On December 1, 2020, Nasdaq submitted to the SEC a rule filing to adopt listing rules related to board diversity. The rule filing proposes a diverse board representation rule and a board diversity disclosure rule.
Diverse Board Representation Rule. The proposed diverse board representation rule would require each Nasdaq-listed company, subject to certain exceptions, to have, or explain why it does not have, at least two "diverse" directors, including (1) at least one director who self-identifies as "female," and (2) at least one director who self-identifies as an "Underrepresented Minority" or "LGBTQ+." The terms diverse, female, underrepresented minority and LGBTQ+ are defined in the proposed rules as follows:
- "Diverse" means an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority or LGBTQ+.
- "Female" means an individual who self-identifies her gender as a woman, without regard to the individual's designated sex at birth.
- "Underrepresented Minority" means 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.
- "LGBTQ+" means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender or as a member of the queer community.
A company that does not meet the two diverse directors requirement must provide an explanation as to why this is the case in its proxy statement or information statement for its annual meeting of shareholders or on its website. If a company fails to have at least two diverse directors and fails to provide the required explanation, the company would be notified that it has until the later of its next annual shareholders meeting, or 180 days from the event that caused the failure, to cure. If the company fails to cure the failure (either by satisfying the two diverse directors requirement or by providing the required disclosure) within the applicable cure period, it will be subject to possible delisting. Nasdaq has indicated that it will not assess the substance of a company's explanation, but it will verify that the company has provided one.2
The timeframe to satisfy the proposed rule would be based on a company's listing tier. Each company would be required to have, or explain why it does not have, one diverse director no later than two calendar years after the date that the SEC approves the proposed rule and two diverse directors no later than (1) four calendar years after the date of SEC approval for companies listed on Nasdaq Global Select Market or Nasdaq Global Market, or (2) five calendar years for companies listed on Nasdaq Capital Market. An additional phase-in period would be available to IPO and other newly listed companies, including SPAC listings in connection with a business combination, which would have the remainder of the four- or five-year timeframe or one year from the date of listing, whichever is longer, to satisfy the proposed rule.
Board Diversity Disclosure Rule. The proposed board diversity disclosure rule would require each Nasdaq-listed company3 to publicly disclose, to the extent permitted by applicable law, information on each director's voluntary self-identified gender and racial characteristics and LGBTQ+ status. Companies would be required to annually provide this board diversity disclosure in a format substantially similar to the board diversity matrix set forth in the proposed rule, which calls for:
- The number of directors based on gender identity.
- The number of directors based on race and ethnicity identity.
- The number of directors based on LGBTQ+ identity.
The board diversity matrix and associated instructions in the Nasdaq rule filing are reproduced at the end of this note for reference.
The board diversity disclosure must be provided in the company's proxy statement or information statement for its annual meeting of shareholders or on its website. The proposed rule would become operative one year after the date the SEC approves the rule filing. For the first year a company is required to make the board diversity disclosure, the company would have to report statistics for the current year only, and for each subsequent year, the company would have to report statistics for the current year and the prior year.
In the rule filing, Nasdaq outlined that it had considered how the recent social justice movement has brought heightened attention to the commitment of public companies to diversity and inclusion. Nasdaq surveyed both its own research that shows that while some companies have made progress in diversifying boards, the market generally would benefit from an additional regulatory push to embrace meaningful and multi-dimensional board diversity, and the extensive academic research that demonstrates that diverse boards are positively associated with improved corporate governance and financial performance. Nasdaq also noted that the pace of diversity in the boardroom has been gradual with the United States falling behind other jurisdictions that have imposed requirements related to board diversity. As part of its rule filing, Nasdaq reviewed its own research and the empirical studies in this area. We expect the SEC, as it reviews this rule proposal, will similarly consider this same research and these issues as it assesses whether this rule change is in the public interest. We expect the New York Stock Exchange will also review the rule filing carefully; the NYSE has not yet proposed board diversity listing rules of its own, but launched in 2019 the NYSE Board Advisory Council to expand board diversity.
The proposed listing standard is a "comply or explain" rule, rather than mandating specific numbers or board composition requirements, like California and Washington have adopted for companies headquartered in those states. Although the proposed listing standard will be viewed as a step forward by some advocates for board diversity, like institutional investors, public pension funds and proxy advisory firms, some may not consider that this proposal goes far enough.
We expect the leadership changes at the SEC that will happen in connection with the new Biden administration will support this rule filing, but we also expect that the new SEC leadership will make board diversity and diversity disclosure more generally an important part of its agenda.
1 Foreign Issuers and Smaller Reporting Companies, each as defined in the proposed rule, are subject to modified board diversity rules. Foreign Issuers could satisfy the second diverse director requirement by including a second female director or an individual who self-identifies as LGBTQ+ or as an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the company's home country jurisdiction. Smaller Reporting Companies could satisfy the second diverse director requirement by including a second female director or an individual who self-identifies as LGBTQ+ or as an underrepresented minority. The proposed rule lists categories of exempt companies (asset-backed and other passive issuers; limited partnerships; management investment companies; issuers of non-voting preferred, debt and derivative securities; and issuers of other securities covered by Nasdaq Rule 5700 et seq) that would be completely exempt from its requirements.
2 The rule filing included the following as examples of potential explanations: the explanation that the company chooses to define diversity more broadly than Nasdaq's definition by considering national origin, veteran status or individuals with disabilities when identifying nominees for director because it believes such diversity brings a wide range of perspectives and experiences to the board; the explanation that "[t]he Company is incorporated in Israel and required by Israeli law to have a minimum of one woman on the board, and satisfies home country requirements in lieu of Nasdaq Rule 5605(f)(2)(B), which requires each Foreign Issuer to have at least two Diverse directors"; and the explanation that "[d]ue to the unexpected resignation of Ms. Smith this year, the Company does not have at least one director who self-identifies as Female and one director who self-identifies as an Underrepresented Minority or LGBTQ+. We intend to undertake reasonable efforts to meet the diversity objectives of Rule 5605(f)(2)(A) prior to our next annual shareholder meeting and have engaged a search firm to identify qualified Diverse candidates. However, due to unforeseen circumstances, we may not achieve this goal."
3 The proposed board diversity disclosure rules would not apply to exempt companies.
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