SEC Approves New Nasdaq Rule on Board Diversity Disclosures

By Alexandra R. Lajoux


Diversity Disclosure Requirements Securities and Exchange Commission Online Article

On August 7, 2021, US Securities and Exchange Commission (SEC) chair Gary Gensler announced that the agency had approved Nasdaq listing Rule 5605(f) requiring disclosure of board diversity and offering recruitment help. Nasdaq originally proposed the rule on December 1, 2020, and followed up with an amendment promising to provide issuers with a complimentary board recruiting solution.

The SEC’s approval of the rule is a significant development for public company directors in the United States, since Nasdaq is one of the country’s two leading exchanges. Nasdaq has some 3,400 companies listed worth some $22 trillion, compared to approximately 2,300 companies worth $28.8 trillion on the New York Stock Exchange. The new rule joins a growing number of diversity initiatives in the marketplace, as described in our recent Board Diversity FAQ.

The rule has met with a fairly positive reception in the business community. In its February 26, 2021 Response to Comments and Notice of Filing of Amendment No. 1 of Proposed Rule Change to Adopt Listing Rules Related to Board Diversity, Nasdaq summarized the more than 200 responses the proposal had sparked by that time, stating that nearly 85 percent were generally favorable (which means that 15 percent were opposed to the rule altogether). In the past six months, through August 1, 2021, comments followed this largely supportive pattern.

Nasdaq CEO Adena Friedman has emphasized in interviews that while the rule focuses on increasing diversity in boardrooms it is also a mandate to measure progress. In an interview with Fortune given shortly before the new rule was approved, Friedman said that “diversity on boards is correlated with improved outcomes in two areas: risk controls—that’s important to us because investor protection is critical—and financial performance.”

Defining Diversity

The new rule will require Nasdaq-listed companies (with some exceptions) to disclose information on certain self-identified characteristics of a company’s directors, as described in this regulatory release. Under the rule, each Nasdaq-listed company must have, or explain why it does not have, at least two members of its board of directors who are “diverse,” including at least one director who self-identifies as female, and at least one director who self-identifies as an underrepresented minority or LGBTQ+—all terms defined in the rule. During the rule’s comment period, some in the governance community questioned why these were the only diversity categories, and noted additional types of diversity, such as persons with disabilities or veteran status. The final rule does not mandate these categories, but it does encourage companies to include such types of diversity in their board diversity explanations.

Companies must report the above information in the form of a diversity matrix. Individual directors may withhold this information if they so choose: for each type of diversity, the matrix includes a “did not disclose” category.

To help boards adapt to the rule, Nasdaq will provide access to a network of “board-ready” diverse candidates for companies to consider. Nasdaq has posted a fact sheet and a list of FAQs on the new rule covering many practical points.

The Deadline

To comply with the rule, the deadline for adding the first and second diverse directors to Nasdaq-listed company boards is two and four years from the rule’s announcement date, respectively. Special purpose acquisition companies (aka SPACs) are exempt from the rule altogether until they acquire and merge with their targets, and companies with five directors or fewer are only required to make disclosures concerning one diverse director.

If a company fails to make a timely disclosure, there is a grace period before the company would be delisted. The rule states that “a company that does not comply with proposed Rule 5605(f)(2) would be provided until the later of its next annual shareholders meeting or 180 days from the event that caused the deficiency to cure the deficiency, and a company that does not comply with… Rule 5606 would have 45 calendar days to submit a plan of compliance to the Exchange and upon review of such plan, Exchange staff may provide the company with up to 180 days to regain compliance.” For a board with an unanticipated departure of a diverse director, the rule gives a longer period of either one year from the date of the board vacancy or one year from the date the company files its proxy or other informational filing in the calendar year following.

Nasdaq Leadership

The Nasdaq stock market has become an active champion of board diversity as detailed in NACD’s recently published FAQ on board diversity. Since September 2020, it has supported The Board Challenge, which asks all boards without a Black director to add at least one such board member in the next 12 months. Boards such as Nasdaq’s own governing body, which already have one or more Black directors, back the effort as charter partners and supporters.

One of the reasons to encourage diversity is that it can improve financial performance. The regulatory release cites several studies that show a positive correlation between diversity and financial performance. A commenter quoted in the release asked Nasdaq to commit to publishing a study on the relationship between diversity and financial results. Nasdaq summarized its response by saying that “the greater benefit of publicly disclosing board diversity data would be that all interested parties can adequately conduct their own analyses of the impact of the proposal on board diversity and its relationship with company performance” and that “the Exchange welcomes these analyses.” For an overview of scholarship on this link, see the NACD FAQ on the link between corporate governance and financial performance.

NACD recognizes the need for a strong, diverse, and highly qualified pipeline of professionals to serve as tomorrow’s directors. Learn more about NACD Accelerate™, a program that creates a pathway for executives with little or no experience in the boardroom to prepare for board service, here. If you’re seeking strong candidates to join your board now, explore NACD Board Search here.

Alexandra R. Lajoux
Alexandra Reed Lajoux, Ph.D., M.B.A., is a founding principal of Capital Expert Services, LLC (CapEx). She serves NACD as chief knowledge officer emeritus.