When, in August 2020, the SEC considered adopting a new requirement to discuss human capital as part of an overhaul of Regulation S-K, the debate centered largely on principles-based versus prescriptive regulation—a debate that continues to this day. In that instance, notwithstanding a rulemaking petition and clamor from numerous institutional and other investors for transparency regarding workforce composition, health and safety, living wages and other specifics, the "principles-based" team carried the day; the SEC limited the requirement to a "description of the registrant's human capital resources, including the number of persons employed by the registrant, and any human capital measures or objectives that the registrant focuses on in managing the business (such as, depending on the nature of the registrant's business and workforce, measures or objectives that address the development, attraction and retention of personnel)." What was the result? In this new Human Capital Disclosure Report: Learning on the Job, Intelligize took a look at how companies responded to the new disclosure mandate. Its conclusion: most companies made a "sincere effort to fulfill the scantly defined disclosure obligation"; nevertheless, the report contends, companies "capitalized on the fact that the new rule does not call for specific metrics," as "[r]elatively few issuers provided meaningful numbers about their human capital, even when they had those numbers at hand."
SideBar
Both the principles-based approach and the prescriptive approach are based on the concept of "materiality" as defined in TSC Industries, Inc. v. Northway, Inc., specifically, whether there is a substantial likelihood that a reasonable investor would consider the information important in decision-making and whether a reasonable investor would view the information to significantly alter the "total mix" of information available. Principles-based rules give much discretion to management: they "articulate a disclosure objective and look to management to exercise judgment in satisfying that objective." On the other hand, some requirements "prescribe" quantitative thresholds to minimize uncertainty in determining materiality and to identify when disclosure is required, leaving less to the discretion of management. While principles-based rules are necessarily imprecise, may be difficult to apply and can result in a loss of comparability among reporting entities, they can help to eliminate irrelevant information by permitting tailored responses that focus on information that is material to the particular business and are more flexible and adaptable as circumstances change. Prescriptive standards can help promote comparability, consistency and completeness of disclosure, but they can sometimes be circumvented, become stale and may not address or capture all the important information.
In the original proposing release for the inclusion of a human capital disclosure requirement, the SEC had asked for comment on whether the final rule should include more examples of measures or objectives that may be material, such as the number of full-time, part-time, seasonal and temporary workers; voluntary and involuntary turnover rates; measures regarding average hours of training per employee per year; information regarding human capital trends, such as competitive conditions and internal rates of hiring and promotion; measures regarding worker productivity; and the progress that management has made with respect to any objectives it has set regarding its human capital resources. But the SEC elected not to include more prescriptive elements—or even these additional non-exclusive examples—because of its belief that the exact measures and objectives may vary significantly depending on the industry and the company, as well as "the then-current macro-economic and other conditions that affect human capital resources, such as national or global health matters."
According to former SEC Chair Jay Clayton, the SEC's principles-based disclosure "framework in providing the public with the information necessary to make informed investment decisions has proven its merit time and again as markets have evolved when we have faced unanticipated events." As applied to human capital disclosure, he said, the approach requires companies to
"incorporate the key human capital metrics, if any, that they focus on in managing the business, again to the extent material to an understanding of the company's business as a whole. Experience demonstrates that these metrics, including their construction and their use, [vary] widely from industry to industry and issuer to issuer, depending [on] a wide array of company-specific factors and strategic judgments. As I have said previously, I would expect that the material human capital information for a manufacturing company will be vastly different from that of a biotech startup, and again vastly different from that of a large healthcare provider. And the human capital considerations for a multi-national car manufacturer will be different from that of a regional home manufacturer. It would run counter to our proven disclosure system, particularly as we first increase regulatory emphasis in an area of such wide variance, for us to attempt to prescribe specific, rigid metrics that would not capture or effectively communicate these substantial differences. That said, under the principles-based approach, I do expect to see meaningful qualitative and quantitative disclosure, including, as appropriate, disclosure of metrics that companies actually use in managing their affairs."
