What investors need to know about the SEC’s human capital disclosure requirement

Despite its getting dragged into debates over “wokeness,” investors should expect it to remain—and evolve
What investors need to know about the SEC’s human capital disclosure requirement
Illustration: Leremy (Shutterstock)
We may earn a commission from links on this page.

For most of the past 50 years, the only workforce data US public companies have been required to disclose is the number of employees, which was mandated in 1973. Back then, only about 17% of the combined total assets of companies in the S&P 500 index came from intangible assets, including talent. Tangible assets, like land, plants, and equipment, played a much larger role in company valuations.

Today, more than 90% of the index’s value is made up of intangible assets, much of which is comprised of human capital, according to Cambria Allen-Ratzlaff, co-chair of the Human Capital Management Coalition. Yet it’s rarely reflected in the financial statements of public companies.

In response, the coalition, which is made up of 38 institutional investors representing more than $9 trillion in assets, proposed that public companies be required to disclose more robust metrics about their people management, to help investors make more informed decisions.

The US Securities and Exchange Commission agreed. In August 2020, it adopted new requirements for companies to disclose human capital information in their 10-K annual filings.

It wouldn’t be long before a backlash began.

A growing political attack from the right

Disclosure requirements related to workforce composition have gotten swept up in the recent right-wing rhetoric against diversity, equity, inclusion (DEI), environment, social, and governance investing (ESG), and the strawman political issue of critical race theory.

Douglas Chia, president of the consulting firm Soundboard Governance and a senior fellow at the Rutgers Center for Corporate Law and Governance, says investors should stay focused on what will create long-term value for companies, and shouldn’t get distracted by messaging from politicians about human capital disclosure being “woke.”

“Politicians throw stuff at the wall to see what sticks, and this is sticking,” Chia says. “To them, human capital disclosure is code for DEI and CRT. It resonated with the 2022 midterms, so expect more of it leading into the 2024 elections.”

Allen-Ratzlaff says the Human Capital Management Coalition doesn’t view human capital management as an ESG issue. Like physical assets and financial capital, the value of labor is directly related to how profitable a company can be.

“This is about protecting investors, fair and efficient capital markets, facilitating capital formation and valuing the workforce and their labor,” she says, noting that the petition for human capital disclosure requirements started in 2017, during the Trump administration. “These are foundational American values. This is an issue that should transcend politics.”

Both Allen-Ratzlaff and Chia agree that requests for this type of information will continue to increase. There is already evidence of an expanding appetite for it.

For example, Nasdaq’s new board diversity rule requires companies listed on its exchange to publicly disclose board-level diversity statistics annually using a standardized template, or to explain why they do not meet the quota for directors who are female, LGBTQ+, or from an underrepresented minority. According to the new disclosure rule, by the end of 2023 they must have at least one director who meets that profile, or provide an explanation as to why they don’t. And by the end of 2025, they must have at least two directors who add diversity to the board.

As for investor interest in this aims, RBC Capital Markets recently noted that “[g]iven the emerging research supporting the link between employee satisfaction and financial performance, we anticipate that sustainability-linked [investment] instruments focused on corporate culture and employee well-being…will become increasingly popular.”

Reporting requirements are expected to evolve, but so are the potential legal challenges

Right now the reporting on human capital is all narrative, which is hard for investors to work with. But investors should expect disclosures to become more prescriptive and standardized.

The Human Capital Management Coalition has proposed that all companies disclose four pieces of standardized information in addition to their principles-based disclosure. They include: the number of full-time, part-time, contingent, and contracted workers directly involved in firm operations; labor costs; turnover; and workforce diversity data.

The SEC is still reviewing these.

Chia is hopeful that evolving disclosure requirements will benefit investors. “The first round of reporting was lawyer gobbledygook that didn’t say much and was not comparable across companies,” says Chia, a former assistant general counsel at pharmaceutical giant Johnson & Johnson. “If you don’t make it standardized and mandatory, people don’t know how to report or use it, so it’s useless.”

But he also warns that further tinkering by the SEC is likely to invite legal challenges.

“As soon as the SEC writes something that makes human capital disclosure more prescriptive and standardized, and then adopts it, someone will probably take that decision to court and there will be an injunction,” Chia says. “Then it will be stuck in court for years.”

He’s basing this prediction on pushback the SEC is already facing regarding its proposed climate change disclosure requirements. Opponents say the SEC does not legally have the authority to write these kinds of requirements and that it is doing what the US Environmental Protection Agency is supposed to do. As a result, the SEC has gone back to the drawing board on climate disclosure, but once it goes into effect, someone will likely challenge it in court, Chia says.

“The same thing could happen with more prescriptive human capital disclosure. Someone could say, ‘Who made the SEC like the Department of Labor?’” Chia says.

A canary in the coal mine

“Investors should look at climate change disclosure as the canary in the coal mine for human capital disclosure,” he advises. “[W]hat happens on the climate change front, might be a good indicator of what happens on the human capital management front.”

And if a Republican takes the White House in 2024, Chia says the next US president easily could tell the SEC to put the brakes on more prescriptive and standardized disclosures or even find a way to repeal the human capital disclosure requirement altogether.

Allen-Ratzlaff doesn’t think this is a likely outcome, however, given that the first human capital disclosure requirement already has gone into effect, and that the SEC is looking to improve it. “It is very telling that the SEC revisited this topic so soon,” she says. “We didn’t expect this to come up again for a while since the SEC is so backed up.”

Meanwhile, thanks to international accounting standards, investors interested in multinational companies will have access to more prescriptive human capital metrics regardless of what the SEC, US courts, or future presidents decide. For example, 100% of companies in the FTSE 100, all of which are listed on the London Stock Exchange, report the type of human capital data breakdown that the Human Capital Management Coalition is proposing.

How soon might the US catch up? “[W]e’ll just have to see how it goes,” Allen-Ratzlaff says.