Nasdaq has long been a proponent of environmental, social and governance (ESG) disclosures and initiatives, having published a guide for listed companies on the subject over six years ago (see HERE). In December 2020, Nasdaq took it a step further and proposed a rule which would require listed companies to have at least one woman on their boards, in addition to a director who is a racial minority or one who self-identifies as lesbian, gay, bisexual, transgender or queer. Companies that don’t meet the standard would be required to justify their decision to remain listed on Nasdaq. To help facilitate the proposed rule, Nasdaq has also proposed to offer a complimentary board recruiting solution. A final decision on the proposals is expected this summer.
The SEC recently extended the consideration period and will either approve or disapprove the proposal by August 8, 2021. The newest Regulatory Flex Agenda which was published last week and will be a topic of a future blog, included the subject in proposed rule making stage with action slated by October 2021. Its anyone’s call where this will land. The current SEC regime is more likely to pass a rule than previous administrations but there is still significant pushback. The SEC could also kick the can down the road and ask Nasdaq to strengthen the data backing its proposal.
Nasdaq Proposed Board Diversity Rule
Nasdaq proposes to adopt Rule 5605(f) to the corporate governance requirements for listing and continued listing which would require Nasdaq listed companies, subject to certain exceptions, to: (i) to have at least one director who self identifies as a female, and (ii) have at least one director who self-identifies as Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, two or more races or ethnicities, or as LGBTQ+, or (iii) explain why the company does not have at least two directors on its board who self-identify in the categories listed above.
Nasdaq also proposed to add to its list of services for listed companies to provide a complimentary board recruiting solution to help advance diversity on company boards. The service would provide companies that have not yet achieved a certain level of diversity with one-year complimentary access for two users to a board recruiting solution, which will provide access to a network of board-ready diverse candidates, allowing companies to identify and evaluate diverse board candidates, and a tool to support board benchmarking. To access the service a listed company must make a request on or before December 1, 2022.
The rule would also require Nasdaq listed companies to disclose statistical information regarding its board’s diversity. Statistical information will be required in an annual report or proxy statement, or on the company’s website. Although not required, the proposed rule encourages disclosure of other diverse attributes such as nationality, disability or veteran status. It could be that a company’s reasoning for not having board members that specifically fit the diverse attributes in the rule, is that it has otherwise a diverse board composition based on other considerations. Under the proposed rule Nasdaq will not assess the substance of an explanation but would just verify that the company has provided one.
Foreign issuers will be required to disclose the gender of board members; voluntary disclosure of LGBTQ+ status; and information regarding underrepresented groups in their home jurisdiction. Also, foreign issuers will be required to have at least two diverse directors including at least one female. Both foreign issuers and smaller reporting companies may satisfy the two diverse director requirements by having two female directors.
The following types of companies would be exempt from the requirements: (i) SPACs; (ii) asset backed issuers; (iii) cooperatives; (iv) limited partnerships; (v) management investment companies; (vi) issuers of non-voting preferred securities, debt securities or derivative securities; and (vii) ETFs and similar funds.
If adopted, the Rule would provide each company with one calendar year from adoption to comply with the Rule’s requirement to provide statistical information disclosures. A company that goes public via a business combination with a SPAC, an IPO, a direct listing, a transfer from another exchange or an uplisting from the OTC Markets would have one year to comply with the disclosure requirements. Failure to provide the disclosure would result in a listing deficiency with the ability to submit a plan for cure and to cure within 180 days. Ultimate non-compliance could result in delisting.
A company would have two calendar years to have, or explain why it does not have, at least one diverse director. A Nasdaq Global Select or Global Market listed company would then have four calendar years to either have, or explain why it does not have, at least two diverse directors and a Nasdaq Capital Markets listed company would have five calendar years.
Purpose of the Proposed Rule
Simply put, Nasdaq is of the view that diversity in the board room equates to good corporate governance. They believe that increased diversity brings fresh perspectives, improved decision making and oversight and strengthened internal controls. Further, Nasdaq asserts that the increased focus on diversity by companies, investors, legislators and corporate governance organizations provides evidence that investor confidence is enhanced by greater board diversity. In conducting an internal study on diversity amongst listed companies, Nasdaq found they fell short and that a regulatory impetus would help.
Nasdaq’s rule proposal indicates it conducted extensive research including reviewing a substantial body of third-party research and conducting interviews. Among the questions it sought to answer were (i) whether there is empirical evidence to support the proposition that board diversity increases shareholder value, investor protections and board decision-making; (ii) investors interest in board diversity information; (iii) the current state of board diversity and disclosure; (iv) causes of underrepresentation; (v) various approaches to encourage board diversity; and (vi) the success of approaches taken by other groups, both domestic and foreign.
