On August 6, the U.S. Securities and Exchange Commission (SEC) approved Nasdaq’s proposal to hold companies listed on the exchange accountable for board diversity. The new Nasdaq Board Diversity Rule sets a baseline requirement for diverse board membership and specifies a consistent set of disclosures so stakeholders can evaluate the current board compositions of listed companies. Nasdaq has clarified that the rule is “a disclosure-based framework and not a mandate” and that businesses “can choose to disclose as much or as little insight into the company’s circumstances or diversity philosophy as the company determines.” Nevertheless, Nasdaq has reserved the option to delist the company if it fails to comply by its applicable deadline. In addition, companies choosing not to take boardroom diversity seriously face possible investor discontent. The rule is structured with generous provisions allowing a non-diverse board ample time to transition.
The activist investor community has been advocating for more diverse workforces and boards for years. Earlier diversity initiatives have led to the presently voluntary environmental, social and governance (ESG) and the recently required human capital reporting, and have relied on disclosures as the primary mechanism to prompt businesses to become more socially responsible. This theme continues with the Board Diversity Rule, which is the first of its kind in that it requires companies to explain board diversity shortfalls. Other stock exchanges may follow suit with similar rules, as markets react to Nasdaq’s approach.
The rule has its detractors, with some asserting that it violates civil rights laws and the Constitution and others claiming it imposes arbitrary racial and gender quotas. Nasdaq has rejected these claims because companies can meet its requirements by explaining why they haven’t met the diversity standards. In effect, the rule deploys a benchmark to create transparency for the market to work through the issue.
The rule requires larger U.S.-based Nasdaq-listed businesses to have “at least one director who self-identifies as female” and at least one director who “self-identifies as an ‘underrepresented minority’ or ‘LGBTQ+.’” Further, these businesses must disclose information about the composition of the company’s board of directors based on the “voluntary self-identified gender, racial, ethnic and LGBTQ+ status” of its members. After the first disclosure, businesses must show information for both the current and prior year.
The SEC also approved Nasdaq’s companion proposal to offer a year of free recruiting resources to ease the burden on companies as they pursue more diverse board hires.
There are relaxed versions of the Board Diversity Rule for foreign issuers and smaller boards:
- Foreign issuers can meet requirements with “at least two directors who are diverse, including at least one diverse director who self-identifies as female and a second diverse director who may include an individual who self-identifies as one or more of the following: female, LGBTQ+, or an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the country of the company’s principal executive offices.”
- Smaller boards – those with five or fewer members – can meet Nasdaq’s requirements with one diverse director, or two female directors.
The Board Diversity Rule specifies various deadlines to phase in its requirements:
- August 8, 2022: The earliest compliance date for disclosures.
- August 7, 2023: The earliest compliance date by which listed Nasdaq companies must have one diverse director on board or explain why they don’t have one. (Note: This compliance date applies to smaller boards as well.)
- August 6, 2025: The earliest compliance date by which Nasdaq Global Select Market and Nasdaq Global Market companies must have two diverse directors on board or explain why they don’t have them.
- August 6, 2026: The earliest compliance date by which Nasdaq Capital Market companies must have two diverse directors on board or explain why they don’t have them.
In the case of all of the above dates, the deadline may be a later date that same year when the business files its proxy or information statement.
Some Nasdaq clarifying color commentary
It is important to note that Nasdaq will not be evaluating companies’ explanations for failing to meet board diversity thresholds. In his correspondence with the SEC last February, Nasdaq’s Chief Regulatory Officer John Zecca stated:
A company that chooses to not meet the diversity objectives will not face consequences or be delisted. Rather, they can describe their reasons for following a different path. Nasdaq will not adjudicate the merits of a company’s reasons for not achieving the diversity objectives, and will not assess the substance of a company’s explanation… The company can choose to disclose as much, or as little, insight into the company’s circumstances or diversity philosophy as the company determines, and shareholders may request additional information directly from the company if they need additional information to make an informed voting or investment decision.
He provided examples of acceptable explanations, including statements that a company:
- doesn’t believe Nasdaq’s listing rule is appropriate; or
- doesn’t believe achieving Nasdaq’s diversity objectives is feasible under current circumstances; or
- considers a variety of professional, industry, and personal backgrounds and skill sets; or
- is committed to ensuring that the board’s composition appropriately reflects the company’s needs
Between the lines, however, is the Nasdaq’s objective: to shine the spotlight on the diversity, or lack thereof, of a board’s composition, and let the market drive whether it is fit for purpose.
Businesses are already responding to stakeholder requests regarding their board diversity, have made statements at annual meetings or have included board diversity information in filings. With that as a starting point, following are some recommendations:
- No director should be compelled to disclose personal information to achieve the Nasdaq targets. It may be useful to review past Directors and Officers (D&O) questionnaires to see what diversity information has already being reported.
- Don’t view the Nasdaq rule in a vacuum. Seek legal counsel assistance in understanding Nasdaq’s diversity requirements and contrasting them with applicable laws and regulations. For example, Maryland, New York and Washington have all adopted board diversity disclosure laws, and several other states are considering similar laws now. Consider the diversity goals being specified by proxy advisors, relevant asset managers and other stakeholders.
- Review and revise current policies and practices regarding board diversity to support compliance. If necessary, amend governance and nominating committee charters to comply with Nasdaq and other board diversity rules.
- Review current board members’ terms and expirations. Consider creating or modifying board retirement policies to gain near-term board diversity. Based on this insight, take the earliest opportunity to rotate in diverse members at upcoming annual meetings. Consider diverse applicants for every new vacancy.
- Develop management succession plans that consider diversity requirements to establish a pipeline of diverse internal candidates as an integral part of the company’s executive bench strength.
- Businesses that plan to go public and list on Nasdaq should treat compliance with the Board Diversity Rule as part of their overall IPO readiness activities.
Achieving diversity is about acting with intention. This means that a commitment to diversity, equity and inclusion is a continuous process that is so entrenched into the nominating committee’s mindset, criteria and expectations for considering board candidates, it is virtually inseparable from the selection process itself. But this can only happen when greater diversity is achieved. That is why, for the shorter term at least, the selection process should be disproportionately focused on advancing diversity in the boardroom.
Studies conducted over the years have shown that the varied life experiences and viewpoints of diverse teams result in businesses that perform better – in terms of top-line, bottom-line and innovation performance. But suffice it to say that activist investors and other stakeholders have been lobbying for more diversity in the boardroom for a long time and now Nasdaq is listening — and responding. And, with these new disclosures, investors and other stakeholders will be watching, too.