The U.S. Securities and Exchange Commission just published its final rule on human capital reporting on Aug. 26. This follows the proposed rule issued one year ago on Aug. 8, 2019. The final rule makes very few changes to the proposed rule discussed in my Aug. 10 update on the SEC and ISO initiatives for human capital reporting. The rule mandates, for the first time, public reporting of human capital metrics by companies subject to SEC reporting requirements, which includes all U.S. companies issuing stocks, bonds or derivatives. The rule becomes effective 30 days after publication in the Federal Register, which should happen by mid-September.
Today, companies have to report only one human capital metric: number of employees. The new rule will still require reporting the number of employees, but it also encourages companies to report the number of full-time, part-time and temporary employees as well as independent contractors and contingent workers if they are material to an understanding of the company’s business. “Material” means anything that an investor would want to know before buying or selling a stock, bond or derivative
More important, the new rule mandates, for the first time, that companies provide “to the extent such disclosure is material to an understanding of the registrant’s business taken as a whole, a description of a registrant’s human capital resources, including any human capital measures or objectives that the registrant focuses on in managing the business.” The SEC goes on to specifically call out the three areas of “attraction, development and retention of personnel as non-exclusive examples of subjects that may be material, depending on the registrant’s business and workforce.”
SEC Chair Jay Clayton commented in the public release, “I cannot remember engaging with a high-quality, lasting company that did not focus on attracting, developing and enhancing its people. To the extent those efforts have a material impact on their performance, I believe investors benefit from understanding the drivers of that performance.”
In other words, the SEC expects to see these three areas discussed and measures reported if they are material, and it is hard to imagine companies where they are not. Consequently, public companies will need to start disclosing and commenting on them beginning with results released as early as late October this year.
And this is just the starting point. The rule calls for all material matters to be disclosed so each company will need to decide what other human capital matters might be considered material by an investor. Depending on a company’s particular situation, this might include total workforce cost or productivity, diversity (especially at the leadership level) and culture (revealed by employee engagement and leadership surveys). Discussion may also be required about the implementation of a new performance management system or a significant change in compensation and benefit philosophy.
Where can companies get guidance on specific metrics they might use to meet the new rule? We suggest starting with the 2018 recommendations by the International Organization for Standardization, which include 10 metrics for public reporting by all organizations and an additional 13 for reporting by large organizations. ISO also recommends 36 other metrics for internal reporting. These are organized by area or cluster. Here are the recommended metrics for the three SEC focus areas with metrics recommended for all organizations in italics:
- Attraction: Time to fill vacant position, time to fill critical vacant positions, percentage of positions filled internally, percentage of critical positions filled internally
- Development: Development and training cost, percentage of employees who have completed training on compliance and ethics
- Retention: Turnover rate
These metrics provide a starting point for a company’s human capital reporting strategy to meet SEC requirements. Additional metrics are available from ISO for the area of development, including percentage of employees who participate in training, average hours of formal training per employee, percentage of leaders who participate in training and percentage of leaders who participate in leadership development.
In addition to these metrics for the three focus areas, ISO recommends a number of other metrics that could address areas of material concern such as workforce cost, workforce productivity, diversity, diversity of the leadership team and leadership trust. Of course, companies may wish to supplement the ISO metrics with other metrics (such as employee engagement), and they will need to find their own metrics in areas not addressed by ISO. They will also need to comment on material initiatives, which may not have metrics apart from percentage complete.
Publication of the final rule by the SEC, combined with the comprehensive recommendations by ISO, ushers in a new era of transparency in human capital which will fundamentally change the way organizations operate. And these changes will go far beyond U.S. publicly traded companies. In five to 10 years, privately held companies, nonprofits and other types of organizations will be compelled (or shamed) into adopting the same level of transparency.
In the future world of human capital transparency, what investor will buy stock in a company that refuses to disclose material human capital information, which is already the primary driver of value in many companies? What employee will go to work for an organization that refuses to share its key human capital metrics when the only reason for refusal is because they are embarrassed to share? Why would anyone work for an organization where the culture is terrible, where they don’t invest in you, where turnover is high and where there are not enough employees to do the work?
Today, you can say you didn’t know. Tomorrow, you will know. Change is coming. The new world of human capital transparency just arrived.
The final rule on human capital reporting is part of a much larger revision to what is called Regulation S-K, which governs what companies must disclose to investors initially (form S-1), quarterly (form 10-Q) and annually (form 10-K). The name of this effort, which has been underway by the SEC for four years, is Modernization of Regulation S-K Items 101, 103 and 105. Item 101 governs description of the business, and this is where new rules for human capital reporting are found. (Item 103 covers legal proceedings and item 105 cover risk factors.) Read the rule here, pages 45-54 for human capital.
The ISO document (ISO 30414:2018 Human resource management — Guidelines for internal and external human capital reporting) is available for purchase here for $140. ISO is just beginning to release technical specifications on how the metrics are defined and used. By mid-2021, specifications should be available on all 59 metrics. The specifications for five of the eight training and development metrics are now complete and in publication. They should be available soon.