
disadvantages to requiring these disclosures under Item 402? If so, 
please explain why.
    2. Should the scope of the proposed Item 407(i) disclosure 
requirement cover transactions that are not expressly listed in 
Exchange Act Section 14(j) but have economic consequences comparable to 
the purchase of the financial instruments specifically identified in 
Section 14(j), as proposed? If not, why not?
    3. Should the scope of transactions covered by proposed Item 407(i) 
be clarified? We are of the view that there is a meaningful distinction 
between an index that includes a broad range of equity securities, one 
component of which is company equity securities, and a financial 
instrument, even one nominally based on a broad index, designed to or 
having the effect of hedging the economic exposure to company equity 
securities. Should we clarify the application of Item 407(i) to account 
for this situation? If so, how? For example, if an issuer prohibited 
hedging generally, but permitted the purchase of broad-based indices, 
should we specify that the issuer could nonetheless disclose that it 
prohibits all hedging transactions? Should the rule explicitly 
distinguish between instruments that provide exposure to a broad range 
of issuers or securities and those that are designed to hedge 
particular securities or have that effect? Would a principles-based or 
numerical threshold approach be most helpful in this regard? If not, 
what other clarification should be provided?
    4. If a company prohibits some, but not all, of the categories of 
transactions described in the proposed amendment, in order to fully 
describe what hedging transactions are permitted and by whom, is it 
necessary to require disclosure, as proposed, of both the categories of 
transactions that are permitted and the categories of transactions that 
are prohibited? If not, please explain why not. Does proposed 
Instruction 3 to Item 407(i) provide a way for companies that permit or 
prohibit only certain covered transactions to disclose this information 
in a clear and effective manner? Alternatively, should the company 
simply be required to describe its policy, if any, without further 
elaboration?
    5. A company that permits hedging transactions would be required to 
disclose sufficient detail to explain the scope of such permitted 
transactions. For example, a company may permit hedging transactions 
only if pre-approved, or only after the company's stock ownership 
guidelines have been met. Should proposed Instruction 4 be more 
specific about the types of details, such as a pre-approval 
requirement, that the company must disclose?
    6. Does our proposal to define the term ``equity securities'' as 
equity securities of the company or any of its parents, subsidiaries or 
subsidiaries of its parents that are registered under Exchange Act 
Section 12 appropriately capture the disclosure that shareholders would 
find useful? Should the Commission limit the term ``equity securities'' 
to only equity securities of the company? If so, please explain why and 
the costs and benefits that would result. How often are directors and 
employees compensated through equity securities of an affiliated 
company that are not registered under Section 12(b) of the Exchange 
Act? If the definition of equity securities includes only equity 
securities registered under Section 12(b) of the Exchange Act, would 
that affect either compensation structure or corporate structure? Do 
companies typically have policies addressing hedging of equity 
securities of their parents, subsidiaries or subsidiaries of their 
parents? What would be the costs and benefits of disclosing whether 
hedging the equity securities of these affiliates is permitted or 
prohibited? Would any on-going compliance efforts be different? If so, 
please explain why and the costs and benefits that would result.
    7. Should the proposed definition be broadened to include equity 
securities that are not registered under Exchange Act Section 12 or 
narrowed to only include equity securities registered under Section 
12(b) of the Exchange Act? If so, explain why and the costs and 
benefits that would result. Alternatively, should the proposed 
definition be revised to exclude equity securities that do not trade in 
an established public market? If so, how would ``established public 
market'' be defined? To the extent the amendment applies to equity 
securities that do not trade on an established public market, should we 
provide guidance about how to interpret ``market value'' for purposes 
of the proposed amendment? In either case, please explain why, and what 
costs and benefits would result from the recommended change.
    8. Should we define ``parent'' and ``subsidiary'' specifically for 
purposes of this disclosure requirement? The definition of ``parent'' 
of a person in the Exchange Act Rules is an affiliate controlling such 
person directly, or indirectly through one or more intermediaries.\38\ 
Similarly, the Exchange Act Rules definition of ``subsidiary'' of a 
person is an affiliate controlled by such person directly, or 
indirectly through one or more intermediaries.\39\ Will these 
definitions, in the context of hedging disclosure, present any 
implementation challenges in determining what needs to be disclosed? 
Should we consider an alternative term, or alternative definition of 
``parent'' for this disclosure requirement, such as an affiliate that 
owns a majority of the voting securities in the company? Similarly, 
with respect to subsidiaries, should we consider an alternative term, 
or alternative definition of ``subsidiary'' for this disclosure 
requirement, such as a majority-owned subsidiary, wholly-owned 
subsidiary, consolidated subsidiary or significant subsidiary? In each 
case, please explain why, and what costs and benefits would result from 
the recommended change.
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    \38\ Exchange Act Rule 12b-2 [17 CFR 240.12b-2].
    \39\ Exchange Act Rule 12b-2 [17 CFR 240.12b-2].
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    9. Section 14(j) does not define the circumstances in which equity 
securities are ``held, directly or indirectly'' by an employee or 
director. Is the concept of ``held, directly or indirectly'' unclear, 
such that we should provide more certainty about what is meant by the 
phrase? If so, how should we clarify it? Section 14(j) also does not 
define who is a ``designee,'' nor is this term otherwise defined in the 
rules under the Securities Act or the Exchange Act. One commenter has 
recommended that the Commission define the term ``designee.''\40\ 
Should the proposed amendment include an instruction clarifying who is 
a ``designee''? If so, please explain how this term should be defined, 
and the costs and benefits that would result.
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    \40\ See Letter from Compensia, Inc. (Oct. 4, 2010). To 
facilitate public input on the Act, the Commission has provided a 
series of email links, organized by topic, on its Web site at http://www.sec.gov/spotlight/regreformcomments.shtml. The public comments 
we have received on Section 955 of the Act are available on our Web 
site at http://www.sec.gov/comments/df-title-ix/executive-compensation/executive-compensation.shtml.
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    10. Section 14(j) is directed to ``any employee'' and we interpret 
that to mean anyone employed by the issuer. Should we limit the 
definition of ``employee'' to the subset of employees that participate 
in making or shaping key operating or strategic decisions that 
influence the company's stock price? \41\ Why or why not? If so, how 
would that distinction be defined for practical purposes? 
Alternatively, should we add an express materiality condition to the 
definition, as is the case under CD&A,

[[Page 8491]]

to permit each issuer to determine whether disclosure about all its 
employees would be material information for its investors? Why or why 
not?
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    \41\ See Section IV.C.1.
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    11. Should the amendment define ``hedge''? If so, what concepts 
other than the statutory reference to ``offset[ting] any decrease in 
the market value of equity securities'' would be necessary to define 
this term?
    12. One commenter has recommended that the Commission ``should not 
only require disclosure of whether hedging is permitted, but should 
also require disclosure of any hedging that has occurred--both in 
promptly filed Form 4 filings and in the annual proxy statement.'' \42\ 
Should the Commission require such disclosure in the final rule for 
those already subject to Form 4 reporting requirements?
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    \42\ See letter from Brian Foley & Company, Inc. (Sept. 22, 
2010).
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D. Implementation

1. Manner and Location of Disclosure
    Section 14(j) calls for disclosure in any proxy or consent 
solicitation material for an annual meeting of the shareholders. 
Shareholder annual meetings are typically the venue in which directors 
are elected.\43\ Although the language of Section 14(j) refers to 
disclosure in any proxy or consent solicitation material for an annual 
meeting of the shareholders, this language, construed strictly, would 
result in the disclosure appearing in different instances than we 
currently require other corporate governance related disclosure. In 
particular, under our current rules, if a company solicits proxies \44\ 
with respect to the election of directors, its proxy statement must 
include specified corporate governance information required by Item 407 
of Regulation S-K, whether or not the election takes place at an annual 
meeting.\45\ We believe that Item 407(i) disclosure would be relevant 
information for shareholders evaluating the governance practices of the 
company and the election of directors. By providing the disclosure in a 
proxy statement if action is to be taken with respect to the election 
of directors, shareholders will be able to consider the proposed 
disclosure at the same time as they are considering the company's other 
corporate governance disclosures and voting for the election of 
directors, without regard to whether at an annual or special meeting of 
shareholders or in connection with an action authorized by written 
consent.\46\ We therefore propose to implement Section 14(j) by 
amending Items 7 and 22 of Schedule 14A to call for new Item 407(i) 
information to be provided if action is to be taken with respect to the 
election of directors. In addition to including the new disclosure 
requirement, the proposal would amend Item 7 of Schedule 14A to 
streamline its current provisions by more succinctly cross-referencing 
disclosure Items.\47\
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    \43\ 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. In Delaware, for example, where more than 50% of 
the publicly traded issuers are incorporated according to the State 
of Delaware's official Web site, Delaware General Corporation Law, 
Section 211(b) is viewed as requiring an annual meeting for the 
election of directors. See Delaware Law of Corporations & Business 
Organizations, Third Edition by R. Franklin Balotti, Jesse A. 
Finkelstein at Sec.  7.1, Folk on the Delaware General Corporate 
Law, 2013 Edition by Edward P. Welch, Andrew J. Turezyn, and Robert 
S. Saunders at Sec.  211.2, and the text of DGCL Section 211(b), 
which reads in relevant part, ``unless directors are elected by 
written consent in lieu of an annual meeting as permitted by this 
subsection, an annual meeting of stockholders shall be held for the 
election of directors on a date and at a time designated by or in 
the manner provided in the bylaws.'' See also Corporations and Other 
Business Associations, Seventh Edition by Charles R.T. O'Kelley and 
Robert B. Thompson at page 167 (explaining that the ``paramount 
shareholder function is the election of directors'' and that 
``[m]ost corporation codes protect this right by specifying 
immutably that directors shall be elected at an annually held 
meeting of shareholders.''), California Corporations Code, Section 
600(b), and 1984 Model Business Corporation Act (as amended through 
2006), Section 7.01(a) (each requiring an annual meeting of 
shareholders for the election of directors).
    \44\ 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.
    \45\ See Items 7(b)-(d) and 8(a) of Schedule 14A.
    \46\ 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 proposed amendment 
would not require the proposed disclosure in the proxy statement.
    \47\ Proposed amended Item 7(b) and Instruction to Item 7 of 
Schedule 14A.
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    The information required under proposed Item 407(i) would need to 
be included in proxy or consent solicitation materials and information 
statements with respect to the election of directors. Section 14(j) 
specifically calls for the disclosure to be made in the proxy 
solicitation materials, and we believe the information would be most 
relevant to shareholders if action is to be taken with respect to the 
election of directors. We therefore do not propose to require Item 
407(i) disclosure in Securities Act or Exchange Act registration 
statements or in the Form 10-K Part III Item 407 disclosure,\48\ even 
if that disclosure is incorporated by reference from the company's 
definitive proxy statement or information statement filed with the 
Commission not later than 120 days after the end of the fiscal year 
covered by the Form 10-K.\49\
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    \48\ 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 of Form 10-K.
    \49\ As permitted by General Instruction G to Form 10-K. 
Proposed Instruction 5 to Item 407(i) would provide that information 
disclosed pursuant to Item 407(i) would not be deemed incorporated 
by reference into any filing under the Securities Act, the Exchange 
Act or the Investment Company Act. As proposed, the disclosure also 
would not be subject to forward incorporation by reference under 
Item 12(b) of Securities Act Form S-3 [17 CFR 239.13].
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2. Disclosure on Schedule 14C
    The statutory language of Section 14(j) expressly calls for proxy 
or consent solicitation materials for an annual meeting of the 
shareholders of the issuer to include the disclosure contemplated by 
the proposed amendments. These solicitation materials are required by 
our proxy rules to be filed under cover of Schedule 14A.\50\ As 
provided in Item 1 of Schedule 14C, however, an information statement 
filed on Schedule 14C must include the information called for by all of 
the items of Schedule 14A to the extent each item would be applicable 
to any matter to be acted upon at a meeting if proxies were to be 
solicited, with only limited exceptions.\51\ An information statement

[[Page 8492]]

filed on Schedule 14C in connection with an election of directors 
therefore already is required to include the information required by 
Item 7 of Schedule 14A. Absent an amendment to Schedule 14C to exclude 
proposed Item 407(i) from the requirements for the information 
statement, the disclosure contemplated by the amendments would be 
required in Schedule 14C pursuant to existing Item 1 of Schedule 14C.
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    \50\ As stated above, Exchange Act Rule 14a-1(f) [17 CFR 
240.14a-1(f)] defines the term ``proxy'' to include every proxy, 
consent or authorization within the meaning of section 14(a) of the 
[Exchange] Act. Exchange Act Rule 14a-3(a) [17 CFR 240.14a-3(a)] 
prohibits any proxy solicitation unless each person solicited is 
currently or has been previously furnished with a publicly-filed 
preliminary or definitive proxy statement containing the information 
specified in Schedule 14A [17 CFR 240.14a-101], and Exchange Act 
Rule 14a-6(m) [17 CFR 240.14a-6(m) requires proxy materials to be 
filed under cover of Schedule 14A.
    \51\ 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].
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    We are not proposing to exclude Item 407(i) disclosure from 
Schedule 14C.\52\ Applying the proposed disclosure obligation to 
Schedule 14C filings would have the effect of expanding the requirement 
to comply with Item 407(i) to companies that do not solicit proxies 
from any or all security holders but are otherwise authorized by 
security holders to take an action with respect to the election of 
directors.
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    \52\ Because our proposal would not add a new exclusion for 
information called for by the proposed amendment to Item 7 of 
Schedule 14A, the effect of the proposal will be to require Item 
407(i) disclosure in Schedule 14C.
---------------------------------------------------------------------------

