By Soyoung Ho
The SEC on August 26, 2020, voted 3 to 2 to adopt a new disclosure rule on how public companies manage their workforce—commonly called human capital management—information that investors have been clamoring for in the past few years.
However, to the disappointment of some investor advocates, the SEC decided against a prescriptive requirement under Item 101 of Regulation S-K to allow companies to decide whether it is important enough to warrant disclosure.
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.
Moreover, investors more recently said that human capital management is especially important because of COVID-19, the respiratory disease caused by a novel coronavirus. In order to contain the spread of the virus, many company employees have been working from home. Companies have also taken steps to implement policies to protect their workers from the virus. And investors said they want to know more about what exactly companies are doing, and how that has impacted their business operations.
The human capital management disclosure rule was included in a larger set of revisions to Reg S-K to update the disclosure requirements for the description of business in Item 101, legal proceedings in Item 103, and risk factors in Item 105 to better reflect today’s business environment and reduce compliance costs for companies.
The final rules are in Release No. 33-10825, Modernization of Regulation S-K Items 101, 103, and 105. The rules become effective 30 days after publication in the Federal Register. The move is part of the agency’s broader effort to simplify and modernize the disclosure rules in Reg S-K, which lays out the reporting requirements for periodic reports.
“Today we modernized our public company business disclosure rules for essentially the first time in over 30 years,” SEC Chairman Jay Clayton said. “Building on our time-tested, principles-based disclosure framework, the rules we adopt today are rooted in materiality and seek to elicit information that will allow today’s investors to make more informed investment decisions.”
A few of the revised disclosure requirements are prescriptive, but the rules are largely principles-based. And this emphasis on principles-based requirements was one of the reasons that Democratic Commissioners Allison Herren Lee and Caroline Crenshaw voted against the final release. They also criticized the lack of specific disclosure requirements concerning climate change risk and diversity.
The final rules revise Item 101 to make it largely principles-based and replaces the prescribed five-year timeframe with a materiality framework. It also lets a company provide only an update of the general development of the business focused on material developments that have happened since its most recent full description of its business, which will be incorporated by reference.
The SEC also refocused Item 101(c) on the regulatory compliance disclosure requirements by including all material government regulations, not just environmental laws.
On Item 103, the SEC expressly stated that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document.
The disclosure threshold was modified for certain monetary sanctions from governmental environmental proceedings from $100,000 to $300,000. Companies can also select a different threshold based on materiality, provided that the threshold does not exceed the lesser of $1 million or 1 percent of the current assets of the company.
On Item 105, the summary risk factor disclosure must not be more than two pages if the risk factor section is more than 15 pages.
The SEC also refined the principles-based approach by requiring disclosure of only “material” risk factors. In addition, the final rule requires risk factors to be organized under relevant headings in addition to subcaptions currently required.
Commissioners Lee and Crenshaw’s Dissent
In explaining her dissent, Commissioner Lee pointed out that the SEC received thousands of comments seeking disclosure on workforce development diversity, and climate risk. They said they needed both principles-based and prescriptive requirements.
“In addition to these comments, recent events have provided a real-time case study on the need for many of these disclosures,” Lee said. “It has never been more clear that investors need information regarding, for example, how companies treat and value their workers, how they prioritize diversity in the face of profound racial injustice, and how their assets and business models are exposed to climate risk as the frequency and intensity of climate events increase.”
She said the crises in 2020 have highlighted that environmental, social, and governance (ESG) risks, like those associated with diversity and climate change, are important predictors for resilience and maximizing risk-adjusted returns on investments.
“I would have supported today’s final rule if it had included even minimal expansion on the topic of human capital to include simple, commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity,” she added. “But we have declined to take even these modest steps.”
In the meantime, even as risks related to climate change are ever increasing, Commissioner Crenshaw said that the final rule will reduce certain environmental risk disclosures by up to 30 percent.
By contrast, businesses, which have always favored principles-based requirements, welcomed the rule changes.
“The U.S. Chamber Center for Capital Markets Competitiveness has long advocated for these changes that modernize and simplify disclosure requirements for public companies while ensuring investors are still provided with material information,” Thomas Quaadman, executive vice president of the U.S. Chamber Center for Capital Markets Competitiveness, said in a statement.
The adopted rules in Release No. 33-10825 are substantially similar to the proposed amendments issued in August 2019 in Release No. 33-10668, Modernization of Regulation S-K Items 101, 103, and 105.
This article originally appeared in the August 27, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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