CII proposes legislation on diversity disclosure and multi-class shares

The Council of Institutional Investors (CII) is calling for Congress to pass a law seeking to address board diversity disclosures and unequal stock voting rights via SEC-imposed listing standards.

In a recent letter to Senate Banking Committee chair Sherrod Brown, D-Ohio, and the panel’s ranking member Pat Toomey, R-Pennsylvania, CII general counsel Jeffrey Mahoney presents draft legislation he says would implement recent recommendations from the SEC’s investor advocate.

In terms of diversity disclosure, CII’s draft legislation largely mirrors a bill introduced by Democratic Senator Bob Menendez of New Jersey, with the support of nine other Senate Democrats including Brown, that would require public companies to disclose information regarding the racial, gender, ethnic and veteran composition of their boards and senior management.

CII’s proposal would direct the SEC to adopt rules under which national securities exchanges and associations would implement listing standards requiring companies to disclose data, based on voluntary self-identification, on the racial, ethnic and gender composition of a company’s board of directors and nominees for a board seat, in addition to executive officers. It would also require disclosure through voluntary self-identification as a veteran, disabled or LGBTQ+. Companies would have to disclose any policy, plan or strategy adopted by the board aimed at promoting racial, ethnic and gender diversity at the company.

‘We… believe that diverse boards can have a significant positive effect on financial performance and that diverse boards can be achieved without quotas that can result in ‘check-the-box’ diversity,’ Mahoney writes.

CII supports this disclosure-focused approach on the grounds that it would give investors material information that is difficult to obtain and enable them to compare companies against their peers. The group also argues that the draft legislation’s required disclosures would likely contribute to boards’ consideration of diversity and ‘such consideration can benefit long-term shareholder value.’ CII argues that disclosure is cost-effective means to achieve these ends.

CII is not the only organization looking at exchange-level rules regarding diversity. Nasdaq last year filed a proposal with the SEC to adopt new listing rules that 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+. Listed companies would also have to disclose consistent, transparent diversity statistics regarding their board.

The Nasdaq proposal attracted much positive feedback, including from commenters from both the investor and corporate communities. Republican members of the Senate Banking Committee have, however, urged the SEC to shut down the initiative.

MULTIPLE CLASSES
CII’s draft legislation would also direct the SEC to adopt rules under which exchange would introduce standards prohibiting the listing of any security that has for more than a certain period two or more classes of stock with unequal voting rights.

The governance principle of ‘one share, one vote’ was among the first of CII’s membership approved policies, Mahoney notes. ‘The principle is based on the belief that when a corporation goes to the capital markets to raise money from the public, public investors are entitled to certain protections and basic rights, including a right to vote that is proportional to the size of the investor's holdings,’ he writes.

However, exchanges permit multi-class stock structures that have become particularly popular among technology startups as a means to give their founders the time and space to carry out their vision for the company.

‘That process can take years, and patience, as well as faith in the founder, can in theory reap enormous rewards for investors. Alphabet… and Facebook… are the paradigm examples of this model,’ Mahoney says. ‘Of course, not every startup is a Google or a Facebook. And recent academic research has been critical of unchecked grants of unequal voting power over time.’

He adds: ‘We believe the academic research and developing market practice suggest a logical compromise: put in place a simple, effective sunset mechanism on multi-class voting structures, so that investors and markets do not suffer long-term damage from perpetual or long-lasting unaccountability.’ Requiring multi-class voting structures to sunset within a specified period following an IPO – CII favors seven years or less – would enable companies to tackle concerns about short-termism without shareholders having to give up the ability to hold managers accountable, Mahoney argues.

CII proposes what it calls a safety valve providing for unlimited extensions of the multi-class structure beyond the seven-year startup period if a founder can convince shareholders in each class of shares. The group has noted 41 US companies that went public with time-based sunsets since 2004, including 27 between 2017 and 2020.

Beyond diversity and multi-class share structures, CII notes that the law limits the SEC’s ability to step in and create new listing standards when necessary.

‘Experience suggests that in today’s fast-moving marketplace, there may be times when the SEC is in the best position to move swiftly to respond to a situation, rather than waiting for legislation to be enacted or an exchange to make a proposal,’ Mahoney writes. ‘Thus, we applaud the investor advocate’s decision to raise this important issue and encourage Congress to ‘revisit this allocation of responsibility.’’