SEC disclosure proposal sharpens human capital focus

The inclusion of human capital matters in regulatory plans to revamp corporate disclosures is likely to attract attention and require companies to examine how they approach that work, according to Laura Richman, counsel with Mayer Brown.

The SEC last week proposed rule amendments that would update the description of business, legal proceedings and risk factor disclosures that registrants must make under Regulation SK, taking a more principles-based approach than has been the case until now.

The planned changes are intended to improve disclosures for investors and to simplify companies’ compliance efforts by enhancing the readability of disclosure documents and discouraging repetition and disclosure of non-material information.

One of the proposed changes would include human capital resources as a disclosure topic, including ‘any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business.’

At present, companies only need to disclose the number of their employees. But human capital is attracting a growing level of attention among investors and other groups. The SEC notes in its rulemaking proposal that the agency’s 2016 concept release on updating corporate disclosures solicited and received feedback on human capital. In addition, the Human Capital Management Coalition in July 2017 filed a rulemaking petition requesting that the SEC require registrants to disclose information about their human capital management policies, practices and performance.

‘Item 101(c)(1)(xiii) [of Reg SK] dates back to a time when companies relied significantly on plant, property and equipment to drive value,’ SEC officials write in the new proposal. ‘At that time, a prescriptive requirement to disclose the number of employees may have been an effective means to elicit information material to an investment decision. Today, intangible assets represent an essential resource for many companies… [H]uman capital may represent an important resource and driver of performance for certain companies.’

This aspect of the proposal is likely to spark a number of comments, Richman tells Corporate Secretary. One issue will be how much information on human capital investors and others – such as employees and customers – are looking for, she notes.

Assuming the SEC approves the proposal, companies will be figuring out how to comply during the first year, Richman says. Then they will look at what their peers have done and any SEC comments, which will lead to an evolution in how the measure is implemented, she adds.

In the meantime, the proposed human capital disclosure requirement is something many companies will be thinking about internally and will consider discussing with industry groups – which are likely to file comment letters with the SEC, Richman says. ‘There’s a lot to talk about.’

The principles-based nature of the proposal and its focus on materiality offers flexibility to companies and could, over time, lead to improvements in the disclosures that investors receive, Richman says. ‘That said, there’s not going to be a magic formulation’ for making disclosures shorter and more focused, she comments.

Companies will need to look at what they are doing in terms of disclosure, but they won’t be starting with a blank page because investors are used to seeing certain information that companies will need to continue delivering, she adds. 

PROPOSAL DETAILS
The proposal is part of a broader evaluation of SEC disclosure requirements that was recommended in an agency staff report that was mandated by the JOBS Act. It is now out for a 60-day public comment period.

In terms of the description of business, the proposed changes would include:

• Providing a non-exclusive list of the types of information that a registrant may need to disclose, and requiring disclosure of a topic only to the extent that information is material
• Eliminating a prescribed timeframe for making the disclosure
• Allowing a company - in filings made after its initial filing - to provide only an update of the general development of the business that focuses on material developments during the reporting period.

The proposed amendment regarding legal proceedings would:

• State that the required information may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document in an effort to avoid duplicative disclosure
• Revise the $100,000 threshold for disclosure of environmental proceedings involving the government to $300,000 to adjust for inflation.

The proposed amendment regarding risk factor disclosures would:

• Require summary risk factor disclosure if the risk factor section exceeds 15 pages
• Refine the principles-based approach of the rule by changing the disclosure standard from the ‘most significant’ factors to the ‘material’ factors that must be disclosed
• Require that risk factors are organized under relevant headings, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.

‘The world economy and our markets have changed dramatically in the more than 30 years since the adoption of our rules for business disclosures by public companies. Today’s proposal reflects these significant changes, as well as the reality that there will be changes in the future,’ SEC chair Jay Clayton said in a statement.

He added: ‘I applaud the staff for their efforts to modernize and improve our disclosure framework, including recognizing that intangible assets, and in particular human capital, often are a significantly more important driver of value in today’s global economy.’