    We believe that doing so would retain consistency in the corporate 
governance disclosure provided in proxy statements and information 
statements with respect to the election of directors. Exchange Act 
Section 14(c) was enacted to apply to companies not soliciting proxies 
or consents from some or all holders of a class of securities 
registered under Section 12 of the Exchange Act entitled to vote at a 
meeting or authorize a corporate action by execution of a written 
consent.\53\ It creates disclosure obligations for a company that 
chooses not to, or otherwise does not, solicit proxies, consents, or 
other authorizations from some or all of its security holders entitled 
to vote. An example of when such a situation could occur is in the case 
of a controlled company \54\ not listed on the New York Stock Exchange, 
NYSE Market or NASDAQ. In instances where management and/or a 
shareholder affiliate may control sufficient shares to assure a quorum 
and a favorable voting outcome, as in the case of a majority-owned 
subsidiary, or where a solicitation of proxies, consents or 
authorization is made of only certain security holders in connection 
with an election of directors, Section 14(c) would operate to ensure 
that security holders not solicited would receive disclosure 
substantially equivalent to that which would have been included in a 
proxy statement had a solicitation of all security holders been 
made.\55\ In light of this purpose, we believe requiring Item 407(i) 
disclosure in information statements filed pursuant to Section 14(c) 
furthers the regulatory objective of Section 14(j) of the Exchange Act 
and would mitigate the regulatory disparity that otherwise might 
result.\56\
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    \53\ 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.
    \54\ A controlled company is generally understood to be a 
company in which more than 50% of the voting power is held by an 
individual, a group or another issuer. See e.g., Exchange Act 
Section 10C(g)(2) [15 U.S.C. 78jC(g)(2)].
    \55\ At the time Section 14(c) was being considered by Congress 
as an amendment to the Exchange Act, the Securities and Exchange 
Commission provided an official statement that reported findings 
associated with a study that examined the proxy solicitation 
practices of 556 industrial and other companies. ``Twenty-nine 
percent of these companies did not solicit proxies and 24 percent 
did not even send shareholders a notice of meeting.'' Statement of 
the Securities and Exchange Commission with respect to Proposed 
Amendments to Sections 12, 13, 14, 15, 16, 20(c), and 32(b) of the 
Securities Exchange Act of 1934 and Section 4(1) of the Securities 
Act of 1933, at 2. Existing Disclosures by Over-the-Counter 
Companies, Hearings before a Subcommittee of the Committee on 
Banking and Currency for the U.S. Senate, Eighty-Eighth Congress, 
First Session on S. 1642, June 18-21 and 24-25, 1963. Simply 
extending the coverage of the proxy rules to reach over-the-counter 
issuers was not viewed as a solution, and was believed to have been 
a decision that would have accentuated the problem of non-
solicitation ``because of management's relatively larger holdings.'' 
Statement of William L. Cary, Chairman, U.S. Securities and Exchange 
Commission, cited in n. [51] above.
    \56\ Of the approximately 6845 operating companies with at least 
one class of securities registered under Section 12 of the Exchange 
Act, 4018 have a class of securities listed on an exchange. Based on 
our review of and experience with NASDAQ, the New York Stock 
Exchange or NYSE Market, collectively referred to here as primary 
market exchanges, companies with a class of common or voting 
preferred stock (or their equivalents) listed on these exchanges are 
generally required to solicit proxies from shareholders for all 
meetings of shareholders, including those to elect directors. See, 
e.g., NYSE Listed Company Manual Section 402.04, and NASDAQ Rule IM-
5620--Meetings of Shareholders or Partners. Operating companies with 
a class of voting stock listed on a primary exchange that comply 
with the listing exchange's requirements, therefore, will be 
providing the proposed disclosure in proposed amended Item 7 of 
Schedule 14A and proposed Item 407(i) of Regulation S-K for each 
election of directors. By contrast, the approximately 2827 non-
exchange listed companies with a class of securities registered 
under Section 12 may not be subject to compulsory requirements 
analogous to the primary market exchange rules that impose an 
affirmative obligation to solicit shareholders. Consequently, these 
non-exchange listed companies, if not subject to a compulsory 
requirement to solicit proxies, could avoid the proposed disclosures 
if the new requirement were limited to only companies soliciting 
proxies or consents pursuant to Section 14(a), especially given that 
companies with a class of securities registered only under Exchange 
Act Section 12(g) may be able to effectuate a corporate action (as 
referenced in Exchange Act Rule 14c-2) without soliciting security 
holder approval and thus would need only comply with Section 14(c) 
and Regulation 14C.
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3. Relationship to Existing CD&A Obligations
    One of the non-exclusive examples currently listed in the Item 
402(b) requirement for CD&A calls, in part, for disclosure of any 
registrant policies regarding hedging the economic risk of company 
securities ownership,\57\ to the extent material. CD&A applies only to 
named executive officers and is part of the Item 402 executive 
compensation disclosure that is required in Securities Act and Exchange 
Act registration statements, and Exchange Act annual reports on Form 
10-K, as well as proxy and information statements relating to the 
election of directors.\58\ Smaller reporting companies, emerging growth 
companies, registered investment companies and foreign private issuers, 
however, are not required to provide CD&A disclosure.
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    \57\ Item 402(b)(2)(xiii) of Regulation S-K.
    \58\ As required by Item 8 of Schedule 14A.
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    By requiring proxy statement disclosure of whether employees 
generally are permitted to hedge equity securities that they receive as 
compensation or otherwise hold, the disclosure mandated by Section 
14(j) includes within its scope hedging policies applicable to named 
executive officers.\59\ To reduce potentially duplicative disclosure in 
proxy and information statements, we propose to amend Item 402(b) of 
Regulation S-K to add an instruction providing that a company may 
satisfy its CD&A obligation to disclose material policies on hedging by 
named executive officers by cross referencing the information disclosed 
pursuant to proposed Item 407(i) to the extent that the information 
disclosed there satisfies this CD&A disclosure requirement.\60\ This 
instruction, like the Item 407(i) disclosure requirement, would apply 
to a company's proxy statement or information statement with respect to 
the election of directors. We believe that

[[Page 8493]]

amending Item 402(b) to add this instruction will, in certain 
circumstances, make it easier for companies that are subject to both 
Item 407(i) and Item 402(b) to prepare their proxy and information 
statements by avoiding the potential for duplicative disclosure.\61\ In 
addition, we believe that locating all the responsive disclosure in one 
place in the proxy or information statement will make it easier for 
investors to find.
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    \59\ See Section III, above.
    \60\ Proposed Instruction 6 to Item 402(b).
    \61\ 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 made part of CD&A 
pursuant to the proposed cross-reference instruction, the proposal 
will not effect any change in the scope of disclosure currently 
subject to say-on-pay votes. We also note that the cross-reference 
is optional and issuers may, if they prefer, avoid making the Item 
407(i) disclosure part of CD&A by not cross-referencing the 
disclosure.
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4. Issuers Subject to the Proposed Amendments
    In proposing amendments to implement Section 14(j), we have 
considered whether certain categories of issuers should be exempted 
from the proposed Item 407(i) disclosure requirements, or, 
alternatively, whether they should be subject to a delayed 
implementation schedule.\62\ In making these determinations, we have 
been guided by what we understand to be the statutory purpose behind 
Section 14(j), namely, to provide transparency to shareholders, if 
action is to be taken with respect to the election of directors, about 
whether employees or directors are permitted to engage in transactions 
that mitigate or avoid the incentive alignment associated with equity 
ownership.
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    \62\ 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.
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a. Registered Investment Companies
    We are proposing to require closed-end investment companies that 
have shares that are listed and registered on a national securities 
exchange (``listed closed-end funds'') to provide the proposed 
disclosure. Investment companies registered under the Investment 
Company Act of 1940 (``funds'' or ``registered investment companies'') 
that are not listed closed-end funds would be excluded from these 
requirements, as discussed in more detail below.\63\
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    \63\ Business development companies are a category of closed-end 
investment company that are not registered under the Investment 
Company Act [15 U.S.C. 80a-2(a)(48) and 80a-53-64]. As proposed, 
business development companies would be treated in the same manner 
as all issuers (other than certain funds as discussed in this 
section) and therefore would be subject to the requirements of 
proposed Item 407(i). We believe that this would be consistent with 
the Commission's treatment of business development companies 
regarding other disclosure requirements. See the 2006 Executive 
Compensation Disclosure Release, at Section II.D.3.
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    Funds generally have a management structure and regulatory regime 
that differs in various respects from issuers that are operating 
companies, which we believe makes the proposed disclosure less useful 
for investors in funds that are not listed closed-end funds. Nearly all 
funds, unlike other issuers, are externally managed and have few, if 
any, employees who are compensated by the fund.\64\ Rather, personnel 
who operate the fund and manage its portfolio generally are employed 
and compensated by the fund's investment adviser.\65\ Although fund 
directors may hold shares of the funds they serve,\66\ fund 
compensation practices can be distinguished from those of operating 
companies. We believe that the granting of shares as a component of 
incentive-based compensation is uncommon (and in some cases is 
prohibited) \67\ for funds. Concerns about avoiding restrictions on 
long-term compensation, which we understand to be one of the reasons 
Congress mandated this disclosure, may therefore be less likely to be 
raised with respect to funds.
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    \64\ Some funds do have employees, who might also hold fund 
shares. See also footnote 36 and accompanying text (explaining that 
the parenthetical ``(including officers)'' in proposed Item 407(i) 
is intended to include officers employed by an issuer).
    \65\ Funds also typically will contract with other service 
providers in addition to the investment adviser.
    \66\ 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.
    \67\ Registered open-end and closed-end investment companies are 
generally prohibited from issuing their securities for services. See 
Sections 22(g) (open-end funds) and 23(a) (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,'' our staff has provided 
guidance concerning the circumstances under which funds may 
compensate fund directors with fund shares consistent with sections 
22(g) and 23(a). See Interpretive Matters Concerning Independent 
Directors of Investment Companies, Investment Company Act Release 
No. 24083 (Oct. 14, 1999). With respect to registered closed-end 
funds, some of which would be subject to the proposed amendments, 
our staff stated that ``[c]losed-end funds also may wish to 
institute policies that encourage or require their directors to use 
the compensation that they receive from the funds to purchase fund 
shares in the secondary market on the same basis as other fund 
shareholders.'' See id. at n.73. The staff also stated that it 
``would not recommend enforcement action to the Commission under 
Section 23(a) if closed-end funds directly compensate their 
directors with fund shares, provided that the directors' services 
are assigned a fixed dollar value prior to the time that the 
compensation is payable,'' while noting that ``any closed-end fund 
that compensates its directors by issuing fund shares would 
generally be required to issue those shares at net asset value, even 
if the shares are trading at a discount to their net asset value.'' 
See id. at n.74.
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    In addition, most funds, other than listed closed-end funds as 
discussed below, also are generally not required to hold annual 
meetings of shareholders.\68\ Exchange-traded funds (``ETFs''), 
although traded on an exchange, also do not generally hold annual 
meetings of shareholders, and some ETFs do not have boards of 
directors.\69\
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    \68\ The requirement to hold an annual meeting of shareholders 
at which directors are to be elected generally is imposed by a 
source of authority other than the federal securities laws. See 
footnote 43 above. Funds are typically organized under state law as 
a form of trust or corporation that is not required to hold an 
annual meeting. See Robert A. Robertson, Fund Governance: Legal 
Duties of Investment Company Directors 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. 
See also footnote 73 and accompanying text.
    \69\ 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. See Section 4(2) of the Investment Company Act 
(``Unit investment trust'' means an investment company which (A) is 
organized under a trust indenture, contract of custodianship or 
agency, or similar instrument, (B) does not have a board of 
directors, and (C) issues only redeemable securities, each of which 
represents an undivided interest in a unit of specified securities, 
but does not include a voting trust.'').
---------------------------------------------------------------------------

    Open-end funds differ from operating companies in the way that 
their shares are purchased and sold. For example, mutual funds sell 
shares that are redeemable, meaning generally that shareholders are 
able to present the shares to the fund at the shareholder's discretion 
and receive the net asset value (``NAV'') per share determined at the 
end of each day.\70\ For funds like mutual funds whose shares do not 
trade on an exchange, it may be less efficient or not possible to 
engage in certain hedging transactions with respect to the fund's 
shares. And although ETF shares

[[Page 8494]]

trade on exchanges, they often trade on the secondary market at prices 
close to the NAV of the shares, rather than at discounts or premiums to 
NAV.
---------------------------------------------------------------------------

    \70\ The term ``redeemable,'' as used with respect to fund 
shares, refers to shares that are redeemable at the discretion of 
the investor holding the shares. See Section 2(a)(32) of the 
Investment Company Act (defining the term ``redeemable security''). 
Closed-end fund shares, in contrast, generally are not redeemable, 
and these shares trade at negotiated market prices, including on 
national securities exchanges.
---------------------------------------------------------------------------

    Based on these considerations, the proposed amendments would not 
require funds, other than listed closed-end funds, to provide the 
proposed disclosure.
    We are, however, proposing to require listed closed-end funds to 
provide Item 407(i) disclosure. Although listed closed-end funds are 
similar to other funds in certain respects, including with respect to 
their management structure and regulatory regime, there are several 
features of listed closed-end funds that may make requiring the Item 
407(i) disclosure appropriate. Shares of listed closed-end funds, 
unlike mutual fund shares, trade at negotiated market prices on a 
national securities exchange and are not redeemable from the funds. The 
shares thus may, and often do, trade at a ``discount,'' or a price 
below the NAV per share.\71\ Requiring listed closed-end funds to 
provide the proposed disclosure would allow shareholders to know if a 
listed closed-end fund permits its directors and employees (if any) to 
hedge the value of the fund's securities held by these persons and thus 
whether they, like the fund's other shareholders, would receive that 
discounted price upon a sale of the shares without an offset from any 
hedging transactions. This information may be important to the voting 
decision of an investor when evaluating the extent to which a fund 
director or employee's interest is aligned with that of the fund's 
other shareholders, including in considering whether the director or 
employee may be more or less incentivized as a result of holding shares 
in the fund to seek to decrease the discount. It also may be more 
efficient to engage in certain hedging transactions with respect to 
shares of a listed closed-end fund as compared to certain other types 
of funds. Market participants can and do sell these types of fund 
shares short, for example.\72\ Hedging transactions might thus be more 
likely with respect to shares of listed closed-end funds, and thus 
potentially of greater interest to those funds' shareholders.
---------------------------------------------------------------------------

    \71\ Based on staff review of information available from 
Morningstar Direct and filings with the Commission.
    \72\ Based on staff review of market data available from the 
Bloomberg Professional service.
---------------------------------------------------------------------------

    Finally, unlike other types of funds as discussed above, listed 
closed-end funds generally are required to hold annual meetings of 
shareholders.\73\ Listed closed-end funds thus more closely resemble 
operating companies that would be subject to the proposed disclosure 
requirements in this respect.\74\ We also note that officers and 
directors of listed closed-end funds, like officers and directors of 
emerging growth companies and smaller reporting companies which would 
be subject to the proposed disclosure requirements as discussed below, 
are subject to the requirement in Section 16(a) of the Exchange Act to 
report hedging transactions.\75\
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    \73\ See, e.g., Section 302.00 of the New York Stock Exchange's 
Corporate Governance Standards (``Listed companies are required to 
hold an annual shareholders' meeting during each fiscal year.'').
    \74\ Listed closed-end funds also are similar to operating 
company issuers in other respects. For example, listed closed-end 
funds, like operating companies, do not issue redeemable securities 
(i.e., at the option of the holder); rather, they issue securities 
in traditional underwritings, which are subsequently listed on an 
exchange or traded in the over-the-counter markets. In addition, 
listed closed-end funds and operating companies each may be able to 
issue preferred shares and are not restricted in the amount of 
illiquid assets they may hold, although the assets of an operating 
company are generally more illiquid than the securities held by a 
listed closed-end fund.
    \75\ See Section 30(h) of the Investment Company Act (``Every 
person who is . . . an officer, director, member of an advisory 
board, investment adviser, or affiliated person of an investment 
adviser of [a registered closed-end fund] shall in respect of his 
transactions in any securities of such company (other than short-
term paper) be subject to the same duties and liabilities as those 
imposed by section 16 of the Securities Exchange Act of 1934 upon 
certain beneficial owners, directors, and officers in respect of 
their transactions in certain equity securities.'').
---------------------------------------------------------------------------

    For all of these reasons and those discussed in Section IV below, 
we propose to require listed closed-end funds to provide Item 407(i) 
disclosure and to exclude all other registered investment companies 
from these requirements. We request comment below on this proposed 
approach and, more generally, on the application of the proposed 
disclosure requirements to funds, including whether these requirements 
should apply to additional specific types of funds, such as ETFs. We 
seek input and data on the prevalence of hedging by employees and 
directors for all registered investment companies.
b. Emerging Growth Companies and Smaller Reporting Companies
    We do not propose to exempt smaller reporting companies or emerging 
growth companies from Item 407(i) disclosure. We are not aware of any 
reason why information about whether a company has policies affecting 
the alignment of shareholder interests with those of employees and 
directors would be less relevant to shareholders of an emerging growth 
company or a smaller reporting company than to shareholders of any 
other company. In this regard, we believe it is consistent with the 
statutory purpose of Section 14(j) to require these companies to 
provide disclosure about their hedging policies. Moreover, given its 
narrow focus, the proposed disclosure is not expected to impose a 
significant compliance burden on companies. For these reasons, the 
proposed disclosure would apply to smaller reporting companies and 
emerging growth companies to the same extent as other companies subject 
to the federal proxy rules.
    We acknowledge that the JOBS Act excludes emerging growth companies 
from some, but not all, of the provisions of Title IX of the Act, of 
which Section 955 is a part,\76\ and that emerging growth companies and 
smaller reporting companies are in many instances subject to scaled 
disclosure requirements, including with respect to executive 
compensation.\77\ We believe that it would be more consistent with our 
historical approach to corporate governance related disclosures,\78\ as 
well as the statutory objectives of Section 14(j), not to exempt these 
companies from the proposed disclosure requirement. We recognize that, 
since emerging growth companies and smaller reporting companies are not 
required to provide CD&A disclosure required by Item 402(b) and 
therefore may not have had the occasion to consider a hedging policy, 
these companies may have a greater initial cost than companies that 
already have a policy or already disclose one. Further, these companies 
would also have on-going costs implementing and administering their 
policies. On balance, however, we believe the proposed rule would not 
constitute a substantial, incremental burden for smaller reporting 
companies or emerging growth companies.
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    \76\ Section 102 of the JOBS Act exempts emerging growth 
companies 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.
    \77\ See Section 102(c) of the JOBS Act and Item 402(l) of 
Regulation S-K.
    \78\ 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 that provides 
a phase-in period for smaller reporting companies from the 
disclosure required by Item 407(d)(5) of Regulation S-K and does not 
require smaller reporting companies to provide the disclosures 
required by Item 407(e)(4) and (5) of Regulation S-K. In addition, 
as noted above, officers and directors at smaller reporting 
companies and emerging growth companies are subject to the 
obligation under Exchange Act Section 16(a) to report transactions 
involving derivative securities.

