On August 6, 2021, a divided group of five SEC Commissioners approved a proposal submitted in December 2020 by Nasdaq (originally, an abbrevation of National Association of Securities Dealers Automated Quotations) that will require most of the 4,000 companies whose stock is traded on the exchange to publicly disclose information about the diversity of their boards of directors, and, if they have not satisfied Nasdaq’s new standards in this regard, to publicly explain.
Although full compliance is expected to begin in two to five years (depending on the type of company), this initiative creates exciting opportunities not only for current executives but also for law and business students, educational institutions, governance advisors, board recruitment and placement firms, and independent organizations devoted to increasing board diversity.
● The Basics
As described in the 82-page SEC Release No. 34-92590 (download), under the new requirement of Nasdaq Listing Rule 5605(f), each listed company will, “subject to some exceptions, . . . publicly disclose in an aggregated form, to the extent permitted by applicable law, information on the voluntary self-identified gender and racial characteristics and LGBTQ+ status. . . of the company’s board of directors.”
In addition, each company must “have, or explain why it does not have, at least two members of its board of directors who are Diverse, including at least one director who self-identifies as female and at least one director who self-identifies as an Underrepresented Minority or LGBTQ+.” Companies whose boards have five or fewer members should have, or must explain the absence of, at least one member who is “Diverse.” (See “Defined Terms,” below.)
● Concurrences and Dissents
SEC Chair Gary Gensler stated that these new requirements—in conjunction with a second newly-approved proposal, to enhance compliance by providing board recruiting services for free to Nasdaq-listed companies —“will allow investors to gain a better understanding of [the] companies’ approach to board diversity, while ensuring that those companies have the flexibility to make decisions to best serve their shareholders.”
SEC Commissioners Allison Herren Lee and Caroline A. Crenshaw supported the diversity proposal as “a step forward for investors,” and suggested that further regulation in this area could include “disability [as] a relevant characteristic, as well as diversity among senior management and the workforce more broadly.”
Commissioner Elad L. Roisman, though concurring that “Public company boards of directors should not be private clubs with membership limited to narrow social circles,” supported the recruiting proposal but dissented from the diversity disclosure proposal, finding it questionable whether the initiative fell within the Securities and Exchange Act of 1934’s Section 6(b)(5).
Under that provision, an exchange’s rules must be “designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, . . , to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest,” without allowing “unfair discrimination between customers, issuers, brokers, or dealers,” and without attempting to regulate “matters not related to the purposes of this title or the administration of the exchange.”
Commissioner Roisman also warned vaguely that if Nasdaq were (against the weight of precedent) to be seen as a state actor, or if the SEC (as a state actor) were to involve itself further in diversity disclosure issues, there might be Constitutional concerns and complications.
Also writing in opposition, Commissioner Hester M. Peirce similarly objected that the proposal was not authorized by Section 6(b)(5), and added that Nasdaq had not definitively correlated boardroom diversity with enhanced corporate performance.
The latter subject had been addressed in some detail, including by a survey of a variety of scholarly analyses, on pages 20-29 and 183-200 of Nasdaq’s February 26, 2021 letter to the SEC [412 pages, including attachments (download)], in which the exchange had responded to “over 200 letters” commenting on the original proposal, and indicated the amendments it had made to its original submission..
Although the SEC, in approving the proposed rule, noted that the researchers’ results “are mixed, . . are generally inconclusive, and suggest that the effects of even mandated changes remain the subject of reasonable debate,” it found that “at a minimum, the academic and empirical studies support the conclusion that board diversity does not have adverse effects on company performance.”
● Defined Terms
Among the terms defined in Nasdaq’s Listing Rule 5605(f)(1) are:
“Diverse” means an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority, or LGBTQ+.
“Female” means an individual who self-identifies her gender as a woman, without regard to the individual’s sex at birth.
“LGBTQ+” means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.
“Underrepresented Minority” means an individual who self-identifies as one or more of the following: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or Two or More Races or Ethnicities.
“Two or More Races or Ethnicities” means a person who identifies with more than one of the following categories: White (not of Hispanic or Latinx origin); Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander.
These categories are further defined in the amended proposal’s instructions for completing the required matrix for disclosing board diversity. See “Page 327 of 354” in an attachment to Nasdaq’s February 26 letter.
● Comply or Explain
Both the SEC and Nasdaq emphasized that the exchange’s revised listing standards do not force boards to meet specific diversity “quotas,” and that companies could satisfy the requirements by disclosing why they had not seated the specified number of “Diverse” directors.
The SEC indicated that Nasdaq “would not evaluate the substance or merits of a company’s explanation.”
Nasdaq’s letter to the agency clarified that a 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.”
