Nasdaq Proposes New Rules on Board Diversity

Nasdaq has filed a proposal with the U.S. Securities and Exchange Commission to adopt new listing rules regarding board diversity and disclosure. The proposed rules would require a Nasdaq-listed company to have at least two diverse directors (including at least one woman and at least one member of an underrepresented community) or explain why it has failed to do so. In either case, companies would be required to disclose board diversity on an annual basis in a prescribed tabular format. The proposal also addresses certain updates and conforming changes to existing rules in connection with the proposed rules described in this alert.

Background

Nasdaq stated that the rules were proposed because current reporting of board diversity data was inconsistent and not widespread, hampering the ability of investors to compare statistics across companies. Nasdaq also cited third party studies demonstrating that diverse boards are positively associated with improved corporate governance and financial performance. The proposal noted various challenges with current diversity disclosure (and non-disclosure) practices.

The proposal notes efforts by investor groups, such as the Human Capital Management Coalition, and proxy advisory firms to acquire more information regarding board diversity. In particular, it noted that, on November 12, 2020, Institutional Shareholder Services (ISS) updated its guidelines to recommend against the chair of nominating committees of companies that do not have at least one racially/ethnically diverse board member (see our discussions on ISS’s efforts regarding requests for board diversity disclosures and board diversity requirements and our discussion of Glass Lewis’s updates to its board diversity policies in its 2021 proxy voting policy guidelines).

This focus on board diversity has produced some gains, particularly for women. According to Fenwick’s Corporate Governance Survey - 2019 Proxy Season Results, the number of SV150 companies with at least one woman director reached 91.3% in 2019, representing an increase of 13.1% over a two-year period. This represented a continuation of the slow growth trend discussed in our bi-annual survey, Gender Diversity Survey - 2018 Proxy Season Results, which disclosed that board representation of women in the SV150 increased at a faster rate than the S&P100. This trend has continued, which will be shown in the forthcoming 2020 proxy season editions of these publications.

Despite these gains, progress has still been slow, particularly for members of underrepresented minority groups prompting the calls from various stakeholders for more expansive diversity disclosure.

Proposed Rule 5605(f): Diverse Board Representation

Proposed Rule 5605(f) would require all companies listed on Nasdaq’s U.S. exchange to have at least:

• One self-identified woman director
• One director who self-identifies as an underrepresented minority (defined below) or LGBTQ+

If a company does not satisfy both of these criteria, the proposal would require it to explain why it does not. Issuers outside the U.S. and smaller reporting companies would have additional flexibility in satisfying this requirement. The rule defines an “underrepresented minority” as someone who self-identifies as Black or African American, Hispanic or Latinx, Asian, Native American or Alaskan Native or Pacific Islander, or two or more races or ethnicities. It also defines “LGBTQ+” as an individual who self-identifies as lesbian, gay, bisexual, transgender or as a member of the queer community. These categories fairly closely track the requirements of California’s A.B. 979 (discussed in our prior alert, “New Law Requires Racial, Ethnic or LGBT Diversity on Boards of California-Based Public Companies”).

Under the proposed rule, if a company does not have two diverse directors, the company must:

• Specify the particular aspect(s) of board diversity it fails to satisfy
  
• Provide the reasons why it does not have two diverse directors

Such disclosure must be provided in the company’s proxy statement or information statement for its annual meeting of shareholders or on its website. If the company chooses to disclose the information on its website, it must also provide Nasdaq with the URL link for the location of such disclosure through the Nasdaq Listing Center no later than 15 calendar days after the company’s annual shareholder meeting. According to the proposal, Nasdaq would only verify that the company provided the information without assessing its substance.

Transition Period

Nasdaq has modelled its approach after California’s diversity statutes, S.B. 826 and A.B. 979 (described below), where companies must achieve one target by an earlier date and satisfy the entire diversity objective at a later date. The period for achieving compliance depends on the company’s tier:

Phase-in Period

Under the proposed rule, a newly-listed company that was not previously subject to a substantially similar requirement of another national securities exchange would be allowed one year from the date of listing to satisfy the requirements. This “phase-in” period would apply to companies listing in connection with an initial public offering, a direct listing, a transfer from another exchange or the over-the-counter market, or through a business combination with certain acquisition companies (SPACs). Such companies would effectively have until the later of the general transition period discussed above or one year from the date of listing to satisfy the requirements.

Defining “Diverse”

Nasdaq looked to state and federal legislation, stakeholder sentiment and academic studies to develop its definition of “diverse.” In particular, the proposal cites both S.B. 826, the California law requiring board gender diversity (previously described here), and A.B. 979, the California law requiring racial/ethnic or LGBTQ diversity (previously described here) as models for the definition of “diverse.” The rule also utilizes existing EEO-1 reporting categories with which many companies are already familiar (see the Annex below for those definitions).

One downside to Nasdaq’s reliance on EEO-1 category definitions is that, unlike the “underrepresented community” definition of A.B. 979, the proposed Nasdaq definition of “underrepresented minority” does not leave room for the potential inclusion of directors of North African, Middle Eastern and Central Asian descent (which under A.B. 979 could potentially have been included by a broader reading of the sub‑categories). It is not apparent why such directors should not be considered “diverse” as a matter of policy or investor interest, and they may have not been specifically considered by Nasdaq when it determined to rely on the EEO-1 definitions which specifically exclude Middle Eastern and North African descent from the minority categories and do not address Central Asian descent at all. It is possible that this issue may be addressed during the review and comment process for Nasdaq’s proposed rule.

