[Federal Register Volume 84, Number 25 (Wednesday, February 6, 2019)]
[Rules and Regulations]
[Pages 2402-2426]
[FR Doc No: 2018-28123]

Vol. 84

Wednesday,

No. 25

February 6, 2019

Part IV

Securities and Exchange Commission

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17 CFR Parts 229 and 240

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

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

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229 and 240

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

Disclosure of Hedging by Employees, Officers and Directors

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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

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

FOR FURTHER INFORMATION CONTACT: Carolyn Sherman, Special Counsel, or
Anne Krauskopf, Senior Special Counsel, at<PHONE_NUMBER>, in the
Office of Chief Counsel, Division of Corporation Finance, U.S.
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549.

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

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

I. Introduction

    On February 9, 2015, the Commission proposed rule amendments \2\ to
implement Section 955 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the ``Act'').\3\ Section 955 added Section 14(j) to the
Securities Exchange Act of 1934 (the ``Exchange Act'').\4\ Section
14(j) directs the Commission to require, by rule, each issuer to
disclose in any proxy or consent solicitation material for an annual
meeting of shareholders whether any of its employees or members of its
board of directors, or any designee of such employee or director, is
permitted to purchase financial instruments (including prepaid variable
forward contracts, equity swaps, collars, and exchange funds) that are
designed to hedge or offset any decrease in the market value of equity
securities either (1) granted to the employee or director by the issuer
as part of the compensation of the employee or director; or (2) held,
directly or indirectly, by the employee or director.
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    \2\ See Rel. No. 33-9723 (Feb. 9, 2015) [80 FR 8485 (Feb. 17,
2015)] (the ``Proposing Release''), available at: http://www.sec.gov/rules/proposed/2015/33-9723.pdf.
    \3\ Public Law 111-203, 124 Stat. 1900 (July 21, 2010).
    \4\ 15 U.S.C. 78a et seq.
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    The Senate Committee on Banking, Housing, and Urban Affairs stated
in its report on the Act that Section 14(j) is intended to ``allow
shareholders to know if executives are allowed to purchase financial
instruments to effectively avoid compensation restrictions that they
hold stock long-term, so that they will receive their compensation even
in the case that their firm does not perform.'' \5\ In this regard, we
infer that the statutory purpose of Section 14(j) is to provide
transparency to shareholders at the time of an annual meeting, which is
when directors are elected, about whether a company's employees or
directors may engage in transactions that reduce or avoid the incentive
alignment associated with equity ownership related to their employment
or board service.
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    \5\ See Report of the Senate Committee on Banking, Housing, and
Urban Affairs, S. 3217, Report No. 111-176 (Apr. 30, 2010) (``Senate
Report 111-176'').

