Boardroom Diversity Rules for Public Companies

UPDATE as of May 18, 2022: Although the SEC approved Nasdaq’s proposed diversity rule, the fate of the rule remains uncertain in light of a challenged filed by The Alliance for Fair Board Recruitment. In addition, the fate of California’s AB 979 is uncertain in light of a Los Angeles Superior Court ruling that found AB 979 to be violate the Equal Protection Clause of California’s constitution. The State of California is appealing this decision. Finally, the law suit challenging California’s SB 826 in Los Angeles Superior Court was successful. As of the writing of this update, the State of California had not decided whether it would appeal the decision.

Diversity is no longer a “nice to have” in the boardroom; regulators are increasingly demanding compliance with rules designed to bolster diversity on boards.

One such regulator is Nasdaq, which has proposed board diversity listing and disclosure requirements that the Securities and Exchange Commission is currently reviewing. In addition, companies headquartered in California--already subject to a set of gender diversity rules--are now also subject to a new law intended to further promote the inclusion of underrepresented groups in the board room.

Proposed Nasdaq Rules

If approved by the SEC, Nasdaq will implement a “comply or “explain” regime with its proposed rules. This is a more aggressive stance than the way the SEC has historically (since 2010) handled the question of diversity in the boardroom.

Specifically, item 407(c)(2)(vi) of Regulation S-K requires that companies disclose:

… whether, and if so how, the nominating committee (or the board) considers diversity in identifying nominees for director. If the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees, describe how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy.

The new Nasdaq rule would require “most Nasdaq-listed companies to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+” per the Nasdaq press release.

Nasdaq defines an underrepresented minority as “an individual who self-identifies in one or more of the following groups: Black or African American, Hispanic or Latino, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander or Two or More Races or Ethnicities.” Nasdaq further outlines in its proposed rules that ‘female’ means an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.

Nasdaq stated that foreign companies and smaller reporting companies “would have additional flexibility in satisfying this requirement with two female directors.”

If the rule is approved, compliance is outlined as follows:

Under proposed Rule 5605(f)(2), no later than two calendar years after the Approval Date, each company must have, or explain why it does not have, one Diverse director. Further, each company must have, or explain why it does not have, two Diverse directors no later than: (i) four calendar years after the Approval Date for companies listed on the Nasdaq Global Select or Global Market tiers; or (ii) five calendar years after the Approval Date for companies listed on the Nasdaq Capital Market tier.

Nasdaq’s proposed rules seem largely aligned with California legislation on diversity (more on this, below). Though with the Nasdaq rule, there aren’t any fines or penalties–-just the disclosure piece that may put some companies in an awkward position of explaining why they are not meeting the Nasdaq requirements.

California Laws on Diversity

In 2018, California implemented its first major law on board diversity with SB 826. SB 826 requires publicly traded companies with principal offices in California to increase the number of women on the board to comply with minimum requirements.

Fast-forward to September 2020 and boards of publicly held companies headquartered in California are required to comply with AB 979, a rule that addresses broader diversity goals beyond just gender for boardroom representation.

AB 979 maintains and expands SB 826’s requirement for female directors on the board. Picking up on the requirements of SB 826, AB 979 states that publicly held companies with principal offices in California must have at least one female director.

Further requirements for female board members depend on the size of the board. Companies must comply by the end of 2021 as follows:

AB 979 adds the requirement for boards of California-headquartered public companies to have at least one director from an underrepresented community by the close of 2021.

Underrepresented community is defined by AB 979 as “ an individual who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender.”

By 2022, the requirements are as follows for public companies with principal offices in California:

Note that SB 826 and AB 979 are two separate laws and can be enforced separately. The law firm Fenwick published a piece in the Harvard Law School Forum on Corporate Governance that includes a robust FAQ for the new law as well as timely advice for corporations attempting to comply with AB 979.

These diversity laws have had and continue to have their detractors. To date, the suits challenging SB 826 have met with limited success. Crest v. Padilla I, was brought by a California taxpayer seeking to enjoin the California Secretary of State from using taxpayer funds to implement and enforce this law that allegedly violates California’s constitution. This action is proceeding. A second suit, Meland v. Padilla, was brought by a corporate shareholder and was dismissed for lack of standing. This dismissal is being appealed.

There is already a suit challenging AB 979, Crest v. Padilla II. The same conservative group that brought a similar suit against SB 826 brought this California taxpayer suit. Note that to date, no board member candidate or company has stepped forward to be a plaintiff in one of these suits.

While California is certainly ahead of the curve when it comes to diversity requirements for public company board members, it is not alone. According to Bloomberg, at least 12 more states have some version of a proposed board diversity statute in the works.

Notably, corporations themselves do not seem to be struggling against these state-mandated diversity requirements. This may in part be because the owners of most corporations—large institutional shareholders—have expressed support for these types of diversity initiatives. BlackRock was calling for diversity in the boardroom and having at least two women as board members in 2018.

What’s Next

A 2020 report by the California Partners Project showed that the number of women on California boards increased about 67% since 2018 when SB 826 went into effect. The study looked at 650 public companies headquartered in California and found that 29% of the companies had no female directors in 2018. By 2020, though, only 2.3% lacked a female director.

It is very likely California-headquartered companies will comply with the new legislation just as they did with SB 826. Like SB 826, however, AB 979 may be challenged on the grounds of constitutionality or other reasons.

Outside of compliance with the law, companies may also face more diversity lawsuits in 2021. You may remember that notable derivative lawsuits against Facebook, Oracle, and Qualcomm around diversity disclosures made headlines in 2020.

These diversity suits are largely premised on the idea that the defendant companies made insincere statements about their commitments to diversity. These suits are a good reminder that however a board of directors chooses to approach these tricky issues, accuracy and follow-through when it comes to disclosure remain important elements of good corporate governance.

It’s also worth noting that insurance carriers are increasingly focused on a company’s board of directors, something we saw in the insurance underwriter survey we summarized in our 2021 D&O Looking Ahead Guide.

Boards that lack any element of diversity may increasingly be regarded as “out of touch,” something that could be taken as a signal of a board’s lack of engagement with best practices in other areas as well. This is, of course, the opposite of how a board would want to be regarded by its shareholders. It is also not how any board would want to be viewed by D&O insurance underwriters, particularly given the current, very difficult market conditions.