The Securities and Exchange Commission (SEC) on Friday approved rule changes proposed by Nasdaq last year that will put in place a new board diversity “comply or explain” mandate and further require companies listed on Nasdaq’s U.S. exchange to make public disclosures regarding the composition of their boards.
Under the SEC’s approval order, Nasdaq-listed companies, subject to certain exceptions, are encouraged to have at least two “diverse” directors, including at least one who self-identifies as female and at least one who self-identifies as either an “underrepresented minority or LGBTQ+,” terms of which are defined in the approval order.
All operating companies listed on Nasdaq’s U.S. exchange will need to use the Board Diversity Matrix, or “a format substantially similar,” to annually disclose their board-level diversity data. This disclosure must be done by Aug. 8, 2022, or the date the company files its proxy or information statement for its annual shareholder meeting during 2022—whichever comes later.
“All U.S. public companies, Nasdaq-listed or otherwise, should be paying attention to what investors do with the data disclosed as a result of Nasdaq’s board diversity rules. If they don’t want to fall behind the curve, they should act to address diversity concerns before that data is used against them.”
Valeska Pederson Hintz, Partner, Lowenstein Sandler
Companies that do not meet the diversity objectives must provide an explanation as to why, “which could include a description of a different approach,” Nasdaq stated. This disclosure must be provided in the company’s proxy statement, information statement for its annual shareholder meeting, or on its Website concurrently with its proxy statement or its information statement.
Failure to meet the requirements could subject a company to delisting.
Smaller reporting companies and foreign issuers can meet the diversity objective by including two female directors or one female director and one director who is an underrepresented minority or LGBTQ+. All companies with five or fewer directors can meet the diversity objective by including one diverse director.
Special purpose acquisition companies (SPACs) are exempt from the board diversity rule.
Nasdaq explicitly stated it “will verify that the company has provided an explanation but will not assess the merits of the explanation. There is no right or wrong reason that a company may give for not having at least two directors.” To assist companies in their search for qualified, diverse, board-ready candidates, Nasdaq has established partnerships with Equilar, Athena Alliance, and the Boardlist.
In a public statement, SEC Commissioner Elad Roisman said that, while he supports the wider goal of having more diverse and inclusive boards, he does not support the disclosure requirements. “Regrettably, I do not believe that the Commission has fulfilled its obligations to find that this Proposal, which has delisting implications for companies, meets the legal standards that we are required to apply in evaluating rules proposed by self-regulatory organizations,” he said.
Roisman concluded the Commission “did not undertake its own ‘reasoned analysis’ to evaluate the merits of the proposal at issue.”
Commissioner Hester Peirce also opposed the proposal, expressing numerous concerns, including the dangers of forcing self-identification. “Even assuming that all board members self-identify in a consistent manner and that they all self-identify in accordance with some generally accepted norm, the rule will not facilitate comparisons across all firms,” she said.
Peirce further argued that “micromanag[ing] the delicate process of composing a board … does not lend itself well to standardization” and puts a company “at reputational, legal, and financial risk regardless of which path it takes.”
For example, a company might choose to hire a woman who doesn’t meet the expertise needed for its board simply to comply with the diversity target, resulting in “possible longer-term reputational, legal, and financial consequences, as it finds itself without necessary expertise.” Failing to meet a mandate, however, “may lead to outcry, a drop in its stock price, and a shareholder suit,” Peirce said.
“While the SEC approved Nasdaq’s proposal, it made clear that Nasdaq-listed companies who did not wish to comply with the new rules may choose to list on another exchange,” says Susan Resley, a partner in the Securities Enforcement and Litigation practice at Morgan Lewis. “At this point, it does not appear other exchanges will follow Nasdaq’s lead.”
That is not to say the SEC’s decision won’t have broader impact overall. “I do think this will add momentum to what has become an important goal among investors and shareholders to have corporate boards become more reflective of the diversity that exists within society,” says Marvin Owens, chief engagement officer at Impact Shares, a socially conscious investment management firm and nonprofit exchange-traded fund issuer.
“The SEC’s decision to approve Nasdaq’s proposed board diversity rules shines a further spotlight on board diversity,” says Valeska Pederson Hintz, a partner at Lowenstein Sandler. On a nationwide level, at least a dozen states have enacted or are weighing statutes that directly address diversity in the boardroom—or lack thereof. While some states mandate strict quotas, others are taking a softer approach by urging diversity efforts through disclosure requirements, as Nasdaq has done here.
Board best practices
Prudent companies recognize diverse and inclusive boards create a competitive advantage. Owens adds, however, “there needs to be greater alignment between a company’s internal [diversity, equity, and inclusion] goals and board recruitment practices.”
“Boards and management now recognize composition sets a tone for the organization and demonstrates a company’s commitment to diversity and inclusion,” Resley says. “As a result, companies should be mindful to consider their public statements on diversity and inclusion vis-à-vis their policies and public disclosures regarding director recruitment, the director nomination process, and overall board diversity. They should ensure the composition of their boardroom and their nomination process is cohesive with those statements.”
“All U.S. public companies, Nasdaq-listed or otherwise, should be paying attention to what investors do with the data disclosed as a result of Nasdaq’s board diversity rules,” Hintz says. “If they don’t want to fall behind the curve, they should act to address diversity concerns before that data is used against them.”
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