United States: Nasdaq's New Board Diversity Rule

On August 6, 2021, the Securities and Exchange Commission (the "SEC") approved the Nasdaq Stock Market's ("Nasdaq") proposed listing rule related to board diversity (the "Board Diversity Rule").

The purpose of the Board Diversity Rule is two-fold to: (1) promote greater diversity among the membership of the boards of directors of Nasdaq-listed companies and (2) provide stakeholders with consistent board diversity disclosure. According to Nasdaq, the Board Diversity Rule is "not a mandate and does not set a hard target that companies must adhere to regardless of their circumstances."¹

Certain aspects of the Board Diversity Rule are effective as early as next August, and other aspects do not become effective until 2026, with the timeframes to satisfy the minimum diversity representation requirements based on a company's Nasdaq listing tier.

Diverse Board Representation

The Board Diversity Rule requires each Nasdaq-listed company² to have, or explain why it does not have, at least two "Diverse" directors ("Diverse Board Requirement"), including one who self-identifies as "Female" and one who self-identifies as either an "Underrepresented Minority" or "LGBTQ+." These terms are defined in the Board Diversity Rule as follows:

• "Diverse" means an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority or LGBTQ+.

• "Female" means an individual who self-identifies her gender as a woman, without regard to the individual's designated sex at birth.

• "Underrepresented Minority" means 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 or two or more races or ethnicities.

• "LGBTQ+" means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender or as a member of the queer community.

Disclosure by a director is voluntary and directors are not required to self-identify. A Diverse member of a company's advisory board will not satisfy the Diverse Board Requirement.

Any Nasdaq-listed company that does not satisfy the Diverse Board Requirement must provide the reasons for its non-compliance in its annual proxy statement or on the company's website.³ Nasdaq will verify compliance only to confirm that an explanation was provided, but will not review the substance of the explanation.

If a company does not have the required number of Diverse directors or provide the alternative explanatory disclosure within the timeframes outlined by the Diverse Board Requirement, it will have until the later of its next annual shareholders meeting or 180 days from the event that caused the deficiency to cure the non-compliance. The company can cure the deficiency either by meeting the applicable minimum diversity objectives of the Diverse Board Requirement or, in the alternative, by providing the required explanatory disclosure. A company that does not regain compliance within the applicable cure period will be notified of its non-compliance and issued a Staff Delisting Determination Letter, which may be appealed.

Board Diversity Disclosure

The Board Diversity Rule also requires each non-exempt Nasdaq-listed company⁴ to annually disclose board-level diversity statistics for the current year, and after its first year of reporting, for the current and immediately prior year ("Diversity Disclosure Requirement"). The information must be summarized using a standardized disclosure matrix template (reproduced for reference with its associated instructions at the end of this note) or a substantially similar format. A reporting company must include the matrix in its proxy statement for its annual shareholders meeting (or, if the company does not file a proxy, in its Form 10-K or Form 20-F) or on the company's website.

Required information includes each director's self-identified gender, race/ethnicity, sexual orientation and the number of directors who do not self-identify. Reporting companies may supplement their disclosure by providing additional relevant information, such as skills, experience or attributes of each of its directors. Nasdaq has published examples of acceptable and unacceptable board matrixes and has provided FAQs on its website.

If a company fails to disclose board diversity information, Nasdaq will notify the company of its noncompliance and provide the company with 45 calendar days to submit a plan to comply with the Diversity Disclosure Requirement. If the company does not do so, or if the plan is not acceptable to Nasdaq, the company may be subject to delisting.

Effective Date and Transition Period

Diverse Board Requirement. A company subject to the Diverse Board Requirement must have, or explain why it does not have, one Diverse director by the later of: (1) August 7, 2023 or (2) the date of its 2023 proxy statement (or, if the company does not file a proxy statement, in its Form 10-K or Form 20-F filed in 2023). This requirement increases to two Diverse directors as follows:

Boards with five or fewer members, regardless of listing tier, are required to have, or explain why they do not have, one Diverse director by August 7, 2023.

The Diverse Board Requirement includes a transition period for newly listed companies, which includes direct listings or companies listed in connection with an IPO or a business combination with a SPAC. A SPAC is exempt from the Diverse Board Requirement until it completes a de-SPAC transaction. Newly listed companies must comply with the Diverse Board Requirement by the later of: (1) two years from the date of listing or (2) the date the company files its proxy statement for its second annual shareholder meeting after listing (or, if the company does not file a proxy statement, in its Form 10-K or Form 20-F). A newly listed company can benefit from the initial four- or five-year transition period (as applicable based on its Nasdaq tier).

Diversity Disclosure Requirement. Companies subject to the Diversity Disclosure Requirement must disclose diversity data by the later of: (1) August 8, 2022 or (2) the date of its 2022 proxy statement (or, if the company does not file a proxy statement, in its Form 10-K or Form 20-F filed in 2022).

Other Board Diversity Initiatives

The Board Diversity Rule supplements the ever-growing list of mandates related to board diversity. Various states have passed legislation aimed at increasing gender and racial diversity on corporate boards. Some states have only gone as far as requiring disclosure of the diversity makeup of the board, while California has taken a more substantive stance by mandating female and minority board representation for companies headquartered in California. The California mandate is currently being challenged in court as an unconstitutional, discriminatory quota, and there are concerns that the Diverse Board Requirement could be challenged on the same grounds. Nasdaq has stated its belief that its "comply or explain" standard is not a quota.

In addition to state mandates, institutional shareholders, proxy advisory firms and investment banks are pushing for diverse board representation. Proxy advisory firms, including ISS and Glass Lewis, have announced they will recommend voting against certain directors at companies that do not meet their articulated board diversity expectations. Institutional shareholders, such as State Street, have also announced their intention to vote "No" to certain or all board members on a company's slate if the company does not have a diverse board. In addition, as of 2021, Goldman Sachs will not underwrite IPOs in the United States or Europe unless the company going public has at least two diverse directors.

Our Take

Board diversity initiatives are gaining momentum. Companies should examine their board composition and assess their diversity goals. It will become important for companies to articulate a message focused on board diversity objectives, what steps the board is taking to change its recruitment practices and whether the board has set a target for diverse representation within a specific timeframe. Companies may also want to consider what their disclosure will look like under these requirements. As companies begin their planning, the board and nominating and governance committee should assess:

• Current board composition and size;

• Candidates for reelection in the upcoming proxy season;

• Director tenure and succession plans; and

• Impact on board efficiency and effectiveness if board size was increased to add Diverse directors.

The demand for diverse director talent has intensified over recent years. Companies should consider new and different sources for director candidates over traditional recommendations and whether to engage a search consultant to introduce candidates who satisfy certain diversity criteria.⁵ Companies must also be cognizant of whether a candidate might be considered "overboarded" under relevant guidelines.

We expect the New York Stock Exchange (NYSE) will take similar action in the future. Although the NYSE has not yet proposed board diversity listing rules of its own, there will be pressure on both the NYSE and NYSE-listed companies to establish their own framework. The SEC is also expected to propose new rules related to board diversity disclosure later in 2021.

Special thanks to attorney Ariel Woldar who contributed to this publication.

Footnotes