Nasdaq Proposes New Board Diversity Composition and Disclosure Requirements

The Nasdaq Stock Market (Nasdaq) announced that it had submitted a proposal to the US Securities and Exchange Commission (SEC) seeking approval of new listing rules to advance board diversity and increase transparency to investors regarding the diversity characteristics of Nasdaq-listed company boards. This LawFlash provides a summary of the proposed rules, including the proposed timing for compliance, and a list of certain implications for companies to consider with respect to the proposed rules.

According to Nasdaq’s proposal, a supermajority of listed companies have at least one woman on the board; however, Nasdaq is unable to provide definitive estimates regarding the number of listed companies that will be affected by the proposal due to the inconsistent disclosures and definitions of diversity across companies and the extremely limited disclosure of race and ethnicity information. If these proposed rules are approved by the SEC, companies will need to carefully navigate their disclosure requirements to maintain good standing with the Nasdaq exchange.

SUMMARY OF PROPOSED RULES

Board Diversity Composition Requirements

Requirements

Proposed Rule 5605(f) would require each Nasdaq-listed company to have, or explain why it does not have, at least two “Diverse” directors, including (a) at least one director who self‑identifies as female; and (b) at least one director who self-identifies as an Underrepresented Minority, or as LGBTQ+. For purposes of proposed Rule 5605(f), “Diverse” means an individual who self identifies in one or more of the following categories: female, Underrepresented Minority or LGBTQ+. “Underrepresented Minority” means any person who self-identifies 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. “Female” means an individual who self identifies her gender as a woman, without regard to the individual’s designated sex at birth.

If Rule 5605(f) is approved, a Nasdaq-listed company that fails to satisfy the diversity requirements will be required to specify which requirements have not been satisfied and provide public disclosure of the board’s reasons for not satisfying such requirements. This disclosure must be provided on the company’s website or in the company’s proxy statement. If the company elects to provide the disclosure on its website, it will also be required to provide Nasdaq with a URL link to the information within fifteen calendar days of the company’s annual meeting via the initial listing center.

Under the proposed rule, failure to comply with the board diversity expectations would not, in and of itself, result in delisting by Nasdaq. However, companies that both (i) fail to meet the board diversity expectations within the requisite timeframes, and (ii) do not publicly disclose the company’s rationale for doing so would have a cure period of at least six months to remedy the deficiency and would be subject to delisting if unable to do so.

Exemptions and Exceptions for Certain Companies

Under proposed Rule 5605(f), certain companies will be exempt from the diversity requirements described above, while others, including foreign issuers[1] and smaller reporting companies[2], will be provided with greater flexibility with respect to the requirement for the second Diverse director, as described below.

Exempt Companies: Acquisition companies listed under IM-5101-2 (i.e., SPACs prior to a business combination), asset backed issuers and other passive issuers, cooperatives, limited partnerships, management investment companies, and issuers of non-voting preferred securities, debt securities and derivative securities (each as set forth in Rules 5615(a)(1)-5615(a)(6), respectively) and issuers of securities listed under the Rule 5700 series would be exempt from proposed Rule 5605(f).

Foreign Issuers: Foreign issuer boards will be required to satisfy the requirement of having at least one director who self-identifies as female, but will not necessarily need to have a director who self-identifies as an Underrepresented Minority. Instead, foreign issuer boards may have a second female director, an individual who identifies as LGBTQ+, or an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious, or linguistic identity in the company’s home jurisdiction.

Smaller Reporting Companies: Boards of smaller reporting companies may satisfy the proposed diversity requirements either by complying with the standard requirements described above, or by having two female directors.

Effective Date for Currently Listed Companies and Phase-In for Newly Listed Companies

Each Nasdaq-listed company on the Nasdaq Global Select Market or the Nasdaq Global Market must have, or explain why it does not have, at least one Diverse candidate by no later than two calendar years after the date on which the SEC approves the Nasdaq’s proposal (the Approval Date) and at least two Diverse candidates by no later than four calendar years after the Approval Date.