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

II. Background

    The Commission's rules currently require some disclosure about
company hedging policies and practices. Item 402(b) of Regulation S-K
requires a Compensation Discussion and Analysis (``CD&A'') that
discloses material information necessary to an understanding of a
company's compensation policies and decisions regarding the ``named
executive officers.'' \8\ Under Item 402(b)(2)(xiii), an example of the
kind of information that should be provided, if material, includes a
description of the company's equity or other security ownership
requirements or guidelines (specifying applicable amounts and forms of
ownership) and any company policies regarding hedging the economic risk
of such ownership. This CD&A disclosure item requirement by its terms
addresses only hedging by the named executive officers. In providing
their CD&A disclosure, however, some companies describe policies that
address hedging by employees and directors, as well as the named
executive officers. CD&A does not apply to smaller reporting companies
(``SRCs''),\9\ emerging growth companies (``EGCs''),\10\ registered
investment companies \11\ or foreign private issuers (``FPIs'').\12\
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    \8\ As defined in Item 402(a)(3) of Regulation S-K, ``named
executive officers'' are all individuals serving as the company's
principal executive officer during the last completed fiscal year,
all individuals serving as the company's principal financial officer
during that fiscal year, the company's three other most highly
compensated executive officers who were serving as executive
officers at the end of that year, and up to two additional
individuals who would have been among the three most highly
compensated but for not serving as executive officers at the end of
that year.
    \9\ As defined in Exchange Act Rule 12b-2 [17 CFR 240.12b-2].
The Commission recently amended the definition of ``smaller
reporting company'' to include registrants with a public float of
less than $250 million, as well as registrants with annual revenues
of less than $100 million for the previous year and either no public
float or a public float of less than $700 million. See Smaller
Reporting Company Definition, Release No. 33-10513 (Jun. 28, 2018)
[83 FR 31992 (Jul. 10, 2018)].
    \10\ Section 101 of the Jumpstart Our Business Start-Ups Act
(the ``JOBS Act'') [Pub. L. 112-106, 126 Stat. 306 (2012)] codified
the definition of ``emerging growth company'' in Section 3(a)(80) of
the Exchange Act and Section 2(a)(19) of the Securities Act. See
also Exchange Act Rule 12b-2 [17 CFR 240.12b-2], which reflects
inflation adjustments to the definition of ``emerging growth
company.''
    \11\ Registered investment companies are investment companies
registered under Section 8 of the Investment Company Act of 1940
(``Investment Company Act''). 15 U.S.C. 80a et seq.
    \12\ As defined in Rule 3b-4 [17 CFR 240.3b-4].
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    Other disclosure requirements also may reveal when company equity
securities have been hedged:
     For companies with a class of equity securities registered
pursuant to Section 12 of the Exchange Act,\13\ hedging transactions by
officers and directors in transactions involving one or more derivative
securities--such as options, warrants, convertible securities, security
futures products, equity swaps, stock appreciation rights and other
securities that have an exercise or conversion price related to a
company equity security or derive their value from a company equity
security--are subject to reporting within two business days on Form 4,
pursuant to Exchange Act Section 16(a).\14\
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    \13\ 15 U.S.C. 78l.
    \14\ 15 U.S.C. 78p(a). For Section 16 purposes, the term
``derivative securities'' is defined in Exchange Act Rule 16a-1(c)
[17 CFR 240.16a-1(c)], which excludes rights with an exercise or
conversion privilege at a price that is not fixed. Exchange Act Rule
16a-1(d) defines ``equity security of the issuer'' as any equity
security or derivative security relating to the issuer, whether or
not issued by that issuer. See also Exchange Act Rule 16a-4, which
provides that for Section 16 purposes, both derivative securities
and the underlying securities to which they relate shall be deemed
to be the same class of equity securities.
    The Commission has clarified that Section 16 applies to equity
swap and similar transactions that a Section 16 insider may use to
hedge and has addressed how these derivative securities transactions
should be reported, including specifically identifying them through
the use of transaction code K. See Ownership Reports and Trading by
Officers, Directors and Principal Security Holders, Release No. 34-
34514 (Aug. 10, 1994) [59 FR 42449 (Aug. 17, 1994)] at Section
III.G; and Ownership Reports and Trading by Officers, Directors and
Principal Security Holders, Release No. 34-37260 (May 31, 1996) [61
FR 30376 (Jun. 14, 1996)] at Sections III.H and III.I. The
Commission also has clarified how transactions in securities futures
should be reported. Commission Guidance on the Application of
Certain Provisions of the Securities Act of 1933, the Securities
Exchange Act of 1934, and Rules thereunder to Trading in Security
Futures Products, Release No. 33-8107 (June 21, 2002) [67 FR 43234
(Jun. 27, 2002)] at Q. 13.
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     Some hedging transactions, such as prepaid variable
forward contracts,\15\ may involve pledges of the underlying company
equity securities as collateral. Item 403(b) of Regulation S-K, which
requires disclosure of the amount of company equity securities
beneficially owned by directors, director nominees and named executive
officers,\16\ also requires disclosure of the amount of shares that are
pledged as security.\17\
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    \15\ A prepaid variable forward contract obligates the seller to
sell, and the counterparty to purchase, a variable number of shares
at a specified future maturity date. The number of shares
deliverable will depend on the per share market price of the shares
close to the maturity date. The contract specifies maximum and
minimum numbers of shares subject to delivery, and at the time the
contract is entered into, the seller will pledge to the counterparty
the maximum number of shares. The Commission has indicated that
forward sales contracts are derivative securities transactions
subject to Section 16(a) reporting. Mandated Electronic Filing and
Website Posting for Forms 3, 4 and 5, Release No. 33-8230 (May 7,
2003) [68 FR 25788 (May 18, 2003)], text at n. 42.
    \16\ Item 403(b) of Regulation S-K [17 CFR 229.403(b)].
Disclosure is required on an individual basis as to each director,
nominee, and named executive officer, and on an aggregate basis as
to executive officers of the issuer as a group and must be provided
in proxy statements, annual reports on Form 10-K [referenced in 17
CFR 240.310], and registration statements under the Securities Act
and under the Exchange Act on Form 10.
    \17\ See Executive Compensation and Related Person Disclosure,
Release No. 33-8732A (Aug. 29, 2006) [71 FR 53158 (Sept. 8, 2006)]
(the ``2006 Executive Compensation Disclosure Release'') at Section
IV.