Clearly Nasdaq is confident that the answers to these questions support not only the value of board diversity and related disclosure, but the value of regulations requiring same. In addition to the results of its studies, Nasdaq cites the increasing call for diversity by large institutional investors such as Vanguard and BlackRock in their corporate engagement and proxy guidelines. Nasdaq also believes that the SEC disclosure regime supports disclosure requirements in this context.
The 127-page Nasdaq proposed rule release contains an in-depth discussion of Nasdaq’s research, findings, and conclusions. Nasdaq also presents counter-information. There is a lack of studies or information of the association between LGBTQ+ diversity and board representation, stock or other financial performance. Many studies support a correlation between women on the board and increased earnings and other financial metric performance, but some also show a lack of correlation between the two. Studies which include other factors, such as strong shareholder rights, show a decreasing impact of diversity to performance.
Interestingly, I believe it is the non-financial aspects, including investor protections (through increased internal controls, public disclosure and management oversight) and confidence, that are compelling Nasdaq to put forth the proposed rule. As it states in its release “[A]t a minimum, Nasdaq believes that the academic studies support the conclusion that board diversity does not have adverse effects on company financial performance.” Moreover, as most directors are chosen from the current directors and C-Suite executive’s social and business network, without a compelling reason to search elsewhere, such as regulatory compliance, a natural impediment to increased diversity will remain.
Although Nasdaq’s finding and arguments are compelling, I remain on the fence as to whether regulatory action setting quotas is appropriate. Certainly, in today’s environment, there is a strong faction of support for the rule and for improvement in diversity in business as a whole. As a woman, I of course support diversity in business and the boardroom. Where I am on the fence regarding the quota issue, I support the disclosure aspects of the proposed rule. Transparency and disclosure on the topic will only provide better information to make sound decisions moving forward.
Board Diversity – Beyond Nasdaq
Putting aside Nasdaq’s rule publication, a lot of groups and thought leaders have been tackling the question of whether board diversity is a benefit or detriment to corporations with thorough arguments to support both sides of the fence. Board composition is consistently one of the most important topics on the agenda for shareholder engagement, and voting.
Harvard Law Professor Jesse Fried has publicly questioned the empirical value of Nasdaq’s board diversity proposal. Also, University of MN Law Professor and former chief White House ethics lawyer Richard Painter wrote a thorough rebuttal to Nasdaq’s findings. That rebuttal was met with its own rebuttal’s pointing out the lack of, and age, of the data presented. It seems one of the best sources of information is California which imposed a board diversity obligation on corporations domiciled in the state two years ago. Since enactment of the statute there has been a significant increase of women on the boards of California entities, though other minorities, including women of color, continue to lag.
Getting ahead of this year’s proxy season, Glass Lewis published an in-depth report on Board Gender Diversity with an overview of where things stand in the U.S. and internationally, investor and state efforts to promote balance in the boardroom, and academic research on the benefits of diversity. Glass Lewis recognizes the complexity of the issue and the recruiting involved to find uniquely qualified directors who bring a breadth of experience and insight to the board table. Simply adding women to the board for diversity’s sake and without careful consideration of qualifications and experience is unlikely to automatically effect any positive corporate change. With that said, the report also concludes that bringing women and diverse board members will add to the overall viewpoints and knowledge base of a board thereby improving corporate performance.
Many companies are not waiting for a rule to increase diversity disclosure. To help stakeholders compare disclosure practices, KPMG recently launched a free new web-based tool that tracks disclosure about board diversity. The software compares disclosure practices by sector, index (Russell 3000 and S&P 500) and company size. There are several comparative publications as well with one by Deloitte and the Alliance for Board Diversity including information through 2020.
The voluntary increase in disclosure comes, at least partially, from pressure by institutional investors which have been vocal on the subject. In 2020 many of those entities promised to put their views to action by increasing diversity in their own house. The data is not in yet as to whether specific vocal proponents of diversity have made significant internal changes, but some are putting on a better show than others. The Carlyle Group announced a new policy calling for at least one candidate who is Black, Latino, Pacific Islander or Native American to be interviewed for every new position and that at least 30% of its portfolio companies will have ethnic diversity on the board of directors.
Besides investor financial incentives, D&O insurers have started to include diversity practices among the many considerations in granting and pricing liability policies.
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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