[Federal Register Volume 80, Number 31 (Tuesday, February 17, 2015)]
[Proposed Rules]
[Pages 8485-8510]
[FR Doc No: 2015-02948]

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

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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<EMAIL_ADDRESS>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<PHONE_NUMBER>, in the
Office of Chief Counsel, Division of Corporation Finance, and Nicholas
Panos, Senior Special Counsel, at<PHONE_NUMBER>, 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

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

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

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

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,

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

    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

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

    \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.
---------------------------------------------------------------------------

    \57\ Item 402(b)(2)(xiii) of Regulation S-K.
    \58\ As required by Item 8 of Schedule 14A.
---------------------------------------------------------------------------

    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

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

    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

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.

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

    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

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\

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

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

    \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.
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    \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.
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    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

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