United States: SEC Approves Nasdaq's Board Diversity Rules

On August 6, 2021, the Securities and Exchange Commission ("SEC") made history when it issued its order (the "Approval Order")¹ approving the Nasdaq Stock Market LLC's ("Nasdaq") board diversity rule request (the "Proposal")², the first ever stock exchange board diversity requirement in the United States.

Beginning August 7, 2021, every company listed on or seeking to be listed on Nasdaq will be required, after a transition period, to disclose the composition of its board diversity and either meet specified diversity thresholds or explain why it does not. The Proposal was submitted in December 2020, and after garnering an overwhelming majority of supportive comments over the course of several months, it was revised in March 2021.³ The revised rule request was approved by the SEC in its requested form. The Approval Order explained that by statute the SEC could either approve or deny the request but not modify it. After a lengthy analysis of the details of the request and its reasoning, the SEC approved the request, with three commissioners in support and two commissioners opposing. ⁴

I. The Approval Order

The The Approval Order explains that Rules 5605(f) and 5606 (the "Rules") will establish a disclosure-based framework that will make consistent and comparable statistics widely available to investors and thereby enhance voting and investment decisions. The SEC observed that Board-level diversity statistics are currently not widely available on a consistent and comparable basis, even though Nasdaq and many commenters argue that this type of information is important to investors. The SEC concluded that the Proposal will augment existing SEC requirements that companies disclose whether, and how, their boards or board nominating committees consider diversity in nominating new directors and will mitigate concerns regarding unequal access to information that may currently exist between certain larger investors who can more easily obtain board diversity information and other smaller investors who may not be able to do so.

The SEC found compelling the "comply or explain" structure of the Proposal and found that it was distinguishable from the board diversity mandates some commenters referred to in their opposition to the Proposal. In considering the potential cost to listed companies, the SEC noted that because the Proposal would not mandate any particular board composition, companies that choose to meet the diversity objectives (rather than explain why they do not) are likely to be the ones who stand to benefit the most, or incur the least cost. By focusing on transparency and not mandating any particular board composition, the Rule will provide information and explanations that will enhance investor decision making. In regard to Nasdaq's definition of "diverse,"⁵ the SEC believes it is not an unreasonable definition in that it uses categories already familiar to employers and that, by adopting a uniform definition and format for disclosure, it will make it less costly and more efficient for investors to compare information and make investment and voting decisions.

II. Nasdaq Board Diversity Rule

The new Rules have two parts: (1) Rule 5606 requires companies listed on Nasdaq to publicly disclose statistical information on their board diversity, and (2) Rule 5605(f) requires listed companies to have at least two diverse directors or explain why they do not.⁶ In addition to the disclosure requirement and diversity objective, the SEC noted in the Approval Order that the Rules include a complimentary board recruiting service to help advance diversity on company boards. Nasdaq will host webinars to help companies access these recruiting services and inform them about its partnerships with Equilar, Athena Alliance, and the Boardlist.⁷ This service is meant to help Nasdaq-listed companies in their search for highly-qualified, diverse, board-ready candidates.⁸

Rule 5606: Disclosure Requirement

Compliance with Rule 5606 requires Nasdaq-listed companies to disclose demographic information about their board members in an annual board diversity matrix.⁹ Importantly, the board diversity matrix anticipates that some demographic information will not be available as directors may decline to provide certain information.¹⁰ See Exhibit A attached to this memorandum for the Board Diversity Matrix.

Rule 5605(f): Board Diversity Objective

Compliance with Rule 5605(f) requires Nasdaq-listed companies to have at least two diverse directors, including one self-identified woman director and one director who self-identifies as an underrepresented minority or as LGBTQ+.¹¹ If a company does not meet this threshold, the company must explain which category of company it falls into, the requirements for companies in that category and an explanation as to why that requirement has not been met. Nasdaq will not evaluate whether the disclosure's substance is satisfactory.¹² The objective of this disclosure is to provide transparency to shareholders. The requirement to explain will not be met by simply stating that the company does not comply with Nasdaq's diversity Rule.

