Yesterday, Commissioners Robert Jackson and Allison Lee published a joint statement to encourage public comment about two aspects of the proposal to modernize Reg S-K (see this PubCo post), released on August 8, about which they had some, uh, reservations. They both indicated their support for release of the proposal, particularly its focus on adding “human capital” as a disclosure topic, but—and it’s a significant “but”— they took issue with the proposal’s “shift toward a principles-based approach to disclosure and the absence of the topic of climate risk.”
First, they viewed as problematic the proposal’s tilt toward “a principles-based approach to disclosure rather than balancing the use of principles with line-item disclosures as investors—the consumers of this information—have advocated.” They note here that, while issuers “prefer the discretion afforded to them by principles-based disclosure,” investors “favor a balanced approach using some line-item disclosure rules.”
Although a principles-based approach offers flexibility and “makes sense in some cases,” they believe that the proposal did not adequately weigh the costs of that approach against the benefits. One cost that they believe was not adequately considered was the level of discretion “that it gives company executives…over what they tell investors. Another is that it can produce inconsistent information that investors cannot easily compare, making investment analysis—and, thus, capital—more expensive.” Under a principles-based approach, can the SEC be sure that investors will be given the information they need?
For example, they believe that the proposal “takes a crucial step forward” with regard to the mandate for human capital disclosure, which they viewed as recognition that “companies that invest in their workers perform better over time.” But, because the proposal “favors flexibility over bright-line rules, the proposal may give management too much discretion—sacrificing important comparability—when describing a company’s investments in its workers.”
Although the two commissioners appreciated the language in the proposal suggesting potential disclosure regarding the “attraction, retention, and development of personnel,” they were looking for comment on “more specific metrics that are important to investors. For example, commenters might consider whether measures of the company’s use of independent contractors and temporary workers as opposed to full-time employees would be useful….. Commenters might also consider whether the final rule should retain our current requirement to disclose the number of employees, which research has shown is a valuable data point.” To that end, they cited a study showing that “‘abnormal reductions in the number of employees’ are useful in predicting financial misstatements and ‘reductions in the number of employees’ may be an indicator of declining demand for a firm’s product.”
In support of their argument, Jackson and Lee cite the petition for rulemaking regarding human capital management disclosure submitted in 2017 by the Human Capital Management Coalition, a group of 25 institutional investors with more than $2.8 trillion in assets under management (see this PubCo post), and the recommendations of the SEC’s Investor Advisory Committee, which, they maintain, “have urged the SEC to require specific, detailed disclosures reflecting the importance of human capital management to the bottom line.” (See this PubCo post.) The two commissioners welcomed feedback about the “specific measures” that investors would find useful.
Jackson and Lee also addressed what they perceived to be a major deficiency in the proposal: it did “not seek comment on whether to include the topic of climate risk in the Description of Business under Item 101. Estimates of the scale of that risk vary, but what is clear is that investors of all kinds view the risk as an important factor in their decision-making process. Yet it remains tough for investors to obtain useful climate-related disclosure. One argument against mandating such disclosure is that climate risk is too difficult to quantify with acceptable accuracy. Whatever one thinks about disclosure of climate risk, research shows that we are long past the point of being unable to meaningfully measure a company’s sustainability profile.”
The two commissioners refer to various studies showing the value of material sustainability measures, particularly the work of the independent standard-setting organization, the Sustainability Accounting Standards Board, or SASB, “which has carefully refined its measures through extensive engagement with investors and issuers alike in order to emphasize metrics most material to investors.” The two commissioners invite more public comment on “whether and how this topic should be included in a final rule,” including “data and analysis to help guide that important work.”