The U.S. Securities and Exchange Commission (SEC) approved Nasdaq Stock Market LLC’s proposed rule changes related to board diversity and disclosure on Aug. 6, 2021.1
A Nasdaq-listed issuer, subject to some exceptions discussed below, will now be required to include two “Diverse” members on its board or explain why it does not meet this standard. For purposes of this rule, “Diversity” is defined as an individual who self-identifies in one or more of the following categories: 1) Female,2 2) Underrepresented Minority3 or 3) LGBTQ+.4
The phase-in period for public disclosure of board-level diversity statistics will begin within one year of the SEC’s approval of the rule. The SEC will require all companies to have one diverse director, or explain why not, within two years of the SEC’s approval of the rule. Depending on the listing tier of the company, companies will need two diverse directors within four years (for Nasdaq Global Select Market and Nasdaq Global Market) or five years (for Nasdaq Capital Market) of the SEC approval of the rules related to board diversity and disclosure.
Overview of the Rule
The newly approved Nasdaq rules will generally require Nasdaq-listed issuers to have at least two diverse members on their boards of directors or explain why they do not. In addition, the new rules will mandate specific disclosures regarding the diversity of board composition. Nasdaq noted that nearly 85 percent of the substantive comment letters it had received supported the new rules for reasons including:
- Enhances Corporate Governance. Commenters felt that board diversity enhances corporate governance and board decision-making.
- Business-Driven Approach. Commenters commended Nasdaq’s pragmatic, disclosure-based approach to improving board diversity without undue burden, coercion or mandates.
- Advances Board Diversity. Commenters believe that Nasdaq’s new rule will help meaningfully improve board diversity related to race, ethnicity, sexual orientation and gender identity.
- Facilitates Transparency. By standardizing board diversity disclosures that are material to investors, commenters felt that the new rule will reduce data collection costs and improve data quality, availability and comparability.
- Reflects Core Values. Commenters believe that Nasdaq’s new rule reflects the commenters’ and/or their clients’ core values.
- Enhances Corporate Performance. Commenters believe that board diversity is linked to enhanced corporate performance, innovation and/or long-term sustainable returns.
- Facilitates Decision-Making. Investors seek board diversity statistics that are widespread, consistent and/or transparent so they can integrate diversity into their decision-making.
- Promotes Investor Confidence. Commenters felt that the new rule will enhance investor confidence and/or improve capital market efficiency.
Notwithstanding, the SEC was not unanimous in approving the new rules, with Commissioner Hester M. Peirce issuing a statement in opposition to the adoption of the new rules, primarily based on the view that the Securities Exchange Act of 1934, as amended, does not empower the SEC to exercise authority over board composition, nor do the rules enhance investor protection or market integrity.
Board Composition Requirements
The SEC approved Nasdaq’s adoption of Rule 5605(f), which will apply to all Nasdaq-listed companies, with different requirements for foreign issuers,5 smaller reporting companies6 or companies with a “Smaller Board.”7 This rule would require each Nasdaq-listed company to have, or explain why it does not have, at least one self-identified female director and at least one LGBTQ+ or underrepresented minority director. Emeritus directors, retired directors and members of an advisory board are excluded from the count of diverse directors.
For companies newly listed on the Nasdaq Global Select Market or the Nasdaq Global Market, the company must have or explain why it does not have at least one diverse director by the later of one year from date of listing (Listing Date) or the date the company files its proxy statement or its information statement (or, if the company does not file a proxy, in its Form 10-K or 20-F) for the company’s annual meeting of shareholders subsequent to the company’s listing (Proxy Date) and have or explain why it does not have at least two diverse directors by the later of two years from the Listing Date or Proxy Date.
For companies newly listed on the Nasdaq Capital Market, the company must have or explain why it does not have at least two diverse directors by the later of two years from the Listing Date or Proxy Date.
Foreign Issuers. For companies classified as Foreign Issuers, the definition of diverse varies slightly. Foreign Issuers must have a director that self-identifies as female, LGBTQ+ or as an underrepresented individual based on “national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the country of the company’s principal executive offices (as reported on the company’s Form F-1, 10-K, 20-F or 40-F).” Foreign Issuers must have or explain why it does not have at least one self-identified female director and at least one director meeting the above definition of diverse.
Smaller Board Companies. For companies with a smaller board, proposed Rule 5605(f)(2)(D) would require at least one diverse board member, or an explanation of why the company does not have one diverse member.
For newly listed smaller board companies, the company must have or explain why it does not have at least one diverse directors by the later of two years from Listing Date or Proxy Date.
Smaller Reporting Companies. A smaller reporting company can satisfy Rule 5605(f) with at least one self-identified female director and at least one self-identified female, LGBTQ+ or underrepresented minority director. Allowing smaller reporting companies to meet the diversity requirement with two female directors is intended to give more flexibility.
Nasdaq’s Listing Qualification Department will notify companies that fail to adhere to the diversity requirement, and non-compliant companies must cure the deficiency by the later of the next annual shareholder meeting or 180 days from the event that caused the deficiency. If the deficiency is not cured, then the Listings Qualification Department will issue a Staff Delisting Determination Letter. A company can cure the deficiency by electing the sufficient amount of diverse directors or by adequately disclosing the deficiency.