The following exceptions to Rule 5605(f) apply: (1) companies with five or fewer board members will only need to have one diverse board member by the later of (a) two years from the date of listing or (b) the date of filing of its proxy or information statement for its second annual meeting following listing¹³ and (2) foreign issuers (issuers organized outside of the U.S.) and smaller reporting companies (as defined in Rule 12b-2 under the Securities Exchange Act of 1934) are able to satisfy the board diversity objective by having two self-identified woman directors or one self-identified woman director and one director who self-identifies as an underrepresented minority or as LGBTQ+.¹⁴

Special purpose acquisition companies (SPACs), asset-backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies and issuers of certain specified securities are exempt from both the board diversity objectives and the disclosure requirements of the new Rules.¹⁵

Footnotes

1. Securities and Exchange Commission, Self-Regulatory Organizations; The Nasdaq Stock Market LLC; Order Approving Proposed Rule Changes, as Modified by Amendments No. 1, to Adopt Listing Rules Related to Board Diversity and to Offer Certain Listed Companies Access to a Complimentary Board Recruiting Service, Exchange Act Release No. 34-92590, https://www.sec.gov/rules/sro/nasdaq/2021/34-92590.pdf, 82 (Aug. 6, 2021).

2. Nasdaq, NASDAQ'S PROPOSAL TO ADOPT LISTING REQUIREMENTS FOR BOARD DIVERSITY (Feb. 26, 2021) https://listingcenter.nasdaq.com/assets/Board%20Diversity%20Disclosure%20Five%20Things.pdf,

3. For a discussion of these revisions to the Proposal, see our firm memorandum dated March 12, 2021, which can be found here.

4. SEC Chair Gary Gensler and Commissioners Caroline A. Crenshaw and Allison Herren Lee supported the Proposal. Commissioners Hester M. Peirce and Elad L. Roisman opposed Rules 5605(f) and 5606 but Commissioner Roisman supported the proposal to offer listed companies recruiting services that may help them identify diverse members. Gary Gensler, Statement on the Commission's Approval of Nasdaq's Proposal for Disclosure about Board Diversity and Proposal for Board Recruiting Service, https://www.sec.gov/news/public-statement/gensler-statement-nasdaq-proposal-disclosure-board-diversity-080621 (Aug. 6, 2021); Caroline A. Crenshaw and Allison Herren Lee, Statement on Nasdaq's Diversity Proposals – A Positive First Step for Investors, https://www.sec.gov/news/public-statement/statement-nasdaq-diversity-080621 (Aug. 6, 2021), Hester M. Peirce, Statement on the Commission's Order Approving Proposed Rule Changes, as Modified by Amendments No. 1, to Adopt Listing Rules Related to Board Diversity submitted by the Nasdaq Stock Market LLC, https://www.sec.gov/news/public-statement/peirce-nasdaq-diversitystatement-080621 (Aug. 6, 2021), Elad L. Roisman, Statement on the Commission's Order Approving Exchange Rules Relating to Board Diversity, https://www.sec.gov/news/public-statement/roisman-board-diversity (Aug. 6, 2021).

5. "Diverse" is defined as (i) female, (ii) Underrepresented Minority or (iii) LGBTQ+. The definition of "Underrepresented Minority" is consistent with the categories that companies are required to report to the Equal Employment Opportunity Commission and is defined as "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."

6. The Nasdaq Stock Market LLC Rules, §§ 5605(f), 5606 (Aug. 6, 2021) https://listingcenter.nasdaq.com/rulebook/nasdaq/rules/nasdaq-5600-series.

7. Nasdaq, Nasdaq's Board Diversity Rule: What Nasdaq-Listed Companies Should Know, 1, 3 (Aug. 6, 2021).

8. Id.

9. The Nasdaq Stock Market LLC Rules, § 5606(a).

10. Id.

11. The Nasdaq Stock Market LLC Rules, § 5605(f)(2)(A).

12. See e.g. FAQ, Nasdaq's Board Diversity Rule Proposal https://listingcenter.nasdaq.com/Material_Search.aspx?mcd=LQ&cid=157&sub_cid=&years=2020&criteria=1&materials ("FAQ"), Identification Number 1771. Nasdaq has noted that the following statements are examples of what would satisfy Rule 5605(f)'s explanation requirement: "A U.S. company may disclose that it chooses to define diversity more broadly than Nasdaq's definition by considering national origin, veteran status or individuals with disabilities when identifying nominees for director because it believes such diversity brings a wide range of perspectives and experiences to the board. If under Israeli law regarding board diversity, an Israeli company is required only to have a minimum of one woman on the board and such Israeli company chooses to comply with Israeli home country law in lieu of meeting the diversity objectives of Rule 5605(f)(2)(B), it may choose to disclose that "the Company is incorporated in Israel and required by Israeli law to have a minimum of one woman on the board, and satisfies home country requirements in lieu of Nasdaq Rule 5605(f)(2)(B), which requires each Foreign Issuer to have at least two diverse directors."

13. The Nasdaq Stock Market LLC Rules, § 5605(f)(2)(D).

14. The Nasdaq Stock Market LLC Rules, § 5605(f)(2)(B).

15. The Nasdaq Stock Market LLC Rules, § 5605(f)(4).

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