In an earlier posting, I reported on how the SEC has changed its Regulation S-K to require disclosure of information on human capital as part of the MD&A (Management Discussion and Analysis) section of companies’ financial reports. I noted back then that two Democratic members of the SEC voted against the new rule because the changes didn’t go far enough in requiring disclosure on Environmental, Social, and Governance (ESG) issues. As I stated then, this may foreshadow additional action by the SEC in this area.
Now SEC is taking another step with the announcements of a task force on enforcement of disclosures on climate change and ESG and an enhanced focus on climate change risk as part of the agency’s enforcement priority. The Commission is also seeking public input on possible new disclosures on climate change.
This interest in climate change and other ESG issues comes in response to calls from investors in both the US (see “BlackRock Chief Pushes a Big New Climate Goal for the Corporate World“) and in other countries (see “Accounting needs to be stepped up for climate change costs“).
Will increased attention to ESG issues spill over to intangibles? The answer is unclear. The driving interest in the new requirements for disclosure of human capital was focused on ESG issues of diversity and inclusion – not on economic performance such as improving innovation and productivity. And the focus of these efforts seems to be on outputs (i.e. the impact, costs, and risk) rather than inputs (i.e. intangible assets).
The attention to EGS issues is, however, useful in honing in on the guiding principle that the disclosures be consistent, comparable, and reliable. The only way to achieve these goals is for the disclosures to be mandatory. Voluntary disclosures leave information gaps that undercut reliability and do not allow the enforcement of standards of uniformity required for consistency and comparability. The question of mandatory disclosure is one that has bedeviled regulators since the beginning. And is especially of importance when it comes to understanding the impact of intangibles (see my working paper Reporting Intangibles).
One way forward would be for the SEC to build on existing requirements. Specifically, the SEC could allow for an alternative reporting of companies’ sales, general, and administrative costs (SG&A). This alternative would refine the current reporting of SG&A to breakout spending on intangibles from more routine spending. As I described in an earlier posting, SG&A would be divided into four components: R&D, advertising, Maintenance Main SG&A (basically the cost of sales such as office and warehouse rents, customer delivery costs, and sales commissions, and Investment Main SG&A (which would be the residual after subtracting R&D, advertisement and Maintenance Main SG&A ). The assumption is that Investment Main SG&A reflects spending that seeks to build organizational assets. Investment in intangibles would constitute the three categories of R&D, advertising and Investment Main SG&A.
Creating this new measure of intangibles is not without difficulties (for more detail see One Job: Expectations and the Role of Intangible Investments by Michael J. Mauboussin and Dan Callahan of Morgan Stanley and “Should Intangible Investments Be Reported Separately or Commingled with Operating Expenses? New Evidence” by Luminita Enache and Anup Srivastava). However, the SEC could allow this calculation under a “safe-harbor” provision – a process that I have long advocated for that would expand reporting on intangibles.
At first blush the concerns over ESG issues and the disclosure of intangible assets seem rather distant. But they share a common underlying problem: that investors are not getting the information they need to make intelligent investment decisions. I hope the heightened discussion over ESG disclosures will raise awareness of this basic problem. And that the SEC will be able to use the current concerns over companies’ disclosures to make meaningful change on all aspects of the problem.