Energy Companies Must Prepare Now for New Board Diversity Regulations


December 14, 2021

The composition of the average company’s board of directors is more varied and unique than ever before. Nonetheless, as a whole, the energy sector lags behind the average publicly traded company in terms of increasing the number of women and underrepresented minorities as board members. A series of new US state legislation and rules promulgated by stock exchanges present energy companies with the challenge of how to comply with board diversity legislation. But, more importantly, it also presents energy companies with opportunities to take a leadership role in the composition of their boards, effectuate their pro-diversity policies, and communicate with shareholders regarding a prescient topic for which they are highly interested.

Public Company Boards

Throughout the 20th century, the boards of directors for public companies have long-been proverbial “old boys clubs” with members who were predominantly male and white. Increasingly, companies have expressed in their policies a commitment to adding new voices to boards and have followed through by increasingly nominating board members from underrepresented communities. For example, according to a 2021 report by consulting firm Spencer Stuart, directors from historically underrepresented groups—including women and Black, Asian, Hispanic/Latino, American Indian/Alaska native, and multiracial men—accounted for 72% of all new directors nominated to the boards of S&P 500 companies, compared with a just as significant 59% in 2020.

Still, public company boards remain much whiter and more male compared with the general US population. For example, based on a 2018 study cited by the California State legislature in passing board diversity laws, the percentages of Fortune 500 company board seats held by people who identified as Black, Hispanic/Latino, and Asian/Pacific Islander were 8.6%, 3.8%, and 3.7%, respectively. Yet, based on census data, the US population is 12.4% Black, 18.7% Hispanic/Latino, and 6% Asian/Pacific Islander. Likewise, despite making up more than half of the US population, women hold only 25% of board seats for companies on the Russell 3000 Index. 

Diversity in Energy Boardrooms

As a sector, energy company boards have lagged behind in the push for more diverse board members. While more than half of the energy companies on the S&P 500 (55%) disclosed a commitment to including directors from underrepresented communities in searches for new directors, directors from underrepresented communities (Women, Black, Hispanic/Latino, and Asian) constitute a mere 35% of directors on energy boards, the lowest of all primary sectors and significantly below the 43% of S&P 500 boards as a whole. Additionally, less than 15% of board seats of energy companies on the Russell 3000 Index are held by people who identify as Black, Hispanic/Latino, or Asian. Likewise, the energy sector trails other sectors in gender diversity at the board level. Less than 5% of Russell 3000 energy companies have gender-balanced boards, and the energy sector has the lowest number of companies with more than three board seats held by women.

State Legislation

Since 2017 and following the #MeToo movement, state legislatures have proposed, considered, and passed various forms of board diversity-related legislation. Initially, these efforts focused on closing the gender gap that was, and still is, persistent on public corporation boards. Over the last two years, legislatures have become increasingly interested in board diversity legislation to increase the minority representation at the board level. 

California passed the strongest legislation with SB 826 and AB 979. SB 826 requires reporting gender demographic information of board members and requires companies with six or more directors to have at least three female directors, companies with five directors to have at least two female directors, and companies with four or fewer directors to have at least one female director. AB 979 requires reporting of ethnicity and LGBTQ+ status information of board members at an aggregate level. It also requires California-based companies to have at least one board member from an underrepresented community by the end of 2021 and between one and three board members from underrepresented communities by the end of 2022 depending on the size of the board of directors. In March 2022, the office of the California Secretary of State is expected to release its first report detailing the companies that failed to meet the 2021 diversity mandate.

Washington state has passed a law mandating that boards be composed of at least 25% women. Illinois, New York, and Maryland have passed less-aggressive legislation requiring mandatory disclosure of board demographic information but no mandate. Energy companies headquartered in these states must carefully review the legislation to understand what compliance obligations they may have, if any.

