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E-MailLuis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.
Today [February 9, 2015], the Commission issued proposed rules on Disclosure of Hedging by Employees, Officers and Directors. These congressionally-mandated rules are designed to reveal whether company executive compensation policies are intended to align the executives’ or directors’ interests with shareholders. As required by Section 955 of the Dodd-Frank Act, these proposed rules attempt to accomplish this by adding new paragraph (i) to Item 407 of Regulation S-K, to require companies to disclose whether they permit employees and directors to hedge their companies’ securities.
Over the last three decades, we have witnessed an unprecedented growth in the compensation of corporate executives. Much of that growth reflects the trend towards equity-based and other incentive compensation, which intends to meet the worthy goal of aligning the interests of the corporate overseers of public companies with their shareholders. However, some have suggested that company policies that permit hedging of the company’s equity securities could have the opposite effect. By allowing corporate insiders to protect themselves from stock declines while retaining the opportunity to benefit from stock price appreciation, hedging transactions could permit individuals to receive incentive compensation, even where the company fails to perform and the stock value drops.
Just as problematic, hedging transactions can be structured so that executives or directors monetize their shareholdings while they still technically own the stock, which makes the fact that the hedging took place less transparent to investors. Indeed, in the absence of this proposed disclosure, shareholders may not be aware of the executive officers’ and directors’ true economic exposure to the company’s equity. Accordingly, the proposed hedging rules are intended specifically to address this lack of transparency, and attempt to provide greater clarity to investors regarding employees’ and directors’ actual incentives to create shareholder wealth. In addition, better information about equity incentives could be useful for investors’ evaluation of companies, enabling investors to make more informed investment and voting decisions.
It is important to note what the proposed rules do not do: they do not prohibit hedging transactions by employees or directors of public companies. This is a disclosure rule that is intended to shed some sunlight on this practice. Accordingly, if a company specifically prohibits certain hedging transactions but allows others, it would need to disclose those hedging transactions that are permitted. However, the proposed amendments could result in companies implementing changes in hedging policies that improve the alignment of interest between shareholders and executive officers or directors.
The proposed rules on hedging disclosures are only one in a series of Congressionally-mandated rules that are intended to promote accountability by making executive compensation decisions more transparent to company shareholders. The Commission has already adopted some of these rules. Unfortunately, other significant executive compensation-related disclosure rules have yet to be adopted, including disclosures related to:
- The relationship between executive compensation actually paid and the financial performance of the issuer (known as “pay-for-performance”);
- The ratio between the compensation of the chief executive officer and the total annual compensation of its average worker (known as “pay ratio”); and
- Reports by large investment managers of their advisory shareholder votes about executive compensation and golden parachutes (known as “say-on-pay” votes).
It is my hope that the Commission moves promptly to adopt these additional disclosure rules to provide maximum transparency to investors about companies’ executive compensation decisions. Without such transparency, the true owners of public companies—the shareholders—most assuredly will have a difficult time holding company directors and officers accountable for their executive compensation decisions.
This proposing release is a positive step in the direction of providing more information to shareholders as to whether the interests of corporate insiders are truly aligned with their own. As with all proposing releases, this proposing release includes many requests for comment regarding the approach that the Commission has decided to take to implement the statutory mandate.
Public comments are always an important part of the rulemaking process, and I especially encourage investors to review and submit their thoughts on the proposed release.
