Skip to main content
Oct 30, 2019

CalPERS raises materiality concerns over SEC disclosure reforms

Emphasis on principles-based disclosures makes materiality more important, according to pension fund

CalPERS is concerned about how companies would treat materiality in their regulatory disclosures under SEC plans to modernize corporate reporting.

CEO Marcie Frost writes in a recent letter to the commission that, although the pension fund supports the proposal’s goals, the planned changes would ‘fall short’ of improving disclosures for investors and would require companies to go through a difficult transition to principles-based disclosures.

The commission has proposed changing the rules – often in a principles-based direction – to update the description of business, legal proceedings and risk-factor disclosures companies must make under Regulation SK. The intention is to improve disclosures for investors and simplify companies’ compliance efforts.

Among other things, the proposed amendments relate to Item 101(c), which covers the narrative description of the business. They would clarify and expand its principles-based approach by including disclosure topics drawn from a subset of the topics already included in the item.

The amended Item 101(c) would include as a topic for disclosure human capital resources, such as any human capital measures or objectives that management focuses on in managing the business, to the degree such disclosures would be material to an understanding of the business. Depending on the nature of the company’s business and workforce, these would be measures or objectives that address the attraction, development and retention of personnel.

The proposal has sparked widespread feedback. Roughly 80 bespoke comment letters have been filed in response, alongside more than 2,800 copies of a form letter complaining that the principles-based approach will curb information provided to investors.

‘In the US, we assert registrants will make the minimum required disclosures unless additional information makes the registrant look better to investors and analysts,’ Frost writes. ‘The moves to principles-based disclosure could lead to more transparency but could make it easier for registrants to avoid certain disclosures required under the existing rules.

‘Much depends on how registrants institute the changes and how the registrants apply the concept of materiality as transformed in the proposed rule.’

The greater emphasis on principles-based disclosures in the proposed rule makes materiality more important in determining what companies will disclose, Frost says. But instead of clarifying materiality, ‘the commission makes the concept substantially more confusing in a manner that would only benefit those trying to avoid disclosure,’ she writes, adding that the SEC does not use a single definition of materiality and that this shifts within the proposal rule for items 101, 103 and 105.

Frost also points to what she describes as multiple footnotes in the proposed rule that try to get rid of ‘double materiality’ problems written into the rule. ‘The commission submits in footnote 160 that it can see no cases where using multiple layers of materiality to determine whether disclosure is required could be problematic. We do not agree,’ she says.

According to Frost, an example of this is sexual harassment laws where an issuer could argue that those laws are not material to its business but faces violations or allegations that could be material. ‘Here, there would be no requirement to disclose a material compliance concern with an immaterial law, regardless of the magnitude of the violations,’ she says.

CalPERS asks the SEC to clarify and simplify the multiple definitions of materiality and urges the agency to remove the risk of double-materiality problems that can arise under principles-based disclosures, arguing that companies are aware of the issue and that not addressing it benefits them. ‘As proposed, material compliance effects resulting from immaterial laws would not need to be disclosed,’ Frost writes. ‘This does not align with our interpretation of principles-based disclosures or material information.’

The pension fund’s recommended definition for materiality is that used in Regulation SX. This states that materiality, when used to qualify a requirement for providing information on any subject, limits the information required to those matters about which an average prudent investor ought reasonably to be informed.

CalPERS sees human capital as ‘a clear driver of value’ and supports the agency’s inclusion of human capital management disclosure under the proposed Regulation SK reforms. But the pension fund does not believe the proposed approach would lead to ‘sufficient comparable disclosure’ for investors. CalPERS recommends metrics that should be disclosed by all companies, such as: the number of full-time, part-time and contingent workers, employee turnover rates and diversity statistics.

‘These disclosures should not be overly burdensome as many US public companies already collect some of these metrics as part of their human capital efforts and others, such as diversity statistics, are required by the Department of Labor,’ Frost writes. There is a need for certain line-item disclosures regarding human capital, and a need for additional disclosures in line with the human capital disclosures produced by the Sustainability Accounting Standards Board, she adds.

In another comment letter on the proposal, General Motors (GM) officials raise concerns about, among other things, the expansion of Item 101(c) to require the disclosure of material changes to business strategy. They argue that investors can already get a clear picture of GM’s strategy from its MD&A and other presentations such as quarterly earnings press releases, analyst calls, investor presentations and other investor events.

The GM officials write that they believe human capital matters are of interest to some of the company’s investors and stakeholders, and that the company addresses this in its annual sustainability report. ‘However, we believe the commission’s proposal to expand Item 101(c)(xiii) of Regulation SK to require human capital disclosure would not further the goals of the proposed rule, which are to improve these disclosures for investors, and to simplify compliance efforts for registrants.’

They argue that adding human capital measures as a separate disclosure item in the business section is unnecessary because this information, to the extent it is necessary to an investor’s understanding of a company’s business, must already be disclosed under Item 303(a) and Item 105. They also write that including human capital matters in Form 10K would create new timing and operational challenges for companies.

Ben Maiden

Ben Maiden is the editor-at-large of Governance Intelligence, an IR Media publication, having joined the company in December 2016. He is based in New York. Ben was previously managing editor of Compliance Reporter, covering regulatory and compliance...