Alert April 07, 2022

Board Diversity — An Overview for Nonprofits

Board diversity is one of the most visible corporate governance topics today. As the pressure to diversify boards continues to increase, we anticipate that key constituencies for all types of entities, including nonprofits, may urge for more diverse board membership. Below we discuss (1) recent diversity initiatives, influences, and requirements that public companies and their boards must navigate, (2) how these initiatives, influences, and requirements in the public company space might spill over into the nonprofit space, and (3) key takeaways and possible next steps for boards seeking to emphasize diversity.

Diversity is a term that means different things to different people and entities. Generally, when this article uses the term, it refers to gender and other factors such as racial and ethnic background and sexual orientation. Where a specific initiative or other influence uses a specific definition of diversity, this article will include that definition below.

Recent diversity initiatives, influences, and requirements

During the last several years, diversity initiatives, influences, and requirements have been developing at the U.S. Securities and Exchange Commission, Nasdaq, and various state legislatures. Similarly, various institutional investors have adopted voting guidelines relating to diversity as well.

For example, in August 2021, the U.S. Securities and Exchange Commission approved Nasdaq’s Board Diversity Rules. Nasdaq’s rules define diversity as an individual who self-identifies in one or more of the following categories: female, underrepresented minority, or LGBTQ+, and the rules generally require Nasdaq-listed companies to have or explain why they do not have at least two self-identified diverse directors. The Nasdaq rules also require companies to annually disclose statistical information on board diversity using a standardized matrix.

Some states such as Maryland and Illinois, have adopted laws requiring the disclosure of diversity information about board membership. Maryland law requires business entities — foreign or domestic, profit or nonprofit — headquartered in Maryland and with operating budgets or total sales above $5 million to disclose in their annual reports data on female board membership. The law does not apply to a privately held company where at least 75% of the company's shareholders are family members. Illinois law requires certain publicly-listed businesses headquartered in Illinois to disclose in their annual reports data on female and minority board membership. For purposes of Illinois law, a minority person means a person who is a citizen or lawful permanent resident of the United States and who is any of the following races or ethnicities: American Indian or Alaska Native, Asian, Black or African American, Hispanic or Latino, or Native Hawaiian or Other Pacific Islander. Other states, most notably California, have adopted laws that require publicly-traded companies headquartered in California to have a minimum number of directors who are diverse or female. For purposes of the California laws, diverse directors are those individuals who self-identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual or transgender.

The California law developments and the Nasdaq rules described above are the subject of pending lawsuits that could be decided at any time. In fact, as of the time of publication, a Los Angeles County Superior Court has held that one of the California laws (Assembly Bill 979, requiring a certain number of diverse directors) violates the state constitution. As of the time of publication, it was not yet clear whether California would appeal the ruling. Additionally, California Senate Bill 826 (requiring a certain number of female directors) remains in effect, as do the Nasdaq rules, although they are, as noted above, subject to pending lawsuits. At this time, the significance of any rulings striking down the California laws is unclear because the Nasdaq rules remain in effect and apply to all Nasdaq-listed companies and there are also pressures from other sources for companies to diversify the composition of their boards, but the prevalence of lawsuits in these areas is worth noting.

In addition to the state law developments described above, various institutional investors and proxy advisory services have adopted voting guidelines relating to diversity as well. Proxy advisory services such as Institutional Shareholder Services (ISS) and Glass Lewis have adopted policies that take account of board diversity. Beginning in 2021, ISS generally began issuing negative vote recommendations against board members of companies in certain indexes if the board of those companies did not include at least one female director. In 2021, Glass Lewis also generally began issuing negative vote recommendations against a nominating committee chair of companies in certain indexes if the board did not include at least one female director. For shareholder meetings held beginning in 2022, Glass Lewis will generally recommend voting against the nominating committee chair of boards of companies in certain indexes that have fewer than two female directors.

Along with proxy advisory services, companies face pressure from leading institutional investors, including BlackRock, Goldman Sachs, State Street, Vanguard, and CalPERS. Several institutional investors have adopted various disclosure and voting policies that support board diversity. For example, BlackRock has publicly stated that it expects to see at least two female directors on every board and reported that in 2021 it had cast 1,862 votes against directors globally due to lack of board diversity. Goldman Sachs’ asset management business (Goldman Sachs Asset Management) announced updates to its proxy voting policies, noting that it will expect certain larger public companies to have at least one diverse director from an underrepresented ethnic minority group on their board and all public companies to have at least two women on their board. Even before such changes to the proxy voting policies were implemented, Goldman Sachs announced that it would only underwrite IPOs in the U.S. and Europe if the relevant company has at least one diverse board member in 2020. That number increased to two members starting in 2021. Likewise, State Street has stated that it expects boards to have at least one female director and may vote against the chair of the nominating committee if this requirement is not satisfied.

Spill over into the nonprofit space

Currently, by and large, the initiatives, influences, and requirements described above currently do not apply to nonprofit boards. One notable exception is Maryland, which, as explained above, requires business entities — foreign or domestic, profit or nonprofit — headquartered in Maryland and with operating budgets or total sales above $5 million to disclose in their annual reports data on female board membership. Because of the growing focus on board diversity, we anticipate that key constituencies for all types of entities, including nonprofits, may urge for more diverse board membership in the future. And while not yet a formal legal requirement, some funders and donors to nonprofits have already been focused on the board diversity of organizations they are funding, and may require disclosure of certain diversity information in connection with their giving.

Key takeaways and possible next steps

Board diversity continues to be one of the most visible corporate governance topics today. Key constituencies may begin to urge that boards articulate their goals and strategies relating to diversity at the board level, including how the board reflects the diversity of the entity’s workforce, community, and other key stakeholders. As the pressure to diversify boards continues to grow and intensify, boards may begin to take action to address diversity and to prepare to meet the demands and pressures of their constituencies.

Although there is no reasonable and immediate solution to non-diverse board composition, boards can begin to lay the groundwork now that will promote improved diversity in the future. Below are a few specific practices a board can put into operation to promote improved diversity:

  • Board questionnaires. To the extent a board utilizes a directors' & officers' (D&O) questionnaire, it should be revised to collect diversity information on the board’s current membership so that the board is able to identify its current diversity and areas where diversity could be enhanced.

  • Annual self-assessment. Routine self-assessments can help boards think critically about their overall performance as well as matters related to composition, such as succession planning and turnover. A board can use an annual self-assessment to identify areas where diversity could be enhanced and use this information to help identify, recruit, and appoint diverse members.

  • Succession planning. Generally, a board should regularly engage in succession planning in the event key individuals decide to leave, or are otherwise unable to serve on, the board. By incorporating diversity considerations into its succession planning a board can begin to identify, recruit, and appoint diverse members.

  • Communication. As the pressure to diversify continues to increase, we expect key constituencies, including funders and donors, to urge or otherwise request information on the board’s diversity. Boards should start thinking about how they will publish this information and, if its diversity could be considered inadequate, it should also consider whether it could make any commitments to take or consider further actions to increase diversity.

Disclaimer: This is a general article about changing issues. It should not be construed as legal advice because we are not considering the facts of your specific situation. The opinions provided are those of the individual authors and not the views of Goodwin.