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[[Page 8495]]

    In light of what we believe to be the minimal burden imposed by 
proposed Item 407(i) in terms of additional disclosure and the time 
necessary to prepare it, we are not proposing a delayed implementation 
schedule for smaller reporting companies and emerging growth companies. 
We are requesting comment, however, on the need for either an exemption 
for smaller reporting companies or emerging growth companies or a 
delayed implementation schedule for these companies.
c. Foreign Private Issuers
    As noted above, Section 14(j) calls for disclosure in any proxy or 
consent solicitation material for an annual meeting of the shareholders 
of the issuer. Because securities registered by a foreign private 
issuer are not subject to the proxy statement requirements of Exchange 
Act Section 14,\79\ foreign private issuers would not be required to 
provide Item 407(i) disclosure.
---------------------------------------------------------------------------

    \79\ Exchange Act Rule 3a12-3(b) [17 CFR 240.3a12-3(b)] 
specifically exempts securities registered by a foreign private 
issuer from Exchange Act Sections 14(a) and 14(c).
---------------------------------------------------------------------------

Request for Comment
    13. Should Item 407(i) disclosure be required whenever action is 
taken with respect to the election of directors, as proposed? Instead, 
should we require disclosure in any proxy or information statement 
relating to an annual meeting of shareholders, irrespective of whether 
directors are to be elected at that meeting? Should the disclosure be 
limited only to annual meetings, and not special meetings, even if 
directors are to be elected at a special meeting?
    14. Should proposed Item 407(i) disclosure also be required in 
Securities Act and Exchange Act registration statements? Should it be 
required in Exchange Act annual reports on Form 10-K? Would such 
information be material to investors in any of those contexts?
    15. To retain consistency in the corporate governance disclosure 
provided in proxy statements and information statements with respect to 
the election of directors, Item 407(i) disclosure as proposed would 
apply to Schedule 14C as well as Schedule 14A. Is there any reason that 
the proposed Item 407(i) disclosure should be limited to issuers that 
are soliciting proxies? Why or why not?
    16. In addition to including the new disclosure requirement, the 
proposed amendment to Item 7 of Schedule 14A would amend this Item to 
more succinctly organize its current provisions without changing the 
substance. As so revised, would the requirements of Item 7 be easier to 
understand? Alternatively, should we retain the current structure of 
Item 7, with the addition of the Item 407(i) disclosure?
    17. We propose to amend the CD&A requirement of Item 402(b) of 
Regulation S-K to add an instruction providing that the obligation 
under that item requirement to disclose material policies on hedging by 
named executive officers in a proxy or information statement with 
respect to the election of directors may be satisfied by a cross 
reference to the Item 407(i) disclosure in that document to the extent 
that the information disclosed there satisfies this CD&A disclosure 
requirement. Is there an alternative way to avoid possibly duplicative 
hedging disclosure in these proxy and information statements?
    18. Is there a better way to align the requirements of Item 402(b) 
of Regulation S-K and proposed Item 407(i) of Regulation S-K? Are there 
circumstances in which the current CD&A requirement in Item 402(b) of 
Regulation S-K would result in more complete disclosure about the 
company's hedging policies than what would be required under proposed 
Item 407(i)? For example, although Section 14(j) addresses only hedging 
of equity securities, would disclosure of employees' and directors' 
ability to hedge other securities further the statutory purpose? In 
this regard, should we expand the proposed disclosure in Item 407(i) to 
include debt securities?
    19. We request comment on all aspects of the proposed disclosure 
requirements as applied to funds, including whether all funds or 
additional types of funds other than listed closed-end funds should be 
required to provide the proposed disclosure. Should we require all 
funds, including mutual funds and ETFs, to provide the proposed 
disclosure? Should we, instead, require different specific types of 
funds to provide the proposed disclosure? For example, should we 
require ETFs to provide the proposed disclosure? Would shareholders in 
mutual funds, ETFs, or other types of funds benefit from the 
information provided by the proposed disclosure?
    20. If we were to require additional types of funds to provide the 
proposed disclosure, why and how, if at all, should we modify the 
disclosure requirements for such funds? As noted above, some ETFs are 
organized as UITs, which do not have boards of directors, and ETFs 
generally do not hold annual meetings of shareholders. How should any 
disclosure under Section 14(j) accommodate these or other 
characteristics of ETFs if we were to require ETFs to provide the 
proposed disclosure?
    21. Are there additional characteristics of funds that we should 
consider in determining which funds should be required to provide the 
proposed disclosure or whether the disclosure requirements should be 
modified for funds or particular types of funds? If we were to require 
some or all funds to provide the proposed disclosure, including listed 
closed-end funds as proposed, what are the benefits and costs expected 
to result?
    22. Should we modify the Item 407(i) disclosure requirements for 
listed closed-end funds? Would this information be material to an 
investor in contexts other than those relating to voting decisions, 
such as an investment decision? Should we also require the disclosure 
in listed closed-end funds' other disclosure documents, such as an 
annual report or shareholder report next following a meeting of 
shareholders, for example? If we were to require all funds or a broader 
group of funds to provide Item 407(i) disclosure, should we also 
require the disclosure in other disclosure documents, such as the 
funds' Statements of Additional Information?
    23. As proposed, listed closed-end funds would be required to 
provide proposed Item 407(i) disclosure. Should we not require listed 
closed-end funds to provide this disclosure? If so, please explain why, 
and the benefits and costs that would result.
    24. Do funds generally have policies concerning their employees and 
directors engaging in hedging transactions of securities issued by 
their respective funds, or policies that prohibit such hedging 
transactions? To what extent do employees or directors of listed 
closed-end funds receive shares of such funds as a form of 
compensation? Do employees or directors of listed closed-end funds 
currently effect hedging transactions with respect to the shares of 
those funds and, if so, what kinds of transactions do they effect?
    25. How could employees or directors effect hedging transactions 
with respect to shares of funds other than listed-closed end funds, in 
particular mutual funds? How prevalent are these hedging transactions?
    26. As proposed, listed closed-end funds, like the other issuers 
covered by the proposed amendments, would be required to provide 
disclosure concerning hedging of the equity securities issued by the 
fund or any of the fund's parents, subsidiaries or subsidiaries of the 
fund's parents that

[[Page 8496]]

are registered under Section 12 of the Exchange Act.\80\ Should we 
instead require listed closed-end funds to provide disclosure only 
about hedging transactions concerning the funds' shares? Would 
investors in listed closed-end funds benefit from receiving information 
about the funds' directors' and employees' holdings of the funds' 
parents, subsidiaries or subsidiaries of the fund's parents?
---------------------------------------------------------------------------

    \80\ Item 22 of Schedule 14A defines terms used in that Item, 
including the terms parent and subsidiary. Item 22(a)(1)(ix) defines 
the term ``parent'' to mean ``the affiliated person of a specified 
person who controls the specified person directly or indirectly 
through one or more intermediaries.'' Item 22(a)(1)(xii) defines the 
term ``subsidiary'' to mean ``an affiliated person of a specified 
person who is controlled by the specified person directly, or 
indirectly through one or more intermediaries.''
---------------------------------------------------------------------------

    27. As proposed, business development companies would be required 
to provide proposed Item 407(i) disclosure. Should we modify the 
disclosure requirements for business development companies? Should we 
not require business development companies to provide this disclosure? 
If so, please explain why, and the benefits and costs that would 
result. Should we only require a business development company to 
provide the proposed disclosure if the business development company's 
shares are listed on a national securities exchange?
    28. Should smaller reporting companies or emerging growth companies 
be exempted from proposed Item 407(i) or subject to a delayed 
implementation schedule? If so, please explain why and the benefits and 
costs that would result. As discussed below, a component of the 
disclosure costs (especially initial costs) may be fixed, which may 
have a greater impact on smaller reporting companies and emerging 
growth companies. Do the proposed disclosure requirements also impose 
other potential costs on smaller reporting companies or emerging growth 
companies that are different in kind or degree from those imposed on 
other companies?) Would the proposed disclosure requirements be as 
meaningful for investors in smaller reporting companies and emerging 
growth companies as for those in other companies? Do investors in 
smaller reporting companies and emerging growth companies place more, 
less, or the same value on corporate governance disclosures of the type 
proposed here than do investors in larger, more established companies, 
either alone or in relation to other disclosures?
    29. Should foreign private issuers be required to provide the 
disclosure? If so, please explain why and specify the filing(s) in 
which the disclosure should be required?
    30. Are there any other categories of issuers that should be exempt 
from the requirement to provide Item 407(i) disclosure? If so, please 
explain why, and the benefits and costs that would result.
General Request for Comment
    We request and encourage any interested person to submit comments 
on any aspect of our proposals, other matters that might have an impact 
on the proposed amendments, and any suggestion for additional changes. 
With respect to any comments, we note that they are of greatest 
assistance to our rulemaking initiative if accompanied by supporting 
data and analysis of the issues addressed in those comments and by 
alternatives to our proposals where appropriate.

IV. Economic Analysis

A. Background

    Section 955 of the Act added Section 14(j) to the Exchange Act, 
which directs the Commission to adopt rules requiring an issuer to 
disclose in any proxy or consent solicitation material for an annual 
meeting of its shareholders whether any employee or director of the 
issuer, or any designee of an employee or director, is permitted to 
engage in transactions to hedge or offset any decrease in the market 
value of equity securities granted to the employee or director as 
compensation, or held directly or indirectly by the employee or 
director.
    To implement the mandate of Section 14(j), we are proposing new 
paragraph (i) of Item 407 of Regulation S-K and amendments to Schedule 
14A under the Exchange Act. Further, to reduce potentially duplicative 
disclosure, we propose to allow a company to satisfy its obligation to 
disclose material policies on hedging by named executive officers in 
the CD&A by cross reference to the information disclosed under proposed 
Item 407(i) to the extent that the information disclosed there 
satisfies this CD&A disclosure requirement.
    We are mindful that our proposed amendments can both impose costs 
and confer benefits. Exchange Act Section 3(f) requires us, when 
engaging in rulemaking that requires us to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition and capital formation. 
Exchange Act Section 23(a)(2) requires us, when adopting rules under 
the Exchange Act, to consider the impact that any new rule would have 
on competition and not to adopt any rule that would impose a burden on 
competition that is not necessary or appropriate in furtherance of the 
purposes of the Exchange Act.
    The discussion below addresses the economic effects of the proposed 
amendments, including likely benefits and costs, as well as the likely 
effect of the proposal on efficiency, competition and capital 
formation. We request comment throughout this release on alternative 
means of meeting the statutory mandate of Section 14(j) and on all 
aspects of the costs and benefits of our proposals and possible 
alternatives. We also request comment on any effect the proposed 
disclosure requirements may have on efficiency, competition and capital 
formation. We appreciate comments on costs and benefits that are 
attributed to the statute itself and, to the extent that they are 
separable, the costs and benefits that are a result of policy choices 
made by the Commission in implementing the statutory requirements, as 
well as any data or analysis that helps quantify the potential costs 
and the benefits identified.

B. Baseline

    The proposed amendments affect all issuers registered under Section 
12 of the Exchange Act, including smaller reporting companies 
(``SRCs''), emerging growth companies (``EGCs''), and listed closed-end 
funds, but excluding foreign private issuers (``FPIs''), and other 
types of registered investment companies, including non-listed closed-
end funds, open-end funds, and unit investment trusts. We estimate that 
approximately 7,447 companies would be subject to the proposed 
amendments, including 4,620 listed Exchange Act Section 12(b) 
registrants and 2,827 non-listed Exchange Act Section 12(g) 
registrants. Among the Section 12(b) registrants subject to the 
proposed amendments, we estimate that 602 are listed closed-end funds, 
916 are SRCs or EGCs, and the remaining 3,102 are other operating 
companies. Among the Section 12(g) registrants subject to the proposed 
amendments, 2,220 are SRCs or EGCs, and the remaining 607 are operating 
companies that are not SRCs or EGCs.\81\

[[Page 8497]]

Other affected parties include these issuers' employees (including 
officers) and directors who hold equity securities of these issuers, 
and investors in general. Because almost all listed closed-end funds 
are externally managed by investment advisers and only a small number 
of listed closed-end funds are internally managed where the portfolio 
managers are employees of the closed-end funds, the proposed amendments 
will generally affect the funds' employees and directors; employees of 
the funds' investment advisers (e.g., portfolio managers) will not be 
affected by the amendments.\82\ Equity securities covered by the 
proposed amendments include equity securities issued by the company, 
any parent of the company, any subsidiary of the company or any 
subsidiary of any parent of the company that are registered under 
Section 12 of the Exchange Act.\83\
---------------------------------------------------------------------------

    \81\ We estimate the number of operating companies subject to 
the proposed amendments by analyzing companies that filed annual 
reports on Form 10-K in calendar year 2012 with the Commission. This 
set excludes ABS issuers (SIC 6189), registered investment 
companies, issuers that have filed registration statements but have 
yet to file Forms 10-K with the Commission, and foreign issuers 
filing on Forms 20-F and 40-F. We identify the companies that have 
securities registered under Section 12(b) or Section 12(g) from Form 
10-K. We also determine from Form 10-K whether a company is a SRC. 
We determine whether a company is an EGC by reviewing both its Form 
10-K and any registration statement. We estimate the number of 
listed closed-end funds based upon data from the 2014 Investment 
Company Fact Book, page 170 (available at http://www.ici.org/pdf/2014_factbook.pdf).
    \82\ Among the approximately 602 listed closed-end funds in 
2012, Commission staff has identified only 4 internally-managed 
closed-end funds from a review of filings with the Commission.
    \83\ In some instances, equity of a company's subsidiary may be 
granted as compensation for that company's officers (He et al. 
2009). Stock holdings in a company's subsidiary provide officers 
with an incentive to make decisions to improve the subsidiary's 
performance, which in turn may positively affect the economic 
prospects of the parent company. As discussed later, it is important 
for shareholders (of both the company and its subsidiary) to better 
understand whether incentives can be reduced by hedging. See He W., 
M. K. Tarun, and P. Wei, 2009, ``Agency Problems in Tracking Stock 
and Minority Carve-out Decisions: Explaining the Discrepancy in 
Short- and Long-term Performances'' Journal of Economics and Finance 
33(1): 27-42.
---------------------------------------------------------------------------

    To assess the economic impact of the proposed amendments, we use as 
our baseline the state of the market as it exists at the time of this 
release. For Section 12 registrants (other than SRCs, EGCs, and listed 
closed-end funds) that are subject to the proposed amendments, the 
regulatory baseline is the current CD&A disclosure requirement in Item 
402(b)(2)(xiii) of Regulation S-K. Item 402(b)(2)(xiii) calls for 
disclosure of ``any registrant policies regarding hedging the economic 
risk'' of security ownership by named executive officers as one of the 
``non-exclusive'' examples of information includable in CD&A, if 
material. To the extent that a registrant does not have a policy 
regarding hedging by named executive officers, there is no obligation 
to disclose. For SRCs, EGCs, and listed closed-end funds, CD&A 
disclosure pursuant to Item 402(b)(2)(xiii) is not currently required.
    Additionally, officers and directors of companies with a class of 
equity securities registered under Section 12, including SRCs and EGCs, 
are currently required to report their hedging transactions involving 
the company's equity securities pursuant to Exchange Act Section 16(a). 
Further, Section 30(h) of Investment Company Act specifies that 
officers and directors of closed-end funds are subject to the same 
duties and liabilities as those imposed by Section 16 of the Exchange 
Act.
    Table 1 below draws a comparison between the current requirements 
for CD&A disclosure and Section 16 reporting, where applicable, and the 
proposed disclosure requirement for the registrants that would be 
affected by the proposed amendments.

