SEC Approves Nasdaq’s Board Diversity Listing Requirements

On August 6, 2021, the Securities and Exchange Commission (the “SEC”) approved new listing standards of the Nasdaq Stock Market LLC (“Nasdaq”) regarding director diversity. Generally, the new rules require a Nasdaq-listed company to have or explain why it does not have, at least two diverse directors, including one female director and one director of a historically underrepresented community. Companies currently listed on the Nasdaq Global Select Market (“NGS”) or the Nasdaq Global Market (“NGM”) will have two years to have, or explain why they do not have at least one female or diverse director and four years to have, or explain why they do not have both a female and a diverse director (or five years for companies listed on the Nasdaq Capital Market (“NCM”)). Nasdaq-listed companies will also be required annually to disclose board-level diversity data in a prescribed tabular format.[1] Additionally, the SEC approved Nasdaq’s board recruitment service proposal, which will provide certain eligible companies with a one-year complimentary recruitment service to facilitate their recruitment of board-ready diverse candidates.

Background

On December 1, 2020, Nasdaq submitted a proposal (the “Proposal”) to the SEC to amend its listing requirements regarding board diversity and disclosure, described in more detail in our prior Client Alert. On February 26, 2021, in response to more than 200 comments received on the Proposal, Nasdaq amended the Proposal to, among other things, provide: (i) additional flexibility for companies in complying with the new rules; (ii) grace periods for companies to regain compliance for failing to comply due to a board vacancy; and (iii) longer phase-in periods for newly-listed companies to comply with the diversity disclosure requirements.

Key Provisions of the New Rules[2]

New Rule 5605(f): Diverse Board Representation

New Nasdaq Rule 5605(f) requires the board of directors of a Nasdaq-listed company to have, or explain why it does not have at least two diverse directors, including: (i) one director who voluntarily self-identifies as female; and (ii) one director who voluntarily 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 LGBTQ+.

• Compliance Timeline. The new rule provides a gradual compliance period for currently and newly-listed companies.
  • Currently Listed Companies. Companies currently listed on the NGS or the NGM have two years to have, or explain why they do not have, at least one female or diverse director and four years to have both a female and a diverse director. Companies currently listed on the NCM have two years to have, or explain why they do not have, at least one female or diverse director and five years to have both a female and a diverse director.
  • Newly-listed Companies: Newly-listed companies[3] on the NGS or the NGM have one year to have, or explain why they do not have, at least one female or diverse director and two years to have both a female and a diverse director. Newly-listed companies on the NCM do not have to comply with the one-year requirement and are only required to have, or explain why they do not have, both a female and a diverse director within two years.
• Comply or Explain. If a listed company’s board does not comply with the diversity requirements following the implementation period, the company is required to specify the particular aspect(s) of board diversity with which it fails to comply and explain the reasons for its non-compliance. Nasdaq indicated that it will not evaluate the substance or merits of a company’s explanation but also that it would not be sufficient for a company just to state its non-compliance.

• For a company that is required to explain why it is not in compliance with the board diversity requirement, such disclosure must be provided in advance of the company’s next annual meeting of shareholders: (i) in its proxy statement or information statement (or, if the company does not file such statements, in its annual report on Form 10-K or 20-F); or (ii) on the company’s website. If the company provides such disclosure on its website, it must add the disclosure to its website concurrently with the filing described in  (i) above and submit a URL link to the disclosure through the Nasdaq Listing Center within one business day after such posting.

• Cure and Grace Periods. Failure to comply with the new rule could eventually lead to delisting; however, a company would have until the later of its next annual meeting and 180 days from the event that caused the deficiency to regain compliance with its diversity objectives. Additionally, there is a one-year grace period for a company that no longer meets the diversity objectives as a result of a board vacancy.[4]

• Smaller Reporting Companies and Foreign Issuers. Smaller reporting companies and foreign issuers can satisfy the board diversity objective or provide an explanation as to why they do not by having two female directors.[5] Additionally, the standard for a diverse director for a foreign issuer may be based on diversity classifications that recognize underrepresented individuals (versus underrepresented minorities) in the issuer’s home country jurisdiction.

