Focus on Board Diversity

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If you watch enough cooking shows (some of us may have watched too many during the past year of social isolation), you’ll notice that almost every chef has an obsession with the source and quality of their ingredients. The cooking techniques and preparations can seem secondary. If you don’t start with high-quality ingredients, the final product will be lacking. And so, you see chefs devoting a huge amount of time and energy sourcing their ingredients—finding a farm that grows tomatoes that are just right or a vendor who has access to a specific ingredient from some far-off place. By focusing so intently on obtaining the best ingredients, these chefs set themselves up for success when they finally get into the kitchen.

Assembling a board of directors for a financial institution presents similar challenges and opportunities. Like a rare truffle, high-quality directors can be exceedingly difficult to find and sometimes even more difficult to convince to join your board. But if you manage to put together a good group, your organization will be set up for success.

Diversity in all its forms has always been an important ingredient to a successful and well-functioning board of directors. Many financial institutions have been committed to diversity both at the board level and enterprise-wide for years. Until recently, these goals have been established internally by each institution and monitored to varying degrees by boards and management. But this is all changing as regulators, legislators, and private actors increasingly turn their attention to corporate diversity.

Perhaps the biggest news in this space over the past year is Nasdaq’s proposed listing rule on board diversity. A large number of publicly traded financial institutions are listed on the Nasdaq Stock Market, so this will directly impact many banking organizations. Even for those institutions not subject to these rules, Nasdaq’s listing standards are widely used as a benchmark for good corporate governance.

Nasdaq’s proposed rule would require listed companies to disclose diversity statistics regarding their boards of directors. It would also require companies to have at least two diverse directors (one if the board consists of five or fewer members), including one who identifies as female and one who identifies as an “underrepresented minority” or LGBTQ+. An “underrepresented minority” is defined here as an individual who identifies in one or more of the following groups: “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.” Companies that are considered “smaller reporting companies” under Securities and Exchange Commission (“SEC”) rules may satisfy the requirement by having two female directors.

Nasdaq-listed companies will be required to publicly disclose board diversity statistics within one year of the SEC’s approval of the rule. All companies must have one diverse director within two years of SEC approval. Companies on the Nasdaq Global Select and Global Markets must have the second diverse director within four years of SEC approval. Companies on the Nasdaq Capital Market must have the second diverse director within five years of SEC approval. If companies cannot meet the requirements within these timeframes, they must provide a public explanation of their reasons for not meeting the objectives. Companies that do not meet the objectives will not be subject to delisting from Nasdaq, but must provide the required disclosure as to why they do not meet the objectives.

The banking regulators are also focusing on diversity. Your institution has probably received a request from its primary federal regulator to complete a diversity self-assessment. The self-assessment program is an outgrowth of a policy statement issued by the federal banking regulators for assessing the diversity policies and practices of regulated institutions. Participation is encouraged but not mandatory. The banking agencies use the data they obtain from the self-assessments to monitor diversity and inclusion progress and trends in the financial services industry.

At the state level, corporate laws have not traditionally mandated board composition, but some state legislatures are taking action in this area. California enacted a law in 2018 requiring that public companies headquartered in the state have at least two female directors by the end of 2021 (three if there are six or more directors). In 2020, California enacted another law that requires public companies headquartered in the state to have at least one director (more depending on the size of the board) on their board who is from an underrepresented community, which is defined as “an individual who self‑identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self‑identifies as gay, lesbian, bisexual, or transgender.” Fines for noncompliance are authorized in the amounts of $100,000 for the first violation and $300,000 for each subsequent violation. Washington state also has a gender diversity law for public companies, and a number of other states are considering such legislation. North Carolina has not enacted any such laws to date.

Last but not least, private parties are also exerting their influence on issues of diversity, equity, and inclusion. Institutional investors with large ownership positions in companies are pushing for more transparency on these issues and may vote their shares against management’s proposals at annual shareholder meetings if they are not satisfied with a company’s response. Service providers are also adopting diversity policies applicable to their clients and customers. Most notably, Goldman Sachs has a policy that it will only underwrite initial public offerings in the United States and Europe of companies that have at least two diverse board members.

As these examples demonstrate, board diversity is no longer being left to individual institutions to prioritize on their own. Diversity mandates and disclosure requirements are proliferating, and financial institutions will be expected to be ready.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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