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

III. Discussion of the Amendments

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

transactions that could reduce the extent to which their equity
holdings and equity compensation are aligned with shareholders'
interests. Because Section 14(j) calls for disclosure about employees
and directors and their alignment with shareholders' interests, it is
more closely related to the Item 407 corporate governance disclosure
requirements than to Item 402 of Regulation S-K, which focuses only on
the compensation of named executive officers and directors. Two
commenters expressed general support for locating the new disclosure
requirement in the Commission's corporate governance-related disclosure
rules.\18\ Accordingly, we are implementing Section 14(j) by amending
Item 407 to keep the disclosure requirements relating to corporate
governance matters together in a single item of Regulation S-K.\19\
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    \18\ See letters from Business Roundtable and CFA Institute.
    \19\ As a result, the new disclosure would not be subject to
shareholder advisory votes to approve the compensation of named
executive officers, as disclosed pursuant to Item 402, that are
required pursuant to Section 14A(a)(1) of the Exchange Act and Rule
14a-21(a) [17 CFR 240.14a-21(a)]. We recognize, however, that there
is an executive compensation component of the new disclosure as it
relates to existing CD&A obligations. See Section III.D.3, below.
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    The final amendments will:
     Require the company to describe any practices or policies
regarding the ability of employees, directors or their designees to
purchase financial instruments, or otherwise engage in transactions,
that hedge or offset, or are designed to hedge or offset, any decrease
in the market value of company equity securities. A company will be
required either to provide a fair and accurate summary of any practices
or policies that apply, including the categories of persons covered and
any categories of hedging transactions that are specifically permitted
and any categories that are specifically disallowed, or to disclose the
practices or policies in full;
     if the company does not have any such practices or
policies, require the company to disclose that fact or state that
hedging transactions are generally permitted;
     specify that the equity securities for which disclosure is
required are only equity securities of the company or of any parent or
subsidiary of the company or any subsidiary of any parent of the
company;
     require the disclosure in any proxy statement on Schedule
14A or information statement on Schedule 14C \20\ with respect to the
election of directors; and
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    \20\ 17 CFR 240.14c-101.
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     clarify that the term ``employee'' includes officers of
the company.
    Nothing in these amendments or this release should be construed as
suggesting companies need to have a practice or policy regarding
hedging, or a particular type of practice or policy. These amendments
relate only to disclosure of hedging practices or policies.

A. Scope of the Disclosure Requirement

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

    \61\ See letter from Clinton Carlisle.
---------------------------------------------------------------------------

B. Defining the Term ``Equity Securities''

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

    \62\ In addition, the Exchange Act's and Exchange Act Rules'
definitions of ``equity security'' do not limit the scope of this
term to equity securities of a particular company.
    \63\ 15 U.S.C. 78c(a)(11). Exchange Act Section 3(a)(11) defines
``equity security'' as any stock or similar security; or any
security future on any such security; or any security convertible,
with or without consideration, into such a security, or carrying any
warrant or right to subscribe to or purchase such a security; or any
such warrant or right; or any other security which the Commission
shall deem to be of similar nature and consider necessary or
appropriate, by such rules and regulations as it may prescribe in
the public interest or for the protection of investors, to treat as
an equity security.
    \64\ 17 CFR 240.3a11-1. Exchange Act Rule 3a11-1 defines
``equity security'' to include any stock or similar security,
certificate of interest or participation in any profit sharing
agreement, preorganization certificate or subscription, transferable
share, voting trust certificate or certificate of deposit for an
equity security, limited partnership interest, interest in a joint
venture, or certificate of interest in a business trust; any
security future on any such security; or any security convertible,
with or without consideration into such a security, or carrying any
warrant or right to subscribe to or purchase such a security; or any
such warrant or right; or any put, call, straddle, or other option
or privilege of buying such a security from or selling such a
security to another without being bound to do so.
    \65\ Proposed Instruction 1 to Item 407(i).
---------------------------------------------------------------------------

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

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

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

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

    Disclosure of whether a company has adopted practices or policies
regarding a director's or employee's ability to hedge such equity
securities granted as compensation or otherwise held from whatever
source acquired will more fully inform shareholders whether employees
and directors are able to engage in transactions that reduce the
alignment of their interests with the economic interests of other
shareholders of the company and any affiliated company in which the
employees or directors might have an interest. For example, companies
may grant equity securities of affiliated companies to their employees
or directors that are intended to achieve similar incentive alignment
as grants in the company's equity securities, or have ownership
requirements or guidelines regarding such equity securities.\76\ In
instances such as these, the rule would require disclosure regarding
whatever practice or policy regarding hedging applies.
---------------------------------------------------------------------------

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

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

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

C. Employees and Directors Subject to the Disclosure Requirement

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

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

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

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

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

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

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

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

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

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

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

D. Implementation

1. Manner and Location of Disclosure
1. Proposed Amendments
    Section 14(j) calls for disclosure in any proxy or consent
solicitation material for an annual meeting of the shareholders.
Shareholder annual meetings are typically the venue in which directors
are elected.\94\ We proposed to implement Section 14(j) by amending
Items 7 and 22 of Schedule 14A to require the new Item 407(i)
information if action is to be taken with respect to the election of
directors. Although the language of Section 14(j) refers to disclosure
in any proxy or consent solicitation material for an annual meeting of
the company's shareholders, this language, construed strictly, could
result in the disclosure appearing in different instances than we
currently require other corporate governance related disclosure. In
particular, under our current rules, if a company solicits proxies \95\
with respect to the election of directors, its proxy statement must
include specified corporate governance information required by Item 407
of Regulation S-K, whether or not the election takes place at an annual
meeting.\96\ The proposal reflected the view that Item 407(i)
disclosure similarly would be relevant information for shareholders
evaluating a company's corporate governance practices in the context of
director elections.
---------------------------------------------------------------------------