Proposed Rule 5606: Board Diversity Disclosure

Intended as a response to investors’ demands for greater transparency into the diversity characteristics of a company’s board composition, proposed Rule 5606(a) would require companies, except those exempted as described below, to publicly disclose statistical information on their boards’ diversity in substantially the format shown below.

Transition Period

Companies would have one year from the date of approval of the proposed rule to provide the required statistical information. After the first year of applicability, the rule would require disclosure for the current year and the immediately preceding year.

Disclosure Format

Under the proposed rule, companies would be required to annually provide board-level diversity data using the following format:

Any director who does not wish to disclose a gender would be included under “gender undisclosed” in the above board diversity matrix. Any director who does not wish to identify as a particular race or as LGBTQ+ would be counted in the “undisclosed” category at the bottom of the table. Under the proposal, non-U.S. issuers would be able to provide a modified board diversity matrix.

One clear potential issue with the proposed disclosure matrix is that it appears to require cross-disclosure of gender category and minority category. This could necessarily lead to the implied identification of individual directors, at least in some instances – defeating the privacy-preserving aspect of aggregated disclosure.

Disclosure Location

Under the proposed rule, a company must provide the board diversity matrix in either its proxy statement or information statement for its annual meeting or on its website. If it chooses the latter, the company must also submit the information, including a URL link to the information, through the Nasdaq Listing Center within 15 calendar days of its annual shareholder meeting. The proposed time period to submit the information to Nasdaq coincides with the time period for it to explain why it does not have two diverse directors under Rule 5605(f).

Certain Exemptions

Under the proposed rules, SPACs, asset-backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies and issuers of certain specified securities would be exempt from the diversity disclosure requirement.

Phase-in Period

The proposed rule would allow a company newly listing on Nasdaq, including a company listing in connection with a business combination under IM-5101-2, to satisfy the requirement of Rule 5606 within one year of its listing. The company would have to provide its board diversity information in its annual proxy statement or information statement for its annual meeting of shareholders or on its website. If the company provides such disclosure on its website, the company must also submit the disclosure and a URL link to the disclosure through the Nasdaq Listing Center no later than 15 calendar days after its annual shareholder meeting.

Next Steps

After the SEC publishes the proposed rule in the Federal Register, the public will have an opportunity to provide comments, and the SEC will have a maximum of 240 days to approve the proposal from the date of publication.

Practical Advice

Based on the demand for greater board diversity and related disclosure, we believe there will be additional rulemaking in this area from federal and state authorities, as well as other self-regulatory organizations such as the New York Stock Exchange. Companies can take steps now to address their potential obligations under the proposed rules, as well as investor requests and other legal requirements. We recommend that companies do the following:

• Thoughtfully approach the solicitation of racial/ethnic and LGBTQ+ self-identity, including explaining the form in which such information may be disclosed. In consultation with advisors, the board of directors should determine the best way to gather this potentially sensitive information.
• Consider providing more specific disclosure on gender, racial/ ethnic and LGBTQ+ board diversity in the company’s 2021 proxy statement, including early adopting the board diversity matrix. Companies that do not currently have a racially or ethnically diverse board should include discussions of their plans for achieving it.
• Consider adopting a policy requiring that women, underrepresented minorities and members of the LGBTQ+ community be included in the initial pool of candidates when selecting new director nominees (i.e. a form of the “Rooney Rule”).
• To the extent that statistics or other information regarding gender, racial/ethnic/ LGBTQ+ diversity will be included in the proxy statement or information statement or on the corporate website, establish appropriate disclosure controls and procedures in connection with the recording, aggregation and disclosure of such sensitive information.

Annex

Definitions:

• Black or African American (not of Hispanic or Latinx origin) – A person having origins in any of the Black racial groups of Africa.
• Alaskan Native or American Indian – A person having origins in any of the original peoples of North and South America (including Central America), and who maintain cultural identification through tribal affiliation or community recognition.
• Asian – A person having origins in any of the original peoples of the Far East, Southeast Asia, or the Indian subcontinent, including, for example, Cambodia, China, India, Japan, Korea, Malaysia, Pakistan, the Philippine Islands, Thailand and Vietnam.
• Hispanic or Latinx – A person of Cuban, Mexican, Puerto Rican, South or Central American, or other Spanish culture or origin, regardless of race. The term Latinx applies broadly to all gendered and gender-neutral forms that may be used by individuals of Latin American heritage, including individuals who self-identify as Latino/a/e.
• Native Hawaiian or Pacific Islander – A person having origins in any of the peoples of Hawaii, Guam, Samoa or other Pacific Islands.
• White (not of Hispanic or Latinx origin) – A person having origins in any of the original peoples of Europe, the Middle East or North Africa.
• Two or More Races or Ethnicities – A person who identifies with more than one of the above categories.
• Underrepresented Individual in Home Country Jurisdiction – A person who self-identifies as an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in a Foreign Issuer’s home country jurisdiction.
• LGBTQ+ – A person who identifies as any of the following: lesbian, gay, bisexual, transgender or as a member of the queer community.