Nasdaq’s amended proposal suggests that one explanation that a board might offer is that it “believe[s] that defining diversity more broadly than Nasdaq (by considering national origin, veteran status and disabilities) brings a wide range of perspectives and experiences to the board.”
As the exchange noted in its amended proposal, the “comply or explain” approach also appears in several federal securities regulations, including those governing a company’s inclusion of a financial expert on the board’s audit committee, and a company’s adoption of an ethics code that applies to its CEO and senior financial or accounting officers.
● Nine Areas Seeing Development About Qualifications
Among the resulting opportunities, and areas to monitor for further development (and study) are:
First, the revisions should draw increased attention to, and possibly the creation of new, independent groups devoted to preparing potential directors who would qualify as “Diverse” under the Nasdaq definition.
(Without endorsing any in particular,) those organizations include: 50/50 Women on Boards; Alliance for Board Diversity; Boardlist; Catalyst; DirectWomen; Ellevate; Executive Leadership Council; Hispanic Association on Corporate Responsibility; International Women’s Forum; Interorganization Network (ION); New America Alliance; 30% Club (U.S. Chapter); 30% Coalition; Women Corporate Directors; and Women in the Boardroom.
Second, there will certainly be renewed interest in conferences and organizations that prepare professionals (whether lawyers or not) to be directors; and in written information, including blogs and lists of recommended reading, on the basic and advanced functions of directors.
Third, students and alumni of law and business schools might decide to enroll in (regular or continuing/executive education) courses to prepare and position them for the boardroom, possibly to help advance not only a specific corporation’s financial performance but also its contributions to social initiatives. Some educational institutions might create, or enlarge, specialized programs or centers for this purpose.
Fourth, the Nominating Committees (sometimes known as Nominating and Governance Committees) of corporate boards, which are charged with identifying candidates for directorship, will probably become more active in reviewing and updating not only candidate lists but also their companies’ governance documents.
In the absence of an SEC-mandated definition of the term, the (non-binding, easily and quietly-revised) Corporate Governance Principles (sometimes called Corporate Governance Guidelines) posted on major corporations’ Web sites (often under “About Us,” or “Investor Relations”) can be notably broad in their dimensions and denotations of “diversity”: for instance, they might refer to, “diversity (including diversity with respect to race, ethnicity, national origin, gender, sexual orientation, and age),” or, “diversity with respect to gender, ethnicity, race, nationality, skills and experience in the context of the needs of the Board.”
Committees might well clarify this issue, and also revisit the disclosure that the SEC does require them to make: “how a board implements any policies it follows with regard to the consideration of diversity in identifying director nominees.”
In that regard, some boards might add to, or refine in, their Corporate Governance Principles such Rooney Rule-related statements as, “When a professional search firm is used, the Corporate Governance and Nominating Committee directs the firm to provide a diverse slate of candidates for the Board’s consideration,” or “the Governance and Nominating Committee will instruct the search firm to include in its initial list of candidates qualified candidates who reflect diverse backgrounds, including diversity of gender and race or ethnicity.”
Fifth, corporations might amend their governing documents to enlarge the number (or range, if they prefer not to indicate one specific number) of directors on the board, in order to add new and diverse candidates without necessarily forcing out incumbent directors. Alternatively or in addition, to ensure regular “refreshment” of the board, Nominating and Governance Committees could adopt, and more strictkly enforce (since their application is often left to the board’s ultimate discretion), term and/or age limits for directors.
Sixth, significant shareholders who through “proxy access” rules can nominate candidates for directorships might be more likely to nominate individuals who would enhance the diversity of the board. More generally, shareholders could launch proposals, to be submitted to a vote of shareholders, concerning the extent and transparency of the board’s definition(s) and dislosure(s) of, and efforts to increase, diversity among directors.
Seventh, California might be joined by other states in requiring certain forms and norms of diversity on the boards of publicly-traded companies whose “principal executive offices” are in the state.
In September 2018, California amended its Corporations Code to mandate that such companies have a minimum number of female directors (three, for boards with six or more directors; two, for those with five directors, and one, for those with four or fewer directors), and a minimum number of directors “from underrepresented communities” (three for boards with nine or more directors; two, for those with five to eight directors; and one, for those with four or fewer directors).
(On the other hand, some state legislators might argue that such rules are less necessary in light of Nasdaq’s revised listing standards.)
Eighth, it remains to be seen whether the New York Stock Exchange (NYSE) will amend its own listing requirements in a comparable way..
Ninth, leading investment funds, like State Street Global Advisors and BlackRock; proxy advisors, like Glass Lewis and Institutional Shareholder Services (ISS); and investment banks, like Goldman Sachs, might become even more active in encouraging board diversity practices among the companies whose shares they hold in their portfolios.
For shareholders large and small, as well as existing and prospective directors, the Nasdaq rules may well have added new boardroom-related meanings to the phrase, “the company you keep.”
