Three Quick Takeaways on the SEC’s Approval of Nasdaq’s Board Diversity Rules
By Sarah Fortt
On Friday, August 6, the SEC approved Nasdaq’s board diversity proposals. Nasdaq’s board diversity rules, one regarding board composition (the “Board Diversity Rule”) and one regarding access to complimentary board recruiting services (the “Board Recruiting Service Rule”) were each first proposed back in December 2020 and amended in February 2021 in part to provide companies with additional flexibility. As approved by the SEC, Nasdaq’s Board Diversity Rule generally requires each Nasdaq-listed company to (i) publicly disclose in an aggregated form and to the extent permitted by applicable law, information on the voluntary self-identified gender and racial characteristics and LGBTQ+1 status of the company’s board of directors,2 and (ii) have, or explain why it does not have (in advance of its annual meeting of shareholders), at least two members of its board who are Diverse,3 including at least one director who self-identifies as Female and at least one director who self-identifies as an Underrepresented Minority4 or LGBTQ+.
Certain exceptions apply for foreign issuers, companies with small boards and Smaller Reporting Companies;5 phase-in periods apply to newly listed companies and companies that cease to be foreign issuers, Smaller Reporting Companies, or otherwise except from the Board Diversity Rule; and cure and grace periods apply for companies that cease to meet the Board Diversity Rule’s objectives. The Exchange has indicated that it will not evaluate the substance of a company’s explanation regarding why it does not meet the board diversity threshold, Nasdaq will only confirm that a company has provided an explanation. As approved by the SEC, Nasdaq’s Board Recruiting Service Rule provides certain Nasdaq-listed companies6 with one year of complimentary access for two users to a board recruiting service to promote access to a network of board-ready diverse candidates for companies to identify and evaluate. The new Nasdaq rules generally become effective between 2023 and 2026 based on each company’s listing tier.
There has been a lot of discussion of these rules, and in particular, the Board Diversity Rule, since the rules were first proposed, and there will no doubt be more discussion and debate in the weeks to come. Below, I have briefly outlined three takeaways for what companies should consider now about the new rules.
- The new rules do not impose board diversity mandates or quotas, but…. When the Board Diversity Rule was first proposed, hue and cry quickly followed. Articles and blog posts argued that the proposed rule was outside of the scope of Nasdaq and the SEC’s authority, pointed out that studies have failed to show causation between diverse boards and enhanced corporate performance, and denounced the proposed rule as potentially undermining both the effectiveness of boards by meddling with their composition and true diversity by treating diverse individuals as interchangeable or somehow “forcing” them to disclose personal information. These positions can be relatively easily swept aside for a number of reasons, not the least of which is that the Board Diversity Rule does not impose board diversity mandates or quotas, it is a “comply or explain” rule. Ultimately, a board could never include a single woman or diverse individual ever and still fully comply with the Nasdaq rule. But, and in today’s ESG environment this is becoming an increasingly bigger “but,” the Nasdaq rules do effectively require companies to self-shame by disclosing why they do not have at least the minimum diversity set forth in the rules. For companies that are closely held or in industries that generally struggle with board diversity, this diversity disclosure may pack less of a punch than it does for others. To the extent that the Board Diversity Rule does incentivize companies to create more diverse boards, this is clearly prioritized by the Exchange after other criteria which are explicitly required by Nasdaq for most companies, including criteria regarding independence and the skills to oversee the financial reporting processes.
- Investors and other stakeholders will still establish the ceiling for board diversity. Now that the Nasdaq rules have been adopted, I expect more sound and fury to result. However, ultimately, these rules only serve to establish a floor, not a ceiling, and considering that the rules ultimately only require companies to explain their status quo, one could argue that the rules barely do even that. Far more importantly, shareholder proposals regarding board diversity have received growing support in recent years, and investors large and small have continued to adopt voting and engagement policies regarding board diversity. This year, BlackRock has indicated that it voted against the re-election of 1,862 directors at 975 companies because of a lack of board diversity.7 What does this mean when coupled with Nasdaq’s Board Diversity Rule? Investor engagement continues to rise in importance. Companies that have boards that do not meet the Nasdaq diversity thresholds should not go into their annual meeting season without having engaged with their key investors on the topic of board diversity, even if the Nasdaq rule is not yet applicable to the specific company.
