More financial information about human capital? FASB looks to require disaggregation of expenses on the income statement
In June, the Working Group on Human Capital Accounting Disclosure, a group of ten academics that includes former SEC Commissioners Joe Grundfest and Robert Jackson, Jr. and former SEC general counsel, John Coates, submitted a rulemaking petition requesting that the SEC require more disclosure of financial information about human capital. According to the petition, there has been “an explosion” of companies “that generate value due to the knowledge, skills, competencies, and attributes of their workforce. Yet, despite the value generated by employees, U.S. accounting principles provide virtually no information on firm labor.” (See this PubCo post.) The Group may be about to have its wishes granted—at least in part—but not by the SEC. Rather, the FASB is hard at work on a project to disaggregate income statement expenses, and high on all of the FASB board members’ lists was the need to separately disclose labor costs/employee compensation. Of course, as reported by Bloomberg (here and here), there has been a push for disaggregation of expenses on the income statement since at least 2016, but in 2019, the FASB voted (5 to 2) “to put its once-high priority financial reporting project on pause.” It’s been quite a lengthy pause, but, in February 2022—perhaps hearing the call from investors and others—the FASB decided to restart work on the project to “improve the decision usefulness of business entities’ income statements through the disaggregation of certain expense captions.” It seemed from the FASB Board discussion that the Board members were favorably inclined to proceed with a disaggregation requirement—especially with respect to labor costs.
The SEC has posted its Spring 2022 Reg-Flex agenda and it’s crammed with pending and new rulemakings—and they’re all going to be proposed or adopted in October! (Ok, admittedly, that’s an exaggeration, but not much of one.) Here is the short-term agenda and here is the long-term agenda. According to SEC Chair Gary Gensler, the “U.S. is blessed with the largest, most sophisticated, and most innovative capital markets in the world….But we cannot take that for granted. As SEC alum Robert Birnbaum and his team said decades ago, ‘no regulation can be static in a dynamic society.’ That core idea still rings true today.” Gensler’s public policy goals for the agenda are “continuing to drive efficiency in our capital markets and modernizing our rules for today’s economy and technologies.” As with recent prior agendas, SEC Commissioner Hester Peirce has almost no kind words for the agency’s plans—“flawed goals and a flawed method for achieving them.” In fact, she went so far as to characterize the agenda as “dangerous”: in her view, the agenda represents “the regulatory version of a rip current—fast-moving currents flowing away from shore that can be fatal to swimmers. Just as certain wave and wind conditions can create dangerous rip currents, the pace and character of the rulemakings on this agenda make for dangerous conditions in our capital markets.” There’s no dispute that the agenda is laden with major proposals—human capital, SPACs, board diversity. What’s more, many of these proposals—climate disclosure, cybersecurity, Rule 10b5-1—are apparently at the final rule stage. Whether or not we’ll see a load of public companies submerged by the rip tide of rulemakings remains to be seen, but there’s not much question that implementing them all would certainly be a challenge in any case.
Do companies disclose enough information about investments in their workforces? Not according to the Working Group on Human Capital Accounting Disclosure, a group of ten academics that includes former SEC Commissioners Joe Grundfest and Robert Jackson, Jr. and former SEC general counsel, John Coates. The Working Group has submitted a new rulemaking petition requesting that the SEC require more disclosure of financial information about human capital. According to the petition, there has been “an explosion” of companies “that generate value due to the knowledge, skills, competencies, and attributes of their workforce. Yet, despite the value generated by employees, U.S. accounting principles provide virtually no information on firm labor.” The petition requests that the SEC “develop rules to require public companies to disclose sufficient information to allow investors to assess the extent to which firms invest in their workforce”—in the same way that “SEC rules have long facilitated analysis of public companies’ investments in their physical operations.” Asked about the petition, Grundfest told Bloomberg that it “aims to move the accounting treatment of a company’s workforce to the same level as its physical capital….’Current accounting rules give us more information into the economic consequences of buying or leasing a drill press than of hiring and training a software engineer….How much sense does that make in today’s world?’”
When, in August 2020, the SEC adopted a new requirement to discuss human capital as part of an overhaul of Reg S-K, the SEC applied a “principles-based” approach, limiting 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, SEC 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.) 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.) Accordingly, Corp Fin is reportedly working on a proposal to enhance company disclosures regarding human capital management. Now, Senators Sherrod Brown and Mark Warner, the Chair and a member, respectively, of the Senate Committee on Banking, Housing, and Urban Affairs, have written a letter to SEC Chair Gary Gensler, calling on the SEC to include in its proposal a requirement that companies report about—not just employees—but also the number of workers who are not classified as full-time employees, including independent contractors. It may be a topic to keep in mind as companies prepare the disclosures for this proxy season.