Commissioner Allison Lee, on the other hand, argued for a more balanced approach that would have included some prescriptive line-item disclosure requirements and provided more certainty in eliciting the type of disclosure that investors were seeking. According to Lee, the SEC received thousands of comments seeking more explicit disclosure, including disclosure on workforce development and diversity, "explaining why principles-based disclosure requirements, without at least some specifics, would not produce the disclosures investors need." However, she observed, the SEC "takes the position that it does not need to require or specify these types of disclosures because our principles-based disclosure regime is on the job and will produce any disclosures on these topics that are material. Investors are asked to trust that each individual company has gauged materiality on these complex issues with flawless precision and objectivity." But, she asks, hundreds of companies have not previously provided disclosure on diversity – should we assume that it is therefore not material? As Lee has previously written (with former Commissioner Robert Jackson), while issuers may "prefer the discretion afforded to them by principles-based disclosure," investors "favor a balanced approach using some line-item disclosure rules." Although a principles-based approach offers flexibility and "makes sense in some cases," the costs must be weighed against the benefits. One cost could be the level of discretion "that it gives company executives...over what they tell investors. Another is that it can produce inconsistent information that investors cannot easily compare, making investment analysis—and, thus, capital—more expensive." (See this PubCo post, this PubCo post and this PubCo post.)
For its report, Intelligize analyzed 427 Annual Reports on Form 10-K filed by companies in the S&P 500 between November 9, 2020, and March 5, 2021. As noted above, Intelligize considered the disclosure to largely reflect a sincere effort, evidenced most notably by the near-universal inclusion of discussions of issues with the most profound impact this past year—diversity and racial injustice and health and safety of the workforce. Intelligize determined that 424 filings discussed diversity and inclusion, while 425 discussed health and 425 discussed safety. But few companies provided much data or detail. In terms of form and content, Intelligize found wide disparities, ranging from brief unstructured paragraphs that did not differ significantly from prior disclosure, to detailed tables and graphics. Some of the disclosure focused on identifying primarily aspirational goals. Others focused their discussion on selected topics, and a smaller group provided "more robust disclosures, which included data in the form of tables and graphs."
Although the rule did not mandate discussion of any particular measure, other than the number of employees, it did call for disclosure regarding human capital "measures or objectives" that the company "focuses on in managing the business," suggesting as examples, "measures or objectives that address the development, attraction and retention of personnel." Intelligize found that, in response, many companies discussed "development" (or training) and "attraction" (or recruiting); "retention" of employees was discussed by over half of companies in the survey. "Turnover" was discussed by over 140 companies and succession planning by about 200 companies. Many companies also discussed oversight of human capital, both by the board and management.
But many companies also went beyond the specific examples provided by the SEC. As noted above, over 90% of companies discussed diversity and inclusion, sometimes under a separate caption. However, very few provided much in the way of statistics—only 16 disclosed the diversity statistics that they file with the EEOC on Form EEO-1, a form filed by all public companies. Instead, some described their goals and objectives, as well as personnel charged with responsibility for diversity, such as diversity councils and committees.
As noted in the SideBar above, Clayton had commended the SEC's principles-based system for its flexibility in eliciting necessary information when the nation has faced unanticipated events, such as the pandemic. And, consistent with that view, Intelligize found a high incidence of disclosure regarding workforce health and safety. Of the 425 companies that discussed safety and/or health, many discussions were also under separate captions. Topics included safety enhancements in light of the pandemic, continuity planning in connection with remote work, as well as company wellness programs and employee assistance programs (EAPs). Beyond the pandemic, one frequent topic was workplace injuries.