                                 Table 1--Comparison of Disclosure Requirements
----------------------------------------------------------------------------------------------------------------
                                                                        Current officer &    Company  reporting
                                                      Current company        director        requirement  under
        Covered company            Covered persons       reporting          reporting          the  proposed
                                                        requirement        requirement           amendments
(1)                              (2)...............  (3)..............  (4)..............  (5)
----------------------------------------------------------------------------------------------------------------
12(b) companies other than       NEOs..............  Item 402(b)......  Section 16(a)....
 SRCs, EGCs, and listed closed-
 end funds [Number = 3,102].
                                 Other employees...  None.............  Section 16(a), if
                                                                         an officer.
                                 Directors.........  None.............  Section 16(a)....
12(g) companies other than SRCs  NEOs..............  Item 402(b)......  Section 16(a)....
 and EGCs [Number = 607].
                                 Other employees...  None.............  Section 16(a), if  Item 407(i).\84\
                                                                         an officer.
                                 Directors.........  None.............  Section 16(a)....
SRCs & EGCs under 12(b) [Number  Employees           None.............  Section 16(a), if
 = 916].                          (including NEOs)                       an officer or
                                  & Directors.                           director.
SRCs & EGCs under 12(g) [Number  Employees           None.............  Section 16(a), if
 = 2,220].                        (including NEOs)                       an officer or
                                  & Directors.                           director.
Listed closed-end funds [Number  Employees &         None.............  Section 30(h) of
 = 602].                          Directors.                             the Investment
                                                                         Company Act.
----------------------------------------------------------------------------------------------------------------

[[Page 8498]]

    As illustrated in Table 1, disclosure requirements will increase 
for all companies subject to the proposed amendments, although the 
extent of the increase may vary for different categories of 
registrants.
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    \84\ As proposed, companies would be required to make disclosure 
under proposed Item 407(i) when they file proxy or information 
statements with respect to the election of directors. Proxy 
statement disclosure obligations only arise under Section 14(a), 
however, when an issuer with a class of securities registered under 
Section 12 chooses to solicit proxies (including consents). Since 
the federal securities laws do not require the solicitation of 
proxies, the application of Section 14(a) is not automatic. Whether 
or not an issuer has to solicit therefore depends upon any 
requirement under its charter and/or bylaws, or otherwise imposed by 
law in the state of incorporation and/or by the relevant stock 
exchange (if listed). For example, NYSE, NYSE Market, and NASDAQ 
generally require solicitation of proxies for all meetings of 
shareholders. If a listed company then chooses to hold a meeting at 
which directors are to be elected and solicit proxies, Section 14(a) 
would then apply and compel the disclosure identified in Item 
407(i). Section 12(g)-registered companies also can make the 
decision to solicit proxies and thus similarly will have to comply 
with Section 14(a), to the same extent Section 12(b)-registered 
companies. When Section 12 registrants that do not solicit proxies 
from any or all security holders are nevertheless authorized by 
security holders to take an action with respect to the election of 
directors, disclosure obligations also arise under proposed Item 
407(i) due to the requirement to file and disseminate an information 
statement under Section 14(c).
---------------------------------------------------------------------------

    To establish the baseline practices for Section 12 companies 
subject to Item 402(b)(2)(xiii), we reviewed the disclosures of 
``policies regarding hedging'' by named executive officers from two 
samples of exchange-listed companies. The first sample included all S&P 
500 companies that filed proxy statements during the calendar year 
2012, totaling 484 companies.\85\ Our analysis revealed that 
disclosures are not uniform across companies. Out of the 484 proxy 
statements, 158 companies (33%) did not disclose hedging policies for 
named executive officers, six companies (1%) disclosed that the company 
did not have a policy regarding hedging by named executive officers, 
284 companies (59%) disclosed that named executive officers were 
prohibited from hedging, and 36 companies (7%) disclosed that they 
permitted hedging by named executive officers under certain 
circumstances.
---------------------------------------------------------------------------

    \85\ To be included in the S&P 500 index, the companies must be 
publicly listed on either the NYSE (NYSE Arca or NYSE MKT) or NASDAQ 
(NASDAQ Global Select Market, NASDAQ Select Market or the NASDAQ 
Capital Market). Because this index includes foreign companies, 
there were fewer than 500 proxy statements filed.
---------------------------------------------------------------------------

    The second sample included 100 randomly selected companies from the 
494 S&P Smallcap 600 index companies that filed proxy statements during 
the calendar year 2012. These companies are significantly smaller and 
less widely followed than S&P 500 companies, and, as a result, may have 
significantly different disclosure practices. These companies are all 
exchange-listed, and none are SRCs or EGCs. We found that 71 companies 
(71%) did not disclose hedging policies for named executive officers, 
four companies (4%) disclosed that the company did not have a policy 
regarding hedging by named executive officers, 23 companies (23%) 
disclosed that named executive officers were prohibited from hedging, 
and two companies (2%) disclosed that they permitted hedging by named 
executive officers under certain circumstances.
    Our analysis of the two samples revealed that a significant 
percentage (34%) of S&P 500 companies, and an even larger percentage of 
the subset of S&P Smallcap 600 companies (75%) either did not make a 
disclosure or reported that they did not have a policy for named 
executive officers. This baseline analysis suggests that smaller 
companies will likely have a greater initial disclosure burden under 
the proposed amendments than larger companies.
    As mentioned above, SRCs, EGCs, and listed closed-end funds are not 
required to make Item 402(b) disclosure and, consequently, are not 
currently required to disclose any policies regarding hedging by named 
executive officers. However, officers and directors at SRCs and EGCs 
with a class of equity securities registered under Section 12 are 
currently required to report their hedging transactions involving the 
companies' equity securities pursuant to Section 16(a), and officers 
and directors of registered closed-end funds are required to make 
similar reports by Section 30(h) of the Investment Company Act. 
Notwithstanding these reports, investors' ability to use reported 
insider hedging transactions, if any, to infer these companies' 
policies regarding hedging by officers and directors is imperfect at 
best. First, an investor must track all the accumulated insider trades 
reported to assess whether there is hedging. Disclosures of particular 
hedging transactions by officers and directors could indicate that the 
company permits that particular type of transaction, that the company 
has no hedging policy, or that a company policy was violated but the 
transaction was reported in accordance with current rules. The absence 
of reported hedging transactions could indicate that the company 
prohibits hedging, that the company permits hedging but the officers 
and directors do not engage in hedging transactions, or that officers 
and directors engage in hedging transactions but are not complying with 
Section 16(a) reporting requirements.

C. Discussion of Benefits and Costs, and Anticipated Effects on 
Efficiency, Competition and Capital Formation

1. Introduction
    From an economic theory perspective, an executive officer's 
ownership in the employer company ties his or her financial wealth to 
shareholder wealth, and hence can provide the executive officer with an 
incentive to improve the company's performance, as measured by stock 
price.\86\ Permitting executive officers to hedge can be perceived by 
shareholders as a problematic practice \87\ because hedging can have 
the economic effect of taking a short position on the employer's stock, 
which is counter to the interests of other shareholders.
---------------------------------------------------------------------------

    \86\ The literature in economics and finance typically refers to 
a principal-agent model to describe the employment relationship 
between shareholders and executive officers (managers) at a company. 
The principal (shareholders) hires an agent (manager) to operate the 
company. However, because shareholders cannot perfectly observe 
managerial actions, this information asymmetry gives rise to a moral 
hazard problem: managers may act in their own self-interest and not 
always in the interest of shareholders. This potential misalignment 
of incentives is ameliorated when managers are also owners of the 
company, and thus must internalize the cost of any actions that harm 
shareholders or do not otherwise maximize the value of the company. 
See, e.g., Jensen, M. C. and W. H. Meckling, 1976. ``Theory of The 
Firm: Managerial Behavior, Agency Costs and Ownership Structure'' 
Journal of Financial Economics 3: 305-360; Holmstrom, B., 1979. 
``Moral Hazard and Observability'' Bell Journal of Economics 10: 
324-340; Holmstrom, B. and Ricart I Costa, J., 1986 ``Managerial 
Incentives and Capital Management'', Quarterly Journal of Economics 
101, 835-860.
    \87\ See, e.g., Institutional Shareholder Services Inc., ``2013 
Corporate Governance Policy Updates and Process: Executive 
Summary'', Nov. 16, 2012 at http://www.issgovernance.com/file/files/2013ExecutiveSummary.pdf.
---------------------------------------------------------------------------

    Alternatively, permitting executive officers to hedge, under 
certain circumstances, could align officers' and shareholders' 
preferences more closely and thereby promote more efficient corporate 
investment. Compared with well-diversified shareholders, executive 
officers are likely to be disproportionately invested in their company 
and thus inherently undiversified.\88\ The concentrated financial 
exposure, together with executive officers' concerns about job security 
in the event of a stock price decline, could lead them to take on fewer 
risky projects (i.e., projects with uncertain future cash flows) that 
are potentially value enhancing than would be in the interest of well-
diversified shareholders, resulting in underinvestment.\89\ This

[[Page 8499]]

underinvestment concern can be addressed by providing downside price 
protection to executive officers' equity holdings, in case high-risk 
projects--that are in the interest of shareholders at the time of the 
investment decision--do not turn out to be successful and thereby cause 
a decline in the stock price.\90\ One way to do so is to permit 
executive officers to seek downside price protection by hedging their 
equity holdings. However, the value of hedging to address potential 
underinvestment depends on the availability and cost-effectiveness of 
other solutions to the underinvestment concern.\91\
---------------------------------------------------------------------------

    \88\ Meulbroek (2005) points out that employees may be even more 
undiversified than their equity holdings suggest: ``their continued 
employment and its relation to the fortunes of the firm, outstanding 
deferred compensation owed to the employee, and any firm specific 
human capital exacerbate employees' firm-specific risk exposure.'' 
See Meulbroek, L. 2005, ``Company Stock in Pension Plans: How Costly 
Is It?'' Journal of Law and Economics, vol. XLVIII: 443-474; Hall, 
B., and K. Murphy. 2002. ``Stock options for undiversified 
executives'' Journal of Accounting and Economics 33: 3-42. Moral 
hazard and adverse selection issues cause boards of directors to 
compel executive officers to maintain large personal investment in 
their companies. Executive officers may not be able to diversify 
this exposure because of explicit stock ownership guidelines for 
executives and directors, contractual restrictions on trading equity 
grants within the vesting periods, and retention plans that prohibit 
the sale of unrestricted stock for some time after vesting.
    \89\ This underinvestment concern has been studied in a long 
strand of academic literature. See e.g., Rappaport, A. 1978, 
``Executive Incentives vs. Corporate Growth'' Harvard Business 
Review 57: 81-88; Smith, C., and R. Stulz. 1985. ``The Determinants 
of Firms' Hedging Policies'', Journal of Financial and Quantitative 
Analysis 20: 391-405; Kaplan, R., 1982, ``Advanced Management 
Accounting'' Englewood Cliffs, N. J.: Prentice-Hall; and Lambert, 
R., 1986, ``Executive Effort and the Selection of Risky Projects'' 
Rand Journal of Economics 17, 77-88.
    \90\ See Hemmer, T., O., Kim, and R. Verrecchia, 1999, 
``Introducing Convexity into Optimal Compensation Contracts'' 
Journal of Accounting and Economics 28: 307-327.
    \91\ For example, requiring executive officers to hold stock 
options can also provide them with incentives to take on risky but 
value-enhancing investment projects. Such risk-taking incentives 
depend on option moneyness: the incentives are the strongest when 
options are near the money, but quickly diminish when options go 
deep in the money. If a company experiences a sharp stock price 
increase, which causes executive officers' option holdings to become 
deep in-the-money, such holdings likely would not provide effective 
risk-taking incentives. In this situation, permitting executives to 
hedge may be a better solution to the underinvestment concern than 
for the company to grant new at-the-money options, because the 
latter may cause the company to overpay the executives. Hedging of 
corporate operations, as opposed to personal hedging by executive 
officers, could also increase the executives' incentives to take 
higher risk but value-enhancing corporate projects, but corporate 
hedging can be costly. See Smith C. and R. Stulz, 1985, ``The 
Determinants of Firms' Hedging Policies'' Journal of Financial and 
Quantitative Analysis 20(4): 392-405).
---------------------------------------------------------------------------

    The theories of equity incentives described above for executive 
officers may also apply to critical employees (e.g., key research 
scientists), because these individuals' actions and decisions can also 
impact company stock price. These theories can also apply to directors, 
who typically receive equity-based compensation to align their 
interests with those of the shareholders they represent. However, 
directors may have less incentive to hedge because their financial 
wealth is typically better diversified than executive officers', and is 
therefore less sensitive to company stock price. Nevertheless, 
directors' compensation, particularly in the form of equity 
compensation, grew significantly during the 2000s, contributing to a 
significant increase in directors' equity incentives.\92\ The increased 
level of directors' equity incentives suggests that equity incentives 
could be playing an increasingly important role in influencing 
directors' actions on corporate decisions.
---------------------------------------------------------------------------

    \92\ 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. Yermack (2004) show that, in Fortune 500 companies, some 
directors near the top of the distribution receive very significant 
equity awards that can provide ex-post performance rewards exceeding 
those of some CEOs. Altogether, equity holdings, turnover, and 
opportunities to obtain new board seats provide outside directors 
serving in their fifth year with wealth increases of approximately 
11 cents per $1,000 rise in firm value. Although typically smaller 
than incentives for CEOs, director incentives can be significant 
given that many directors serve on multiple boards. See Yermack, D. 
2004, ``Remuneration, Retention, and Reputation Incentives for 
Outside Directors'', The Journal of Finance LIX: 2281-2308; Farrell 
K., G. Friesen, and P. Hersch, 2008, ``How Do Firms Adjust Director 
Compensation?'', Journal of Corporate Finance 14: 153-162; J. Linck, 
J. Netter, and T. Yang, 2009, ``The Effects and Unintended 
Consequences of the Sarbanes-Oxley Act on the Supply and Demand for 
Directors'', The Review of Financial Studies 22: 3287-3328; and 
Fedaseyeu V., J. Linck, and H. Wagner, 2014, ``The Determinants of 
Director Compensation'' Bocconi University and Southern Methodist 
University working paper (available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id= 2335584). Note that these studies used 
samples prior to 2011; however, we have no reason to believe that 
director incentives and compensation have declined significantly in 
more recent years.
---------------------------------------------------------------------------

    These theories of equity incentives may not apply to employees who 
do not participate in making and shaping key operating or strategic 
decisions that influence stock price. While some of these employees may 
also receive equity grants as part of the companies' broad-based equity 
plans, their equity ownership on average is much lower than that of 
executive officers. Equity ownership for these employees mainly serves 
the purpose of recruitment and job retention, and on an individual 
employee basis, is unlikely to have a notable impact on the company's 
equity market value.\93\ In other words, for employees below the 
executive level who typically do not make decisions that influence 
stock price, information about their equity incentives and hedging of 
their equity holdings may be less relevant for investors.
---------------------------------------------------------------------------

