On December 1, 2020, The Nasdaq Stock Market LLC (Nasdaq) filed a proposal with the Securities and Exchange Commission (SEC) to adopt listing rules that would enhance board diversity and transparency among companies listed on its exchange. The proposed rules would require Nasdaq-listed companies (other than exempt entities, as discussed below) to:

• have, or explain why they do not have, at least two “Diverse” members of their boards of directors; and
• publicly disclose diversity statistics regarding their boards of directors in their proxy statement or information statement filings, or alternatively on their websites.

Nasdaq’s proposal is subject to review by the SEC and was published in the Federal Register on December 11, 2020. The proposal has also undergone a public comment process. The SEC has until March 11, 2021 to consider public comments received and determine whether to approve the proposed rules.

Diverse board representation

The proposed rules would require the boards of certain Nasdaq-listed companies to have at least two “Diverse” directors, including one director who self-identifies as a “Female” and at least one director who self-identifies as an “Underrepresented Minority” or as “LGBTQ+.”

The terms Diverse, Female, LGBTQ+ and Underrepresented Minority are defined as follows:

• Diverse: an individual who self-identifies as Female, as an Underrepresented Minority or as LGBTQ+.
• Female: an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.
• LGBTQ+: an individual who self-identifies as lesbian, gay, bisexual, transgender and/or a member of the LGBTQ+ community.
• Underrepresented Minority: an individual who self-identifies as 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.

If the company does not have two Diverse directors, then the company must disclose why it does not. To the extent the board of a company does not meet the diversity objectives, the opportunity for the company to provide an explanation for not doing so is intended to provide both the company and investors with additional transparency.

Board diversity disclosure

The proposed rules would also require Nasdaq-listed companies, subject to certain exceptions, to annually disclose statistical information related to self-identified gender, race and self-identification as LGBTQ+ for each member of its board of directors. Companies would be required to make this disclosure using the following Board Diversity Matrix or a substantially similar format:

Companies would be required to provide this disclosure in their proxy statement or information statement for their annual shareholder meeting, or on their website. If the company chooses to disclose the information on its website, the company must also include a URL link to the disclosure through the Nasdaq Listing Center no later than 15 calendar days after the company’s annual shareholder meeting. Notably, the proposed diversity disclosure requirement is limited only to the boards of directors of Nasdaq-listed companies, and does not require disclosure of diversity metrics for management and staff.

After the first year of including the new required disclosure, all companies must disclose diversity statistics for the current year and year immediately prior using the Board Diversity Matrix or a substantially similar format.

Exempt entities

Entities exempt from compliance with the proposed rules include: acquisition companies; asset-backed issuers and other passive issuers; cooperatives; limited partnerships; management investment companies; issuers of non-voting preferred securities, debt securities and derivative securities; and issuers of certain other securities listed under Nasdaq’s Rule 5700 Series.¹

Nasdaq exempts “management investment companies” from certain of its corporate governance listing rules, including the proposed rules, based on the premise that funds “registered under the Investment Company Act of 1940 are already subject to a pervasive system of federal regulation in certain areas of corporate governance.” The current Nasdaq definition of “management investment companies” excludes business development companies (BDCs) because BDCs are not technically registered under the 1940 Act, even though BDCs are subject to almost all of the same corporate governance regulation under the 1940 Act as registered investment companies. Due to this distinction, BDCs would be subject to the requirements of the proposed rules. However, we are aware of some inconsistent interpretations of the potential applicability of the proposed rules to BDCs. We believe that BDCs should be included in the definition of “management investment companies” for purposes of all Nasdaq rules and are seeking an audience with Nasdaq representatives to discuss this issue.

Compliance requirements and timing

If the proposed rules are approved, listed companies must be in compliance based on the following timetable, beginning from the date that the SEC approves the proposed rules (Approval Date):

Phase-in period for newly listed issuers

Newly listed companies, so long as they were not previously subject to a substantially similar requirement of another national securities exchange, will be required to comply with the proposed rules by the later of (a) the compliance periods described above or (b) one year after the date of listing.

Foreign issuer compliance

Foreign Issuers (including Foreign Private Issuers) and Smaller Reporting Companies² have more flexibility in how they may comply with the proposed rules. Both may satisfy proposed Rule 5605(f) requirements by having two Female directors (in lieu of one Female and one Underrepresented Minority or LGBTQ+ director). Foreign Issuers would be able to comply with the second Diverse director requirement with a director who meets a distinct definition of “diverse” based on where the company is located.³

Cure period

Under the current Nasdaq proposal, if a company fails to comply with the proposed rules, it has until the latter of (i) its next annual shareholder meeting or (ii) 180 days from the event that caused the deficiency, to cure. The company can cure the deficiency either by nominating additional directors so that its board satisfies the diversity requirement or by providing the requisite disclosure via proxy statement, information statement or on the companies’ websites. If a company does not regain compliance within the applicable cure period, it will become subject to delisting.

Comparison to CA board diversity requirements

Nasdaq’s proposed rules come on the heels of various state measures that also aim to address corporate diversity. Notably, Nasdaq’s proposed rules differ from the rules mandated by California’s recently adopted diversity legislation in the following ways:

• Definition of Diverse: Nasdaq’s proposed rules include, in the definition of Diverse, directors who self-identify as (i) Female, (ii) an Underrepresented Minority, or (iii) LGBTQ+. California does not specifically include the LGBTQ+ community or a director identifying with two or more races in its definition of diverse.
• Diverse Directors Requirement: Nasdaq’s proposed rules require a total of two Diverse directors regardless of board size. California’s rules have a varying number of required diverse board members depending on the size of the board.
• Compliance Timing: Nasdaq’s timing requirements (detailed above) for compliance with the proposed rules would require one Diverse director within two years of the Approval Date and two Diverse directors within four or five years of the Approval Date, depending on which Nasdaq exchange a company is listed. California requires companies to have had at least one female director by the end of 2019 and, by the end of 2021, at least two female directors if the corporation has five directors, or three female directors if the corporation has six or more directors. Further, California requires companies to have one director from an underrepresented community by the end of 2021 and, by the end of 2022, at least two directors from underrepresented communities if the corporation has more than four but fewer than nine directors, and at least three directors from underrepresented communities if the corporation has nine or more directors.
• Compliance Flexibility: Nasdaq’s proposed rules provide flexibility for smaller reporting and foreign companies and a one-year transition period for newly listed companies that were not previously subject to a substantially similar requirement of another national securities exchange. California’s rules provide no similar flexibility and apply to any U public company with its principal executive offices in California.

What comes next

Nasdaq’s proposal is subject to review by the SEC and was published in the Federal Register on December 11, 2020. The SEC has until March 11, 2021 to determine whether to approve the proposed rules.

While the new Nasdaq requirements resulting from the proposed rules would not become immediately effective upon SEC approval, Nasdaq-listed companies may consider starting to compile diversity statistics for their boards and reviewing Diverse candidates for director seats.

A copy of the proposed rules can be found here.

[View source.]