The US Securities and Exchange Commission (SEC) approved new disclosure rules on August 6 regarding board member diversity of Nasdaq-listed companies. Nasdaq’s new rules require most companies to tell shareholders how many of their board members are diverse in terms of race, gender, and LGBTQ+ status and, if they do not have at least two diverse directors, they must explain to shareholders why by August 2022. The SEC’s decision provides insight into the agency’s increased focus on transparency, responsiveness to shareholder concerns, flexibility in exchange rulemaking, and other key issues. Companies will need to develop strategies to comply with these new rules.
On December 1, 2020, Nasdaq proposed the new listing rules (5605(f) and 5606). In a previous article, we discussed Nasdaq’s Rules in detail but the key aspects of the Rules are as follows:
The Comply-or-Explain Rule (Rule 5605(f)) would require most Nasdaq-listed companies to have, or explain why they do not have, at least two “diverse” directors, including (a) at least one director who self‑identifies as female; and (b) at least one director who self-identifies as an underrepresented minority (Black, Latino, Asian, Native American, Alaska Native, Native Hawaiian, or multiple ethnicities), or as LGBTQ+. Certain companies are exempted from this requirement, and foreign issuers and smaller companies have greater flexibility in complying with the Rule. Companies would need to explain why they have not met Nasdaq’s diversity objectives to shareholders but would not be scrutinized by Nasdaq for the explanation. A failure to comply or explain could result in delisting.
The Diversity Disclosure Rule (Rule 5606(a)) requires most Nasdaq-listed companies to publicly disclose statistical information about the self‑identified gender, race, and self-identification as LGBTQ+ of the companies’ directors. This disclosure must be provided on the company’s website or in the company’s proxy statement, or similar disclosure.
As part of the proposal, Nasdaq has offered help to companies that do not currently meet the diversity guidelines. Nasdaq is offering one-year free access to a network of board-ready diverse candidates to eligible companies.
Nasdaq’s proposal generated significant commentary from numerous news organizations and the public. Some wrote articles praising the Rules as an important step in improving access to the boardroom for women and minority groups. Others panned the new rules, accusing Nasdaq of overstepping its role as an exchange. Members of the public (including advocacy groups, individuals, companies, law firms, and legislators) sent hundreds of letters to the SEC for, against, and in favor of modifications to the Rules. The SEC took the matter under advisement in April 2021 and issued its official decision on August 6, 2021, approving the Rules in full.
As with all rules proposed by self-regulatory organizations (SROs) like Nasdaq, the SEC had to review and approve the rules before they go into effect. Based on an analysis of the Rules, the applicable legal authority, and comments from the public, the SEC found that the Rules were appropriately designed to prevent fraudulent practices, promote just and equitable principles of trade, remove impediments to free and open market system, and protect investors.
Despite the heated rhetoric by some commentors and journalists regarding the debate of diversity mandates, the SEC approved the Rules in light of shareholder interest in consistent director diversity information and the flexible compliance regime proposed by Nasdaq. The SEC found that board-level diversity statistics are not currently available on a consistent and comparable basis even though a broad array of investors have expressed interest in this information. And, while investors and commentors are divided on the importance of diversity at the board level and its effect on company performance, the disclosure of such information may facilitate investors’ evaluation of companies and impact investment (and shareholder voting) decisions. The commission also found that these Rules augmented existing commission rules that require companies disclose whether, and how, their boards or board nominating committees consider diversity in nominating new directors. Finally, the commission determined that Nasdaq’s free one-year service to help companies identify diverse candidates was appropriate.
All five SEC commissioners penned statements regarding the decision. Chairman Gary Gensler wrote a brief letter extolling the ruling because it would allow investors to have access to information about “who leads our public boards” and that “markets work best when investors have access to such information.” Commissioners Allison Herren Lee and Caroline Crenshaw wrote a joint letter calling it a step forward and expressing hope that it would be a “starting point for initiatives related to diversity, not the finish line.” Lee and Crenshaw indicated support for further rules including considering disability as a relevant characteristic in the definition of diverse, as well as rules involving diversity among “senior management and the workforce more broadly.”
Commissioner Elad Roisman issued a statement dissenting in part; while he supported Nasdaq’s service center, he opposed the new rules. He opined that the commission had not conducted enough analysis regarding whether the rules were consistent with the Securities and Exchange Act of 1934 (the Exchange Act or the Act) and whether the Rules could be considered “state action” resulting in potential stricter scrutiny considering the rule’s diversity focus. Commissioner Hester M. Pierce issued a strongly-worded, lengthy statement against the Rules finding they are inconsistent with the Exchange Act – arguing the rules did not protect investors and actually undermined market integrity – and “offensive to important Constitutional principles.”
The entire decision is worth reading but a few key points are worth highlighting because it shines a light into the SEC’s thinking and what the new rules mean for companies, including:
Unless Nasdaq-listed companies plan on leaving the Nasdaq exchange, they will need to comply with the new diversity disclosure and the comply-or-explain rules.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Michael D. Blanchard
Jason D. Frank
Jordan D. Hershman
Emily E. Renshaw
Bernard J. Garbutt III
Thomas P. Giblin, Jr.
Brian A. Herman
Howard A. Kenny
Finnbarr D. Murphy
David W. Pollak
Kimberly M. Reisler
Kenneth I. Schacter
Justin W. Chairman
Michael L. Kichline
James W. McKenzie
Laura Hughes McNally
Joanne R. Soslow
Korey R. Inglin
David C. Schwartz
Joseph E. Floren
Susan D. Resley
Charlene S. Shimada
David A. Sirignano
Grace E. Speights
George G. Yearsich