This summer, the Securities and Exchange Commission (“SEC”) approved the Nasdaq Stock Market LLC (“Nasdaq”) listing rule changes related to board diversity, which have been implemented as Listing Rules 5605(f) and 5606. These rules can be found here. Information from Nasdaq related to the board diversity rules is available at this link.
Rule 5605(f) – Disclosure-Based Board Diversity Standard
In the next few years, each company listed on Nasdaq, subject to exceptions discussed below, will need to either (i) have two diverse directors consisting of at least one female director and at least one director who is an underrepresented minority or LGBTQ+ or (ii) explain why it does not have these two diverse directors (hereinafter the “Rule”).
The Rule sets a disclosure-based standard and is not a requirement. Companies do not have to have two diverse directors but will be required to explain why they do not meet the diversity standard in such cases. The substance or merits of a company’s explanation, should the company choose to explain why it does not meet the diversity standard, will not be evaluated by Nasdaq for purposes of compliance with the Rule, but may be scrutinized by investors and the public at large.
Who is Diverse Under the Rules?
For purposes of the Rule, a person is diverse if they self-identify as female, an underrepresented minority, or a member of the LGBTQ+ community. The rule elaborates that these categories mean people who self-identify as follows:
- Female: female, regardless of sex designated at birth.
- LGBTQ+: lesbian, gay, bisexual, transgender, or members of the queer community.
- Underrepresented Minorities: 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.
- Two or More Races or Ethnicities: based on self-identification as at least two of the following categories: White (not of Hispanic or Latinx origin), and the underrepresented minority categories.
The question of a director’s diversity status is based on self-identification by the director, is self-reported and is meant to be voluntary. If a director chooses to not report their gender and demographic information, a company cannot rely on that director for the purposes of the Rule. For example, if a director who self-identifies as a member of the LGBTQ+ community does not elect to report this information, then that director would not count as one of the company’s two diverse directors. Thus, while a company may technically meet the diversity standard, if it is unable to disclose board member diversity statistics that meet the Rule, it will have to explain why it does not meet the requirements of the Rule.
Accordingly, it will be critical for upcoming proxy seasons for companies to think ahead about communicating this rule change to their boards and working with management and outside advisors to develop a tailored self-reporting questionnaire.
Smaller Reporting Companies. Smaller reporting companies have greater flexibility in meeting the diversity standard as the second diverse director can be an individual who self-identifies as female, LGBTQ+, or an underrepresented minority. This means smaller reporting companies can meet the diversity standard by having two female directors. Smaller reporting companies also have more time to implement the change as discussed below.
Foreign Issuers. Foreign issuers may also meet the diversity standard by having two female directors. In addition, the classification of an underrepresented minority is broader for foreign issuers as it is not limited to race alone, but can also be established through national, ethnic, indigenous, cultural, religious, or linguistic identity in the country of the company’s principal executive offices.
Companies with Smaller Boards. Companies with boards of directors of five or fewer members, including smaller reporting companies and foreign issuers, are only required to have one diverse director. Moreover, if a company has a five-member board of directors prior to becoming subject to the Rule, it will not be required to have two diverse directors if it adds a sixth board member to meet the diversity standard. This accommodation is removed if a company subsequently expands its board.
Rule 5606 Diversity Matrix and Alternate Disclosures
The reporting requirements for the Rule are set out in Rule 5606 and 5605(f)(3). Beginning in 2022, all Nasdaq-listed companies, unless exempt as discussed below, are required to disclose two years (one year for the first disclosure) of director diversity statistics on a standardized matrix template (the “Matrix”). The templates for both foreign and non-foreign companies are provided in Rule 5606.
A company that does not meet the diversity standard is required to disclose, in addition to and contemporaneously with the Matrix, the specific requirements of Rule 5605(f)(2) that are applicable to it (i.e., the Rule adjusted by any exceptions), and an explanation of the reasons why it does not have the applicable number of diverse directors. For example, a smaller reporting company that does not meet the diversity standard would need to state that it is only required to have one diverse director, provide an explanation why it does not have at least one diverse director, and provide the Matrix.
This disclosure must be made annually before a company’s annual stockholder meeting and can be filed in a proxy or information statement or on a company’s website. If posting via website, companies must post the disclosure contemporaneously with their proxy or information statement and submit a URL link through the Nasdaq Listing Center within one business day. For a company that does not file a proxy or information statement, this rule applies when it files its Annual Report Form 10-K or 20-F.
Some companies are exempt from the Rule and Matrix requirement set forth in Sections 5605 and 5606, including SPACs, asset-backed 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 other securities listed under Nasdaq Rule 5700.
Time to Implement
Rule 5605 Matrix
Most companies must comply with Rule 5606 and provide the Matrix of board diversity statistics by the later of (i) August 8, 2022, or (ii) the filing date of the 2022 proxy statement. Companies newly listed on Nasdaq that have not been held to a substantially similar requirement of another national securities exchange must satisfy the requirements of Rule 5606 within one year of listing.
Rule 5605 Diversity Standard
The deadline for the Rule and having a more diverse board is later than the Matrix disclosure deadline. The Rule provides for a phase-in period for newly listed Nasdaq companies as well as a deadline for existing companies. Deadlines for currently listed companies are:
- August 7, 2023, for all listed companies, including smaller reporting companies, to have (or explain why they do not have) at least one diverse director.
- August 6, 2025, for Nasdaq Global Select Market or Nasdaq Global Market listed companies to have (or explain why they do not have) at least two diverse directors.
- August 6, 2026, for Nasdaq Capital Market listed companies to have (or explain why they do not have) at least two diverse directors.
In August 2021, the Alliance for Fair Board Recruitment filed a petition for review of the SEC approval of the new Nasdaq diversity rules to a federal appeals court. However, barring a ruling from the Fifth Circuit finding the rule unenforceable or improper, companies should ensure they are ready to comply with the new diversity disclosure rules. It is not too early to start thinking about collecting this critical and sensitive information for next proxy season.
The SEC is expected to propose its own board diversity disclosure rules this Fall. Companies should watch for any proposed rules and we will keep you apprised of any changes.
If you have any questions related to Nasdaq’s new board diversity disclosure, the Securities and Capital Markets team at Harter, Secrest & Emery, LLP is ready to help.