SEC’s Pending Rules Put Boards at the Ready

“Time is money. Time is risk.” So said U.S. Securities and Exchange Commission (SEC) Chair Gary Gensler speaking at the European Commission on January 25, 2024, in reference to the timing of the clearance and settlement cycle for securities trading. Beginning on May 28, 2024, a rule takes effect that cuts in half the time it takes for trade clearance and settlement, Gensler said. “For everyday investors who sell their stock on a Monday, they will get their money on Tuesday. For institutional players, it will free up liquidity that might otherwise be trapped in unsettled trades.”

Since succeeding Jay Clayton as SEC chair in 2021, Gensler has proposed or finalized 63 different rules, according to SIFMA, the securities industry trade association that, among other things, tracks SEC rule making. When Gensler released a report on the SEC’s proposed and finalized rules in December, 43 individual items were listed on the agenda. Proposed rules range from disclosures about climate to human capital management to corporate board diversity.

Of the five risks chosen by directors as most likely to impact their company in the next 12 months “increased regulatory requirements” ranked second after “threat of economic recession.” Cybersecurity threats, competition for talent, and the pace of technology change were numbers three, four, and five, respectively, according to the 2024 Governance Outlook produced by the National Association of Corporate Directors.

The concern among directors about regulatory requirements seems particularly well placed with one caveat—the outcome of the general election in November.

 

What’s to Come, When

Boards will likely see SEC rule-making activity this spring. New climate disclosures, as detailed in the 2022 proposal, are expected to be in line with California’s rules, which take effect in 2025—with important distinctions between the two. While the SEC included Scope 3 (also called “value chain emissions”) in its initial proposal in 2022, it is now unclear whether the final rule will include this reporting; in contrast, the California law requires Scope 3 disclosure.

The SEC proposed disclosures apply to public companies while the California law applies to public and private companies that meet certain revenue thresholds.

Another proposed rule related to human capital management would require companies to provide more information about a company’s workforce. Potential new disclosures could include headcounts of full- and part-time employees, more detailed demographics, and a narrative disclosure in management’s discussion and analysis (MD&A) of how “labor practices, compensation incentives, and staffing fit within the broader firm strategy.”

In preparation, companies should evaluate how existing human capital disclosures can be migrated to the 10-K to satisfy requirements and address any gaps in workforce data tracking, including any needs for third-party assurance.

Relative to the composition of boards themselves, a proposed rule would require boards to “enhance” disclosures around its own diversity and that of director nominees.

Most companies already disclose the diversity of their boards, given listing requirements from the exchanges and expectations of institutional investors. However, smaller firms may need to catch up with their larger peers in this regard—and these larger firms can serve as a guide for how to collect and effectively report board diversity information. When reporting on board diversity, many companies go beyond simple demographics to highlight the specific skills and experience of their directors, which provide greater detail on the value their directors bring to the company.

Also worth noting is the re-emergence of incentive-based compensation rules for financial institutions with assets greater than $1 billion. The SEC along with a plethora of bank regulators (Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Federal Housing Finance Agency, and the National Credit Union Administration) want to revisit a rulemaking requirement stemming from Dodd-Frank that was originally proposed in 2011, again in 2016, and then went dormant.

It seems recent bank failures have again raised the attention of regulators prompting scrutiny of incentive-based pay and whether it promotes excessive risk taking that leads to a material loss for the firm. Details remain to be seen but there is speculation a proposal could include stipulations for longer vesting periods and curbs on stock ownership for executives.

 

Farient’s Recommendations

In preparation for compliance with any new regulation, Farient recommends that boards and their compensation committees decide what action needs to be taken, if any, in preparation. Is it better to wait and see what the final rule entails or to anticipate what it might entail and begin to prepare? While each company faces its own set of unique circumstances, some companies and their boards may benefit from doing the following:

• Take an inventory of what information is available to the board today and what might be needed in the future
• Ascertain from management who is on point to deliver what is, or may be, needed for the board to inform their questions
• Monitor peers’ disclosures and activity for comparison
• Quantify your company’s climate risks and carbon footprint to determine if greater or different action is needed
• Consider whether the board has the requisite experience and skills to serve the company’s strategy and oversight needs
• Work with advisors, such as your compensation and governance consultant, to receive updates on current and upcoming regulations and the work steps needed for compliance for your company