The Securities and Exchange Commission issued its long-awaited amendments to Regulation S-K, the regulation which contains the detailed disclosure requirements (other than financial statements) applicable to registration statements, periodic reports, proxy statements, and other filings under the United States federal securities laws. The rulemaking includes a new requirement that public companies disclose information about “human capital resources” in these filings.
We have several observations on the new rule:
1. The SEC stopped short of addressing a broad range of ESG issues, such as climate change, and this led two Commissioners, Allison Herren Lee and Caroline A. Crenshaw, to vote against the rule and to issue dissents. Although SASB has long believed that existing regulatory requirements (in particular, the Management Discussion and Analysis requirement) should prompt companies to disclose financially material ESG risks and opportunities such as climate change, there is little doubt that a broad regulatory ESG mandate would help lead to more (and more comparable) disclosure. But we should not lose sight of what the SEC accomplished via this amendment: this is the first time that the Commission has issued a specific ESG disclosure requirement. This is a step forward.
2. As the SEC had proposed, the final rule is principles-based rather than prescriptive (although it does specifically require a company to disclose the number of its employees). SASB has supported a principles-based approach, and we submitted a comment letter to that effect. But we also stated that, in order for a principles-based rule to result in consistent and comparable company-to-company disclosures, the SEC would need to refer to a disclosure framework or standards; hence, we recommended that the SEC either strongly urge or require companies to make disclosures pursuant to an ESG framework that (like SASB’s) has been developed through due process, is based on financial materiality, and is intended to meet the informational needs of investors. SASB’s letter noted precedents for this approach. This would not be the first time the SEC would make such a reference. The most significant such precedent was the SEC’s internal control reporting rule required by Section 404 of the Sarbanes-Oxley Act. There, the Commission determined not to establish specific evaluative criteria for internal control reports and, instead, referred issuers to the work of COSO (a private sector body, like SASB) as providing a “suitable” framework.
The SEC declined to follow SASB’s recommended approach (which was supported by other commenters). The rule release stated:
“[W]e note that while the final amendments do not require registrants to use a disclosure standard or framework to provide human capital disclosure, as recommended by some commenters, a principles-based approach affords registrants the flexibility to tailor their disclosures to their unique circumstances, including by providing disclosure in accordance with some or all of the components of any current or future standard or framework that facilitates human capital resource disclosure that is material to an understanding of the registrant’s business taken as a whole.”
While the SEC did not take the approach SASB recommended, there is an upside of this statement: the SEC is recognizing that disclosure frameworks can facilitate disclosure pursuant to the new human capital requirement. The SEC said nothing that would discourage use of a set of standards such as SASB. Instead, the rule release said that companies have the flexibility to use standards in order to facilitate an understanding of their business. We think this should encourage companies to explore how standards can be useful in this area — rather than making disclosures on a blank slate, companies can turn to a broadly-accepted, widely-used set of standards, a move that could provide companies with some insulation from investor criticism and (arguably) liability exposure and could also help companies reduce the burden of surveys and one-off ESG information requests.
3. The SEC did make a helpful change in the wording of the rule, as urged by SASB and some others. The proposed rule would have required “description of any human capital measures or objectives that management focuses on in managing the business.” One conceivable interpretation of that language was that a company could say nothing more than, as one example, “we focus on employee turnover,” without including such metrics as the company’s existing or historic rate of turnover and its target rate of turnover, along with a narrative description of why turnover is an important matter for the company.
The final rule seems to have fixed this potential problem, with a greater focus on use of metrics. The rule requires “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).”
4. As noted above, two commissioners voted against the proposal and, in doing so, gave forceful arguments as to why the new rule does not go far enough. Commissioner Lee stated:
“There is room for discussion as to which specific ESG risks and impacts should be disclosed and how. But the time for silence has passed. It’s time for the SEC to lead a discussion—to bring all interested parties to the table and begin to work through how to get investors the standardized, consistent, reliable, and comparable ESG disclosures they need to protect their investments and allocate capital toward a sustainable economy.”
Noteworthy in these dissents is the extent to which the commissioners relied upon SASB’s work for their statements. Commissioner Crenshaw’s statement cited the 2016 Climate Risk Technical Bulletin (in footnote 6) and the 2017 State of Disclosure report (in footnotes 8 and 9); Commissioner Lee also cited the Climate Risk Technical Bulletin (in footnote 21). Also, Commissioner Lee stated (in footnote 28) that the SEC “should partner with and leverage the great work that has already been done by private standard setters and others on many of these issues. See, e.g., SASB, TCFD, PRI, Global Reporting Initiative, International Integrated Reporting Council, and Partnership for Carbon Accounting Financials.”
5. The SEC’s action is a welcome step forward toward improving the comparability and reliability of ESG disclosure. We also note increasing interest in the US Congress on the topic of improving ESG disclosure. Notably, Senator Mark Warner of Virginia sent a letter to the SEC in support of the human capital rulemaking effort. Separately, he requested the General Accountability Office to study the state of ESG disclosure; that report from July (which SASB published a blog about), found a dearth of the sort of comparable, decision-useful disclosures that are sought by investors. Other members of Congress are also very much interested in this area. Indeed, ESG disclosure is increasingly a priority for investors, companies, legislators and regulators around the world. The SEC has taken a small, but significant, step toward requiring material ESG disclosure in SEC filings and has also left the door open to the use of disclosure standards, like SASB’s, in complying with the new rule.