    \94\ The Commission has previously recognized that directors
ordinarily are elected at annual meetings. See, e.g., Rule 14a-6(a)
[17 CFR 240.14a-6(a)], which acknowledges that registrants
soliciting proxies in the context of an election of directors at an
annual meeting may be eligible to rely on the exclusion from the
requirement to file a proxy statement in preliminary form. Rule 14a-
3(b) [17 CFR 240.14a-3(b)] requires proxy statements used in
connection with the election of directors at an annual meeting to be
preceded or accompanied by an annual report containing audited
financial statements. The requirement for registrants to hold an
annual meeting at which directors are to be elected, however, is
imposed by a source of legal authority other than the federal
securities laws, such as state corporate law. See, e.g, Delaware
General Corporate Law, Section 211(b).
    \95\ Rule 14a-1(f) [17 CFR 240.14a-1(f)] defines the term
``proxy'' to include every proxy, consent or authorization within
the meaning of Section 14(a) of the Exchange Act. A solicitation of
consents therefore constitutes a solicitation of proxies subject to
Section 14(a) and Regulation 14A.
    \96\ See Items 7(b)-(d) and 8(a) of Schedule 14A.
---------------------------------------------------------------------------

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

    \97\ This approach is consistent with the disclosure
requirements for registration statements under the Securities Act
and for annual reports on Form 10-K, which include only selected
provisions of Item 407. See Item 11(l) and 11(o) on Form S-1 and
Items 10, 11 and 13 in Part III of Form 10-K.
    \98\ As permitted by General Instruction G to Form 10-K.
---------------------------------------------------------------------------

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

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

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

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

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

    \103\ We are not adopting the proposed amendment to Item 22 of
Schedule 14A because, as discussed in Section III.D.3.c.i., below,
we are excluding listed closed-end funds from the new disclosure
requirement.
    \104\ We note that an annual meeting, the meeting at which
companies generally provide for the election of directors, could
theoretically not include an election of directors. For reasons
explained above, an annual meeting ordinarily involves an election
of directors. In the unlikely event that a company is not conducting
a solicitation for the election of directors but is otherwise
soliciting proxies at an annual meeting, the amendments do not
require Item 407(i) disclosure in the proxy statement.
---------------------------------------------------------------------------

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

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

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

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

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

materials to be filed under cover of Schedule 14A.\108\ As provided in
Item 1 of Schedule 14C, however, an information statement filed on
Schedule 14C must include the information called for by all of the
items of Schedule 14A to the extent each item would be applicable to
any matter to be acted upon at a meeting if proxies were to be
solicited, with only limited exceptions.\109\ An information statement
filed on Schedule 14C in connection with an election of directors
therefore already is required to include the information required by
Item 7 of Schedule 14A.
---------------------------------------------------------------------------

    \107\ Section 14(c) of the Exchange Act was enacted to
``reinforce [ ] fundamental disclosure principles [for companies]
subject to the proxy rules which did not solicit proxies . . .'' By
enacting Section 14(c), Congress was advised that these companies
``would be required to furnish shareholders with information
equivalent to that contained in a proxy statement. . . . [and that
such legislation was needed] [b]ecause evasion of the disclosures
required by the proxy rules is made possible by the simple device of
not soliciting proxies . . .'' Statement of William L. Cary,
Chairman, Securities and Exchange Commission, Part I. K. Other
Amendments Proposed by S. 1642, Hearings before a Subcommittee of
the Committee on Banking and Currency for the U.S. Senate, Eighty-
Eighth Congress, First Session on S. 1642, June 18-21 and 24-25,
1963.
    \108\ As noted above, Exchange Act Rule 14a-1(f) [17 CFR
240.14a-1(f)] defines the term ``proxy'' to include every proxy,
consent or authorization within the meaning of section 14(a) of the
[Exchange] Act. Exchange Act Rule 14a-3(a) [17 CFR 240.14a-3(a)]
prohibits any proxy solicitation unless each person solicited is
currently or has been previously furnished with a publicly-filed
preliminary or definitive proxy statement containing the information
specified in Schedule 14A [17 CFR 240.14a-101], and Exchange Act
Rule 14a-6(m) [17 CFR 240.14a-6(m) requires proxy materials to be
filed under cover of Schedule 14A.
    \109\ Specifically, Item 1 of Schedule 14C permits the exclusion
of information called for by Schedule 14A Items 1(c) (Rule 14a-5(e)
information re shareholder proposals), 2 (revocability of proxy), 4
(persons making the solicitation), and 5 (interest of certain
persons in matters to be acted upon). Other Items of Schedule 14C
prescribe the information to be provided with regard to such of
these topics that are relevant to information statements.
Specifically, Item 3 addresses the interest of certain persons in or
opposition to matters to be acted upon, and Item 4 addresses
proposals by security holders. In addition, Notes A, C, D and E to
Schedule 14A are applicable to Schedule 14C [17 CFR 240.14c-101].
---------------------------------------------------------------------------

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

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

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

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

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

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

    The Commission proposed amending Item 402(b) of Regulation S-K to
add an instruction providing that a company may satisfy its CD&A
obligation to disclose material policies on hedging by named executive
officers by cross referencing the information disclosed pursuant to new
Item 407(i) to the extent that the information disclosed there
satisfies this CD&A disclosure requirement.\113\
---------------------------------------------------------------------------

