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.
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.]
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.
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.)
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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