All companies selling securities in the United States are now required to comply with a new human capital disclosure rule in their quarterly and annual public financial releases.
In 2020, the U.S. Securities and Exchange Commission issued amendments to the Modernization of Regulation S-K rule. One amendment is to Item 101(c) of the rule to include “a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business.”
The final ruling was effective on November 9, 2020. That means all publicly traded companies must disclose material human capital information starting with their November 30, 2020, December 31, 2020, or January 31, 2021, public financial releases.
Businesses Will Have to Decide What to Disclose
The new human capital disclosure rule takes a principle-based approach, which means there is no predetermined definition of the term “human capital.” Like so many other disclosure elements, the SEC is leaving it to the organization to decide how to define human capital in terms that are “material” to an individual entity.
In its ruling, the SEC acknowledges that the definition of human capital will be defined differently by companies in different industries and sectors, writes Marc Siegel, a partner with Ernst & Young’s Financial Accounting Advisory Services. By not defining human capital, he notes, the SEC also indicates an expectation that the disclosures will continuously evolve based on “practice, managerial activities, and business environments change.”
While this flexibility may be a benefit to companies, it may also turn out to be a challenge. Absent a universal definition of “human capital,” the SEC also could not define which metrics are required to be included in the human capital disclosure. So it’s up to individual entities to not only define human capital, but also how to measure it.
Four Steps to Meeting Disclosure Obligations
If your organization isn’t yet collecting and analyzing data, it may be a real struggle to tell your human capital story in a way that meets the new SEC requirement. These four steps can help you develop the people analytics processes necessary to be compliant with the new regulations.
Step 1: Solicit Input From Various Stakeholders
The first thing to do if you don’t already have a robust data analytics strategy in place is to solicit input from different internal stakeholders that are essential when creating a full picture of the company’s human capital story. This can be individuals from HR, legal, finance, marketing, and any other department with a stake in human capital.
Step 2: Determine Metrics to Report
Once there is a collective formed, decide on the metrics you need to disclose to meet SEC filing requirements for human capital disclosure. As discussed above, this could potentially be one of the most difficult steps, especially if you don’t already have data collection and analytics processes and tools in place. The flexibility of the SEC ruling doesn’t give guidance on narrowing down what could be overwhelming amounts of data. So the team needs to spend extra time and energy working through this step.
Step 3: Collect and Analyze the Data
Once you know what metrics you will report, start collecting and analyzing the data. If you don’t already have the right tools and processes in place, this can turn into a time-consuming step as you implement and build them.
Step 4: Use Those Metrics to Tell a Story
Those metrics will be used to drive human capital disclosures. They will tell the company’s human capital story to investors, which is the purpose behind the new rule. Investors want these insights because human capital is an important element in a company’s operational success.
While steps one and four should be relatively simple, steps two and three could prove to be difficult for many companies of all sizes.
Determining the Metrics for Human Capital Disclosure
Step two in this process is going to be the most challenging for a lot of companies because of the lack of specificity in the agency’s requirements. Companies may struggle with determining what to disclose regarding human capital.
As you seek to answer that question, keep in mind that “the requirements are rooted in materiality,” write Sheri Wyatt and Brandon Yerre at PwC. “The SEC considers information material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment or voting decision.”
The agency also gave some guidance by indicating it expects disclosure to focus on “employee attraction, development, and retention,” writes David Vance, executive director for the Center for Talent Reporting. Taken together, these two guideposts can help you not only define human capital for your company, but also determine which metrics should be included in your disclosure to meet the new requirements.
Still not sure where to start defining those metrics?
A good starting point to understanding what you will need to include in the financial filings, writes Leeann Aruthur et al. at Deloitte’s Heads Up Consulting, is to create an inventory of current and future metrics. The metrics in that inventory should be selected as a result of internal functions coordinating their activities, they note. The team suggests reviewing public statements or commitments made by executives to understand the information investors and other stakeholders expect to have disclosed.
Three Approaches to Guide You
If you still struggle to set those definitions and metrics, there are predetermined models to follow that can help.
The Financial Accounting Standards Board
One, recommended by Ernst & Young, is the approach used by the Financial Accounting Standards Board (FASB) in its standard on segment reporting which requires public companies to base disclosures on operating results information provided to a company’s chief operating decision maker. That can be one or more people who are responsible for “evaluating the performance of and allocating resources to a company’s operating segments.”
In that September 2020 report, Siegel and fellow Ernst & Young partners Neri Bukspan and Mark Kronforst (download required) suggest a number of questions to ask that focus on information potentially provided to a board of directors, an executive committee, general counsel, or other stakeholder when following this approach. The authors also suggest asking questions regarding governance, reporting, and communications to guide metrics development.
International Organization for Standardization
Another approach, suggested by Vance, is to follow the International Organization for Standardization (ISO) December 2018 guidelines for internal and external human capital reporting (ISO 30414). These guidelines allow organizations of all sizes to “get a clear view of the actual contribution of its human capital” by providing guidelines on “core HR areas such as organizational culture, recruitment and turnover, productivity, health and safety, and leadership,” writes Clare Naden, news and communications specialist for ISO.
Vance explains the ISO 30414 standard suggests 59 different metrics from the point of view of both employees and investors, including human capital ROI, total development costs, leadership diversity, time to fill vacant positions, and turnover rate. Adopting this standard to develop SEC disclosures should provide a “safe haven” companies can rely on to meet the SEC rule, writes Vance.
Human Capital Management Coalition Recommendations
In 2017, a group of institutional investors, the Human Capital Management Coalition (Coalition), submitted a petition to the SEC to push the agency to adopt a human capital disclosure rule. In its petition, the Coalition wrote, “We view effective human capital management as essential to long-term value creation and therefore material to evaluating a company’s prospects.” It went on to recommend certain baseline disclosures of both quantitative and qualitative information that may help companies determine metrics to meet the new SEC filing rule.
Those disclosures address metrics in areas such as workforce demographics, stability, composition, skills and capabilities, culture and empowerment, health and safety, and compensation and incentives. The Coalition also suggests including disclosures regarding the implementation of human rights commitments.
At the end of the day, defining material human capital and the metrics for reporting it depends on a number of factors that are specific to your company. The important thing is to invest the time and energy to ascertain what metrics matter most to investors to meet the disclosure requirements.
Gathering and Analyzing Data for Disclosures
Step three — collecting and analyzing the data — can also be particularly challenging for companies that don’t already prioritize people analytics in the organization. If your company doesn’t have processes and tools in place to gather and analyze human capital now, now is the time to implement both.
Doing so successfully starts with having a plan for a systematic approach to building people analytics programs across the organization. Elizabeth Ledet, Keith McNulty, Daniel Morales, and Marissa Shandell at McKinsey & Company say that plan should resemble a five-step stairway with each moving toward the goal of a solid people analytics program. Those steps take a company from poor data programs to programs capable of producing reliable predictions.
This cannot be accomplished with data in manual spreadsheets. Companies embarking on the journey of collecting and analyzing people data for SEC human capital disclosure requirements need to adopt technologies that help them along. Talent-acquisition and management platforms can provide valuable data and metrics regarding human capital that can be used in SEC filings.
By creating processes and adopting tools to create people analytics programs, publicly-traded companies are better able to quickly gather and analyze the data needed to inform the metrics for human capital disclosure.
Navigating the SEC’s new human capital disclosure rule isn’t extremely onerous if you already have the systems in place for capturing and measuring data around your human capital. There’s a high level of flexibility in the rule that allows you to define what human capital is to your organization.
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