New Nasdaq Rules

In addition to state regulations, in 2021 the Nasdaq Stock Exchange promulgated new rules requiring companies to disclose how diverse their boards are and explain why they do not have certain numbers of diverse persons on their boards. Subject to certain exceptions, Nasdaq-listed companies must publicly disclose, in aggregate form, information about the self‑identified gender, race, and LGBTQ+ status of the companies’ directors. Additionally, at a high level, each listed company must have, or explain why it does 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 or as LGBTQ+.

Energy companies listed on the Nasdaq exchange must comply with these new rules by August 2022. 

Outstanding Legal Challenges

These laws and regulations—California’s SB 826 and AB 979 in particular—have been subject to a number of lawsuits and may ultimately be held unconstitutional. For example, a lawsuit (Crest v. Padilla) over the enforceability of SB 826 is set for trial in Los Angeles later this month; this law is also being challenged in federal court (Meland v. Padilla). AB 979 is subject to three lawsuits attacking its legitimacy: Crest v. Padilla II, Alliance for Fair Board Recruitment v. Weber, and National Center for Public Policy Research v. Weber. Even Nasdaq’s milder comply-or-explain rules have been challenged in pending petitions to the Third and Fifth Circuit Courts of Appeal disputing the US Securities and Exchange Commission’s approval of the rules.

Practical Advice for Energy Companies

Regardless of the future outcome of these pending legal challenges, California’s laws, Nasdaq’s rules, and other state legislation is currently the law. All companies, including companies in the energy sector, will need to be proactive when it comes to board composition. Following are takeaways that will help start this process:

  • Sense of urgency. It may seem easier to avoid confronting this issue head on and complying with these laws may entail sensitive conversations with board members, but time is of the essence. For example, by December 31, 2021, California-based companies must complete and file disclosures in line with AB 979 and SB 826 or be subject to a potential $100,000 fine. Waiting can be very costly, so it is critical to engage qualified counsel promptly to avoid last-minute compliance fire drills.
  • Understand which laws and regulations apply. This will often include the state of incorporation and state of the company’s principal place of business. Diversity disclosure obligations are only in a few states and only two states have diversity mandates. Nasdaq is the only exchange to have any specific requirement, and it has many exceptions and varying requirements for certain types of companies. Seek knowledgeable counsel on which, if any, rules may apply to a company.
  • Educate stakeholders on what these rules mean. Board diversity legislation has engendered controversy that can lead to misunderstandings. They may appear threatening to current board members or frustrating to shareholders who feel it reduces their options for board members of their choosing. Companies must make an intentional effort to clearly explain the rules and the company’s compliance strategy.
  • Make a plan regarding board diversity consistent with company philosophy and policies. Company leaders need to thoroughly discuss how to comply with legislation and regulation and create a transparent plan. Even if no rules apply, companies may want to get ahead of future legislation and regulation and reevaluate their board diversity policies. At all times, these plans must be in line with the company’s statements on diversity and inclusion and overall philosophy.
  • Gather information in a sensitive way. In complying with any of the board diversity rules, demographic information must be collected from directors. This may feel intrusive to some, so it is necessary to be considerate and sensitive when collecting, maintaining, and reporting information.
  • Nominate new directors. While there is no requirement that existing directors be replaced to comply with new legislation, there may be a need to add directors to comply with the laws, especially diversity mandate laws such as AB979. Companies should, in compliance with their nomination policies, consider adding new directors from underrepresented communities who may contribute different perspectives to the board.
  • Carefully complete the forms. With the assistance of counsel, carefully complete the necessary documentation to comply with the applicable board diversity rules. Hefty penalties for violations and public rancor await companies that fail to comply with the law or comply with the law but demonstrate no commitment to diversity.
  • Overcommunicate with employees, shareholders, and the public. Statements regarding diversity and reports of homogenous boards can negatively affect the investing public’s perception of a company and potentially the company’s stock price. In preparation for complying with board diversity rules, companies must also develop a communications strategy to respond to stakeholder concerns and media inquiries.