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

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

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

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

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

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

    \119\ Exchange Act Rule 14a-21(a) [17 CFR 240.14a-21(a)]
provides that shareholder advisory say-on-pay votes apply to
executive compensation disclosure pursuant to Item 402 of Regulation
S-K, which includes CD&A. Because Item 407(i) disclosure will not be
subject to these votes except to the extent a company chooses to
make it part of CD&A either directly or pursuant to the new cross-
reference instruction, the final rule will not effect any change in
the scope of disclosure currently subject to say-on-pay votes. We
note that issuers may, if they prefer, avoid making the Item 407(i)
disclosure part of CD&A by not cross-referencing or directly
including that disclosure in their Item 402 disclosure.
---------------------------------------------------------------------------

4. Issuers Subject to the Amendments
a. Proposed Amendments
    The Proposing Release discussed whether certain categories of
issuers should be exempted from the new Item 407(i) disclosure
requirement, or, alternatively, whether they should be subject to a
delayed implementation schedule. Under the proposal, the new disclosure
requirement would apply to EGCs and SRCs. Securities registered by an
FPI are not subject to the proxy statement requirements of Exchange Act
Section 14,\120\ and therefore FPIs are not

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

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

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

    \121\ 15 U.S.C. 78l(b).
    \122\ BDCs are a category of closed-end investment company that
are not registered under the Investment Company Act [15 U.S.C. 80a-
2(a)(48) and 80a-53-64]. As proposed, BDCs would be treated in the
same manner as non-investment company issuers.
    \123\ ETFs are organized either as open-end funds or unit
investment trusts (``UITs''). A UIT does not have a board of
directors, corporate officers, or an investment adviser to render
advice during the life of the trust, and does not actively trade its
investment portfolio.
---------------------------------------------------------------------------

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

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

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

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

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

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

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

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

c. Final Amendments
    The amendments will apply to the categories of issuers proposed,
except with respect to listed closed-end funds, which we are exempting
from the Item 407(i) disclosure requirement. In making these
determinations, we have been guided by what we understand to be the
statutory purpose behind Section 14(j), namely, to provide transparency
to shareholders, if action is to be taken with respect to the election
of directors, about whether a company's employees or directors may
engage in transactions that mitigate or avoid the incentive alignment
associated with equity ownership.
i. Investment Companies
    In a change from the proposal, after considering the comments
received, we have determined not to apply the new Item 407(i)
disclosure requirement to listed closed-end funds,\138\ but it will
apply to BDCs. We believe that this approach is consistent with the
Commission's treatment of BDCs regarding executive compensation
disclosure requirements,\139\ and no commenter suggested that BDCs
should be excluded.
---------------------------------------------------------------------------

    \138\ Section 36(a) of the Exchange Act permits the Commission,
by rule, regulation, or order, to conditionally or unconditionally
exempt any person security, or transaction, or any class or classes
of persons, securities, or transactions, from any provision or
provisions of this title or of any rule or regulation thereunder, to
the extent that such exemption is necessary or appropriate in the
public interest, and is consistent with the protection of investors.
    \139\ See 2006 Executive Compensation Disclosure Release, at
Section II.D.3.
---------------------------------------------------------------------------

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

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

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

    Although fund directors, including directors of listed closed-end
funds, may hold shares of the funds they serve, fund compensation
practices can be distinguished from those of operating companies.\141\
We believe that the granting of shares as a component of incentive-
based compensation is uncommon, and in some cases is prohibited, for
both open-end and closed-end funds.\142\ From a practical standpoint,
even if fund directors were to acquire shares of listed closed-end
funds, commenters indicated that it is difficult to hedge such shares
by selling short or trading in derivatives.\143\ Concerns about
avoiding restrictions on long-term compensation, which we understand to
be one of the reasons Congress mandated this disclosure, may therefore
be less likely to be raised with respect to open-end and closed-end
funds.\144\
---------------------------------------------------------------------------

    \141\ See Saitz, Greg, ``Here Are Two Choices: Buy Fund Shares
or Buy Fund Shares,'' July 30, 2013, available at http://www.boardiq.com/c/556021/60971/here_choices_fund_shares_fund_shares.
    \142\ Registered investment companies are generally prohibited
from issuing their securities for services. See Sections 22(g)
(open-end funds) and 23(a) (closed-end funds) of the Investment
Company Act. Recognizing that ``effective fund governance can be
enhanced when funds align the interests of their directors with the
interests of their shareholders,'' the Commission staff has
suggested circumstances under which funds may compensate fund
directors with fund shares consistent with sections 22(g) and 23(a).
See Interpretive Matters Concerning Independent Directors of
Investment Companies, Investment Company Act Release No. 24083 (Oct.
14, 1999) (discussing, among other matters, the staff's views on
application of Section 23(a) to the compensation of directors in
closed-end funds using fund shares).
    \143\ See note 132 above and accompanying text.
    \144\ See note 5 above and accompanying text.
---------------------------------------------------------------------------

