The Securities and Exchange Commission’s recent approval of Nasdaq’s proposed rules on board diversity is part of a growing trend to increase the diversity of corporate boards and address increased investor and public scrutiny of board diversity and other environmental, social, and governance (ESG) issues.
The rules take a “comply or explain” approach, requiring most Nasdaq-listed companies to either (a) include on their boards of directors at least two “diverse” directors, or (b) explain why they do not meet these diversity benchmarks. They also will require Nasdaq-listed companies to disclose aggregate board diversity data.
Under the rules, which were first proposed in December 2020, each Nasdaq-listed company (subject to certain exemptions) will be required to have, or explain why it does not have, at least one director who self-identifies as female and one director who is either an “Underrepresented Minority” or is lesbian, gay, bisexual, transgender or queer (LGBTQ+).
“Underrepresented Minority” is defined as “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.”
If a company does not meet Nasdaq’s applicable standard for board diversity, it will be required to disclose its failure to achieve this standard and the reasons why it was not able to do so. This disclosure must be made in advance of the company’s next shareholder meeting in a proxy statement or on the company’s website. Nasdaq has stated that it will not substantively evaluate companies’ explanations of their failure to meet the standard.
Flexibility for Some Issuers
The new rules provide flexibility for certain issuers through the inclusion of exemptions and transition periods, some of which were added in response to comments to Nasdaq’s initial proposal.
Companies with boards of directors of five or fewer members, companies that qualify as “smaller reporting companies” under Rule 12b-2 under the Securities Exchange Act and foreign issuers can meet the diversity standard with two female directors.
Special purpose acquisition companies (SPACs), asset-backed issuers and certain other issuers will not be subject to the new rule’s diversity or disclosure requirements.
In addition to meeting Nasdaq’s board diversity standard or explaining why it has not met this standard, each Nasdaq-listed company (except for SPACs and other exempt issuers listed above) must disclose aggregate board diversity data in a specified matrix format. This disclosure must include data regarding the gender and race and ethnicity of directors and the number of directors who self-identify as LGBTQ+.
Effective Dates are Staggered
The new rules will go into effect in phases depending on the type of issuer. All Nasdaq-listed companies will be required to have at least one diverse director (or explain why they do not) by Aug. 7, 2023. Companies listed on the Nasdaq Global Select Market or Nasdaq Global Market will be required to fully satisfy the board diversity standard (or explain why they do not) by Aug. 6, 2025; the deadline is extended an additional year until Aug. 6, 2026, for companies listed on the Nasdaq Capital Market.
All Nasdaq-listed companies will be required to disclose their aggregate board diversity data by Aug. 8, 2022 or, if later, the date their next proxy statements are filed. Newly-listed companies will be given additional time to comply with both requirements.
Nasdaq’s rule is part of an increasing trend to encourage board diversity. For example, California enacted a law requiring public companies with their principal offices in California to have at least one board member who self-identifies as an underrepresented minority or as LGBTQ+.
New York similarly requires corporations authorized to do business in the state to report the number of female directors on their boards. Nasdaq’s proposal and the SEC’s approval of it are emblematic of the investor community and regulators’ growing focus on diversity, inclusion and human capital management.
What to Expect from the SEC
The SEC, meanwhile, is expected to propose its own rules regarding board diversity disclosures later this year, and its proposal may seek to impose even more significant requirements than Nasdaq. SEC Commissioners Allison Herren Lee and Caroline A. Crenshaw recently referred to Nasdaq’s rule as “a step forward for investors on board diversity,” and noted that “there is more work to be done in improving both diversity and transparency at public companies and in our capital markets more broadly.”
These sentiments in response to the approval of Nasdaq’s proposal highlight the commissioners’ expressed commitment to prioritizing environmental, social, and governance (ESG) issues under the SEC’s new leadership.
Notwithstanding the flexible “comply or explain” approach reflected in Nasdaq’s new rules, the rules, like other disclosure requirements, are intended to encourage companies to increase the diversity of their boards. We have already seen evidence of progress towards achieving this important goal.
At the time it made its initial proposal in December 2020, Nasdaq stated that more than 75% of its listed companies would have fallen short of the requirements. In the past year, however, companies have made significant strides towards diversifying board representation. For example, according to a Wall Street Journal report, from June 2020 through May 2021, S&P 500 companies added 456 new independent directors, nearly 75% of whom are women or belong to a racial or ethnic minority.
We expect this trend to continue, spurred not only by Nasdaq’s new rules and other forthcoming regulations, but also by growing investor and public scrutiny of board diversity and other ESG issues.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owner
Jeffrey S. Hochman is a partner in the Corporate & Financial Services Department at Willkie Farr & Gallagher LLP. He focuses on mergers and acquisitions, public offerings, private equity transactions and general corporate and securities law and advises boards of directors and executives on corporate governance issues.
William J. Stellmach is a partner in Willkie’s Litigation Department in Washington, D.C., and co-chair of the firm’s White-Collar Defense Group. He is former head of the Department of Justice’s Criminal Division’s Fraud Section. His practice includes compliance counseling, conducting internal and government-facing investigations, and defending clients against federal and state enforcement authorities.
Todd G. Cosenza is a partner in the Litigation Department and co-chair of Willkie’s Securities Litigation Practice Group in New York, where he focuses on complex financial litigation.
The authors wish to thank Willkie associate John Brennan for his contributions to the article.