While you were worrying about conflict minerals, CEO pay ratios, and the Volcker Rule, another disclosure requirement from the Dodd-Frank Act has quietly been drawing closer. Any day now—if hints from various regulators are to be believed—final rules for how companies assess and report data on the diversity of their workforce will emerge.
“All these other issues were whirling around that were more immediate,” says Stephanie Wilson, a partner with law firm Reed Smith. “A lot of people just weren’t paying attention to it.”
The pending rule, from Section 342 of Dodd-Frank, has three requirements. First, various federal regulators had to create their own Office of Minority and Women Inclusion to oversee and document their policies for hiring and retaining minorities. Step two: Those new offices will require the vendors those agencies use to also report on their diversity efforts.
The final step broadens those requirements to all companies those agencies regulate and their supply chain. And since one of the regulators covered by Section 342 is the Securities and Exchange Commission, that means every public company, regardless of sector or size, falls under the law’s scope. In total, as many as 70,000 regulated entities face the new requirements.
The public comment period for the proposed rule ended in 2014. According to regulatory agendas, a final rule was initially on track for early 2015, and Wilson is one of numerous corporate lawyers who say their contacts in the regulatory world confirm that a final rule is indeed coming soon.
“Dodd-Frank is going on five years now, and this is not something many have focused on, but in the past couple of months interest has picked up,” says Doreen Lilienfeld, a partner with the law firm Shearman & Sterling. “People have renewed their focus on the provision.”
The proposed agency rules are built upon a framework companies will use as a guideline for developing diversity and inclusion (D&I) programs. The self-assessments break down into four areas: organizational commitment to diversity and inclusion; workforce profile and employment practices; procurement, business practices, and supplier diversity; and practices to promote transparency of organizational diversity and inclusion.
Specific steps include:
Whether company leadership maintains a commitment to diversity and inclusion and includes those considerations in the strategic plan. Do senior officials have dedicated resources to oversee and direct diversity efforts?
Are regular progress reports sent to senior management and directors? Is management held accountable for D&I efforts?
Does the company use qualitative and quantitative metrics, such as those contained in annual EEO-1 Reports or Affirmative Action Plans filed with the Office of Federal Contract Compliance Programs, to evaluate and assess workforce diversity initiatives? What other metrics are, or could be, used?
What steps are taken to promote a diverse pool of candidates for the board and senior leadership?
To promote transparency, the proposal calls upon companies to publish D&I plans, metrics, and assessments on their website.
“All these other issues were whirling around that were more immediate. A lot of people just weren’t paying attention to this.”
Stephanie Wilson, Partner, Reed Smith
So far the proposed rule lacks several important details. For example, it stops short of actually defining “diversity.” While gender and race criteria are obvious, what about religion, sexual orientation, or socio-economic status? Nor is there any mention of enforcement. While regulators have signaled that the final rule may not include punitive measures, the lack of clarity leaves open the possibility. And as an exercise in data collection, the proposal offers little in the way of timelines, deadlines, or standards for collecting and reporting all that information.
“If I could have a wish list for what I hope these regulations will say, one wish is that there would be some clarity and precision,” says Jeffrey Klein, chair of the law firm Weil’s employment litigation practice group. “There is no statement to date as to the enforcement mechanism. There is no definition of diversity or even a definition of what the goals of what a regulated company’s diversity policies and practices should be.”
Even without enforcement, the disclosures increase reputation risk, since the information will allow the public, shareholders, and activists to pressure companies on diversity practices. “The public will be overseeing this and calling you out if you fall short in their perception,” Wilson says. “The public will put your feet to the fire if they feel they are not following the letter and spirit of the rule.”
As companies disclose their policies, outsiders are likely to study them as a whole, comparing peer groups—“and there will be a lot more scrutiny through social media and public discussion as people compare one company’s diversity practices to another’s,” Klein says. “If it turns out that the diversity information disclosed is used by regulators as another punitive club, then everyone will resort to the minimum disclosure necessary to insulate themselves from liability as opposed to a focus on more expansive disclosure and greater risk taking in driving for a better diversity outcome,” he says.