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

    \145\ The requirement to hold an annual meeting of shareholders
at which directors are to be elected is imposed by a source of
authority other than the federal securities laws. See note 94 above.
Funds are typically organized under state law as a form of trust or
corporation that is not required to hold an annual meeting. See
Robert A. Robertson, Fund Governance: Legal Duties of Investment
Company Directors Sec.  2.-6[5]. Funds may, however, hold
shareholder meetings from time to time under certain circumstances,
including where less than a majority of the directors of the fund
were elected by the holders of the fund's outstanding voting
securities. See Section 16(a) of the Investment Company Act.
    \146\ See, e.g., Section 302.00 of the New York Stock Exchange's
Corporate Governance Standards.
---------------------------------------------------------------------------

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

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

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

    \149\ Section 102 of the JOBS Act exempts EGCs from: The say-on-
pay, say-on-frequency, and say-on-golden parachutes advisory votes
required by Exchange Act Sections 14A(a) and (b), enacted in Section
951 of the Act; the ``pay versus performance'' proxy disclosure
requirements of Exchange Act Section 14(i), enacted in Section
953(a) of the Act; and the pay ratio disclosure requirements of
Section 953(b) of the Act.
    \150\ See Section 102(c) of the JOBS Act and Item 402(l) of
Regulation S-K.
    \151\ See Item 407(a), (b), (c), (d), (e)(1)-(3), (f) and (h) of
Regulation S-K; but see Item 407(g) of Regulation S-K, which
provides a phase-in period for SRCs from the disclosure required by
Item 407(d)(5) of Regulation S-K and does not require SRCs to
provide the disclosures required by Item 407(e)(4) and (5) of
Regulation S-K. In addition, as noted above, officers and directors
at EGCs and SRCs are subject to the obligation under Exchange Act
Section 16(a) to report transactions involving derivative
securities.
---------------------------------------------------------------------------

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

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

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

iii. Foreign Private Issuers
    As noted above, Section 14(j) calls for disclosure in any proxy or
consent solicitation material for an annual meeting of the shareholders
of the issuer. Because securities registered by a FPI are not subject
to the proxy statement requirements of Exchange Act Section 14,\153\
under the amendments, FPIs are not required to provide the new Item
407(i) disclosure.
---------------------------------------------------------------------------