    \93\ See Oyer, P. 2002, ``Stock Options--It's Not Just About 
Motivation'', Stanford Institute for Economic Policy Research 
(available at http://web.stanford.edu/group/siepr/cgi-bin/siepr/?q=system/files/shared/pubs/papers/briefs/policybrief_oct02.pdf); 
Oyer, P. and S. Schaefer, 2005, ``Why Do Some Firms Give Stock 
Options to All Employees?: An Empirical Examination of Alternative 
Theories'', Journal of Financial Economics 76 (1): 99-133.
---------------------------------------------------------------------------

    Like operating companies, listed closed-end funds also confront a 
principal-agent relationship between shareholders and the fund's 
directors and employees, if any. The connection between managerial 
incentives and firm performance is, however, less direct in listed 
closed-end funds than it is in operating companies because almost all 
of these funds are externally managed by investment advisers.
    Fund directors oversee the many service providers that will 
typically serve a listed closed-end fund, including the investment 
adviser. Holding equity shares in the fund can align directors' 
interests with those of the shareholders.\94\ Some listed closed-end 
funds do require or encourage directors to hold fund shares.\95\ The 
proposed disclosure thus would allow the shareholders of a listed 
closed-end fund whose shares, for example, are trading at a discount to 
know if the listed closed-end fund permits its directors to hedge the 
value of the fund's equity securities. The proposed disclosure would 
thereby show whether the fund's directors, like the fund's other 
shareholders, would receive that discounted price upon a sale of the 
shares without an offset from any hedging transactions.
---------------------------------------------------------------------------

    \94\ We have previously published the Commission staff's view 
that ``[f]und directors who own shares in the funds that they 
oversee have a clear economic incentive to protect the interests of 
fund shareholders,'' and that fund policies that encourage or 
require independent directors to invest the compensation that they 
receive from the funds in shares of the funds ``gives the 
independent directors a direct and tangible stake in the financial 
performance of the funds that they oversee, and can help more 
closely align the interests of independent directors and fund 
shareholders.'' See Interpretive Matters Concerning Independent 
Directors of Investment Companies, Investment Company Act Release 
No. 24083 (Oct. 14, 1999).
    \95\ Zhao (2007) studies 316 closed-end funds in 2002. She finds 
that 200, or 62.3%, report positive director ownership. The average 
(median) director ownership is at $105,493 ($30,001). See Zhao, L., 
2007, ``Director Ownership and Fund Value: Evidence from Open-End 
and Closed-End Funds'', Columbia University working paper (available 
at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=963047).
---------------------------------------------------------------------------

    In an operating company, shareholdings also affect the incentives 
of employees, including managers who are making the company's 
decisions. In contrast, almost all listed closed-end funds have few (if 
any) employees. Fund portfolios are almost always managed by portfolio 
managers who are employed by external investment advisers. Because 
listed closed-end fund shares are not redeemable and often trade at a 
discount to NAV, shareholders of those funds may place importance on 
the degree of incentive alignment between funds' key decision makers 
and shareholders when making voting decisions.\96\
---------------------------------------------------------------------------

    \96\ See Wu, Y., R. Wermers, and J. Zechner, 2013, ``Managerial 
Rents vs. Shareholder Value in Delegated Portfolio Management: The 
Case of Closed-End Funds'' working paper. Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2179125&download=yes.

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[[Page 8500]]

    The proposed amendments apply only to employees and directors of 
the fund itself, however. As a result, these amendments would not 
directly affect outside portfolio managers' asset choices. However, 
fund directors may influence the investment adviser's management of the 
fund's portfolio indirectly, through the directors' oversight of the 
investment adviser, which is responsible for managing the fund's 
portfolio consistent with the fund's disclosed strategy and investment 
objectives.
    In summary, information on the company's policies regarding hedging 
by employees and directors may help investors better understand the 
employees' and directors' incentives in creating shareholder wealth. 
For example, in operating companies, because executive officers' and 
directors' reported equity holdings in proxy statements may not reflect 
their actual economic exposure to the company's performance, there may 
in certain cases exist an information asymmetry between insiders and 
other investors regarding the executive officers' and directors' equity 
incentives. The mandated disclosures can help mitigate this information 
asymmetry.
2. New Disclosure Requirements Across Covered Companies
    Before considering the economic effects from proposed Item 407(i), 
we first discuss the new disclosures that would be required for 
different covered companies, and the new information from these 
disclosures. The potential economic effects would likely vary across 
companies depending on the nature and amount of new information from 
the disclosures, the degree of investment opportunities available to 
the company, and the likelihood that employees and directors engage in 
hedging transactions (discussed in detail later).
    Section 12 registrants, with the exception of SRCs, EGCs, and 
registered investment companies (which include listed closed-end 
funds), are currently required under Item 402(b) to disclose their 
hedging policies for named executive officers, if material. Companies 
are not otherwise currently required to provide information about 
whether they have a policy on hedging. They may not be providing such 
disclosures, possibly because their hedging policies are not material, 
or because they do not have a policy. Table 2 divides covered 
companies, which includes both operating companies and listed closed-
end funds, into four categories. The first three categories include 
operating companies. The last category includes listed closed-end 
funds.

              Table 2--Four Categories of Covered Companies
------------------------------------------------------------------------
         Section 12 Companies Subject to the Proposed Amendments
-------------------------------------------------------------------------
(1) Companies that are subject to Item 402(b) and make disclosures for
 named executive officers.
(2) Companies that are subject to Item 402(b) but make no disclosures.
(3) SRCs and EGCs that are not currently required to make Item 402(b)
 disclosures but must disclose under Item 407(i).
(4) Listed closed-end funds that are not currently required to make Item
 402(b) disclosures but must disclose under Item 407(i).
------------------------------------------------------------------------

    Category 1 refers to the subset of companies subject to Item 402(b) 
that currently provide disclosure about hedging policies for named 
executive officers. These companies may be unlikely to change such 
policies as a result of the proposed amendments. For these companies, 
the new disclosures required under proposed Item 407(i) are whether 
employees (other than named executive officers) and directors are 
permitted to hedge.
    Category 2 refers to companies subject to Item 402(b) that do not 
currently disclose information about whether hedging by their named 
executive officers is permitted.\97\ New disclosures under the proposed 
amendments would confirm for shareholders whether hedging is permitted. 
Given that shareholders are likely to view a policy prohibiting hedging 
by named executive officers as shareholder friendly,\98\ the 
requirement to disclose may prompt some of these companies to adopt new 
policies or change their current policies or practices. In light of the 
required say-on-pay vote on executive compensation, we believe that 
companies prohibiting hedging by named executive officers would already 
have an incentive to disclose such a policy. Some shareholders may 
believe it is reasonable to infer that a company that is subject to 
Item 402(b) but does not disclose a hedging policy in effect may permit 
named executive officers to hedge. As a result, because shareholders 
either know through affirmative disclosure under Item 402(b)(2)(xiii) 
or may believe it is reasonable to infer from the absence of disclosure 
that named executive officers are permitted to hedge, the proposed 
amendments may not have much effect in reducing uncertainty as it 
relates to named executive officers. For Section 12 registrants other 
than SRCs, EGCs and listed closed-end funds, the new information 
provided by disclosures under the proposed amendments relates primarily 
to whether employees (other than named executive officers) and 
directors are permitted to hedge.
---------------------------------------------------------------------------

    \97\ For example, as discussed above, we collected data on the 
baseline practice of some Section 12(b) registrants other than SRCs 
and EGCs. The proxy statements filed during calendar year 2012 
indicated that most of the S&P 500 companies disclosed their hedging 
policies for named executive officers: 59% of companies prohibited 
hedging, while 7% permitted hedging. The rest either made no 
disclosure of hedging policy (33% of companies) or disclosed that 
they did not have a policy regarding hedging by named executive 
officers (1% of companies); we include such companies in category 2. 
The incidence of no disclosure tended to be higher among smaller 
companies.
    \98\ See, e.g., Institutional Shareholder Services Inc., ``2013 
Corporate Governance Policy Updates and Process: Executive 
Summary'', Nov. 16, 2012 at http://www.issgovernance.com/file/files/2013ExecutiveSummary.pdf (``Stock-based compensation or open market 
purchases of company stock are intended to align executives' or 
directors' interests with those of shareholders. Therefore, hedging 
of company stock through covered call, collar, or other derivative 
transactions severs the ultimate alignment with shareholders' 
interests. Any amount hedged will be considered a problematic 
practice warranting a negative voting recommendation on the election 
of directors.'').
---------------------------------------------------------------------------

    Category 3 refers to SRCs and EGCs, which are currently exempt from 
Item 402(b). The new information available to investors under proposed 
Item 407(i) would require disclosure, for the first time, about whether 
employees (including named executive officers) and directors are 
permitted to hedge.
    Category 4 refers to listed closed-end funds. Since these funds are 
not currently subject to Item 402(b), the new information that would be 
available to shareholders is comparable in type to that of SRCs and 
EGCs. However, the new information about listed closed-end funds may in 
fact be less substantial than that of SRCs and EGCs for most funds 
because almost all listed closed-end funds are externally managed, as 
discussed above. Only a small number of internally-managed listed 
closed-end funds have employees, which include funds' portfolio 
managers.

[[Page 8501]]

3. Benefits and Costs
    Investors can benefit from the disclosures under the proposed 
amendments in the following ways.\99\ First, as discussed above, 
officers', directors', and non-officer critical employees' equity 
incentives tend to align their interests with those of the 
shareholders. Under the proposed amendments, investors would benefit 
from new disclosures that provide more clarity and transparency about 
these incentives, thereby reducing the information asymmetry between 
corporate insiders and shareholders regarding such incentives. Better 
information about equity incentives could be useful for investors' 
evaluation of companies, enabling investors to make more informed 
investment and voting decisions, thereby encouraging more efficient 
capital allocation decisions.
---------------------------------------------------------------------------

    \99\ Our discussion focuses on officers and non-officer critical 
employees, not on employees who do not participate in making and 
shaping key operating or strategic decisions that influence stock 
price. As discussed earlier, information about these other 
employees' equity incentives and hedging of their equity holdings is 
less relevant for investors.
---------------------------------------------------------------------------

    Second, the proposed amendments may reduce the costs for investors 
in researching and analyzing equity-based incentives. Knowledge that 
employees and directors are not permitted to hedge could confirm for 
investors that the reported equity holdings of officers and directors 
in proxy statements and annual reports on Form 10-K represent their 
actual incentives.\100\ While Section 16(a) reports provide 
transaction-level information on officer and director hedging activity, 
Forms 3, 4, and 5 may be costly to search; investors also may incur 
costs in analyzing whether a reported transaction is indeed a hedge. 
Moreover, hedging activity disclosed on a Form 3, 4, or 5 does not 
indicate whether a transaction was conducted in accordance with the 
company's hedging policy, and therefore may lead to improper inferences 
about the company's hedging policy.
---------------------------------------------------------------------------

    \100\ Between 1996 and 2006, in firms where insiders hedged 
their equity ownership, insiders on average used collars, forwards 
or swaps to cover about 30% of their ownership and placed about 9% 
of their ownership into the exchange funds. See Bettis, C., J. 
Bizjak, and S. Kalpathy, 2013, ``Why Do Insiders Hedge Their 
Ownership? An Empirical Examination'' working paper (available at 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364810). There 
is limited research on hedging transactions by corporate insiders. 
Hedging transactions studied in this paper included those by 10% 
owners. In addition, the sample period was 1996-2006, and thus the 
findings may not reflect the current situation.
---------------------------------------------------------------------------

    Third, the proposed amendments could also benefit investors if the 
public nature of the required disclosures results in changes in hedging 
policies that improve incentive alignment between shareholders and 
executive officers or directors.\101\ Companies that currently already 
disclose whether named executive officers are permitted to hedge may be 
unlikely to substantially change their policies as a result of the 
proposed amendments. However, this could be different for companies 
that do not currently make disclosures on hedging policies for all 
employees or directors.\102\ Without disclosed hedging policies, these 
companies may in fact implicitly permit hedging. However, permitting 
hedging may not necessarily promote efficient investment decisions. 
Employees and directors often demand a premium for receiving equity 
compensation in lieu of cash. However, through hedging they may be able 
to convert the value of that premium into cash. This causes the company 
to overpay relative to its opportunity cost.\103\ If, in light of the 
disclosure requirement under Item 407(i), the company later chooses to 
prohibit hedging, this change could increase shareholder wealth to the 
extent that the change better aligns incentives and hence induces 
officers and directors to make corporate decisions that are more 
beneficial to all shareholders. However, to the extent that changes in 
hedging policies reduce incentive alignment between shareholders and 
officers or directors, and results in underinvesting in potentially 
value-enhancing projects, the opposite effect could result.
---------------------------------------------------------------------------

    \101\ Alternatively, as discussed later, if the change in 
hedging policies reduces incentive alignment, such change can reduce 
shareholder wealth.
    \102\ Such companies include any company that currently does not 
disclose a hedging policy for any category of employees (including 
named executive officers) and directors, so could fall under any of 
the last three categories of companies in Table 2.
    \103\ See Larcker D. and B. Tayan, 2010,''Pledge (and Hedge) 
Allegiance to the Company'', Stanford Closer Look Series, available 
at http://ssrn.com/abstract=1690746.
---------------------------------------------------------------------------

    The benefits discussed above are relevant for investors of all 
companies affected by proposed Item 407(i), including listed closed-end 
funds.\104\ Among operating companies (the first three categories in 
Table 2), the new information elicited from the required disclosures 
increases, so we expect the benefits from the new disclosures also to 
increase similarly. Further, we expect the potential benefits to be 
higher for EGCs and SRCs (category 3) than for non-EGCs and non-SRCs 
(categories 1 and 2), because EGCs and SRCs potentially face greater 
risk of a stock price decline than non-EGCs and non-SRCs. EGCs are 
typically younger firms with high growth options but fewer financial 
resources and are more likely to face financial distress since firm age 
is among the most important determinants of probability of 
failure.\105\ Because employees and directors of EGCs and SRCs 
potentially face greater downside price risk than those of non-EGCs and 
non-SRCs, the former have likely stronger incentives to hedge, thus 
making information about permissible hedging activities more relevant 
for shareholders of these companies.\106\
---------------------------------------------------------------------------

    \104\ Because listed closed-end funds exhibit salient 
differences in organizational structure, and hence incentive 
compensation mechanisms, from operating companies, we do not compare 
the economic effects of the proposed amendments between listed 
closed-end funds and operating companies.
    \105\ See Lane, S., Schary, M.,1991,''Understanding the Business 
Failure Rate'', Contemporary Economic Policy 9: 93-105; Kapadia, N. 
2011. ``Tracking Down Distress Risk,'' Journal of Financial 
Economics 102: 167-182
    \106\ Though no study to our knowledge directly examines whether 
insiders of smaller firms tend to hedge more, indirect evidence 
suggests that this is likely the case. For example, Bettis et al. 
(2001) find a total of 87 zero-cost collar transactions by searching 
Forms 3, 4 and 5 filed between January 1996 and December 1998. Firms 
in this sample have total assets with a mean (median) value of $3.4 
billion ($401 million). These firms are much smaller than S&P 500 
companies over the same time period, whose total assets have mean 
(median) of $16.15 billion ($3.84 billion) based on our calculation. 
This comparison indicates that hedging by zero-cost collars is 
disproportionally more frequent in smaller firms. See Bettis, J., J. 
Bizjak, and M. Lemmon. 2001. ``Managerial Ownership, Incentive 
Contracting, and the Use of Zero-cost Collars and Equity Swaps by 
Corporate Insiders'' Journal of Financial and Quantitative Analysis 
36 (3): 345-370.
---------------------------------------------------------------------------

