Late last year, Nasdaq submitted for approval to the Securities and Exchange Commission the proposed listing Rule 5605(f) and Rule 5606 requiring all, with a few exceptions, of Nasdaq’s roughly 3,249 listed companies to have at least two diverse board members or otherwise explain their reason for not doing so. The rule also would require disclosure of the diversity of their boards on an annual basis. Following slight changes to the language and discussions with a broad spectrum of market participants and stakeholders, on August 6, 2021, the SEC issued its approval of these rules, concluding it would promote transparency, consistency and comparability of listed companies’ board diversity.

SEC’s approval of the Nasdaq rule follows the lead of a number of states, as well as federal legislation pending before Congress, to advance board diversity.¹ Increasingly, as investors evaluate a company’s environmental, social and governance (ESG) strengths and weaknesses, they have begun to scrutinize and demand board diversity because a diverse board is considered a best practice in good corporate governance and effective at enhancing stronger financial returns.

Board Diversity Defined: Women, Underrepresented Minorities and Self-Identifying LGBTQ+ Individuals Included

Specifically, under the proposed Rule 5605(f), each Nasdaq listed company, subject to certain exceptions, must have two diverse board members including at least one director who self-identifies as female and one who self-identifies as an underrepresented minority or LGBTQ+ or explain why they do not satisfy this requirement. Under the rule, an underrepresented minority would be 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; and LGBTQ+ refers to an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community. For companies with five or fewer board members, only one diverse member, rather than two would be required to comply with the rule or otherwise provide a written explanation for their failure to do so.

Board Diversity Disclosure Requirement

Rule 5606 requires board diversity disclosures to be issued by listed companies to provide investors and other market participants with comparable and consistent information regarding Nasdaq companies’ corporate governance. Under this disclosure framework, in making their disclosures, listed companies would rely on board members to voluntarily provide their gender, racial, ethnic or sexual identity(ies). Specifically, companies must disclose the number of directors who self-identify as:

• Female, male or non-binary, or decline to disclose this information;
• Member of underrepresented race or ethnicity (Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, White or Two or More Races or Ethnicities), disaggregated by their gender identity disclosure, or declination to disclose; and
• LGBTQ+ (Lesbian, Gay, Bisexual, Transgender or as a member of the Queer community)

Flexible Framework

According to Nasdaq, several features were incorporated in these rules to avoid imposing additional burdens on listed companies and to enhance flexibility. First, the definition of diversity under the rule was designed to mirror and not conflict with existing Federal securities disclosure laws under Regulation S-K and EEO-1. Second, the diversity rules and disclosure framework are intended to be flexible and not act as mandates. Companies have the option to provide a written explanation in lieu of compliance with the rule, thus, affording companies with the flexibility to take an approach different than what is outlined by the rule. Finally, under the rule, companies have the flexibility to make board diversity disclosures on their website or in an information statement if the company does not file a proxy statement in its Form 10-K or 20-K. Additionally, the rule does not require companies to adopt a diversity policy.

Access to Complimentary Board Recruiting Services

To assist companies in satisfying these new board diversity benchmarks, Nasdaq issued a companion proposal, which also received SEC approval, to provide one year of complimentary board recruitment services. This service includes providing Nasdaq companies with access to a network of board-ready diverse candidates to consider.

Effective Date and Timing to Comply or Risk Delisting

With the SEC’s approval of the rules, listed companies have one calendar year or until its next proxy statement or information statement to shareholders to comply with Rule 5606’s disclosure requirements.  They will have two calendar years to have, or explain why they do not have, one diverse director in compliance with Rule 5605(f), and four calendar years to meet the two diverse directors requirement.  

Listed companies which fail to comply will be subject to delisting proceedings.  If a company does not comply with the disclosure rule, Nasdaq will notify the company of its noncompliance. The company will then have 45 days to submit a plan to bring the company in compliance with the rule. After review of  the plan, Nasdaq will provide the company with up to 180 days to comply. If the company fails to submit a plan or bring itself in compliance with the rule, Nasdaq could issue a delisting determination which the company may appeal.

Although these rules are now in effect, they still face possible challenges since any one of the five SEC Commissioners or an outside appeal could subject the rules to further review.

Conclusion

Investors and other stakeholders are demanding increased board diversity based upon consistent data proving diversity has corporate competitive advantages. While Nasdaq’s new approach is not a mandate, it does establish market-wide benchmarks and a disclosure framework that will allow for more informed investment decision making. Companies must face these calls to take a more vigorous approach to addressing diversity on their boards and mitigating potential legal exposure for inaccurate disclosures and for lack of diversity.

1.See Seyfarth’s Legal Update dated Jan. 21, 2021