Nasdaq proposes board diversity listing standards

On December 1, 2020, Nasdaq filed a proposal with the US Securities and Exchange Commission (SEC) seeking approval of new listing rules related to board diversity and disclosure.  The proposal is the first of its kind among US exchanges and, if approved by the SEC, would mark a significant step toward mandated diversity requirements for the boards of public companies listed in the US.

The proposed rules

First, Nasdaq would require most companies listed on Nasdaq to publicly disclose annually, to the extent permitted by applicable law, diversity statistics regarding their boards of directors in a consistent and transparent manner.  The disclosure would include information on each director’s “voluntary self-identified gender and racial characteristics and LGBTQ+ status” and would be presented in a Board Diversity Matrix to facilitate data collection and comparisons across companies.  Foreign Issuers that may be subject to home country laws limiting or prohibiting self-identification questionnaires would have the option of reporting on a separate Board Diversity Matrix for Foreign Issuers.  The proposed rule would require each company to make its annual disclosure in either its proxy statement or information statement for its annual meeting of shareholders or on its website.

Second, Nasdaq proposes to require most Nasdaq-listed 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 Underrepresented Minority or LGBTQ+, as described in more detail below.  Foreign Issuers and Smaller Reporting Companies would have additional flexibility in satisfying the requirement with two Female directors.

“Diverse,” as defined in the proposed rule, means a director who self-identifies as (i) Female; (ii) an Underrepresented Minority; or (iii) LGBTQ+.  The rule would define these categories as follows:

• “Female”: an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.
• “Underrepresented Minority”:  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.  This definition is consistent with categories reported to the Equal Employment Opportunity Commission.
• “LGBTQ+”: an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or a member of the queer community.

The rationale for the proposed rule

Nasdaq noted that over the past year the social justice movement has heightened the attention to diversity on public company boards, with SEC Commissioners Allison Herren Lee and Caroline Crenshaw, investors, and others calling for greater transparency.  Nasdaq’s goal is to provide stakeholders with a better understanding of a company’s current board composition and enhance investor confidence that all listed companies are considering diversity and inclusion in selecting directors.  The exchange also concluded that the proposed rule fulfills the objectives of the Securities Exchange Act of 1934 because it would remove impediments to and aid in the development of a free and open market system, prevent fraudulent and manipulative acts and practices, protect investors, and serve the public interest.

The exchange supported its proposal with references not only to its own internal study and experience but also with extensive citations to and analysis of more than 20 external studies that found an association between diverse boards and stronger financial performance and corporate governance, including more transparent public disclosures, less likelihood of earnings management, lower likelihood of securities fraud, improved decision-making and oversight, and strengthened internal controls.  Nasdaq’s internal study found that some companies have made progress in boardroom diversity; however, Nasdaq’s review of its currently listed companies found that more than three-quarters of them would fail to meet the proposed rule’s requirements.  While Nasdaq found that many companies have at least one female director, those companies generally did not include underrepresented racial and ethnic minorities or LGBTQ+ directors.  Accordingly, the exchange concluded that the national market system and the public interest would be best served by an additional regulatory impetus for companies to diversify their boards in meaningful ways. 

Nasdaq further stated that the US lags behind other jurisdictions in imposing board diversity requirements, noting as an example that Nasdaq-listed companies in Europe are already subject to diversity requirements.  In the US, Congress is currently considering legislation to require SEC-registered companies to provide board diversity statistics and disclose whether they have a board diversity policy, and 11 states have passed or proposed legislation relating to board diversity.  For example, in September 2020, California’s governor signed into law a bill requiring corporate boards to include directors from underrepresented communities.  (See our prior alert on the topic.)  That law, in turn, joins California’s first-of-its-kind law requiring corporate boards of six directors or more to have at least three female directors by the end of 2021.

