On Wednesday, the SEC’s Investor Advisory Committee held a
jam-packed meeting to discuss, among other matters, human capital
disclosure and the SEC’s proposal on Schedule 13D beneficial
ownership. Wait, didn’t this Committee just have a meeting in
June about human capital disclosure, part of the program about
non-traditional financial information? (See this PubCo post.) Yes, but, as the moderator
suggested, Wednesday’s program was really a “Part II”
of that prior meeting, expanding the discussion from accounting
standards for human capital disclosure to now consider other
labor-related performance data metrics that may be appropriate for
disclosure. The Committee also considered whether to make
recommendations in support of the SEC’s proposals regarding
cybersecurity disclosure and climate disclosure.
SideBar
In her remarks at the opening of the meeting,
Commissioner Hester Peirce criticized the packed meeting schedule
that, in her view, did not allow time for adequate presentation of
“counter-perspectives.” That problem also plagued the
Committee’s last meeting, preventing the presentation of
counter-perspectives or much Committee discussion on the climate
proposal. But that discussion “forms the basis for one of
today’s recommendations. Absent procedural changes to allow
broad, open discussion, the Committee risks undermining its ability
to contribute to the Commission’s work. How am I to weigh a
recommendation that appears to be the product of a one-sided panel,
virtually no intra-Committee discussion after the panel, and only
ten minutes for discussion set aside on today’s calendar? I
understand that you are trying to keep pace with a packed
Commission regulatory agenda, but some Commission habits are not
worth emulating.”
Peirce then raised a number of questions for Committee
discussion, including these on human capital disclosure:
- “In 2020, the SEC adopted a more principles-based
requirement for public companies to disclose material “human
capital resources.” Why are these disclosures insufficient to
inform investors? - A company’s employees are key to its success, but the human
capital measures relevant to one company may not be relevant to
another. Identifying common metrics for comparability may obscure
real differences across companies. Assuming the SEC should
prescribe specific human capital metrics, how can these measures
work across a broad swath of companies and industries? - Would mandating the disclosure of certain human capital data
points change how companies interact with their employees? Is that
the objective of some proponents of these measures?”
She also raised this question regarding the beneficial ownership
proposal:
- “While timelines for 13-D filings were originally set in
the 1960s when paper filings and fax machines were the standard,
the non-technological justification for delay remains
unchanged—allowing an investor who has put in the work to
identify an undervalued company to profit from that effort. Is the
current ten days, the proposed five days, or some other number of
days the right number to foster both appropriate transparency about
impending changes of control and the healthy dynamism that vigilant
investors bring to the market?”
[Based on my notes, so standard caveats apply.]
Human capital
The moderator of the panels on human capital observed that, over
the last decades, as the “primary sources of companies’
value has shifted toward “intangibles”—including
labor resources—investors’ informational needs have
similarly evolved.” In 2020, the SEC adopted a new
principles-based disclosure mandate that required companies to
report on, in addition to the existing requirement to disclose the
number of employees, “any human capital measures or objectives
that the registrant focuses on in managing the business.”
While many viewed the amendment as a step in the right direction,
the moderator contended, “many investors voiced concerns that
the rules fell short in providing the kind of high-quality,
actionable data they needed to develop a clear and effective
understanding of a company’s skill in managing its workforce,
while also permitting corporate management to exercise too much
latitude in what human capital information would be
reported.”
Both panelists on the first panel indicated that, beyond
diversity information, most companies were not providing much in
the way of human capital metrics. The first panelist, a research
director at a nonprofit, studied labor-related disclosure from the
100 largest employers in mid-2021, looking at 29 human capital
metrics in categories such as comp and benefits, DEI, stability,
safety and training. What did she find? That, across the board,
there wasn’t much disclosure. Less than 20% of companies
reported on the majority of identified metrics; the metric for
wages was highest, and it was just under 17%. In addition, while
the metrics with the highest levels of disclosure were in 10-Ks,
most of the reporting was in corporate social responsibility
reports, which are not audited or standardized. Because of the
dearth of disclosure, the data collection process was
laborious.
A professor from Harvard Business School discussed the need to
be able to capitalize some labor costs, a topic discussed at length
at the June meeting. (See this PubCo post.) This panelist also examined
the use of human capital metrics among 2,500 companies following
the adoption in 2020 of the SEC’s principles-based human
capital disclosure requirement. (See this PubCo post.) He found that 86% included a
section captioned “human capital”; 40% discussed DEI.
There was little discussion, however, of employee
retention/turnover (which he found to be a great predictor of
future returns), safety issues or training. A number of companies,
he found, included EEO-1 data or information from their ESG reports
in their 10-Ks (and there was less greenwashing in those cases). He
also found that investors do care about this information, with some
positive market reaction following the 2020 amendment for firms
with “human capital intensity” that disclosed financially
material human capital metrics.