Each Nasdaq-listed company on the Nasdaq Capital Market must have, or explain why it does not have, at least one Diverse candidate by no later than two calendar years after the Approval Date and at least two Diverse candidates by no later than five calendar years after the Approval Date.

A newly listed company that was not subject to substantially similar requirements as those set forth under proposed Rule 5605(f) will have one additional year for compliance, in addition to the transition periods described above. This includes IPOs, transfers, direct listings and SPACs following a business combination.

Board Diversity Disclosure Requirements

Requirements

Proposed Rule 5606(a) would require Nasdaq-listed companies to publicly disclose statistical information about the self‑identified gender, race, and self-identification as LGBTQ+ of the company’s directors. This disclosure must be provided on the company’s website or in the company’s proxy statement. If the company elects to provide the disclosure on its website, it will also be required to provide Nasdaq with a URL link to the information within 15 calendar days after the company’s annual meeting via the initial listing center. For the first year a company is required to disclose board diversity statistics, the company would be required to publish board diversity statistics for the current year only. Each subsequent year, the company will be required to publish its data for the last two years.

Nasdaq’s proposal includes an example “Board Diversity Matrix” that companies may use to structure the presentation of this information. The template is reproduced immediately below. Note that under the proposed rule, directors opting not to disclose a gender would be included under “Gender Undisclosed,” and directors opting not to identify as any race or as LGBTQ+ would be included in the “Undisclosed” category at the bottom of the table.

Exemptions and Exceptions for Certain Companies

Exempt Companies: The same universe of companies that are exempt from proposed Rule 5605(f) described above would be exempt from the diversity disclosure requirements under proposed Rule 5606.

Exception for Foreign Issuers: In lieu of the Board Diversity Matrix presented above, foreign issuers may provide an alternative matrix that would include the following: (1) the number of directors based on gender identity (male, female, or non-binary); (2) the number of directors who are considered underrepresented in the company’s home country jurisdiction; and (3) the number of directors who self-identify as LGBTQ+.

Effective Date and Phase-In for Newly Listed Companies

Proposed Rule 5606 would be effective for Nasdaq-listed companies one year after the Approval Date. A company that is newly listing on Nasdaq—including through an IPO, transfer, direct listing or a SPAC business combination—would be required to satisfy the proposed Rule 5606 disclosure requirements within one year of listing.

The proposed rule will first be published in the Federal Register, and the public will then have 21 days to submit comments. 45 days after publication, or longer if the SEC requires additional time, the SEC will disapprove or approve of the rule which will mark the Approval Date. While the SEC’s position on the rules are unclear, the incoming Biden Administration may be more receptive to approving these rules than the previous administration.

IMPLICATIONS

This proposed rule is subject to a 21-day public comment period and, ultimately, approval by the SEC. While the SEC has not publicly addressed the proposed rule, we expect that it is more likely to be approved with a Biden-appointed Chair. In the meantime, companies should begin considering how to apply and comply with this proposed rule:

• In light of the 21-day public comment period, consider speaking with experienced legal counsel and offering comment on this proposed rule.
• Nasdaq-listed companies should evaluate their existing board composition to determine if the board satisfies the proposed diversity requirements set forth in proposed Rule 5605(f). In connection with this process, companies should also consider what steps will be necessary to maintain, or obtain, as the case may be, compliance by the effective date.

