The Securities and Exchange Commission’s Investor Advisory Committee (IAC) unanimously voted to recommend the commission write a rule that requires publicly traded companies to provide more relevant information about its workforce, including the total cost of the company’s labor, broken down into major components of compensation.
The advisory panel also wants the following information:
- the number of people employed by the company, broken down by whether those people are full-time, part-time, or contingent workers;
- turnover or comparable workforce stability metrics; and
- workforce demographic data sufficient to allow investors to understand the company’s efforts to access and develop new sources of talent, and to evaluate the effectiveness of these efforts.
In addition to the requested metrics, the IAC wants the SEC to require companies to provide a narrative disclosure in the Management’s Discussion and Analysis (MD&A), of how their labor practices, compensation incentives and staffing fit within their broader strategy.
The full advisory committee voted on the set of human capital management (HCM) disclosure recommendations drafted by a subcommittee during a meeting on Sept. 21, 2023.
The panel decided to submit the recommendations for the SEC to consider because investors find current disclosure requirements—inside and outside financial statements—to be inadequate to properly value companies. This is especially true when employees are the most important intangible assets for many companies today. Some 90 percent of the S&P 500 index’s valuation consists of intangible assets, such as intellectual property and brand reputation that are primarily created by employees.
In August 2020, the SEC updated its disclosure rule when Jay Clayton was chairman and decided against a prescriptive requirement under Item 101 of Regulation S-K to allow a company to decide whether it believes the disclosure is important for investors in understanding the company’s business.
The disclosure would be based on a concept of materiality. This means companies should disclose information that a reasonable person would find important in the total mix of information in making a decision to buy or sell a particular company’s stock.
Previously, companies were only required to provide the number of employees, and investors asked the SEC to consider writing a rule that would give them more insight about how companies—especially IT companies who heavily rely on their employees to create value—manage their talent.
After Gary Gensler became chair of the SEC in 2021, he decided to put HCM on the commission’s rulemaking agenda to respond to investor request for more prescriptive rules that would require companies to provide certain standardized HCM metrics.
Clayton advanced rules that were business-friendly under the Trump administration. By contrast, Gensler has been emphasizing the needs of investors by increasing transparency of corporate activities.
“The SEC’s 2020 revisions to the human capital disclosure requirements have proved disappointing to investors as they are so principles-based, the information is qualitative, piecemeal and not connected to the value producing activities of the company,” said Sandy Peters, senior head of global financial reporting policy with CFA Institute.
The commission is planning to issue an HCM proposal in the coming weeks.
Why Investors Want More HCM Information
Cambria Allen Ratzlaff, managing director and head of Investor Strategies at JUST Capital, said that the recommendations are presented against a backdrop of an ever evolving economy, where the source of value for companies has shifted from the tangible—primarily property, plant and equipment—to the intangible, or the collective knowledge, skills and experiences of the workforce which drive innovation and economic success.
“Investment decisions are only as good as the information they are based on, and the information has not kept up,” Ratzlaff said. “But for now, investors the audience for whom securities information is intended by law and regulation, continue to rely on limited approximations of critical workforce data that are often costly, inefficient and unreliable. And some investors still need fundamental HCM metrics… to anchor the wide ranging information provided by companies.”
The IAC recommendations are consistent with a June 2022 rulemaking petition submitted by the Working Group on Human Capital Accounting Disclosure, whose members include former SEC commissioners and officials as well as professors of accounting and securities laws.
SEC IAC: FASB’s Standard-Setting Effort is Inadequate
The advisory panel said that the SEC should act to boost HCM disclosure also because the Financial Accounting Standards Board’s (FASB) standard-setting effort will not result in information that investors need.
The accounting standard-setter at the end of July issued a proposal that would require the disclosure of more disaggregated information in notes to the income statement about expenses.
The FASB would require the disaggregation of major operating costs, including employee compensation costs to be disclosed under (ASU) No. 2023-ED500, Income Statement—Reporting Comprehensive Income—Expense Disaggregation Disclosures (Subtopic 220-40).
CFA Institute’s Peters said that human capital is an important asset, not simply an expense, to many companies today.
“Presently many, if not most, companies do not disclose compensation and labor costs on their income statement,” Peters said.
The FASB’s proposal “seeks to provide employee compensation costs, albeit with less disaggregation than most investors would like because it does not, for example, disaggregate employee compensation by wages, benefits and stock compensation, a requested disclosure within this [SEC IAC] recommendation,” she said.
The accounting board’s proposal also does not require companies to disaggregate employee compensation by segment—the level at which most investors value companies and where human capital can be used differently within business models.
“While I… will comment on these needed improvements in a letter to the FASB, this income statement disclosure is a backward-looking take on employee compensation expense,” Peters said of the FASB’s project. “It does not provide investors with what they need to know about the composition of this intangible assets under our existing 19th century manufacturing accounting model.”
“As investors, we are interested in the ability of the company to maintain, cultivate and grow their human capital intangible asset as it is important to 21st century business models,” she explained.
Peters said that analysts are also interested in understanding to what extent technology may disrupt or displace human input within existing business.
Investors: Benefits Will Outweigh Costs
In addition, she pointed out that if the SEC decides to incorporate the recommendations into its rules, it will represent only a modest additional requirement.
“As one of my colleagues showed to me just yesterday, for technology companies, I know more about the building the software developers are sitting in than how much is being spent within that building on their salaries and the assets they are creating,” she said.
Paul Roye, who retired from Capital Research and Management Company in 2022, pointed out that companies with more than 100 employees are already providing EEO-1 data mandated by the U.S. Equal Employment Opportunity Commission. (EEOC). These companies must submit workforce demographic data by job category and sex and race or ethnicity.
“I don’t think it’s a burden to disclose it. I think, for the reasons that Sandy outlined, many investment managers look at this data as value to help them make assessments of the companies they invest in,” he said.
Similarly, because the data exists, and companies are already reporting in other context, “I don’t think it’s very complicated; therefore, I am not persuaded by any discussion of concerns that it’s going to be misused or over disclosed,” said Christopher Mirabile, a senior managing director with Launchpad Venture Group. “This is a clear case where the benefits—a little tiny bit of additional disclosure and effort—very, very much outweigh the effort in creating the disclosures.”
This article originally appeared in the September 26, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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