When asked by the Committee to identify the three most important
human capital metrics, the two panelists agreed on wages; the first
panelist would add hours and equity (e.g., diversity), and
the second panelist identified turnover and investments in
training. The need to provide breakdowns of data by category was
also discussed, such as wages for part-time/full-time and gig
workers and training by wage band. When asked about likely
challenges to providing this data, the panelists suggested that
companies might express concerns that some information, such as
turnover, might be proprietary or involve legal exposure.
SideBar
In 2017, the Human Capital Management Coalition, a group of 25
institutional investors with more than $2.8 trillion in assets
under management, filed a rulemaking petition with the SEC
requesting adoption of rules requiring “issuers to disclose
information about their human capital management policies,
practices and performance.” (See this PubCo post.) The petition identified 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.)
When, in August 2020, the SEC adopted a new requirement to
discuss human capital as part of an overhaul of Reg S-K, the debate
centered largely on whether the rule should be principles-based or
prescriptive. In that instance, notwithstanding the earlier
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).” At the time,
then-Commissioner Allison Herren Lee 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. (See this PubCo post.)
After adoption of the SEC’s 2020 amendments, the Human
Capital Management 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.”
Subsequent reporting has suggested that 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.” (See this PubCo post.) In June, a new rulemaking petition was submitted by a group of
academics requesting that the SEC require more qualitative and
quantitative disclosure of financial information about human
capital, a topic discussed at the last Committee meeting. (See this PubCo post.) Given the SEC’s current
bent for highly prescriptive rulemaking, presumably a new proposal
on the topic from Corp Fin would involve a much more prescriptive
effort to enhance company disclosures regarding human capital
management. The SEC’s agenda identifies October 2022 as the
target date for issuance of a proposal.
On the next panel, a principal investment officer for a state
investment fund observed that investors benefit from disclosures
regarding human capital. For example, companies with poor practices
in the treatment of their workers may face the risk of adverse
publicity, such as arose during COVID and the racial justice
movement. She also observed that her company looks at diversity
metrics because they are of the view that more diverse companies
tend to outperform others. When a company’s diversity results
are poor, they will take into account whether the company has a
plan of action to address the issue. A chief human resources
officer indicated that he disclosed the metrics to which his
company managed, such as DEI, percentage union membership,
competitive pay information, tenure and voluntary turnover, the
percentage of internal promotions and succession plans for key
jobs. Both panelists suggested use of the SASB standards as a
starting point.
Schedules 13D and 13G Beneficial Ownership
Reports
The SEC has proposed to modernize beneficial ownership reporting
on Schedules 13D and 13G. (See this PubCo post.) According to SEC Chair Gary
Gensler, currently, investors “can withhold market moving
information from other shareholders for 10 days after crossing the
5 percent threshold before filing a Schedule 13D, which creates an
information asymmetry between these investors and other
shareholders. The filing of Schedule 13D can have a material impact
on a company’s share price, so it is important that
shareholders get that information sooner.” The proposed
amendments would accelerate the filing deadline for the initial
Schedule 13D to five days after the date on which a person acquires
more than 5% of a covered class of equity securities. The original
10-day timelines were set were set under the Williams Act in the
1960s, before one of the panelists were even born (he pointed out).
In addition, the proposal would amend the definition of
“group” to specify that when two or more persons
“act as” a group, the group shall be deemed to have
become the beneficial owner of the shares beneficially owned by its
members and provide that “if a person, in advance of filing a
Schedule 13D, discloses to any other person that such filing will
be made and such other person acquires securities in the covered
class for which the Schedule 13D will be filed, those persons shall
be deemed to have formed a group within the meaning of Section
13(d)(3).”
Panelists presented opposing views on the proposal. Among
panelists that opposed the proposal, one indicated that there was
no economic justification for shortening the window, but suggested
five trading days as a compromise. He criticized the
revisions to the “group” definition as more unclear than
the current definition, where an agreement is required, and
susceptible to unintended consequences, such as potential impact on
Section 16. Another panelist contended that the original targets of
the Williams Act were hostile tender offers, which are rare now.
Currently, he said, proxy contests are more common, and the impact
of the proposal seemed to be a reduction in the incentives for
activists, who are typically seeking share appreciation, not
control. (In some cases, he noted, activists are seeking ESG
measures.) The 10-day window, he explained, allows the proponent to
take advantage of share purchases with an adequate return. After
all, the activist is the one who identified the target as a good,
undervalued prospect; if the stock price climbs after the 13D
announcement, he said, that benefits the rest of the shareholders,
who are simply free-riding. He believed the proposal would insulate
firms from shareholder challenges. With regard to the proposed
revisions to the group definition, in his view, the SEC’s real
concerns were tippees and wolfpacks (see this PubCo post, this PubCo post and this PubCo post). He suggested leaving the
10-day window and prohibiting tipping until the 13D is filed. His
concern was the possibility of sweeping in parties and chilling
communications that are part of “proxy contest
persuasion.”