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

IV. Other Matters

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

V. Compliance Dates

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

VI. Economic Analysis

A. Background

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

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

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

B. Baseline and Affected Parties

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

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

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

    We assess the economic effects of the final amendments relative to
the baseline, which includes the existing state of disclosure
requirements and practices. As discussed in Section II above, among the
registrants subject to the final amendments, Section 12 registrants
other than SRCs and EGCs are currently subject to the CD&A disclosure
requirement in Item 402(b) of Regulation S-K. Under Item
402(b)(2)(xiii), an example of the kind of information that should be
provided, if material, includes a description of the company's equity
or other security ownership requirements or guidelines (specifying
applicable amounts and forms of ownership) and any company policies
regarding hedging the economic risk of such ownership. Although Item
402(b)(2)(xiii) addresses only hedging by the named executive officers,
some companies describe policies that address hedging by employees and
directors, as well as named executive officers, in providing their CD&A
disclosure.\162\
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    \162\ Listed closed-end funds, which are not subject to the
final amendments, are not subject to the CD&A disclosure
requirement.
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    Additionally, Section 16(a) of the Exchange Act requires officers
and directors of Section 12 registrants, including SRCs and EGCs, to
report their hedging transactions involving the company's equity
securities.\163\ However, unless a company discloses a policy regarding
hedging by officers and directors, it is not possible for investors to
obtain full information about whether a company has a hedging policy or
how one may apply. For example, investors may not be able to discern
from current disclosure whether the disclosure of hedging transactions
by officers and directors indicates that the company does not have a
hedging policy; the company has a policy regarding hedging, but that
the particular types of transactions are not restricted by the policy;
or a company's hedging policy was violated, but the transaction was
reported in accordance with Section 16(a). Similarly, it is not
possible to discern from current disclosure whether the absence of
reported hedging transactions indicates that the company prohibits
hedging; the company does not prohibit hedging, but that officers and
directors did not engage in hedging transactions; or officers and
directors engaged in hedging transactions but did not comply with
Section 16(a).
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    \163\ Section 30(h) of the Investment Company Act subjects
officers and directors of listed closed-end funds to the same duties
and liabilities as those imposed by Section 16(a) of the Exchange
Act.
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    The extent to which there will be a change in the hedging policy
disclosures under the final amendments will vary for different
categories of registrants subject to the amendments. While a number of
reporting companies already make hedging policy disclosures, others
will need to do so for the first time. To establish the baseline of
existing practices related to disclosure of hedging policies, we
analyzed information from comment letters and industry surveys of large
companies' hedging policy disclosure practices \164\ and reviewed proxy
statements for information on disclosures of hedging policies for four
samples of companies.\165\ The first sample includes a randomly chosen
subset of 100 S&P 500 companies that filed proxy statements during the
calendar year 2017.\166\ The second sample includes 100 randomly
selected companies from the S&P SmallCap 600 that filed proxy
statements during the calendar year 2017.\167\ These companies are
smaller than S&P 500 companies; however, all of them are exchange-
listed, and none are SRCs (based on the pre-2018 definition).\168\ In
addition, we have examined hedging policy disclosure practices for
random samples of 100 SRCs and 100 non-SRC EGCs (using the pre-2018 SRC
definition).\169\
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    \164\ See notes 171-175, below.
    \165\ We did not receive comment on the methodological approach
used in this baseline analysis in the Proposing Release. Our
baseline analysis in this release is generally consistent with the
baseline analysis in the Proposing Release; however, we are
considering data from proxy statements filed in 2017, which is the
most recent full calendar year of filings available to us. We also
are making some modifications in light of the availability of
information in other sources about the prevalence of hedging policy
disclosure among large companies. Specifically, we are considering a
random sample of 100, rather than the set of all, S&P 500 companies,
in light of other information on hedging policies of large companies
that has become available from commenters and industry surveys. See
notes 171-175, below. In light of comments regarding the potentially
greater effects of the disclosure requirement on SRCs and EGCs, in a
change from the baseline analysis in the Proposing Release, we are
adding an analysis of samples of 100 SRCs and 100 non-SRC EGCs.
Similar to the analysis in the Proposing Release, we also examine a
sample of 100 S&P SmallCap 600 companies.
    We note that the estimated rate of hedging policy disclosure
obtained based on a sample of companies, rather than the entire set
of companies, can differ from the actual rate of hedging policy
disclosure for the full set of companies. However, such differences
should not be systematic in light of our use of random sampling.
    \166\ A total of 489 S&P 500 companies filed proxy statements
during the calendar year 2017.
    \167\ A total of 586 S&P SmallCap 600 companies filed proxy
statements during the calendar year 2017.
    \168\ See note 159, above. SRC status is based on status
reported in filings in calendar year 2017. Twenty-one EGCs were
included in the S&P SmallCap 600 index during the calendar year
2017.
    \169\ See note 159, above. SRC status is based on status
reported in filings in calendar year 2017. The SRC sample therefore
does not include companies that would become newly eligible for SRC
status under the expanded SRC definition following the 2018
amendments, while the non-SRC EGC sample may include such companies.
Because companies newly eligible for SRC status under the 2018
amendments would tend to be larger than the companies eligible for
SRC status prior to the 2018 amendments, to the extent that larger
companies are more likely to disclose hedging, the prevalence of
hedging disclosure in the analyzed sample of SRCs from 2017 may be
lower than the prevalence of hedging disclosure among SRCs under the
amended definition.
---------------------------------------------------------------------------

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

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

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

    Table 1 shows that disclosures and hedging policies are not uniform
across covered categories of companies. Almost all of the S&P 500
companies sampled (97%) disclosed policies regarding hedging by named
executive officers. A large majority of the S&P 500 companies sampled
(77%) also disclosed their policy about hedging by directors, but only
51% disclosed hedging policies for non-executive employees. These
percentages are smaller for smaller companies. Of the 100 S&P SmallCap
600 companies sampled, only 71% disclosed hedging policies for named
executive officers, 60% disclosed such policies for directors, and 33%
disclosed hedging policies for non-executive employees. An even smaller
proportion of the sampled SRCs and non-SRC EGCs (based on the pre-2018
definition) \170\ disclosed hedging policies: 7% of SRCs and 15% of
non-SRC EGCs disclosed policies regarding hedging by named executive
officers; 6% of SRCs and 13% of non-SRC EGCs disclosed policies
regarding hedging by directors; and 1% of SRCs and 11% of non-SRC EGCs
disclosed policies regarding hedging by non-executive employees. Among
the different categories of the sampled companies that disclosed
hedging policies, all or almost all such companies disclosed policies
that either prohibited or restricted hedging.
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    \170\ Id.
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    These results are broadly in line with those reported by commenters
and industry reports. One commenter stated that 49% of Russell 3000
companies and 84% of S&P 500 companies have hedging policies governing
their officers and directors.\171\ Another commenter indicated that
approximately 54% of Russell 3000 Companies and 84% of S&P 500
companies have prohibited employees from hedging company shares.\172\ A
different commenter indicated that a survey of 100 companies among the
Fortune 500 found that 95% of companies disclosed hedging policies
during the 2014 proxy season, and the vast majority of these policies
involved a ban.\173\ Another commenter reviewed company disclosures in
Commission filings and corporate governance documents available on
company websites, and found that: (1) 95% of a cross-section of 60
publicly traded companies whose CEOs are members of Business Roundtable
prohibit hedging of company securities by executive officers, and (2)
85% prohibit hedging by directors.\174\ More recent industry studies of
large companies have reported that the majority of the surveyed
companies disallow executive hedging.\175\
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    \171\ See letter from Davis Polk.
    \172\ See letter from CII.
    \173\ See letter from Public Citizen.
    \174\ See letter from Business Roundtable.
    \175\ A 2015 report found that among the 250 largest market
capitalization S&P 500 companies, the prevalence of policies
prohibiting hedging by executives is 92%. See Frederic W. Cook &
Co., Inc., Corporate Governance Study 1 (December 2015), available
at https://www.fwcook.com/content/Documents/Publications/FWC_2015_Corp_Gov_Study_Final.pdf.
    Another recent report found hedging policies to be present in
96% of large publicly traded companies and attributed that
percentage to the influence of legislation, proxy advisory firms,
and shareholder scrutiny. The report considered ``110 companies from
10 industries, selected to provide a broad representation of market
practice among large U.S. public companies.'' See Compensation
Advisory Partnerts (CAP), CAP 100 Company Research Industry Report
2017-2018 13, https://www.capartners.com/cap-thinking/cap-100-company-research-17-18/.
    In another report, 93 of the largest 100 companies (93%) that
have equity securities listed on the NYSE or Nasdaq were found to
prohibit hedging. See 2018 Shearman & Sterling LLP Corporate
Governance survey, at 103.
    An analysis of 2017 data indicated that 98% of a random subset
of S&P 500 companies and 71% of a random subset of S&P SmallCap 600
companies disclosed hedging policies for named executive officers.
In the Proposing Release, an analysis of 2012 data indicated that
67% of S&P 500 companies and 29% of a random subset of S&P SmallCap
600 companies disclosed hedging policies for named executive
officers. See Proposing Release, at 8498. We cannot identify the
causes of increased incidence of hedging policy disclosure among
large companies with certainty and note that estimates based on
samples of companies may contain noise, although differences in
estimates are not likely to be biased because samples are drawn
randomly. The increase in the rate of hedging policy disclosure over
this time period may be partly due to the anticipation of a future
requirement to provide hedging disclosures as a result of the Dodd-
Frank Act and the Proposing Release, as well as due to demand from
shareholders and other market participants. See also Section VI.B
below, analyzing the prevalence of disclosure of hedging practices
and policies in a randomly drawn sample of companies.
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Discussion of Economic Effects

