On August 6, 2021, the Securities and Exchange Commission (“SEC”) approved Nasdaq’s Board Diversity Rule (Nasdaq Stock Market LLC Rules 5605(f) and 5606), which requires listed companies to have at least two diverse board members or to explain their failure to meet the requirement, with some exceptions. The Board Diversity Rule also requires companies to publish statistics on the diversity of their board members. The rule is intended to increase transparency into the diversity of corporate boards, giving investors more information to consider when deciding which companies are worthy of investment. As investors have increasingly voiced concern over enhanced diversity in corporate leadership, the Board Diversity Rule may not only increase board transparency, but also cause Nasdaq-listed companies to increase board diversity.
The Nasdaq Board Diversity Rule is not a mandate, but instead requires listed companies that do not have at least one director that self-identifies as female (regardless of their designated sex at birth) and at least one director who self-identifies as an underrepresented racial or ethnic minority or as LGBTQ+ provide a written explanation for their failure to meet these diversity goals. The explanations must be provided in advance of the company’s next annual shareholders meeting in either a proxy statement, in an information statement, or on the company’s website. The explanation alone is mandatory. Nasdaq and the SEC will not evaluate the substance or merits of any company’s explanation.
There are a number of exceptions to the Board Diversity Rule. Foreign issuers are only required to have one diverse director who is female and one director that is female, LGBTQ+, or a member of an underrepresented community in the context of the country of the company’s principal executive offices, meaning that a board member may be considered ethnically diverse in the foreign issuer’s home country even if they would not be considered diverse in the United States. Smaller Reporting Companies are required to have two diverse directors, so long as one of them self-identifies as female (i.e., a Smaller Reporting Company can satisfy the rule by having two female directors). The Securities and Exchange Act of 1934 defines “Smaller Reporting Companies” as an issuer that is not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent company that is not a smaller reporting company and that (1) has a public float of less than $250 million, or (2) has annual revenues of less than $100 million and either no public float or a public float of less than $700 million. See 17 CFR § 240.12b-2. Finally, a company with a board of directors of five members or fewer is only required to have one member who is diverse. As with other companies subject to the Board Diversity Rule, companies in the above three categories are not required to meet these diversity goals, but they must explain their failure to do so. Other companies are exempt from the Board Diversity Rule based on type, including acquisition companies, asset-backed and other passive issuers, cooperatives, limited partnerships, management investment companies, issuers of non-voting preferred securities, debt securities and Derivative Securities that do not have equity securities listed on Nasdaq, and issuers of securities listed under the Nasdaq Rule 5700 Series.
Companies are required to comply with the Board Diversity Rule at different times, depending on which Nasdaq exchange they are listed. Companies listed on the Nasdaq Global Select Market or the Nasdaq Global Market must have, or explain why they do not have, at least two diverse directors by the later of August 6, 2025 or the date the company files its proxy statement or its information statement for its annual shareholders meeting during the 2025. Companies listed on the Nasdaq Capital Market must have, or explain why they do not have, at least two diverse directors by the later of August 6, 2026 or the date the company files its proxy statement or its information statement during 2026. Companies listed on the Nasdaq Global Select Market, the Nasdaq Global Market, and the Nasdaq Capital Market must have, or explain why they do not have, at least one diverse director by the later of August 6, 2023 or the date the company files its proxy statement or information statement for the company’s annual shareholders meeting during 2023. The Board Diversity Rule also allows newly listed companies to be phased in depending on which of the Nasdaq markets they are listed on.
In addition to the minimum requirements for diverse board membership, companies are required to disclose statistics on the demographics of all of their board members under Rule 5606. Companies will be required to disclose the number of their directors that are male, female, non-binary, or that refused to disclose their gender, as well as the same gender-based statistics broken down by race and ethnicity. Companies must comply with these disclosure requirements by August 6, 2022 or before the date the company files its first proxy statement or information statement for its annual meeting of shareholders, whichever happens first.
The most immediate impact of the Board Diversity Rule will be more information for investors—ideally, consistent and comparable information about board diversity. Whether this information will in turn lead to more diversity at the board level remains to be seen. With more and more investors, including institutional investors, basing investment decisions on Environmental, Social, and Governance factors (“ESG”), companies may choose to add diverse board members to meet the minimum diversity goals to avoid investor scrutiny, or may further increase board diversity in order to maximize their appeal to investors.
Nasdaq certainly hopes that this trend will have the ultimate effect of increasing corporate board diversity. According to Nasdaq, the Board Diversity Rule promotes diversity in company leadership while maintaining companies’ flexibility to choose their leaders, including preserving a company’s choice to not select any diverse leaders, so long as that decision is explained. In defending the Board Diversity Rule, Nasdaq relied on empirical evidence and peer reviewed studies that established a link between diverse boards and enhanced company performance, innovation, long-term sustainable returns, and investor protection.