Thursday, June 16, 2022

Securities law academics urge SEC to do more on human capital

By Mark S. Nelson, J.D.

According to a group of law professors, the SEC should adopt a new round of human capital disclosure rules in order to afford investors greater clarity about the accounting treatment companies employ regarding the costs of developing their labor forces. Specifically, the rulemaking petition would require companies to explain to investors which labor costs are treated by them as investments, as opposed to expenses. The petition was signed by 10 securities law professors, including former SEC commissioners Robert J. Jackson, Jr. and Joseph A. Grundfest, along with John C. Coates IV, who recently served as General Counsel and Acting Director of the SEC’s Division of Corporation Finance until returning to academia.

“We differ in our views about the regulation of firms’ relationships with their employees generally. But we all share the view that investors need additional information to examine whether and how public companies invest in their workforce—and that the Commission’s rules should therefore require that information to be disclosed,” said the petition’s authors. “Here, we focus on key elements of that information that we all agree are important.”

MD&A and tabular disclosure. The centerpiece of the law professors’ petition would be a combination of narrative disclosure made via the Management’s Discussion & Analysis section of Form 10-K and a tabular disclosure that would separate out key employee compensation metrics. According to the petition, discussion of human capital in the MD&A could elicit a company’s views on which labor costs it views as expenses and which labor costs it views as investments. Breaking out labor costs in this way, said the petition, could help investors decide which labor costs incurred by a company should be capitalized, with the added benefit of encouraging companies to treat their employees more as a source of value creation.

The law professors suggested that the proposed tabular disclosure would complement the qualitative disclosures proposed to be made in the MD&A. The law professors also said they agreed with statements made by Sen. Mark Warner (D-Va) in a 2018 letter he sent to then-SEC Chair Jay Clayton in which the senator cautioned that companies that elect to invest in their employees can be perceived by the marketplace under current accounting practices as incurring expenses with the result that investors punish such companies.

The tabular disclosure would emulate existing disclosures for executive compensation. As a result, a human capital chart would focus on items such as mean tenure, turnover, number of employees, salaries, stock options, and other employee compensation topics, including health care and training.

The petition’s authors said their proposal was designed to minimize the costs of regulation and that much of what they propose would fit well within existing accounting frameworks. The petition also asserted that more detailed human capital disclosures are needed because of a global shift in the types of assets companies have from physical assets to intangible assets, including employees.

Current human capital rule. In August 2020, the SEC adopted revisions to Regulation S-K that, among other things, mandate disclosure, to the extent material to understanding a company's business as a whole, information about human capital resources, including the measures or objectives the company uses to manage the business. The requirement covers the number of employees, but also suggests other metrics, such as measures or objectives that address the development, attraction and retention of personnel.

However, with respect to many of the metrics mentioned in the current rule, the Commission explained that they are treated as “examples,” and are not mandatory in nature. Said the commission: “We emphasize that these are examples of potentially relevant subjects, not mandates. Each registrant’s disclosure must be tailored to its unique business, workforce, and facts and circumstances. Consistent with the views expressed by some commenters, we did not include more prescriptive requirements because we recognize that the exact measures and objectives included in human capital management disclosure may evolve over time and may depend, and vary significantly, based on factors such as the industry, the various regions or jurisdictions in which the registrant operates, the general strategic posture of the registrant, including whether and the extent to which the registrant is vertically integrated, as well as the then-current macro-economic and other conditions that affect human capital resources, such as national or global health matters (footnotes omitted).”

Legislation. Legislation on further SEC human capital rules has tended to cover a wide range of topics from diversity and inclusion to offshoring. One of the more targeted bills, however, the Workforce Investment Disclosure Act (S. 1815; H.R. 3471), sponsored by Sen. Warner and Rep. Cynthia Axne (D-Iowa), would require disclosures on a range of topics similar to other bills but with an added emphasis on workforce metrics.

Specifically, companies would have to disclose information about: (1) workforce demographics; (2) turnover; (3) composition (e.g., racial, ethnic, and gender composition); (4) skills and capabilities (e.g., training); (5) health safety, and wellbeing; (6) compensation and incentives; (7) recruiting; and (8) engagement and productivity (e.g., mental well-being of employees and contingent workers as well as freedom of association and work-life balance initiatives). To the maximum extent feasible, data would have to be presented in disaggregated format by workforce composition, wage quintiles, and employment status (e.g., full time or part time). The SEC would be granted authority to exempt emerging growth companies from some of the disclosure requirements. The bill also would explicitly make it unlawful to make false or misleading statements about workforce disclosures but a person could avoid liability if they acted reasonably; however, the bill would bar private causes of action.

A prior version of the Warner-Axne bill (H.R. 5930) was reported on party lines by the House FSC on February 28, 2020 by a vote of 33-25. The current version was included in Title VI of the Corporate Governance Improvement and Investor Protection Act (H.R. 1187), sponsored by Juan Vargas (D-Calif), which passed the House on June 16, 2021 by a vote of 215-214.