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

exposure to their company, which could lead them to avoid making risky
corporate investments, even if such actions would enhance shareholder
value.\177\ Allowing employees and directors to hedge equity holdings
could in some circumstances partly ameliorate the imperfect alignment
of risk-taking incentives created by undiversified exposure.\178\ The
net effect of hedging by employees on the efficiency of corporate
investment decisions would depend on the relative impact of these
tradeoffs; the availability and cost-effectiveness of other tools to
address these concerns;\179\ and the extent and types of hedging used
by employees and directors. In particular, the impact of hedging on the
incentives of employees and directors may depend on the amount of
hedging as well as on the type of hedging transactions used and payoffs
provided by the particular instrument.
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    \176\ See Proposing Release, at 8498, n. 86. See, e.g., Michael
C. Jensen & William H. Meckling, Theory of The Firm: Managerial
Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305-
360 (1976); Bengt Holmstrom, Moral Hazard and Observability, 10 Bell
J. Econ. 324-340 (1979); Bengt Holmstrom & Joan Ricart I. Costa,
Managerial Incentives and Capital Management, 101 Q. J. Econ. 835-
860 (1986). Terms of employee and director compensation contracts,
including holding and vesting periods, may also affect the alignment
of incentives with shareholder value over time.
    \177\ See Proposing Release, at 8498-99, nn. 88-89. See, e.g.,
Lisa Meulbroek, Company Stock in Pension Plans: How Costly Is It?,
48 J. L. & Econ. 443, (2005); Brian J. Hall &Kevin J. Murphy, Stock
Options for Undiversified Executives 33 J. Acct. & Econ.no. 1, 3-42
(2002) (stating that a large literature has studied the resulting
underinvestment concern).
    See, e.g., Alfred Rappaport, Executive Incentives vs. Corporate
Growth, 57 Harv. Bus. Rev. 81-88 (1978); Clifford Smith & Rene
Stulz, The Determinants of Firms' Hedging Policies, 20 J. Fin. and
Quantitative Analysis 391-405 (1985); Robert Kaplan, Advanced
Management Accounting, (Prentice-Hall, 1982); and Richard Lambert,
Executive Effort and the Selection of Risky Projects, 17 RAND J.
Econ. 77-88 (1986).
    \178\ Besides concentrated financial wealth exposure, employees
and directors have human capital exposure to the company. Hedging by
employees and directors affects the former.
    \179\ For example, corporate hedging of cash flow risk, or a
requirement that executive officers hold stock options, also can
strengthen executives' incentives to take on risky but value-
enhancing investment projects; however, both can involve costs. See
Proposing Release, at 8499, n. 91.
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    There is limited research on hedging transactions by corporate
insiders. In an effort to understand these incentives, one academic
study concludes that there is significant variation in the motivations
for the use of derivative transactions for hedging by corporate
insiders.\180\ However, the study does not find evidence that the use