Retake on Double Take: Diversity and Human Capital

We discuss the evolving state of diversity, human capital management, and disclosure at public companies.

In the current corporate environment, companies large and small are flexing their values, and elevating culture and ethics to new lofty levels of importance. Ideas are flowing on ways to enhance diversity, equity and inclusion (DE&I) in the workplace, but how does the corporate messaging compare with actual practice? How precisely can investors effectively account for and quantify the results of DE&I strategies—and judge their materiality? In the latest episode of Double Take, we delve into the current state of diversity, human capital management, and mandated disclosure at publicly traded companies.

In November 2020, the United States Securities and Exchange Commission (SEC) issued a rule requiring public companies to disclose material human capital measures. To better understand the implications of this rule and how it fits into the larger global ecosystem of diversity disclosure, we spoke with Amanda Sonneborn and Darren Gardner, partners at King and Spalding and members of its Global Human Capital and Compliance Practice team. Sonneborn and Gardner are trusted advisors to many of the world’s largest companies in matters ranging from day-to-day cross-border employment issues on a single-country basis, to larger and more complex multi-jurisdictional workforce projects.

The SEC rule, in simple terms, mandates that companies report material information regarding their human capital in their annual Form 10-K filings. According to Sonneborn, few people know that the implementation of the rule was prompted by large pension and benefit plans, which pressed the SEC to require these disclosures. She discusses how the role of human capital has shifted over the last 20 years:

Human capital, and people more generally, are looked at as a very important part of corporate business and strategy today. When I started practicing employment law 20 years ago, employees and issues related to employment were largely seen as simply a cost center, a risk analysis. Today, many companies see their people as a value-add and a strategic resource that they need to recruit, retain and support.

Amanda Sonneborn, Partner at King & Spaulding

According to Sonneborn, the SEC rule reflects an increasingly common view that a company’s operation as an employer should be a key factor when analyzing its potential for future profitability and success. However, as noted by both Sonneborn and Gardner, the SEC rule lacks a clear system for reporting material human capital measures. This lack of guidance leaves companies to determine their method of compliance to the rule, how to effectively quantify material human capital information, and how to best define success in this area. Consequently, interpretation of the rule varies greatly from company to company.

Topics addressed in company filings include DE&I statistics such as the participation of various groups in employee populations, as well as measures related to retention and recruitment. While quantitative representations are included in the overall disclosures, most companies use a narrative form to describe their practices. Sonneborn emphasizes that identifying material aspects of human capital disclosure is challenging for many reasons, not least of which is balancing competing priorities. Confidentiality, she explains, has been a foremost area of concern.

If an employer is anticipating, for example, a large-scale reduction in force or taking some negative employment action, they have struggled with when are they required to disclose that…because the filings may be due prior to the point in time, for example, when it’s announced to employees.

Amanda Sonneborn

On this point, the SEC has recently clarified that it considers large-scale investigations by government agencies, as well as litigation regarding discrimination and harassment, to be material. While these SEC-mandated disclosures may elicit a cautious optimism that a more inclusive and diverse corporate environment is imminent, Sonneborn offers a balanced perspective and acknowledges that real change cannot happen overnight:

Addressing systems to help support diverse employees be successful in a lawful way is something that could take time…companies that I have seen try to set unofficial quotas or put things in place to make challenges rapidly, that often backfires and creates other challenges. In my experience, the clients I work with are very dedicated to the issue. They are spending significant time and resources on it and it’s not simply lip service, but it is not something that can be remedied in one financial year.

Amanda Sonneborn

Obtaining accurate data, particularly with regard to race and ethnicity, is a challenge in itself. In the US, employees are not mandated to respond to employer requests for this information, known formally as category participation status. Furthermore, California is currently in the process of instituting new privacy protections for employees in 2023, though the details are not yet known. Additionally, most countries outside of the US have privacy laws that prevent employers from asking questions related to category participation status. Therefore, statistics reported on category participation status are murky, as data collected by most companies is likely to be inaccurate and undoubtedly incomplete.

There is widespread speculation that the SEC is planning to update the 2020 SEC rule with additional disclosure requirements. The amendment is expected to happen soon and could require companies to provide data on pay equity, which is already required of companies in California, New York, Colorado and Illinois. Additionally, companies may be mandated to disclose changes to compensation and benefits as well as information about administrative litigation actions.

Gardner, who has extensive experience working with global clients, maintains that human capital management practices in the US are different and generally less regulated than any other jurisdiction. For instance, in countries outside the US, companies report on human capital through either a labor authority or a specialized authority overseeing a specific issue. However, the framework for human capital reporting in the US, which is still in its early days of human capital regulation, is the same for all companies irrespective of industry or size.  

For US-based multinational companies, materiality becomes more complex when considering workforces outside the US. As workforce changes are contemplated, these companies must often consult with unions and government agencies to determine what needs to be disclosed stateside. Moreover, the companies must determine how their compliance with US regulations could affect various regulatory and labor obligations in other countries.

Materiality presents a myriad of issues for companies with workfaces in multiple countries, as well as for companies that have adopted pandemic-friendly employment structures with third-party workers engaged in hybrid work arrangements. Given these shifting variables, Gardner is firm in his stance that the evolution of reporting and disclosure in the US has a long way to go. For instance, as employment structures in the US vary greatly from those in Europe, Gardner predicts that disclosure requirements could eventually vary based on the industry and company in question.

On diversity and inclusion, Gardner notes that differences in interpretation and application also vary from country to country. He highlights that ensuring a diverse workforce, specifically related to race, gender and disability, seems to be acknowledged globally as paramount. When it comes to compliance, Gardner states that companies with a local presence tend to fare better than multinational companies without that on-the-ground presence, which aids in the interpretation of disclosure rules.

Multinational businesses are in a position where they are dealing with a matrix of laws that don’t all operate the same way, that are not all conceptually consistent. The advantage Europe has over many other places as a region is that, because of the way that certain directives work and because of the requirements under them and how that is administered under local law, you have a degree of consistency.

Darren Gardner, Chair of Global Human Capital and Compliance Practice at King & Spaulding

In Europe, not only is there a mandate to report, but there are also measures that must be provided. Failure to comply with either of these has consequences. The consistency of required disclosures for companies in Europe is an advantage that multinational companies, which must comply with a multitude of different standards on a country-by-country basis, do not have.

Reporting is even more complex for some of the most important factors being considered in the context of human capital given jurisdiction-specific interpretation. For example, some countries are more homogenous than others, and therefore the ways in which diversity statistics on race are expressed in those countries may vary.

From a technical point of view and from a legal perspective, and from the compliance lens, it creates some serious challenges because what you must do, what you want to do and what you should do don’t necessarily align because of the way the legal concepts are explained and enforced.

Darren Gardner

This, of course, presents the greatest challenges for multinational corporations, which must determine how to remain in compliance with regulators, implementing initiatives to diversify their workforces across a multitude of compliance structures.

As Sonneborn mentioned, most of the clients with which she and Gardner work are truly making efforts to do right by their workforces. How these efforts translate into practice, though, is still evolving in real time. The framework in which material human capital information is disclosed, particularly regarding efforts to diversify workforces across the country, is still a work in progress.

The imminent additions to SEC-mandated disclosures could dictate the next iteration of a growing movement to promote diversity, equity and inclusion. The key for employers, employees and investors alike should be patience. As our experts have advised, change in this space cannot happen overnight, but it should have a significant impact over a gradual time horizon.

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Authors

Raphael J. Lewis

Head of specialist research

Jack Encarnacao

Research analyst, investigative, Specialist Research team