The SEC’s new Fall reg-flex agenda is posted and, no surprise, it’s packed. Here is the short-term agenda and here is the long-term version. And just as with the spring agenda, Commissioners Hester Peirce and Elad Roisman have lambasted it in a dissenting statement. The agenda is laden with major proposals that were on the Spring agenda, but didn’t quite make it out the door, such as plans for disclosure on climate and human capital (including diversity), cybersecurity risk disclosure, Rule 10b5-1, Rule 14a-8 amendments and SPACs, as well as a new, already controversial, proposal to amend the definition of “holders of record.” Some of the agenda items have recently been proposed, for example, new rules regarding mandated electronic filings (see this PubCo post) and amendments to the proxy rules governing proxy voting advice (see this PubCo post). Similarly, three items identified as at the “final rule stage” have already been adopted: universal proxy (see this PubCo post), filing fee disclosure (see this PubCo post) and amendments under the Holding Foreign Companies Accountable Act (see this PubCo post). The agenda also identifies a couple of topics that are still just at the pre-rule stage, such as exempt offerings (updating the financial thresholds in the accredited investor definition, amendments to Rule 701 and amendments to the integration framework). Notably, political spending disclosure is not expressly identified on the agenda (see this PubCo post), nor is there a reference to a comprehensive ESG disclosure framework (see this PubCo post). Below is a selection from the agenda.
SEC Chair testifies before Senate Banking Committee—firmly denies paternity of all public companies!
On Tuesday last week, SEC Chair Gary Gensler gave testimony before the Senate Committee on Banking, Housing and Urban Affairs. His formal testimony covered a number of topics on the SEC’s agenda that Gensler (and others) have addressed numerous times in past: market structure and equity markets, predictive analytics, crypto, issuer disclosure, China, SPACs and Rule 10b5-1 plans. (See, e.g., this PubCo post and this PubCo post.) While the formal testimony covered some well-trod territory, the questioning highlighted the political polarization that we are likely to see continue as these proposals are presented for consideration.
In remarks yesterday at London City Week, SEC Chair Gary Gensler elaborated a bit on the bare bones of some of the almost 50 items on the Reg-Flex Agenda that was made public earlier this month. (See this PubCo post.) In Gensler’s view, disclosure protects investors by helping them invest in “companies that fit their investing needs,” helps companies by facilitating capital formation and benefits markets by helping to keep them fair, orderly and efficient—all core responsibilities within the remit of the SEC.
Late Friday, the SEC announced that its Spring 2021 Regulatory Flexibility Agenda—both short-term and long-term—has now been posted. And it’s a doozy. According to SEC Chair Gary Gensler, to meet the SEC’s “mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation, the SEC has a lot of regulatory work ahead of us.” That’s certainly an understatement. While former SEC Chair Jay Clayton considered the short-term agenda to signify rulemakings that the SEC actually planned to pursue in the following 12 months, Gensler may be operating under a different clock. What stands out here are plans for disclosure on climate and human capital (including diversity), cybersecurity risk disclosure, Rule 10b5-1, universal proxy and SPACs. In addition, with a new sheriff in town, some of the SEC’s more recent controversial rulemakings of the last year or so may be revisited, such as Rule 14a-8. The agenda also identifies a few topics that are still just at the pre-rule stage—i.e., just a twinkle in someone’s eye—such as gamification (behavioral prompts, predictive analytics and differential marketing) and exempt offerings (updating the financial thresholds in the accredited investor definition and amendments to the integration framework). Notably, political spending disclosure is not expressly identified on the agenda, nor is there a reference to a comprehensive ESG disclosure framework (see this PubCo post). Below is a selection from the agenda.
When, in August 2020, the SEC considered adopting a new requirement to discuss human capital as part of an overhaul of Regulation S-K, the debate centered largely on principles-based versus prescriptive regulation—a debate that continues to this day. In that instance, notwithstanding a 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).” What was the result? In this new Human Capital Disclosure Report: Learning on the Job, Intelligize took a look at how companies responded to the new disclosure mandate. Its conclusion: most companies made a “sincere effort to fulfill the scantly defined disclosure obligation”; nevertheless, the report contends, 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.”
In November 2020, amendments to Reg S-K to modernize the required business narrative became effective. The amendments including changes related to disclosure about a company’s human capital resources, replacing a requirement to disclose only the number of employees with a new requirement to disclose, to the extent material, information about human capital resources. In particular, the amendments identified as non-exclusive examples of measures or objectives that the company may focus on in managing the business “measures and objectives that address the attraction, development, and retention of personnel.” Even these measures, the SEC emphasized, were not a mandate. However, then-SEC Chair Jay Clayton said at the time of adoption that he expected “to see meaningful qualitative and quantitative disclosure, including, as appropriate, disclosure of metrics that companies actually use in managing their affairs.” The principles-based rules did not articulate specific metrics for human capital resources disclosure, allowing companies wide latitude in crafting their disclosure to focus on information that is material to each company. At the same time, however, the rules did not provide much direction, leaving many companies at something of a loss for how to proceed. In this paper, Compensation Advisory Partners provides an “early read on developing best practices” regarding human capital disclosure, analyzing the earliest disclosures to provide some guidance on topics, trends and level of detail provided. The CAP paper also includes a number of useful samples. Similarly, Willis Towers Watson reviewed the first three dozen human capital disclosures by companies in the S&P 500 published in 10-Ks filed since the effective date of the new requirement and, in this report, provides some data on the prevalence of topics and metrics.