Under the “Board Recruiting Service Proposal,” eligible companies8 will be able to take advantage of one year of complimentary access for two users to a board recruiting service, which would provide access to a network of board-ready diverse candidates for companies to identify and evaluate. Nasdaq has established partnerships with Equilar, Athena Alliance and the Boardlist to provide companies with board recruiting services.9
Pursuant to proposed Rule 5606(a) (the Reporting Rule), each Nasdaq-listed company will be required to disclose board-level diversity data annually using a format referred to as the “Board Diversity Matrix.” The matrix must include the total number of directors, the breakdown of gender identity and LGBTQ+ status of the board, and the race and ethnicity of the board, as well as information on any directors who did not disclose demographic information.
Foreign Issuers. A company that qualifies as a foreign issuer can elect to provide information in an alternative Board Diversity Matrix format. For a foreign issuer, the company may report the total number of directors on its board, and additionally, 1) its country of principal executive offices; 2) whether it is a Foreign Private Issuer; 3) whether disclosure is prohibited under its home country law; 4) the number of directors based on gender identity (female, male or non-binary) and the number of directors who did not disclose gender; 5) the number of directors who self-identify as Underrepresented Individuals in its home country jurisdiction; 6) the number of directors who self-identify as LGBTQ+; and 7) the number of directors who did not disclose the demographic background under item 5 or 6 above.
Failure to adhere to the requirements of the Reporting Rule will result in Nasdaq notifying the company that it is not in compliance and giving the Nasdaq-listed issuer 45 calendar days to submit a plan to regain compliance. Nasdaq will review the plan and may provide the issuer with up to 180 days to regain compliance. A failure to regain compliance in the applicable periods may result in a Staff Delisting Determination.
A company must be in compliance with the Reporting Rule by the later of: 1) one calendar year from SEC approval of the Rule or 2) the date the company files its proxy statement or its information statement for its annual meeting of shareholders (or, if the company does not file a proxy or information statement, the date it files its Form 10-K or 20-F) during the 2021 calendar year.
For companies already listed on the Nasdaq Global Select Market, the Nasdaq Global Market, and the Nasdaq Capital Market (including smaller board companies), the company must have, or explain why it does not have, at least one diverse director by the later of two years from the date of SEC approval (Aug. 7, 2023) or the date the company files its proxy statement or its information statement for its annual meeting of shareholders during the calendar year two years after SEC approval (2023).
Companies already listed on the Nasdaq Global Select Market or the Nasdaq Global Market must add a second diverse director by the later of four calendar years from SEC approval of the rule (Aug. 6, 2025) or the date the company files its proxy statement or its information statement for its annual meeting of shareholders during the calendar year four years after SEC approval.
Companies already listed on the Nasdaq Capital Market must add a second diverse director by the later of five calendar years from SEC approval of the rule (Aug. 6, 2026) or the date the company files its proxy statement or its information statement for its annual meeting of shareholders during the calendar year five years after SEC approval.
Companies that list after SEC approval of these rules will not need to comply with the earlier date, but will instead follow the timing requirements in Rule 5605(f)(5).
Although the newly adopted rules relating to diversity do not necessarily require a Nasdaq-listed issuer to improve the diversity of its board, the rules likely will lead to greater pressure, consistent with existing market dynamics, on public companies to increase board diversity. The SEC issued a statement that calls these rules a “starting point for initiatives related to diversity, not the finish line.”10
1 See Securities Exchange Act Release No. 34-92590 (Aug. 6, 2021) (order approving SR-NASDAQ-2020-081 and SR-NASDAQ-2020-082) (Order). The full text of the Nasdaq diversity proposal and board diversity services proposal is available on the SEC’s website.
2 Rule 5605(f)(1) defines “Female” as “an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.”
3 Rule 5605(f)(1) defines “Underrepresented Minority” as “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.”
4 Rule 5605(f)(1) defines “LGBTQ+” as “an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender or as a member of the queer community.”
5 Rule 5605(f)(1) defines a “Foreign Issuer” as “(a) a Foreign Private Issuer (as defined in Rule 5005(a)(19)); or (b) a company that (i) is considered a “foreign issuer” under Rule 3b-4(b) under the Act, 17 CFR 240.3b-4(b), and (ii) has its principal executive offices located outside of the United States.”
6 As defined in Rule 12b-2 of the Act.
7 Defined in the Order as five or fewer members.
8 The Board Recruiting Service Proposal generally defines an “Eligible Company” as a Nasdaq-listed company that represents to the SEC that it does not have: 1) at least one director who self-identifies as Female and 2) at least one director who self-identifies as an Underrepresented Minority or LGBTQ+. A Foreign Issuer would be an Eligible Company if it represents to the SEC that it does not have: 1) at least one director who self-identifies as Female and 2) at least one director who self identifies as one or more of the following: Female, an Underrepresented Individual, or LGBTQ+. A Smaller Reporting Company would be an Eligible Company if it represents to the SEC that it does not have: 1) at least one director who self-identifies as Female and 2) at least one director who self-identifies as one or more of the following: Female, an Underrepresented Minority or LGBTQ+.