Panelists that favored the proposal stressed the need to close
loopholes and prevent information asymmetry. Generally, they found
the proposed shift to five calendar days to be acceptable, although
there was some preference expressed for prohibiting all purchases,
once the 5% threshold is reached, prior to filing the 13D.
According to one panelist, although the proposal wouldn’t halt
activism, it would mitigate the problem of information asymmetry by
reducing the time allowed for the accumulation of shares in secret.
He also contended that the proposed definition of “group”
was more consistent with the 14e-3 limits and suggested that the
staff will be able to address any unintended consequences through
guidance and safe harbors. Another panelist contended that the
previous panelists’ focus on activists versus issuers was
wrongheaded because it ignored other market participants; after
all, the profits accruing to activists from the accumulation of
shares come at the expense of other shareholders. That view was
shared by another panelist, who asked who pays for the economic
advantage allowed to hedge fund activists. He also contended that
proxy contests are just another means to the same ends as tender
offers—then, as now, sunlight is still the best disinfectant.
While there may be a few activists that are promoting ESG, most are
focused on restructuring and are associated with curtailing funding
for R&D and other internal investments. Activists, he said, use
the window as a way of compensating themselves. (See this PubCo post.)
Recommendations
The Committee also approved (unanimously, but for a few
abstentions) several recommendations to the SEC, including
recommendations regarding the SEC’s proposals on cybersecurity
and climate disclosure. With regard to the cybersecurity disclosure
proposal (see this PubCo post), the recommendation supported the proposal,
especially the new reporting requirements on Form 8-K (including
the requirement to provide periodic updates to previously disclosed
cybersecurity incidents), and the requirement to describe policies
and procedures, as well as board oversight of cybersecurity
risks.
As enhancements, the Committee recommended that companies be
required “to disclose the key factors they use to determine
the materiality of a cybersecurity incident” in periodic and
current reports. This provision would help investors to consider
comparability “as they assess risk and historical attack
prevalence across companies, while mitigating concerns from
investors that companies may continue to underreport cybersecurity
incidents under the Proposed Rule.” The Committee was also
“concerned that without clear guidance from the Commission, an
issuer may fail to report cybersecurity incidents by misjudging the
extent to which the incident is material to a reasonable investor.
Though the Proposed Rule leaves the materiality determination to
the issuer, we urge the Commission take any steps it deems
necessary to mitigate any confusion around the circumstances under
which an issuer would be expected to report cybersecurity incidents
to investors.” The Committee also recommended that, to the
extent practicable, the required disclosure about
“cybersecurity risk management and strategy, including
applicable policies and procedures, board and management oversight
of cybersecurity risk, and updated disclosure about cybersecurity
incidents” be included in registration statements. The
Committee also favored the omission of an allowance for modified or
delayed incident reporting when requested by law enforcement. The
Committee saw the proposal as “striking a defensible balance
between the interests of investors who require high-quality,
decision-useful information about cybersecurity incidents to inform
decision-making and the needs of issuers seeking to safeguard
sensitive and/or proprietary data from would-be attackers.”
Finally, the Committee recommended that the SEC reconsider the
requirement that issuers disclose certain information about the
board members’ cybersecurity expertise. The term was not
defined in the proposal. In addition, the Committee expected the
entire board to be responsible for oversight and did not want
oversight to be “siphoned off” to just one expert on the
board, an implication that might be drawn from that aspect of the
proposal.
The Committee also supported the SEC climate disclosure proposal
(see this PubCo post, this PubCo post and this PubCo post), especially the
proposal’s use of existing frameworks and protocols and the GHG
emissions disclosure and attestation requirements. The Committee
recognized the concerns raised about the implementation costs of
Scope 3 “but believe that registrants have rapidly increasing
access to a growing community of both experts and tools that will
allow this to be done very cost effectively. Moreover, given
evolving methodologies relating to Scope 3 emissions data, we
support applying a safe harbor to this disclosure.” The
Committee also supported the proposed disclosures regarding risks
and risk management, as well as the disclosure of climate-related
impacts on business strategy, model and outlook. The Committee
recommended that the proposal include a requirement to provide a
“Management’s Discussion of Climate-Related Risks &
Opportunities” to provide a better understanding of how
management is considering the risks an opportunities arising out of
climate change, disclosure of material facility location to
facilitate understanding of the physical risks of climate change,
and, as with the recommendation on cybersecurity disclosure (and
for same reasons), elimination of the disclosure requirement
regarding climate-related board expertise.
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