    The benefits to investors also depend on the likelihood that 
officers and directors engage in hedging transactions. Officers and 
directors can hedge by, for example, entering into exchange-traded or 
over-the-counter derivative contracts. In either case, however, when 
the underlying stock is illiquid, the price of the derivatives 
contracts likely reflects the higher risk and cost that would be 
required to dynamically replicate the exposure of the derivatives 
contracts by trading in the underlying stock. As a result, it is likely 
more costly to hedge the risk of more illiquid stock. Though 
undiversified officers and directors have strong incentives to 
diversify (e.g., through hedging), they may not engage in hedging 
transactions if the cost is too high. In companies whose officers and 
directors are less likely to hedge due to high hedging cost, the 
potential benefits to investors from the required disclosures under the 
proposed amendments might be more limited. In the first three 
categories of companies, each category includes both exchange-listed 
and non-exchange-listed

[[Page 8502]]

companies. Since stocks of exchange-listed companies are typically more 
liquid than stocks of non-exchange-listed companies, the potential 
benefits of the new disclosure to investors of non-exchange-listed 
companies may be lower than for exchange-listed ones. It is possible 
that stocks of smaller companies are less liquid, and hence these 
companies may be subject to the same effect.
    The expected potential benefits from proposed Item 407(i) would not 
be achieved without costs. All covered companies would incur costs to 
comply with the proposed amendments. Such costs include both disclosure 
costs, which stem directly from complying with the proposed amendments, 
and potential costs incurred to implement, administer, or revise a 
hedging policy.
    We first focus on disclosure costs, which should increase with the 
amount of new disclosures required under proposed Item 407(i). As 
discussed above, for operating companies (i.e., the three first 
categories in Table 2), the new required disclosures are higher in 
categories 2 and 3 than in category 1, so disclosure costs should also 
be higher in categories 2 and 3. Specifically, category 1 companies 
would incur costs to determine whether employees (other than named 
executive officers) and directors are permitted to engage in hedging 
transactions, and incur costs to provide the required disclosure.
    Category 2 companies are subject to Item 402(b) but do not 
currently disclose any information about whether hedging by their named 
executive officers is permitted. To the extent that these companies 
permit hedging and that required disclosures under the proposed 
amendments do not change this practice, this category of companies 
would incur small additional costs to disclose their hedging policies 
for named executive officers. If these companies instead decide to 
prohibit hedging by named executive officers, they would incur a small 
additional cost to disclose the revised hedging policies, but they 
could incur other costs that could be more significant, which we 
discuss separately below. Similar to category 1, these companies would 
also incur costs to determine and disclose whether directors and 
employees other than named executive officers are permitted to hedge.
    Category 3 companies, i.e., SRCs and EGCs, are not currently 
subject to Item 402(b). They may be less likely than companies subject 
to Item 402(b) to have policies, or to have articulated their 
practices, on whether hedging is permitted for employees (including 
named executive officers) and directors. Some SRCs and EGCs may incur 
costs in formulating policies for the first time, which will likely 
involve obtaining the advice of legal counsel and may also involve 
retaining compensation consultants. These companies would also incur 
costs in presenting the required disclosures in proxy or information 
statements.
    In Category 4, listed closed-end funds, similar to SRCs and EGCs, 
would incur costs to disclose, and possibly to formulate, policies 
regarding hedging by employees and directors. As noted above, the vast 
majority of listed closed-end funds is externally-managed and thus 
would incur costs to disclose whether hedging by employees (if any) and 
directors is permitted. The limited number of listed closed-end funds 
that are internally managed also would incur costs to disclose if 
employees and directors are permitted to hedge with the difference, 
relative to externally-managed listed closed-end funds, that these 
funds will have portfolio managers and others as employees.
    We expect the above disclosure costs to be minimal for these four 
categories of companies. A component of these costs (especially initial 
costs) may be fixed, which may have a greater impact on the smaller 
companies in category 3. While we cannot quantify these disclosure 
costs with precision, many of the costs reflect the burden associated 
with collection and reporting of information that we estimate for 
purposes of the Paperwork Reduction Act (``PRA''). For purposes of the 
PRA, we estimate the total annual increase in paperwork burden for all 
covered companies to be approximately 19,283 hours of in-house 
personnel time and approximately $2,571,200 for the services of outside 
professionals.\107\
---------------------------------------------------------------------------

    \107\ See Section V of the release.
---------------------------------------------------------------------------

    These disclosure costs, however, do not include costs incurred to 
implement, administer, or revise a hedging policy. For example, under 
the proposed amendments, a company that prohibits hedging by directors 
may incur additional costs to implement this policy, e.g., by analyzing 
whether transactions by a director have the effect of hedging.\108\ If 
a company revises its hedging policy as a result of the proposed 
amendments, additional costs may also arise. Such costs could involve 
obtaining the advice of compensation consultants and legal counsel.
---------------------------------------------------------------------------

    \108\ Such costs are only incremental to the extent that the 
company does not already have procedures in place to administer and 
make such determination for named executive officers.
---------------------------------------------------------------------------

    Perhaps most importantly, disclosing whether employees and 
directors are permitted to hedge might lead to changes in hedging 
policies that reduce incentive alignment between shareholders and 
officers or directors, if the current compensation arrangement is 
already in shareholders' interest. Specifically, a company may 
currently permit hedging by executive officers to promote efficient 
investments in risky projects. As discussed above, companies in 
category 1 currently disclose hedging policy for named executive 
officers, and may be unlikely to substantially change their policies 
under proposed Item 407(i). However, companies in categories 2 and 3, 
which do not disclose their hedging policies for named executive 
officers, may currently permit hedging by named executive officers but 
could switch to prohibiting hedging as a result of public disclosure 
under proposed Item 407(i). Such a change in policy, in certain 
instances, could limit executives' ability to arrive at optimal levels 
of economic exposure to the company--i.e., one that leads executives to 
undertake the optimal level of risk in corporate investment decisions 
for the company's shareholders.\109\ To the extent that compensation 
incentives materially affect a firm's value, such changes could result 
in a reduction in shareholder wealth.
---------------------------------------------------------------------------

    \109\ As discussed above, hedging by officers and directors is 
one of the solutions to the underinvestment concern, and the 
significance of such a problem depends on the availability and cost-
effectiveness of other solutions.
---------------------------------------------------------------------------

    We expect this cost from distorted investment incentives to be 
greater for companies in categories 2 and 3 than those in 1, as the 
latter may be unlikely to substantially change their hedging policies. 
However, between categories 2 and 3, it is not clear whether category 3 
(EGCs and SRCs) would incur a higher cost than category 2. On one hand, 
EGCs and SRCs likely have higher growth options than non-EGCs and non-
SRCs. Since the use of equity incentives to induce officers and 
directors to make proper corporate investment decisions is more 
important for companies with higher growth options, the cost from 
distorting investment incentives could be higher for EGCs and SRCs. On 
the other hand, as discussed above, such cost is limited by the 
availability of other cost-effective solutions to the underinvestment 
concern, e.g., requiring an officer to hold stock options. Without 
adequate data, it is difficult to determine whether and when hedging 
would be more prevalent than stock options in providing incentives for 
officers at EGCs and SRCs as compared to non-EGCs and non-SRCs. 
Evidence

[[Page 8503]]

from academic studies shows that reported hedging transactions by 
officers and directors are infrequent; however, officers' option 
holdings are much more prevalent, and the magnitude of CEO options 
holdings is greater in higher-growth firms to provide risk-taking 
incentives.\110\ Taken together, it is not clear whether costs to EGCs 
and SRCs are higher than to companies in category 2.
---------------------------------------------------------------------------

    \110\ See Guay, W., 1999, ``The Sensitivity of CEO Wealth to 
Equity Risk: An Analysis of the Magnitude and Determinants'', 
Journal of Financial Economics 53, 43-71.
---------------------------------------------------------------------------

    The extent of the cost resulting from distorted investment 
incentives not only depends on a company' growth opportunities, but 
also depends on the likelihood that officers and directors engage in 
hedging transactions. As discussed above, we expect officers and 
directors are less likely to hedge when the equity security is more 
illiquid, because hedging cost is higher. As a result, in these 
companies, hedging by officers and directors is less likely to be used 
as a way to address the underinvestment concern in the first place. 
Thus, the cost to these companies from prohibiting hedging when it 
would otherwise be economically beneficial would also likely to be more 
limited. In company categories 1, 2, and 3, each category includes both 
exchange-listed and non-exchange-listed companies; we expect such cost 
to be lower for non-exchange-listed companies than exchange-listed 
companies, because equity securities of the former typically are more 
liquid than equity securities of non-exchange-listed companies. 
Finally, to the extent that equity securities of smaller companies are 
less liquid, these companies may be subject to the same effect.
    The effects resulting from distorted incentives are likely to be 
different between externally-managed listed closed-end funds and 
internally-managed listed closed-end funds. As discussed above, 
portfolio managers for these externally managed funds are employees of 
the funds' investment advisers and thus are not covered by proposed 
Item 407(i). Policies on whether portfolio managers are permitted to 
hedge, if any, therefore are unlikely to change as a result of listed 
closed-end funds complying with proposed Item 407(i). Since these 
portfolio managers directly make investment decisions, their incentives 
to make portfolio selections are unlikely to be changed by the proposed 
amendments. Directors of listed closed-end funds are covered by 
proposed 407(i), however, and so directors' equity incentives could be 
affected. To the extent that directors do not influence portfolio 
managers' investment decisions, we do not expect listed closed-end 
funds to incur any cost from possible distortion of director incentives 
by the required disclosure under Item 407(i). However, directors 
oversee the fund's investment adviser (and other service providers), 
which employs the portfolio managers for the funds. If directors exert 
some influence over portfolio managers' investment decisions through 
their oversight of the investment adviser, closed-end funds may incur 
cost from distorted director incentives. Out of all listed closed-end 
funds, we estimate only 4 are internally managed, so their portfolio 
managers are covered by proposed 407(i). These four closed-end funds 
may incur cost resulting from distortion to both portfolio managers' 
and directors' incentives by the required disclosure under Item 407(i).
    A revision in hedging policy also could impose costs on employees 
and directors. For example, if the company currently allows hedging for 
named executive officers but decides to prohibit all hedging 
transactions as a result of the new proposed disclosure requirements, 
named executive officers may incur costs stemming from the loss of 
their ability to hedge their current and future equity compensation 
awards or holdings.\111\
---------------------------------------------------------------------------

    \111\ Such loss does not necessarily need to be compensated 
through other forms of compensation. Consider the following three 
alternative scenarios. First, under efficient contracting where 
hedging by officers promotes efficient investment decisions, 
officers are paid their opportunity wage to the extent that their 
labor market is competitive. If hedging is later prohibited as a 
result of public disclosure under the proposed amendments, these 
companies would resort to other, possibly more costly, compensation 
mechanisms to promote efficient investment decisions. While this 
change represents a cost to the company, officers still would 
receive their opportunity wage, so they are not better or worse off 
than before. Note that the dollar amount of the compensation may 
vary due to a potential change in riskiness of compensation. 
Prohibiting hedging may affect the riskiness of officers' 
compensation, but the riskiness also depends on the use of new types 
of compensation mechanism to promote efficient investments 
decisions, so the direction of the net change is not clear. The 
change in the dollar amount of compensation, if any, reflects the 
change in the riskiness of the compensation, and is not a 
compensation for a loss in hedging opportunity. Second, if the labor 
market is not competitive, officers may be paid above their 
opportunity wage. If hedging is used to promote efficient investment 
decisions, prohibiting it as a result of public disclosure under the 
proposed amendments may shift the balance of power between the board 
and officers. While the loss of hedging opportunity is a cost to the 
officers, they may not be compensated for it as long as their 
compensation is still above their opportunity wage. Third, if 
hedging by officers is not in shareholders' interests, a change from 
permitting to prohibiting hedging better aligns incentives. Officers 
may incur a cost from the loss of ability to hedge, but such cost 
merely represents the loss in the rents extracted by officers, and 
the officers should not be compensated for it.
---------------------------------------------------------------------------

    These costs incurred to implement a hedging policy or to revise a 
hedging policy are difficult to quantify. For example, in the absence 
of data on a company's investment opportunities, the magnitude of the 
inefficiency in choosing investment projects as a result of a change in 
hedging policy is difficult to estimate.
    The proposed amendments would also require Item 407(i) disclosure 
in Schedule 14C, in addition to Schedule 14A. This would extend the 
disclosure requirements and potential benefits described above to the 
Section 12(g) companies that do not file proxy statements with respect 
to the election of directors, thereby facilitating better understanding 
of companies' corporate governance policies and practices, without 
regard to whether proxies or consents are solicited or otherwise 
obtained for such an action. At the same time, requiring the disclosure 
specified in proposed Item 407(i) to be included in information 
statements on Schedule 14C would impose costs on companies that file 
Schedule 14C. However, consistency of the disclosure requirements 
applicable to both Schedules 14A and 14C in the context of an action 
with respect to the election of directors would facilitate better 
understanding of how companies address hedging, without regard to 
whether proxies or consents are solicited or otherwise obtained in 
connection with such action.
    The proposed amendment to Item 402(b) would add an instruction 
providing that a company may satisfy its CD&A obligation to disclose 
any material policies on hedging by named executive officers under that 
requirement by cross referencing to the information disclosed pursuant 
to proposed Item 407(i) to the extent that the information disclosed 
there would satisfy this CD&A disclosure requirement. This approach 
would reduce potentially duplicative disclosure in complying with the 
existing CD&A requirements under Item 402(b) and the proposed 
requirements of Item 407(i), thereby reducing issuers' cost of 
compliance. Locating all the responsive disclosure in one place also 
would make it easier for investors to find it.
4. Anticipated Effects on Efficiency, Competition, and Capital 
Formation
    As discussed above, the proposed amendments may improve capital

[[Page 8504]]

allocation efficiency by enabling investors to make more informed 
voting decisions. The disclosure costs incurred by Section 12 
registrants to comply with the proposed amendments would be minimal, 
and hence unlikely to put any company at a competitive disadvantage. 
However, as discussed above, additional costs could arise if companies 
revise their hedging policies from permitting hedging to prohibiting 
hedging by officers and directors. Such a change could aggravate the 
underinvestment concern and result in shareholder wealth reduction. 
However, such costs would be limited by the availability and cost-
effectiveness of other means to promote investments in high risk but 
value-enhancing projects.\112\ The proposed amendments are unlikely to 
have a notable impact on the competition either among U.S. companies or 
between U.S. companies and FPIs. We also do not expect the proposed 
amendments to affect the attractiveness of employment opportunities at 
the company to employees and directors, and hence impact the 
competitiveness of the labor market of employees and directors. The 
proposed amendments would impose new costs on companies seeking to 
become public, but such costs, taken alone, are unlikely to be a 
significant hurdle to companies seeking to become public.
---------------------------------------------------------------------------

    \112\ See footnote 91.
---------------------------------------------------------------------------

