Updated – On August 6, 2021, the U.S. Securities and Exchange Commission approved Nasdaq’s Board Diversity Rules (the “Rules”). The Rules require Nasdaq-listed companies to have or explain why they do not have at least two diverse directors. Companies are also required to annually disclose statistical information on board diversity using a standardized board diversity matrix. To assist companies in identifying diverse directors, the SEC also approved rules that provide Nasdaq-listed companies with free access to a variety of board recruiting services. The Rules apply to nearly all Nasdaq-listed companies, including Smaller Reporting Companies and, with some accommodations for home country requirements, Foreign Private Issuers. The requirement to have or explain the lack of diverse directors becomes effective in two steps that will affect proxy statements for annual meetings of calendar year-end companies in 2023 and 2025 (2023 and 2026 for companies listed on The Nasdaq Capital Market). The requirement to disclose board diversity factors using the Nasdaq matrix will apply to proxy statements for annual meetings of calendar year-end companies starting in 2022.
Key Takeaways for Nasdaq-Listed Companies
Even though the Rules have deferred effective dates and transition periods, Nasdaq-listed companies that have not already begun to do so should begin the process now of identifying and appointing diverse directors. As summarized in the next section of this alert, public company boards are already under a broad range of pressures to diversify board membership. The Rules add a potentially significant new pressure that could ultimately result in Nasdaq delisting a company. Nasdaq-listed companies will want to be prepared to meet the requirements of the Rules and thereby avoid adverse disclosure about their lack of board diversity. They should also consider how to best incorporate the Nasdaq-prescribed board diversity formats into their proxy statements.
Nasdaq-listed companies should plan for how the Nasdaq-prescribed board diversity matrix will affect their upcoming proxy statements as the matrix will need to be provided in proxy statements for annual meetings of calendar year-end companies in 2022. Companies that are not currently soliciting self-identification of diversity status from directors and director nominees, which is typically accomplished through D&O questionnaires, will want to consider how they want to solicit this information. This decision can involve a broad range of potentially important considerations, summarized here.
At the same time, companies should be aware that private sector organizations have already expressed their intent to challenge the Rules through litigation that will seek to delay, modify or overturn the Rules on various grounds, including violations of the U.S. Constitution and the Civil Rights Act of 1964. There are recent precedents involving litigation that challenged SEC disclosure requirements for conflict minerals and resource extraction payments. These lawsuits resulted in years of delay and ultimately significantly altered the disclosure requirements originally adopted by the SEC.
Although predicting the ultimate outcome of this anticipated litigation is impossible at this time, companies can recognize that the Rules are part of a broader range of pressures that seek more diverse board membership. These pressures come from institutional investors, financial markets, legislative bodies and a variety of social commentators. Regardless of the final requirements of the Rules and whether the Rules eventually become effective in any form, board diversity is clearly a serious consideration for public company boards.
Board diversity, reflected in terms of gender and other factors such as racial and ethnic background and sexual orientation, is one of the most visible corporate governance topics today. The Rules are part of an expanding web of diversity initiatives and influences that public companies and their boards must navigate.
Proxy advisory services such as ISS and Glass Lewis have adopted policies that take account of board diversity. Leading institutional investors, including BlackRock, State Street, Vanguard and CalPERS, have adopted various disclosure and voting policies that support board diversity. Goldman Sachs Group Inc. announced in 2020 that it will only underwrite IPOs in the U.S. and Europe if the company has at least one diverse board member, and that starting in 2021, it would raise this target to two diverse candidates for each of its IPO clients.
Some U.S. states, most notably California, have adopted laws that require companies to have directors who are diverse, based on gender and/or status as an underrepresented minority or sexual orientation. In the absence of a mandate from Congress, the SEC’s actions in this area have been limited to interpretive clarifications that existing disclosure requirements under Item 401 and Item 407 of Regulation S-K include some aspects of board diversity (Questions 116.11 and 133.13).