SideBar
In 2017, the Human Capital Management Coalition, a group of 25 institutional investors with more than $2.8 trillion in assets under management, submitted a rulemaking petition to the SEC asking the SEC to adopt rules requiring "issuers to disclose information about their human capital management policies, practices and performance." Although the petition was short on prescriptive recommendations, it did identify the broad categories of information that the proponents viewed as "fundamental to human capital analysis":
- Workforce demographics (number of full-time and part-time workers, number of contingent workers, policies on and use of subcontracting and outsourcing)
- Workforce stability (turnover (voluntary and involuntary), internal hire rate)
- Workforce composition (diversity, pay equity policies/audits/ratios)
- Workforce skills and capabilities (training, alignment with business strategy, skills gaps)
- Workforce culture and empowerment (employee engagement, union representation, work-life initiatives)
- Workforce health and safety (work-related injuries and fatalities, lost day rate)
- Workforce productivity (return on cost of workforce, profit/revenue per full-time employee)
- Human rights commitments and their implementation (principles used to evaluate risk, constituency consultation processes, supplier due diligence)
- Workforce compensation and incentives (bonus metrics used for employees below the named executive officer level, measures to counterbalance risks created by incentives)
The petitioners left it to the SEC to achieve an appropriate balance between "specific, rules-based disclosures, such as the amount spent on employee training in the past year, and more open-ended principles-based disclosures like how training expenditures are aligned with a changing business strategy." (See this PubCo post.)
After adoption of the SEC's final amendments, the Coalition issued a statement observing that "under the new rules shareholders would still face difficulty in obtaining information that is clear, consistent, and comparable in order to make optimal investment and voting decisions. While the rulemaking represents important progress in acknowledging the importance of the workforce, the new rules give public companies too much latitude to determine the content and specificity of the human capital-related information they report." The Coalition looked forward "to working with the SEC to assist in developing a balanced approach to human capital-related reporting." In the statement, the Coalition also urged the SEC to require companies, at a minimum, to report on "four quantitative yet modest disclosures to anchor the principles-based, industry- and company-specific reporting framework relied upon in [the SEC's final] amendments": "(1) the number of employees, including full time, part-time and contingent labor; (2) total cost of the workforce; (3) turnover; and (4) employee diversity and inclusion."
Compensation was also discussed by 425 companies, although, in the main, companies did not discuss pay numbers, but rather focused on their compensation philosophies, as well as incentive and benefits programs. Of course, as Intelligize observes, "only 16 filers included their EEO-1 data, which includes pay rates broken down by race, sex, and ethnicity, and which employers already have to prepare for the government."
According to Intelligize, 382 companies surveyed mentioned company culture or values, a topic that has risen to the fore in light of recent company ventures into the political sphere consistent with company values. Intelligize reports that these descriptions frequently centered around "codes of conduct, core principles and commitment to ethical behavior, including, most often, "employee engagement." Interestingly, here, companies were apparently not averse to providing data: most of the companies "disclosed some form of survey on employee engagement," with some providing data such as the percentage of employees that indicated in the survey that they were proud to work at the company. In the same vein, 330 companies discussed their community efforts, including volunteering and charitable contribution matching programs.
Labor relations was another topic that was widely addressed, with 332 companies touching on this topic. Some companies with unionized employees discussed collective bargaining and provided data about the number of employees belonging to various unions.
Is what's past prologue or does practice make perfect? Intelligize observes that, with no clear guidance about what to disclose and consistent with common practice, companies appeared to have learned from each other: "In a sign that they have been building on each other's work, human capital descriptions filed later in the study period were, on average, longer than those filed toward the start." That practice will likely continue. Will the pattern of excluding specific data continue? Or will pressure from institutional investors and social activists for inclusion of data—such as diversity and compensation data from EEO-1s that companies are already required to collect and provide to the government—lead more companies to provide that data, becoming a more mainstream practice? Will the SEC take further action to elucidate the disclosure mandate? In remarks to the Center for American Progress, entitled A Climate for Change: Meeting Investor Demand for Climate and ESG Information at the SEC, Lee advocated that, in the near term, the SEC should offer "guidance on human capital disclosure to encourage the reporting of specific metrics like workforce diversity, and consider[] more specific guidance or rulemaking on board diversity." She also asked whether the SEC should consider imposing an ESG-specific policies-and-procedures requirement? (See this PubCo post.) Stay tuned.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