Implementation of the proposed board diversity requirements

If the proposed rule is approved, all Nasdaq-listed companies would have until one year after the SEC approves the rule to publicly disclose board-level diversity statistics through Nasdaq’s standardized disclosure framework.  The time frame to meet the minimum board composition would be based on a company’s listing tier:

• All companies would be expected to have, or explain why they do not have, one Diverse director within two years of the SEC’s approval of the rule.
• Nasdaq Global Select Market and Nasdaq Global Market companies would be expected to have, or explain why they do not have, two Diverse directors within four years of the SEC’s approval of the rule.
• Nasdaq Capital Market companies would be expected to have, or explain why they do not have, two Diverse directors within five years of the SEC’s approval.
• Foreign Issuers and Smaller Reporting Companies could comply by having two Female directors.  “Foreign Issuer” means (a) a Foreign Private Issuer as defined in SEC Rule 3b-4(c) or (b) a company that is considered a “foreign issuer” under SEC Rule 3b-4(b) and has its principal executive offices located outside of the US.  “Smaller Reporting Company” is defined in SEC Rule 12b-2.
• Companies that cannot meet the board composition requirements within the time frames would not be subject to delisting if they were able to provide a public explanation of their reasons for not meeting the objectives.  For example, a company may choose to disclose that it does not meet the 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.
• Companies that fail to provide the required disclosures can be subject to delisting if they do not come into compliance.

To help its listed companies harness the social and financial advantages of board diversity, Nasdaq is also leveraging its partnership with Equilar, an independent provider of executive and board compensation data and analysis. Nasdaq provides its listed companies with free access to Equilar, and listed companies that do not currently meet the requirements can access the Equilar Diversity Network, a “registry of registries” of diverse, board-ready candidates who satisfy the proposed rule. Nasdaq also proposes to offer its listed companies “a tool to support board evaluation, benchmarking, and refreshment.”

What to expect next

We anticipate that the proposal will garner significant public comment and a friendly reception from a newly reconstituted Commission in 2021.  The proposal is consistent with legislation Congress is considering, and a number of groups have already published statements in support of Nasdaq’s proposal, including proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis. The proposal aligns with the approach those firms are taking during the 2021 proxy season.

For example, in 2021, ISS will generally recommend voting against or withholding a vote from the chair of the nominating committee (or other directors on a case-by-case basis) at companies with an all-male board.  An exception will be made if there was a woman on the board at the preceding annual meeting and the board makes a firm commitment to return to a gender-diverse status within a year.  ISS will highlight boards with no apparent racial and/or ethnic diversity and will begin generally recommending voting against or withholding a vote from the chair of the nominating committee or other directors on a case-by-case basis in 2022.

Similarly, next year Glass Lewis will generally recommend voting against the chair of the nominating committee (or other directors on a case-by-case basis) if the board is all male.  It will note as a “concern” boards consisting of fewer than two female directors and, in 2022, will recommend voting against the nominating committee chair of a board having fewer than two female directors, unless the board has six or fewer members.  Glass Lewis will also review the quality of diversity disclosure with respect to a company’s overall governance, specifically considering whether the company provides disclosure on:

• the board’s current percentage of racial/ethnic diversity
• whether the board’s definition of diversity explicitly includes gender and/or race/ethnicity
• whether the board has adopted a policy requiring women and minorities to be included in the initial pool of candidates when selecting new director nominees (a/k/a the Rooney Rule) and
• board skills.

While SEC approval of Nasdaq’s proposal is not certain and there would be a time lag in any event before the requirements are imposed, we anticipate that these diversity requirements or something similar will ultimately be put in place for US public companies.  For that reason, it may be prudent for companies to start reexamining now their current processes for recruiting and selecting directors.  Nasdaq’s proposal noted a common current practice of limiting the search for director nominees to the social networks of existing directors and candidates with C-suite experience.  Such practices may no longer be sufficient to meet the requirements of the proposal or other pending legislative changes.  Acting now to identify qualified, diverse board candidates may make any later transition much easier.

Learn more about the implications of Nasdaq’s proposal by contacting any of the authors or your DLA Piper relationship lawyer. 

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