Board Diversity Representation Rule
Under the Rules, Nasdaq-listed companies will need to have two diverse directors or explain their reasons for not doing so. The Rules become effective on a two-stage deferred basis, and also provide transition periods for newly-listed companies and listing transfers, as well as exceptions for certain companies, discussed below. Nasdaq-listed companies that do not have at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+, will need to explain why they have not done so. If a company chooses to explain why it does not meet the diversity objectives, it would provide its explanation in its proxy statement or information statement for its annual shareholder meeting, or on the company’s website. Nasdaq will verify that the company has provided an explanation, but will not assess the merits of the explanation. We anticipate that most Nasdaq-listed companies will choose to have the requisite number of diverse directors within the required time frames. Nasdaq rules provide sanctions for failure to comply with the Rules, which could ultimately result in Nasdaq delisting a company.
A Smaller Reporting Company, as defined in SEC rules, can meet the diversity objective with two female directors, or with one female director and one director who is an underrepresented minority or LGBTQ+. Foreign Private Issuers, as defined in SEC rules, can meet the diversity objective with two female directors, or with one female director and one director who is an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the country of the company’s principal executive offices, or LGBTQ+. Companies with five or fewer directors can meet the diversity objective by having at least one diverse director, and can add a single diverse director to a five-person board without becoming subject to the general requirement to have at least two diverse directors.
SPACs listed under Nasdaq IM-5101-2 are not required to have, or disclose that they do not have, any minimum number of diverse directors until their business combination. Following the business combination, such companies must comply by the later of two years from the date of listing or the date the company files its proxy statement or its information statement for the company’s second annual meeting of shareholders subsequent to the company’s listing.
The Rules require compliance on a two-step deferred basis that provides different timeframes based on the company’s listing tier. Further information on the effective dates is available on the Nasdaq website.
- Companies listed on The Nasdaq Global Select Market and The Nasdaq Global Market will need to have, or explain why they do not have, one diverse director by the later of two years of the SEC’s approval date (August 7, 2023), and two diverse directors within four years (August 6, 2025), or the date the company files its proxy or information statement (or, if the company does not file a proxy or information statement, in its Form 10-K or 20-F) for the company’s annual shareholder meeting in that year. For most companies with a calendar year-end, the Rules will require compliance with these board diversity requirements not later than the date on which the company files its proxy statement for its annual meeting in 2023 and 2025.
- Companies listed on The Nasdaq Capital Market will need to have, or explain why they do not have, one diverse director by the later of two years from the SEC’s approval date (August 7, 2023), and two diverse directors within five years (August 6, 2026), or the date the company files its proxy or information statement (or, if the company does not file a proxy or information statement, in its Form 10-K or 20-F) for the company’s annual shareholder meeting in that year. For most companies with a calendar year-end that are listed on The Nasdaq Capital Market, the Rules will require compliance with these board diversity requirements not later than the date on which the company files its proxy statement for its annual meeting in 2023 and 2026.
- Companies with boards of five or less directors, regardless of listing tier, will need to have, or explain why they do not have, one diverse director by the later of two years from the SEC’s approval date (August 7, 2023) or the date the company files its proxy or information statement (or, if the company does not file a proxy or information statement, in its Form 10-K or 20-F) for the company’s annual shareholder meeting in that year.
Board Diversity Disclosure Rule
Nasdaq-listed companies have until the later of August 8, 2022, or the date the company files its proxy statement or its information statement (or, if the company does not file a proxy statement or information statement, in its Form 10-K or 20-F) for the company's annual shareholder meeting during 2022, to publicly disclose director self-identified board-level diversity statistics using a standardized disclosure matrix template. For most companies with calendar year-ends, the Rules will require this diversity disclosure in the format provided by Nasdaq rules in proxy statements for 2022 annual meetings. Alternatively, rather than providing such disclosure in its proxy statement, a company can publish the information on its website. We anticipate that most domestic Nasdaq-listed companies will provide this disclosure in their annual meeting proxy statements in order to respond to the diversity mandates of institutional investors, proxy advisory services and others.
Sean M. DonahuePartnerChair, Public Company Advisory Practice
John O. NewellCounsel