DIVERSITY DEMANDS SURGE
When the Securities and Exchange Commission and other regulators do issue new reporting guidelines for diversity and inclusion programs, they will simply be the latest in a growing list of voices around the world calling for such efforts.
On the front lines of proxy season this year, roughly 25 board diversity resolutions have been filed for votes at 2015 annual meetings, plus three shareholder resolutions from the New York City Comptroller’s Office asking companies to provide racial breakdowns for their workforce. eBay, for example, recently agreed to revise its Governance Guidelines to include gender and racial diversity among the qualities its seeks in board members. The guidelines led proponents to drop a planned shareholder resolution.
Abroad, the European Union’s Capital Requirements Directive IV, effective January 2014, established diversity requirements for large banks and investment firms. To encourage the inclusion of minorities and women on boards (as well as candidates who vary by age, education, and professional background), nomination committees must develop and disclose a target for underrepresented demographics.
EU rules also call for companies with more than 500 employees to disclose diversity data in annual reports. Also in the works is a requirement that, by 2020, at least 40 percent of nonexecutive directors at listed companies be female. Missing that threshold would trigger a requirement that a new nomination process be developed to prioritize qualified female candidates.
Individual European countries have their own requirements, too. Officials in Norway mandated a 40 percent quota for female directors in 2006. French law requires that by 2017, 40 percent of directors must be female. Belgium will require that 33 percent of boards be female by 2018.
In March, Germany enacted a new law requiring the country's 100 largest companies to appoint women to 30 percent or more on non-executive boards by 2016; a quota that rises to 50 percent in 2018. The United Kingdom’s Corporate Governance Code requires listed companies to include diversity-related policies and procedures in annual reports.
The difficulty companies have had meeting these quotas is why U.S. regulators have so far avoided rigid diversity requirements, says Lisa Zonino, a consultant with Egon Zehnder. “If you look at the European Union, mandates at the board level are very difficult to implement and meet because the minority board candidates are all ‘boarded-up,’ ” she says. “A director could have two or three boards and the dance card is already full for many of the minority candidates.”
One formidable challenge could be the assessment of “procurement and business practices.” Companies are asked to evaluate supplier diversity. Metrics are expected to include data on annual contract spending and the percentage spent with “diverse” vendors, the percentage of contracts with minority-owned sub-contractors, and demographics on suppliers’ workforces. But can companies rely on the accuracy of data they collect? And to what degree can they (or should they) pressure changes throughout their supply chain? Should specific vendors be cut for not meeting company-set quotas?
“I don’t think most companies focus much on supplier diversity,” says Lauri Rasnick, a member of the law firm Epstein Becker & Green’s labor and employment practice. “They may have an interest in using certain vendors that fall within diversity definitions, but at the same time you will find it is unusual that they keep track of it.”
In all likelihood the final rule won’t stray too far from the current framework, says Lisa Zonino, a consultant in the financial services practice for global executive search firm Egon Zehnder. And even with the final rule still pending, companies are already showing an increased focus on diversity issues. A growing number of diversity officers, for example, report directly the CEO. “That’s something new and very cutting-edge,” she says.
Who Owns This
A diversity program should not just be shuffled off to the HR department, Klein says. He urges a company-wide approach that includes senior management, compliance, and legal counsel. “The thrust of good compliance and best practices is to not have a siloed approach,” he says.
The new requirements drive home the point that diversity efforts should seek to improve year-over-year. “There are a lot of programs in place, and a lot of things have been done already, but I think if you were to ask most CEOs if they are where they want to be, in their hearts they know the answer is no. Progress has been made but the company is nowhere near where they want it to be,” says Chuck Gray, a consultant with Egon Zehnder’s financial services practice. His advice for companies is not to focus on hiring practices, but rather show the public that they have training, mentorships, and other efforts in place to stem the attrition of minority employees.
“We are encouraging companies to go on offense in identifying, discussing and defining their diversity goals, objectives and definition of diversity so they are not put in the position here to merely play defense,” Klein says. “That applies across the board to all kinds of shareholder issues. If you are caught flatfooted on this, you will face a lot more regulatory, compliance, and legal risk and be far less effective operationally and in driving the type of culture today’s workforce wants to be affiliated with.”