  If a company will need to recompose the board or add more directors in order to satisfy the diversity requirements, it should, among other items:

  • evaluate the company’s governing documents to determine the permissibility of increasing the size of the board to add more Diverse directors or recomposing the board;
  • determine necessary stockholder approvals for the approval of new directors and the timing thereof;
  • along with the nominating and corporate governance committee(s) of the Board, evaluate and, if necessary, amend the criteria by which director candidates are identified and selected;
  • consider whether the company will need to retain the assistance of a search firm to identify skilled director candidates meeting the Diversity criteria[3]; and
  • ensure that, following the recomposition or increase in the size of the board, the company will continue to satisfy the other applicable Nasdaq corporate governance and board composition/committee requirements.
• To the extent that a company cannot (or will voluntarily choose not to) satisfy the director diversity requirements under proposed Rule 5605(f) in accordance with the applicable transition periods, and instead chooses to publicly disclose the reasons for doing so, the company should consider any negative investor impacts that will result from providing the required explanatory disclosure and implement strategies to address these negative impacts.
• In order to facilitate easier compliance with the proposed Nasdaq rules, Nasdaq‑listed companies should amend their forms of D&O questionnaire so that directors and officers are asked to optionally self-identify with respect to gender, race, and LGBTQ+ status.[4] The questionnaires also should solicit permission to publicly disclose this information in documents filed with the SEC or published on the company’s website.
• Unlike certain state legislation that mandates a minimum number of female and minority directors, such as California’s AB979 and SB826, the proposed Nasdaq rule is cast primarily as a disclosure rule. Nevertheless, public companies should consult with legal counsel on how to deal with compliance with such disclosure requirements, including any privacy concerns relating to the collection and handling of information regarding personal characteristics and potentially conflicting state disclosure requirements.
• Additionally, state legislatures have already passed or are considering board diversity disclosure and mandate laws. Shareholder litigation concerning director diversity also is on the rise.[5] Companies should monitor state and federal legislation and keep abreast of ongoing litigation developments.
• As of the date of this LawFlash publication, the New York Stock Exchange (NYSE) has not proposed similar rules for NYSE-listed companies. However, in anticipation of substantially similar rules being proposed by the NYSE and in light of current state legislation and shareholder litigation, NYSE-listed companies might also consider taking the initial steps set forth above.
• Once the SEC publishes the rule in the Federal Register, interested parties can and should provide their comments and will have a 21-day comment period to do so. It would be prudent to talk with your legal counsel and consider commenting on the rules.
• Companies may want to consider their public statements on diversity and inclusion vis-à-vis their policies and public disclosures regarding director recruitment, the director nomination process, and overall board diversity and ensure that the composition of their boardroom and their nomination process is cohesive with those statements.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Michael D. Blanchard
Laurie Cerveny
Michael Conza
Jason D. Frank
Bryan Keighery
Emily E. Renshaw
Carl Valenstein
Julio Vega

New York
Bernard J. Garbutt III
Thomas P. Giblin, Jr.
Brian A. Herman
Howard A. Kenny
Christina Melendi
Kimberly M. Reisler

Palo Alto
Albert Lung

Philadelphia
Sarah Bouchard
Justin W. Chairman
Michael L. Kichline
James W. McKenzie
Laura Hughes McNally
Joanne R. Soslow

Pittsburgh
Celia Soehner

Princeton
David C. Schwartz

San Francisco
Mark Feller
Joseph E. Floren
Scott Karchmer
Albert Lung
Susan D. Resley
Charlene S. Shimada

Washington, DC
Sharon Masling
Grace E. Speights

[1] A foreign issuer means (a) a Foreign Private Issuer as defined in Nasdaq Rule 5005(a)(1) or (b) a company that is considered a “foreign issuer” under Rule 3b-4(b) of the Securities Exchange Act of 1934 (Exchange Act) and has its principal executive offices located outside of the United States.

[2] A smaller reporting company means a smaller reporting company as defined in Rule 12b-2 under the Exchange Act.

[3] Nasdaq has established a partnership with Equilar to assist companies in the search for diverse director candidates.

[4] If a director chooses not to identify as Diverse, the company may include this choice as a component of its explanation for why it does not satisfy the director diversity requirements under proposed Rule 5605(f).

[5] While Nasdaq’s definition of a “Diverse” director substantially aligns with California’s, there are some key differences. These are highlighted here.