D. Alternatives

1. Changing the Scope of Disclosure Obligations
    The proposed amendments would extend reporting requirements to 
information statements on Schedule 14C. This extension primarily 
affects those Section 12(g) registrants that do not file proxy 
statements given that Section 12(b) registrants are generally required 
to solicit proxies. We have considered alternatives to this extension. 
One alternative would be to require proposed Item 407(i) disclosure in 
proxy statements only, i.e., not in information statements. This would 
reduce the disclosure burden on companies that do not solicit proxies 
from any or all security holders but are otherwise authorized by 
security holders to take an action with respect to the election of 
directors. However, providing Item 407(i) disclosure in information 
statements provides consistency in disclosures in proxy statements and 
information statements, so that the disclosure could be made to all 
shareholders when a company does not solicit proxies from any or all 
security holders but are otherwise authorized by security holders to 
take a corporate action with respect to the election of directors. 
Excluding the Item 407(i) disclosure from information statements, as 
under this alternative, would reduce such benefits.
    We also considered extending the proposed disclosure requirement to 
Form 10-K filings of Section 12 companies in order to impose consistent 
disclosure obligations upon all registrants with a class of securities 
registered under Section 12. This extension would have increased the 
proposed disclosure obligations especially for Section 12(g) companies 
that did not solicit proxies as they then would be required to provide 
the required disclosure in annual Form 10-K filings. Moreover, 
extending the disclosure requirement to all Section 12(g) companies may 
provide limited benefits to shareholders, as non-exchange listed 
companies can have infrequently traded stock, making it more costly and 
thus less likely that employees and directors would pursue hedging 
opportunities.
2. Issuers Subject to the Proposed Amendments
    The proposed amendments apply to all Section 12 registrants, 
including EGCs, SRCs, and listed closed-end funds. We have considered 
the following alternatives about the scope of the proposed amendments.
    The first alternative would be to either exempt or delay the 
application of the proposed amendments to EGCs and SRCs. Doing so would 
reduce costs for these entities, but the potential benefits would be 
eliminated or delayed as well. As discussed above, we expect the 
potential benefits from the required disclosures under proposed Item 
407(i) to be higher for shareholders of EGCs and SRCs (i.e., category 3 
in Table 2) than for shareholders of other operating companies (i.e., 
categories 1 and 2). While EGCs and SRCs likely also incur a higher 
cost from distorted incentives than companies in category 1, it is not 
clear whether such cost is higher than that for companies in category 
2.
    Not exempting EGCs and SRCs from the proposed amendment is also 
consistent with officers and directors at these companies not being 
exempt from the obligation under Exchange Act Section 16(a) to disclose 
hedging transactions involving derivative securities.
    The second alternative is to include all funds, including mutual 
funds and ETFs, or a broader group of funds than listed closed-end 
funds, as proposed. Requiring all funds to provide the proposed 
disclosure would impose costs on the funds. The disclosure also could 
provide benefits, however, although the benefits to investors in funds 
other than listed closed-end funds may not be as significant where fund 
shares do not trade on an exchange. As discussed above, exchange-listed 
fund shares likely are more liquid than non-exchange-listed fund 
shares. Due to increased cost to hedge less liquid shares, directors 
and employees of non-exchange-listed funds may be less likely to engage 
in hedging transactions than those at exchange-listed funds.\113\
---------------------------------------------------------------------------

    \113\ The scope for hedging may be even more limited for mutual 
funds, as investors purchase mutual fund shares from or sell them to 
the fund daily at NAV.
---------------------------------------------------------------------------

    Further, the benefits that would result from applying the proposed 
amendments to ETFs are likely lower than the benefits from applying the 
proposed amendments to listed closed-end funds as proposed. Employees 
(if any) and directors of ETFs may not have as strong an incentive to 
hedge their personal fund shareholdings as those at listed closed-end 
funds. First, listed closed-end funds likely are more volatile than 
ETFs. While the shares of many ETFs often trade on the secondary market 
at prices close to NAV of the shares, one study finds that closed-end 
funds' monthly return on average is 64% more volatile than that of the 
underlying NAV.\114\ The difference in volatility between ETF and 
closed-end fund returns is not driven by the difference in NAV between 
the two types of funds, and the listed closed-end funds' ``excess'' 
volatility is largely idiosyncratic, and cannot be explained by market 
risk or risks that affect other closed-end funds.\115\ Employees and 
directors of listed closed-end funds may therefore have more incentive 
to hedge their fund shareholdings due to the ``excess'' volatility. 
Second, the non-redeemability of listed closed-end fund shares allows 
the funds to take more illiquid positions, or positions that may not be 
possible to sell quickly and at short notice without incurring a 
substantial loss in value. Due to the potentially heightened liquidity 
risk in the funds' portfolios, fund directors and employees may prefer 
not to expose their personal portfolios to the volatility resulting 
from liquidity risk and thus may hedge their personal fund share 
holdings. To the extent that listed

[[Page 8505]]

closed-end funds have greater ability than ETFs to invest in illiquid 
assets, it is possible that employees and directors of listed closed-
end funds would have more incentives to hedge their personal holdings.
---------------------------------------------------------------------------

    \114\ See Pontiff, J., 1997, ``Excess Volatility and Closed-End 
Funds'' American Economic Review 87 (1): 155-169. Day et al. (2011) 
find similar evidence in a much more recent sample. See Day T., G. 
Li, and Y. Xu, 2011, ``Dividend Distributions and Closed-end Fund 
Discounts'' Journal of Financial Economics 100: 579-593.
    \115\ Id.
---------------------------------------------------------------------------

    Another alternative is not to require any funds to provide the 
proposed disclosure. Doing so would not impose costs related to the 
proposed rule on the funds. However, fund investors, including 
investors in listed closed-end funds, also would not derive any 
benefits, including a better understanding of policies that may affect 
incentives provided by fund shareholdings of employees and directors.

E. Request for Comments

    1. We request information including data that would help quantify 
the costs and the value of the benefits of the proposed amendments 
described above. We seek estimates of these costs and benefits, as well 
as any costs and benefits not already defined, that may result from the 
adoption of the proposed amendment. We also request qualitative 
feedback on the nature of the benefits and costs described above and 
any benefits and costs we may have overlooked.
    2. We are interested in any studies or analysis on the number and 
characteristics of companies that have made disclosures of their 
``policies regarding hedging'' under the existing requirement of Item 
402(b)(2)(xiii) or otherwise. In particular, among the companies 
subject to the reporting requirement of Item 402(b)(2)(xiii), how many 
have hedging policies that they do not disclose because they do not 
deem them material? Among companies that disclose hedging policies, 
what are the types of the ``policies'' disclosed?
    3. Among companies currently subject to Item 402(b), some make no 
disclosure of a hedging policy for named executive officers. We believe 
that it may be reasonable to construe the absence of a disclosure of 
hedging policy to mean that the company does not prevent named 
executive officers from hedging. Is there evidence to the contrary? Are 
we correct in thinking that investors may draw the same inference?
    4. To our knowledge, hedging transactions typically involve 
derivative contracts, and fixed price derivative contracts are subject 
to reporting under Section 16(a). Are there any types of hedging 
transactions that are not currently subject to reporting by officers 
and directors under Section 16(a)? If yes, please provide details.
    5. Would the proposed disclosure increase the transparency to 
investors about the incentives provided by employees' and directors' 
equity holdings? Are there alternative ways to make the disclosures 
that would be more useful to investors in evaluating employees' and 
directors' incentive alignment with shareholders while still satisfying 
the mandate of Section 14(j)?
    6. What impact would the proposed amendments have on the incentives 
of employees and directors? Would the proposed amendments likely change 
the behavior of issuers, investors, or other market participants?
    7. Would the proposed disclosure requirements be likely to cause 
companies to change their policies on whether hedging is permitted for 
employees and directors? Why and how? If so, what costs would be 
incurred? What effect, if any, may the proxy voting policies of 
institutional investors and proxy advisory firms have on a company's 
decision to change its policy? Have institutional investors and proxy 
advisory firms already established hedging policy positions that have 
been guiding voting decisions and vote recommendations? Have 
institutional investors and proxy advisory firm recommendations 
regarding such policies encouraged companies to provide transparency 
into hedging transactions that are permitted at the companies? How 
would the transparency into hedging transactions as a result of this 
disclosure impact investor communication with companies about such 
policies? What effect will this proposed disclosure requirement have on 
voting decisions? Would the proposed disclosure requirements be likely 
to cause companies to change their compensation policies for employees 
(including officers) or directors? Why or why not, and if so, how?
    8. If a company revises its hedging policy, would this revision 
influence other corporate decisions, for example, by encouraging or 
discouraging more risky but value-enhancing corporate investments? 
Please explain and provide data.
    9. Relative to other operating companies, would the proposed 
amendments have differential economic effects on EGCs and SRCs that we 
do not currently discuss in the release? If so, what are these 
differential economic effects? Would the impact of the proxy voting 
policies of institutional investors and proxy advisory firms, if any, 
be different for EGCs and SRCs than for other operating companies? In 
the absence of disclosure of hedging policies by EGCs and SRCs, to what 
extent have hedging policy positions of institutional investors and 
proxy advisory firms already been guiding voting decisions and vote 
recommendations for EGCs and SRCs?
    10. Are the costs and benefits of disclosing information about 
whether non-officer employees are permitted or prohibited to hedge 
different from the costs and benefits of disclosing information about 
officers and directors? If so, should the rule be modified to take 
those differences into account?
    11. What impact would the proposed amendments have on competition? 
Would the proposed amendments put registrants subject to the new 
disclosure requirements, or particular types of registrants subject to 
the new disclosure requirements, at a competitive advantage or 
disadvantage?
    12. What impact would the proposed amendments have on efficiency? 
Have we overlooked any positive or negative effects on efficiency?
    13. What impact would the proposed amendments have on capital 
formation? Would there be any positive or negative effects on capital 
formation that we may have overlooked?
    14. Are listed closed-end funds subject to an incentive alignment 
concern due to shareholders' inability to redeem their shares from the 
fund (or often to sell them in secondary transactions at or close to 
the funds' NAV per share) that would relate to hedging considerations? 
What are the characteristics of listed closed-end funds' incentive 
structure with respect to employees and directors that would inform 
this consideration?
    15. We note above that shares of listed closed-end funds are not 
redeemable, and they may trade at a discount to NAV. Will this create 
heightened incentives for these funds' employees and directors to hedge 
personal holdings in listed closed-end funds as compared to employees 
and directors of other types of funds? Are there features of ETFs that 
would make the disclosures under the proposed amendments particularly 
useful for their investors even though ETF shares often trade on the 
secondary market at prices close to NAV of the shares? Are there 
features of mutual funds or other types of funds that would make the 
disclosures under the proposed amendments particularly useful for their 
investors?
    16. The potential cost to companies from distorting investment 
incentives as a result of required disclosures under proposed Item 
407(i) is lower for companies with fewer investment choices. How, if at 
all, does the range of available investment choices for listed closed-
end funds differ from that for operating companies?

[[Page 8506]]

V. Paperwork Reduction Act

A. Background

    The proposed amendments contain ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 1995 
(``PRA''). We are submitting the proposed amendments to the Office of 
Management and Budget (``OMB'') for review in accordance with the 
PRA.\116\ The titles for the collection of information are:
---------------------------------------------------------------------------

    \116\ 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);
    (3) ``Regulation S-K'' (OMB Control No. 3235-0071); \117\ and
---------------------------------------------------------------------------

    \117\ 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.
---------------------------------------------------------------------------

    (4) ``Rule 20a-1 under the Investment Company Act of 1940, 
Solicitation of Proxies, Consents, and Authorizations'' (OMB Control 
No. 3235-0158).
    Regulation S-K was adopted under the Securities Act and Exchange 
Act; Regulations 14A and 14C and the related schedules were adopted 
under the Exchange Act; and Rule 20a-1 was adopted under the Investment 
Company Act. The regulations and schedule set forth the disclosure 
requirements for proxy and information statements filed by companies to 
help investors make informed investment and voting decisions. The hours 
and costs associated with preparing, filing and sending the schedule 
constitute reporting and cost burdens imposed by each collection of 
information. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid OMB control number. Compliance with the proposed 
amendment would be mandatory. Responses to the information collection 
would not be kept confidential, and there would be no mandatory 
retention period for the information disclosed.

B. Summary of the Proposed Amendments

    We are proposing to add new paragraph (i) to Item 407 of Regulation 
S-K that would implement Section 14(j) of the Exchange Act, as added by 
Section 955 of the Act. As discussed in more detail above, proposed 
Item 407(i) would require disclosure of whether employees and directors 
of the company, or their designees, are permitted to hedge or offset 
any decrease in the market value of equity securities that are granted 
to them by the company as part of their compensation, or that are held, 
directly or indirectly, by them. Pursuant to the proposed amendment to 
Item 7 of Schedule 14A, and for listed closed-end funds, the proposed 
amendment to Item 22 of Schedule 14A, this new disclosure would be 
required in proxy or consent solicitation materials with respect to the 
election of directors, or an information statement in the case of such 
corporate action authorized by the written consent of security holders.
    In addition, to reduce potentially duplicative disclosure between 
proposed Item 407(i) and the existing requirement for CD&A under Item 
402(b) of Regulation S-K, we propose to amend Item 402(b) to add an 
instruction providing that a company may satisfy its obligation to 
disclose material policies on hedging by named executive officers in 
the CD&A by cross referencing the information disclosed pursuant to 
proposed Item 407(i) to the extent that the information disclosed there 
satisfies this CD&A disclosure requirement.\118\ This instruction, like 
the Item 407(i) disclosure requirement, would apply to the company's 
proxy or information statement with respect to the election of 
directors.
---------------------------------------------------------------------------

    \118\ Proposed Instruction 6 to Item 402(b).
---------------------------------------------------------------------------

C. Burden and Cost Estimates Related to the Proposed Amendments

    If adopted, proposed Item 407(i) would require additional 
disclosure in proxy statements filed on Schedule 14A with respect to 
the election of directors and information statements filed on Schedule 
14C where such corporate action is taken by the written consents or 
authorizations of security holders, and would thus increase the burden 
hour and cost estimates for each of those forms. For purposes of the 
PRA, we estimate the total annual increase in the paperwork burden for 
all affected issuers to comply with our proposed collection of 
information requirements, averaged over the first three years, to be 
approximately 19,238 hours of in-house personnel time and approximately 
$2,565,200 for the services of outside professionals (see Table 
3).\119\ These estimates include the time and cost of collecting and 
analyzing the information, preparing and reviewing disclosure, and 
filing the documents.
---------------------------------------------------------------------------

    \119\ Our estimates represent the average burden for all 
companies, both large and small.
---------------------------------------------------------------------------

    In deriving our estimates, we assumed that the information that 
proposed Item 407(i) would require to be disclosed would be readily 
available to the management of a company because it only requires 
disclosure of policies they already have but does not direct them to 
have a policy or dictate the content of the policy. Nevertheless, we 
used burden estimates similar to those used in the 2006 Executive 
Compensation Disclosure Release for updating Schedules 14A and 14C, 
which we believe were more extensive.\120\ Since the first year of 
compliance with the proposed amendment is likely to be the most 
burdensome because companies are not likely to have compiled this 
information in this manner previously, we assumed it would take five 
total hours per form the first year and two total hours per form in all 
subsequent years.
---------------------------------------------------------------------------

    \120\ See the 2006 Executive Compensation Disclosure Release.
---------------------------------------------------------------------------

    Based on our assumptions, we estimated that the proposed amendments 
would increase the burden hour and cost estimates per company by an 
average of three total hours per year over the first three years the 
amendments are in effect for each Schedule 14A or Schedule 14C with 
respect to the election of directors.
    We recognize that the burdens may vary among individual companies 
based on a number of factors, including the size and complexity of 
their organizations, and whether or not they prohibit or restrict 
hedging transactions by employees, directors and their designees and if 
they do, the specificity and complexity of such restrictions.
    The table below shows the three-year average annual compliance 
burden, in hours and in costs, of the collection of information 
pursuant to proposed Item 407(i) of Regulation S-K.\121\ The burden 
estimates were calculated by multiplying the estimated number of 
responses by the estimated average amount of time it would take a 
company to prepare and review the proposed disclosure requirements. The 
portion of the burden carried by outside professionals is reflected as 
a cost, while the portion of the burden carried by the company 
internally is reflected in hours. For purposes of the PRA, we estimate 
that 75% of the burden of preparation of Schedules 14A and 14C is 
carried by the company internally and that 25% of the burden of 
preparation is carried by outside professionals retained by the company 
at an average cost of $400 per hour. There is no change to the 
estimated burden of the

[[Page 8507]]

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.
---------------------------------------------------------------------------

    \121\ For convenience, the estimated hour and cost burdens in 
the table have been rounded to the nearest whole number.

