Nasdaq targets board diversity with ‘comply or explain’ plan

Nasdaq is moving to increase diversity on the boards of its listed companies amid growing pressure from investors and state laws for greater inclusion of under-represented groups – or at least disclosure around the issue.

Nasdaq on Tuesday filed a proposal with the SEC to adopt new listing rules. Failure to comply will result in a company being kicked off the exchange. If approved by the SEC, the rules would require companies to have – or explain why they do not have – at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an under-represented minority or LGBTQ+. Foreign companies and smaller reporting companies would be able to comply with the rule by having two female directors.

Nasdaq defines an under-represented minority as a person who self-identifies in one or more of the following groups: 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. This reflects the US Equal Employment Opportunity Commission’s (EEOC) categories.

Listed companies would also have to disclose consistent, transparent diversity statistics regarding their board of directors.

In terms of timing, all Nasdaq-listed companies will have to make the board diversity disclosure within a year of the SEC approving the rule. All companies will be expected to have one diverse director within two years of the SEC’s approval. Companies listed on the Nasdaq Global Select Market and Nasdaq Global Market will have to have two diverse directors within four years of the SEC’s approval. Companies listed on the Nasdaq Capital Market will be expected to have two diverse directors within five years.

‘Our goal with this proposal is to provide a transparent framework for Nasdaq-listed companies to present their board composition and diversity philosophy effectively to all stakeholders; we believe this listing rule is one step in a broader journey to achieve inclusive representation across corporate America,’ Adena Friedman, Nasdaq president and CEO, says in a statement.

Nasdaq’s proposal includes an analysis of more than two dozen studies that found a link between diverse boards and better financial performance and corporate governance.

‘Corporate diversity, at all levels, opens up a clear path to innovation and growth,’ says Nelson Griggs, president of Nasdaq Stock Exchange, in announcing the proposal. ‘We are inspired by the support from our issuers and the financial community with this effort and look forward to working together with companies of all sizes to create stronger and more inclusive boards.’

Candace Jackson, an attorney with the Chicago office of law firm Mayer Brown, describes the Nasdaq initiative as a progression of the increasing investor focus on board diversity in recent years. Some companies have not been exposed to the pressure because they don’t have major institutional investor shareholders and Nasdaq’s proposal seeks to fill that gap, she tells Corporate Secretary.

WHY EXPLAIN?
According to its filing with the SEC, Nasdaq believes the proposal will give investors additional transparency through disclosure by requiring a company to explain why it does not meet the diversity objectives of the new rule 5605(f)(2).

For example, Nasdaq states, the company may choose to disclose that it does not meet the diversity objectives because it is subject to an alternative standard under state or foreign laws and has chosen to meet that standard instead, or has a different board philosophy regarding diversity. ‘Nasdaq believes that such disclosure will improve the quality of information available to investors [that] rely on this information to make informed investment and voting decisions,’ it states.

It adds that studies suggest certain groups may be under-represented on boards because the traditional director nomination process is limited by ‘directors looking within their own social networks for candidates with previous C-suite experience.’

Nasdaq says stakeholders have ‘reinforced the notion that if companies recruit by skill-set and expertise rather than title, they will find there is more than enough diverse talent to satisfy demand.’ It has therefore proposed giving listed companies that have not met the diversity objectives free access to a network of diverse director candidates and a tool to support board evaluation, benchmarking and refreshment.

It states in its SEC filing that ‘diversity in the boardroom is good corporate governance’. For boards that view quotas as intrusive, the exchange is saying diversity is good but is not forcing them to act, Jackson notes. As such, the ‘comply or explain’ formulation may be an effective means to avoid potential legal challenges to the proposal, such as those raised in California against legislation mandating board diversity, she adds.

NEXT STEPS
In a statement on the Nasdaq proposal, Paul Hastings partner Tara Giunta says the new rules have ‘a high likelihood of approval’ under a Biden administration. SEC chairs traditionally depart when an administration ends and the current chair, Jay Clayton, has already said he will step down at the end of the year. The incoming president will pick Clayton’s successor, giving the commission a likely 3-2 majority of Democratic members.

Giunta notes that existing Democratic members of the commission have made comments indicating that there will be movement on public disclosure regarding board diversity and climate change. Commissioner Caroline Crenshaw in August called for the SEC to form ‘an internal task force to undertake an immediate study on how investors can and do use information about human capital management, climate change risk and other [ESG] metrics to assess the long-term financial performance of a company.’

SEC member Allison Herren Lee recently noted the growing consensus that climate change may present a systemic risk to financial markets and suggested the agency should help create standards for banks to release information about the climate-change risks associated with their decisions to finance companies and their activities.

‘When president-elect [Joe] Biden and vice president-elect [Kamala] Harris take office in January 2021, we expect new domestic and international policy priorities and changes, including with regard to [ESG] issues,’ Giunta says. 

‘Among those changes we expect a concerted push for mandatory and standardized reporting on certain ESG issues, particularly regarding climate change and board diversity. President-elect Biden’s commitment to advancing women is already evident – not only with his selection of the first vice president, who is a black, south Asian woman, but also by filling key official and adviser roles with women.’

PRESSURE FOR CHANGE
The Nasdaq proposal comes two months after a new California law was signed that will require all publicly held companies with headquarters in the state to have a minimum ratio of members from under-represented communities. It requires that boards of such companies:

• Have a minimum of one director from an under-represented community on its board no later than December 31, 2021 and
• By no later than December 31, 2022, have at least:
  - Three directors from under-represented communities if the board has nine or more directors
  - Two directors from under-represented communities if the board has more than four but fewer than nine directors, or
  - One director from an under-represented community if the board has four or fewer directors.

California in 2018 introduced a law requiring that every public company in the state have a minimum of one woman on its board by the end of 2019, with that minimum increasing to two by December 31, 2021 if the company has five directors and to three women directors if the company has six or more directors.

A recent report from the California Partners Project states that before the bill was enacted, 29 percent of public companies headquartered in the state had no female directors; that figure fell to 2.3 percent in 2020. The project’s data suggests that more than 665 women still need to join California’s public company boards by the end of next year to meet the legislation’s gender requirement.

There has also been movement toward greater disclosure around diversity by major US companies as a result of investor pressure. Earlier this year, New York City comptroller Scott Stringer sent letters on behalf of the city’s public retirement systems to the CEOs of 67 S&P 100 companies urging them to disclose data that would enable investors to measure the success of their diversity and inclusion practices, which he described as fundamental to the creation of long-term shareowner value.

Stringer in September said 34 of those companies had agreed to release data on the composition of their workforce by race, ethnicity and gender from their annual EEO1 report. Companies must file these reports with the EEOC. Some investors have for decades been asking companies to release the information but have largely been denied until now.

Stringer’s office said that, as of late September, 29 US public companies were disclosing their EEO1 reports, of which only 14 were in the S&P 100. It said Stringer’s campaign increased that number to 48 S&P 100 companies.

Another example of the growing pressure from investors to improve diversity came when State Street Global Advisors (SSGA) global chief investment officer Richard Lacaille wrote to board chairs in late summer explaining that from 2021 the asset manager will ask portfolio companies to explain their risks, goals and strategy relating to racial and ethnic diversity and to make relevant disclosures.

SSGA aims to tackle these issues via engagement. ‘If required, however, we are prepared to use our proxy voting authority to hold companies accountable for meeting our expectations,’ Lacaille wrote.