• Companies with Small Boards. Companies with five or fewer directors (who do not otherwise qualify as smaller reporting companies) must only have one diverse director. If a company has five directors before becoming subject to the new rule and adds one director to satisfy the diversity objective, its diversity objective would remain at one diverse director (even though it would have a six-member board). However, if the company subsequently expands its board, the new rule would then require the company to have at least two diverse directors.

New Rule 5606: Board Diversity Disclosure

Under new Nasdaq Rule 5606(a), each Nasdaq-listed company will be required annually to disclose statistical information on its board’s diversity in substantially the same format as the “Board Diversity Matrix” available here.

As with new Rule 5605(f), companies are required to provide this Board Diversity Matrix (i) in the company’s proxy statement or information statement for its annual meeting of shareholders (or, if the company does not file such statements, in its annual report on Form 10-K or 20-F), or (ii) on the company’s website. Following the first year of disclosure, companies are required to disclose the current year and immediately prior year diversity statistics using the Board Diversity Matrix.

A company must disclose its initial Board Diversity Matrix by the later of: (i) August 6, 2022; or (ii) the date the company files its proxy statement or information statement for its annual meeting in 2022 (or, if the company does not file such statements, in its annual report on Form 10-K or 20-F). Newly-listed companies will have one year from the date of listing on Nasdaq to provide its initial Board Diversity Matrix.

Looking Forward

The SEC’s approval of Nasdaq’s new diversity listing rules once again signals the Commission’s prioritization of environmental, social and governance matters (“ESG”) that are increasingly important to companies, investors and well-functioning markets, which we discussed in our prior Client Alert. It is likely that the SEC’s consideration and approval of the Nasdaq board diversity listing requirements will influence proposed rules on board diversity and human capital disclosure, which are anticipated to be released for public comment this Fall.

Based on Chair Gensler’s statement and the joint statement of Commissioners Allison Lee and Caroline Crenshaw, it is possible that the majority Democratic Commission could propose rules that require reporting companies provide aggregated statistical board diversity metrics in a prescribed manner (i.e., a diversity matrix) that is similar to the Nasdaq’s new rules. The human capital proposed rulemaking could also include requirements to disclose diversity metrics more broadly (i.e., for senior management and the workforce in general).

The SEC’s approval of the Nasdaq board diversity listing requirements also highlights the opposition ahead for board diversity rule disclosures. Republican Commissioners Elad Roisman and Hester Peirce both dissented from the SEC’s vote approving the new rules, noting support of the diversity objectives but taking issue with how the Commission analyzed the Nasdaq proposal and disagreeing that Nasdaq had met its burden in showing how its listing requirement was consistent with the Exchange Act. 

To address the Republican Commissioners’ and potential litigation challenges,[6] the SEC may choose to propose rules premised on a comply or explain model similar to the Nasdaq’s new rules. This would preserve companies’ flexibility in addressing board diversity objectives while maintaining accountability via greater transparency through disclosures of what a company is actually doing to accomplish its publicly stated diversity goals. The comply or explain model may also allow for companies to re-visit or explain their definitions of diversity or address critiques that diversification goals often disproportionately skew in favor of gender diversity versus racial, ethnic, or other underrepresented minority groups.

Finally, could the step forward by Nasdaq on board diversity disclosures and governance objectives encourage other exchanges both in the US and internationally to amend their listing requirements? To date, the New York Stock Exchange has indicated its commitment to board diversity through an advisory council that assists with the recruitment of diverse candidates.[7] It has not indicated that it intends to propose amendments to its listing rules similar to the new Nasdaq rules.    

If you have any questions concerning the material discussed in this client alert, please contact the members of our Securities and Capital Markets practice.

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