              Table 3--Incremental Paperwork Burden Under the Proposed Amendments Affecting Schedules 14A and 14C--Three-Year Average Costs
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                            Incremental        Total                         External        External
                                                             Number of     burden hours/    incremental      Internal      professional    professional
                                                             responses         form        burden  hours   company  time       time            costs
                                                               (A) \122\             (B)     (C)=(A)*(B)    (D)=(C)*0.75    (E)=(C)*0.25    (F)=(E)*$400
--------------------------------------------------------------------------------------------------------------------------------------------------------
Sch. 14A................................................           7,300               3          21,900          16,425           5,475      $2,190,000
Sch. 14C................................................             680               3           2,040           1,530             510         204,000
Rule 20a-1..............................................             590               3           1,770           1,328             443         177,200
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................           8,570  ..............          25,710          19,283           6,428       2,571,200
--------------------------------------------------------------------------------------------------------------------------------------------------------

The proposed amendment to the CD&A requirement under Item 402(b) would 
not be applicable to smaller reporting companies or emerging growth 
companies because under current CD&A reporting requirements these 
companies are not required to provide CD&A in their Commission filings. 
For all other issuers, we do not expect this amendment would materially 
affect the disclosure burden associated with their Commission filings.
---------------------------------------------------------------------------

    \122\ 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. For Rule 20a-1, the number of responses reflected 
in the table is based on an average of three years of data from 
2012-2014 in the 2014 ICI Fact book.
---------------------------------------------------------------------------

D. Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), we request comment in order 
to:
     Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the 
Commission, including whether the information will have practical 
utility;
     Evaluate the accuracy of our assumptions and estimates of 
the burden of the proposed collection of information;
     Determine whether there are ways to enhance the quality, 
utility and clarity of the information to be collected;
     Evaluate whether there are ways to minimize the burden of 
the collection of information on those who respond, including through 
the use of automated collection techniques or other forms of 
information technology; and
     Evaluate whether the proposed amendments will have any 
effects on any other collection of information not previously 
identified in this section.
    Any member of the public may direct to us any comments concerning 
the accuracy of these burden estimates and any suggestions for reducing 
these burdens. Persons submitting comments on the collection of 
information requirements should direct their comments to the Office of 
Management and Budget, Attention: Desk Officer for the U.S. Securities 
and Exchange Commission, Office of Information and Regulatory Affairs, 
Washington, DC 20503, and send a copy to, Brent J. Fields, Secretary, 
U.S. Securities and Exchange Commission, 100 F Street NE., Washington, 
DC 20549-1090, with reference to File No. S7-01-15. Requests for 
materials submitted to OMB by the Commission with regard to the 
collection of information should be in writing, refer to File No. S7-
01-15 and be submitted to the U.S. Securities and Exchange Commission, 
Office of FOIA Services, 100 F Street NE., Washington DC 20549-2736. 
OMB is required to make a decision concerning the collection of 
information between 30 and 60 days after publication of this release. 
Consequently, a comment to OMB is best assured of having its full 
effect if the OMB receives it within 30 days of publication.

VI. Small Business Regulatory Enforcement Fairness Act

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \123\ we solicit data to determine whether 
the rule proposals constitute a ``major'' rule. Under SBREFA, a rule is 
considered ``major'' where, if adopted, it results or is likely to 
result in:
---------------------------------------------------------------------------

    \123\ Public Law 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effects on competition, investment or 
innovation.
    Commentators should provide empirical data on: (1) The potential 
annual effect on the economy; (2) any increase in costs or prices for 
consumers or individual industries; and (3) any potential effect on 
competition, investment or innovation.

VII. Initial Regulatory Flexibility Act Analysis

    This Initial Regulatory Flexibility Analysis has been prepared in 
accordance with the Regulatory Flexibility Act.\124\ This analysis 
involves a proposal to require, in proxy or consent solicitation 
materials, or in an information statement, with respect to the election 
of directors disclosure of whether employees (including officers), 
directors or their designees are permitted to engage in transactions to 
hedge or offset any decrease in the market value of equity securities 
granted to them as compensation, or directly or indirectly held by 
them.
---------------------------------------------------------------------------

    \124\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Reasons for, and Objectives of, the Proposed Action

    The proposed amendments are designed to implement Section 14(j), 
which was added to the Exchange Act by Section 955 of the Act. 
Specifically, the proposed amendments would require disclosure, in any 
proxy or information statement with respect to the election of 
directors, of whether any employee or director of the company or any 
designee of such employee or director, is permitted to purchase any 
financial instruments (including but not limited to prepaid variable 
forward contracts, equity swaps, collars, and

[[Page 8508]]

exchange funds) or otherwise engage in transactions that are designed 
to or have the effect of hedging or offsetting any decrease in the 
market value of equity securities, that are granted to the employee or 
director by the company as compensation, or held, directly or 
indirectly, by the employee or director. The covered equity securities 
would be equity securities issued by the company, any parent of the 
company, any subsidiary of the company or any subsidiary of any parent 
of the company that are registered under Exchange Act Section 12.

B. Legal Basis

    We are proposing the amendments pursuant to Section 955 of the Act, 
Sections 14, 23(a) and 36(a) of the Exchange Act, as amended, and 
Sections 6, 20(a) and 38 of the Investment Company Act, as amended.

C. Small Entities Subject to the Proposed Amendments

    The proposed amendments would affect some companies that are small 
entities. The Regulatory Flexibility Act defines ``small entity'' to 
mean ``small business,'' ``small organization,'' or ``small 
governmental jurisdiction.'' \125\ The Commission's rules define 
``small business'' and ``small organization'' for purposes of the 
Regulatory Flexibility Act for each of the types of entities regulated 
by the Commission. Exchange Act Rule 0-10(a) \126\ defines a company, 
other than an investment company, to be a ``small business'' or ``small 
organization'' if it had total assets of $5 million or less on the last 
day of its most recent fiscal year. We estimate that there are 
approximately 428 issuers that may be considered small entities. The 
proposed amendments would affect small entities that have a class of 
securities that are registered under Section 12 of the Exchange Act. An 
investment company, including a business development company, is 
considered to be a ``small business'' if it, together with other 
investment companies in the same group of related investment companies, 
has net assets of $50 million or less as of the end of its most recent 
fiscal year.\127\ We believe that the proposal would affect some small 
entities that are investment companies. We estimate that there are 
approximately 29 investment companies that would be subject to the 
proposed rule that may be considered small entities.
---------------------------------------------------------------------------

    \125\ 5 U.S.C. 601(6).
    \126\ 17 CFR 240.0-10(a).
    \127\ 17 CFR 270.0-10(a).
---------------------------------------------------------------------------

D. Reporting, Recordkeeping and Other Compliance Requirements

    The proposed amendments would add to the proxy disclosure 
requirements of companies, including small entities, that file proxy or 
information statements with respect to the election of directors, by 
requiring them to provide the disclosure called for by the proposed 
amendment. Specifically, proposed Item 407(i) would require disclosure 
of whether any employee or director of the company or any designee of 
such employee or director, is permitted to purchase any financial 
instruments (including but not limited to prepaid variable forward 
contracts, equity swaps, collars, and exchange funds) or otherwise 
engage in transactions that are designed to or have the effect of 
hedging or offsetting any decrease in the market value of equity 
securities, that are granted to the employee or director by the company 
as compensation, or held, directly or indirectly, by the employee or 
director.

E. Duplicative, Overlapping or Conflicting Federal Rules

    We believe that the proposed amendments would not duplicate, 
overlap or conflict with other federal rules. The proposal would reduce 
potentially duplicative disclosure by adding an instruction permitting 
a company to satisfy any obligation under Item 402(b) of Regulation S-K 
to disclose in the CD&A material policies on hedging by named executive 
officers by cross referencing to the new disclosure required by 
proposed Item 407(i) to the extent that the information disclosed there 
satisfies this CD&A disclosure requirement.\128\ However, as described 
above, the CD&A disclosure obligation does not apply to small entities 
that are emerging growth companies, smaller reporting companies or 
registered investment companies.
---------------------------------------------------------------------------

    \128\ Proposed Instruction 6 to Item 402(b).
---------------------------------------------------------------------------

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider alternatives 
that would accomplish our stated objectives, while minimizing any 
significant adverse impact on small entities. In connection with the 
proposed amendments, we considered the following alternatives:
     Establishing different compliance or reporting 
requirements or timetables that take into account the resources 
available to small entities;
     clarifying, consolidating, or simplifying compliance and 
reporting requirements under the rules for small entities;
     use of performance rather than design standards; and
     exempting small entities from all or part of the proposed 
requirements.
    We believe that the proposed amendments would require clear and 
straightforward disclosure of whether employees or directors are 
permitted to engage in transactions to hedge or offset any decrease in 
the market value of equity securities granted to them as compensation, 
or directly or indirectly held by them. Given the straightforward 
nature of the proposed disclosure, we do not believe that it is 
necessary to simplify or consolidate the disclosure requirement for 
small entities. We have used performance standards in connection with 
the proposed amendments by proposing to use a principles-based approach 
to identify transactions that would hedge or offset any decrease in the 
market value of equity securities. Additionally, the amendments do not 
specify any specific procedures or arrangements a company must develop 
to comply with the standards, or require a company to have or develop a 
policy regarding employee and director hedging activities.
    We considered, but have not proposed, different compliance 
requirements or an exemption for small entities. We believe that 
mandating uniform and comparable disclosures across all issuers subject 
to our proxy rules will promote informed shareholder voting. The 
proposed rule amendments are intended to provide transparency regarding 
whether employees, directors, or their designees are allowed to engage 
in hedging transactions that will permit them to receive compensation 
without regard to company performance, or will permit them to mitigate 
or avoid the risks associated with long-term equity security 
ownership.\129\ We believe this transparency would be just as 
beneficial to shareholders of small companies as to shareholders of 
larger companies. By increasing transparency regarding these matters, 
the proposed amendments are designed to improve the quality of 
information available to all shareholders, thereby promoting informed 
voting decisions. Different compliance requirements or an exemption for 
small entities may interfere with the goal of enhancing the information 
provided by all issuers. We also note that the disclosure is expected 
to result in minimal additional compliance costs for issuers although 
there could be indirect costs for some small entities, depending on 
their current hedging policies. Thus, we

[[Page 8509]]

believe that our proposed amendments will promote consistent disclosure 
among all issuers, without creating a significant new burden for small 
entities.
---------------------------------------------------------------------------

    \129\ See Senate Report 111-176.
---------------------------------------------------------------------------

    Although we preliminarily believe that an exemption for small 
entities from coverage of the proposed amendments would not be 
appropriate, we solicit comment on whether we should exempt small 
entities. At this time, we do not believe that different compliance 
methods or timetables for small entities would be necessary given the 
relatively straightforward nature of the disclosure involved. 
Nevertheless, we solicit comment on whether different compliance 
requirements or timetables for small entities would be appropriate and 
consistent with the purposes of Section 14(j).

G. Solicitation of Comments

    We encourage the submission of comments with respect to any aspect 
of this Initial Regulatory Flexibility Analysis. In particular, we 
request comments regarding:
     How the proposed amendments can achieve their objective 
while lowering the burden on small entities;
     The number of small entities that may be affected by the 
proposed amendments;
     Whether small entities should be exempt from the proposed 
amendments;
     The existence or nature of the potential impact of the 
proposed amendments on small entities discussed in the analysis; and
     How to quantify the impact of the proposed amendments.
    Respondents are asked to describe the nature of any impact of the 
proposed amendments on small entities and provide empirical data 
supporting the extent of the impact. Such comments will be considered 
in the preparation of the Final Regulatory Flexibility Analysis, if the 
proposed amendments are adopted, and will be placed in the same public 
file as comments on the proposed amendments themselves.

VIII. Statutory Authority and Text of the Proposed Amendments

    The amendments contained in this release are being proposed under 
the authority set forth in Section 955 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, Sections 14, 23(a) and 36(a) of the 
Securities Exchange Act of 1934, as amended, and Sections 6, 20(a) and 
38 of the Investment Company Act, as amended.

List of Subjects in 17 CFR Parts 229 and 240

    Reporting and recordkeeping requirements, Securities.

Text of the Proposed Amendments

    For the reasons set out in the preamble, the Commission proposes to 
amend title 17, chapter II, of the Code of Federal Regulations as 
follows:

PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES 
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND 
CONSERVATION ACT OF 1975--REGULATION S-K

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, 78mm, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30, 80a-31(c), 
80a-37, 80a-38(a), 80a-39, 80b-11, and 7201 et seq; and 18 U.S.C. 
1350, unless otherwise noted.

0
2. Amend Sec.  229.402 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. If the information disclosed pursuant to Item 407(i) would 
satisfy the registrant hedging policy disclosure requirements of 
paragraph (b)(2)(xiii) of this Item, a registrant may satisfy this Item 
in its proxy or information statement by referring to the information 
disclosed pursuant to Item 407(i).
* * * * *
0
3. Amend Sec.  229.407 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, disclose whether 
the registrant permits any employees (including officers) or directors 
of the registrant, or any of their designees, to purchase financial 
instruments (including prepaid variable forward contracts, equity 
swaps, collars, and exchange funds) or otherwise engage in transactions 
that are designed to or have the effect of hedging or offsetting any 
decrease in the market value of equity securities--
    (1) Granted to the employee or director by the registrant as part 
of the compensation of the employee or director; or
    (2) Held, directly or indirectly, by the employee or director.
    Instructions to Item 407(i).
    1. For purposes of this Item 407(i), ``equity securities'' (as 
defined in section 3(a)(11) of the Exchange Act (15 U.S.C. 78c(a)(11)) 
and Sec.  240.3a11-1 of this chapter) shall mean only those equity 
securities issued by the registrant or any parent of the registrant, 
any subsidiary of the registrant or any subsidiary of any parent of the 
registrant that are registered under Section 12 of the Exchange Act (15 
U.S.C. 78l).
    2. A registrant that permits hedging transactions by some, but not 
all, of the categories of persons covered by this Item 407(i) shall 
disclose the categories of persons who are permitted to engage in 
hedging transactions and those who are not.
    3. A registrant shall disclose the categories of hedging 
transactions it permits and those it prohibits. In disclosing these 
categories, a registrant may, if true, disclose that it prohibits or 
permits particular categories and permits or prohibits, respectively, 
all other hedging transactions. If a registrant does not permit any 
hedging transactions, or permits all hedging transactions, it shall so 
state and need not describe them by category.
    4. A registrant that permits hedging transactions shall disclose 
sufficient detail to explain the scope of such permitted transactions.
    5. The information required by this Item 407(i) will not be deemed 
to be incorporated by reference into any filing under the Securities 
Act, the Exchange Act or the Investment Company Act, except to the 
extent that the registrant specifically incorporates it by reference.
* * * * *

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

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, 7210 et seq.; and 
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5521(e)(3); 18 U.S.C. 1350; and 
Pub. L. 111-203, 939A, 124 Stat. 1376, (2010), unless otherwise 
noted.

* * * * *
0
5. Amend Sec.  240.14a-101 by:

[[Page 8510]]

0
a. Revising Item 7 paragraph (b);
0
b. Removing Item 7 paragraphs (c) and (d);
0
c. Redesignating Item 7 paragraph (e) as paragraph (c);
0
d. Removing the Instruction to Item 7 paragraph (e);
0
e. Redesignating Item 7 paragraph (f) as paragraph (d);
0
f. Redesignating Instruction to Item 7 paragraph (f) as Instruction to 
Item 7 and revising the newly redesignated Instruction to Item 7;
0
g. Redesignating Item 7 paragraph (g) as paragraph (e); and
0
h. Adding to Item 22(b) paragraph (20).
    The revisions and addition 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.
    * * *
    Item 22. Information required in investment company proxy 
statement.
* * * * *
    (b) * * *
    (20) In the case of a Fund that is a closed-end investment company 
that is listed and registered on a national securities exchange, 
provide the information required by Item 407(i) of Regulation S-K 
(Sec.  229.407(i) of this chapter).
* * * * *

     Dated: February 9, 2015.

    By the Commission.

Brent J. Fields,
Secretary.
[FR Doc. 2015-02948 Filed 2-13-15; 8:45 am]
BILLING CODE 8011-01-P