Alexa Rosen – Made effective on August 6, 2021, by the U.S. Securities and Exchange Commission (“SEC”), the Nasdaq Stock Market (“Nasdaq”) will now require each Nasdaq-listed company, subject to certain exceptions, to have at least two diverse board members or explain why it does not. The following article provides a brief overview of the rule, its receipt by market participants, and considerations for stakeholders in publicly traded markets.
Nasdaq’s Proposal
Nasdaq’s “Board Diversity Proposal” promotes diversity among directors of publicly-traded companies on the exchange by requiring companies to provide information about the make-up of their boards of directors. More specifically, Nasdaq will require companies to (1) “publicly disclose in an aggregated form . . . the voluntary self-identified gender and racial characteristics and LGBTQ+ status of the company’s board of directors[,]” and (2) if a company does not have at least two “diverse” board members, then it must explain why not.
There are three important take-aways from the structuring of Nasdaq’s new reporting rule. First, the Board Diversity Proposal requires disclosures in “aggregated form.” That is, each company will be required to fill out a Board Diversity Matrix, a five-by-ten table which asks the company to indicate the number of directors who voluntarily self-identify as male, female, non-binary, Black, White, Hispanic, Asian, and so forth. Second, because the rule maintains self-disclosure is voluntary, the Matrix includes spaces for those who “did not disclose gender” and “did not disclose demographic background.” So theoretically, if a board made up of twelve white men choose not to disclose their gender (male) or their demographic background (white), the exchange would be none the wiser. Or, at the very least, there is no suggestion in Nasdaq’s Proposal or its February 26 letter responding to commentators that the responses of our hypothetical company would not be compliant with option one (the Matrix). Third, the explain-why-not alternative to filling out and publishing the Board Diversity Matrix allows non-diverse companies to satisfy the new listing requirement without meeting the new diversity objectives. Short of “merely [stating] that ‘the Company does not comply with Nasdaq’s diversity rule[,]” the Exchange will not “not evaluate the substance or merits of a company’s explanation.” The Exchange goes on to offer, “because [the company] does not believe Nasdaq’s listing rule is appropriate,” and “because it does not believe achieving Nasdaq’s diversity objectives are feasible given the company’s current circumstances” as examples of acceptable explanations.
Admittedly, the quasi-deidentified reporting form, “did not disclose” answer, and ability to preserve board uniformity with a simple explanation, makes the Proposal seem perhaps too soft around the edges to actually have an impact. But as we will see in the next section, a certain amount of that flexibility and malleability is crucial to the Proposal’s ability to withstand constitutional and other legal challenges.
Critics Respond
Several commentators have questioned the Proposal’s constitutionality. Some criticized the new standard as “discriminatory as it is based on sex, race, ethnicity, and sexual orientation, and would require Nasdaq-listed companies to discriminate in hiring,” creating a Fifth Amendment violation. Others argued the Proposal would not survive a strict scrutiny analysis and that it impermissibly creates a gender quota and even “violate[s] the First Amendment because it would require companies to engage in compelled disclosure.”
We know, of course, the SEC found these objections unpersuasive—after all, it did approve Nasdaq’s plan. For one, the SEC supported Nasdaq’s claim that it is not a state actor and, therefore, does not come within the purview of the Equal Protection Clause. And two, the SEC and Nasdaq forcefully maintain the Proposal “establish[es] a disclosure-based framework and not a mandate or quota.” In other words, because a company can comply with the new listing rules by either disclosing or explaining, nothing in the Proposal forces companies to make hiring or firing decisions on the basis of sex, race, ethnicity, or sexual orientation.
With respect to free speech, Nasdaq similarly explains that nothing in its Proposal “compel[s] a company to convey any specific message.” In fact, the Exchange goes on to suggest, if a company is not happy with the new listing requirement, it can list on a different exchange. Apparently betting on a pro-diversity market, Nasdaq leaves much in the hands of companies and investors to determine whether and to what extent its new proposal will spark change.
Run the Traps
The saying comes from hunting and trapping times when hunters and fishermen would set traps and then, a short while later, go back over them to see if they caught anything—they would “run the traps” to remove the catch before it became someone or something else’s dinner. The phrase provides a nice metaphor in the business world, as well. Just like the hunter who can’t afford to sleep on his traps, there are certain things businesses must do if they want to stay in the game.
First and foremost, take note that there are other hunters out there. The wait-and-see approach to figure out whether the market—i.e. investors—value diversity is extremely risky. Other hunters will have already spent time figuring out the best spots, cultivating the best talent, and scooping up the best catches.
Second, one good catch won’t feed the family through the winter. The point here is a company that gets by with the bare minimum one year, might not be so lucky the next. As the Commission and Exchange predict, investors will want more than lip service, particularly when they’re getting more from other companies. The market, like a rich hunting field, is an ever-changing landscape. Though the Proposal is new this year, it might be old news the next. And companies that rest on their laurels might find themselves edged out as corporate culture starts to shift towards more diverse boards and more open reporting thereof.
Third, it’s tough to shake the reputation of a good hunter. Of course, this idea works both ways. On one hand, there are the good hunters of yesterday: publicly traded companies, listed on major exchanges, that do not have diverse boards. And for these companies, Nasdaq’s Proposal leaves the door open to the possibility that “the proposed disclosures could inform [investors’] decision[s] to vote to preserve the existing board composition in a company.” On the other hand, what about the good hunters of tomorrow? With heavy-hitters like Goldman Sachs requiring that the next generation of publicly traded companies get behind board diversity, people’s perception of what makes a business—or a board—a good investment is likely changing. Specifically, in January 2020, Goldman Sachs announced, beginning July 1, it would only underwrite IPOs in the US and Europe of private companies that have at least one diverse board member. And starting in 2021, Goldman Sachs increased that target to two diverse candidates for each of its IPO clients. So, it behooves prospective IPOs to start running the traps: figure out how to capture diversity, put it on the board, and measure its impact.