- Board diversity is an imperfect proxy for improved board performance, but maybe that’s not the point (or at least maybe that’s not the only point). A fair number of the arguments against the Board Diversity Rule focus on whether the new rule will or will not improve board or company performance. I am not here to make an argument one way or the other. I do think it is worth pointing out that individuals who identify as women comprise approximately half of the U.S. population, and only about 25% of directorships on U.S. Russell 3000 boards,8 and Underrepresented Minorities comprise about 40% of the U.S. population, and only about 18% of directorships on U.S. Russell 1000 boards.9 Is there some benefit beyond board or company performance that makes board diversity matter? In a world in which the views and sense of belonging of stakeholders beyond investors, including individuals in a company’s communities and its employees, matter, I think yes, representation does matter beyond the ways in which it may contribute to performance in the near term. Regardless of one’s views on these issues, I think it behooves companies to encourage their board members and members of management to consider the implications for their corporate cultures and reputations when these senior members speak publicly on board composition and the role that diversity should, or should not, play. Ultimately, perhaps the best the new rules have to offer is the opportunity to have internal conversations about topics that might otherwise go undiscussed and unexplored.
1 Under the Nasdaq rules, “LGBTQ+” means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.
2 The board diversity matrix generally requires that companies provide the total number of directors on its board and (1) the number of directors based on gender identity (female, male, or non-binary) and the number of directors who did not disclose gender; (2) the number of directors based on race and ethnicity (African American or Black, Alaskan Native or Native American, Asian, Hispanic or Latinx, Native Hawaiian or Pacific Islander, White, or Two or More Races or Ethnicities), disaggregated by gender identity (or did not disclose gender); (3) the number of directors who self-identify as LGBTQ+; and (4) the number of directors who did not disclose a demographic background under item (2) or (3).
3 Under the Nasdaq rules, “Diverse” means an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority or LBGTQ+; “Female” means an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth; “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; and “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.
4 See note 3.
5 Each foreign issuer must have, or explain why it does not have, at least two members of its board who are Diverse (and the definition of “Diverse” for foreign issuers is revised to consider the diversity of the country of the company’s principal executive offices), including at least one Diverse director who self-identifies as one or more of the following: Female, LBGTQ+ or as an underrepresented individuals based on the diversity of the country of the company’s principal executive offices. Foreign issuers also may elect to use an alternative board diversity matrix format. The Nasdaq rules apply to foreign issuers’ supervisory or non-management boards. Each Smaller Reporting Company must have, or explain why it does not have, at least two members of its board who are Diverse, including at least one Diverse director who self-identifies as Female. The second Diverse director may include an individual who self-identifies as one or more of the following: Female, LGBTQ+, or an Underrepresented Minority. Other listed companies with five or fewer directors must have, or explain why they do not have, at least one Diverse director. A company that has five members and adds one director to satisfy the prior sentence will not become subject to the general requirement, but if that company subsequently expands its board, it will.
6 A company is eligible for this service if it represents to Nasdaq that it does not have: (i) at least one director who self-identifies as Female; and (ii) at least one director who self-identifies as an Underrepresented Minority or LGBTQ+ or both. “Smaller Reporting Company” has the definition set forth in Rule 12b-2 under the Securities Exchange Act of 1934.
7 Saijel Kishan, “BlackRock Voted Against 255 Directors for Climate Issues,” Bloomberg (July 20, 2021).
8 According to Equilar’s BoardEdge, as of the end of the second quarter of 2021, 25.2% of all board seats in the Russell 3000 were occupied by women.
9 According to Equilar’s BoardEdge, those identifying as Asian/Pacific Islander, Black/African American, Hispanic/Latino, Middle Eastern/North African or Multi-Racial held approximately 18.4% of all board seats in the Russell 1000 as of the end of the second quarter of 2021.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.