On August 6, 2021, the Securities and Exchange Commission (“SEC”) adopted the Nasdaq Stock Market LLC’s (“Nasdaq”) proposed board diversity rule. The rule is intended to encourage greater board diversity by requiring board diversity disclosures for Nasdaq-listed companies. As explained in more detail below, the new diversity rule does not mandate quota’s or specific numeric targets for achieving diversity on corporate boards. Rather, the new rule establishes a disclosure framework based on a minimum diversity objective and can be characterized as a “comply or explain” model.

The SEC approved the adoption of the new diversity rule along political party lines by a three to two vote, with Democratic Commissioners in the majority and two Republican Commissioners, Elad Roisman and Hester Peirce, each dissenting, including via a lengthy opposition statement from Commissioner Peirce arguing that the rule is fundamentally flawed, outside of the scope of the Securities and Exchange Act of 1934 (“Exchange Act”) and conflicts with certain fundamental Constitutional principles.

In addition, the SEC also approved a related Nasdaq proposal that offers Nasdaq-listed companies one year complimentary access to board recruitment services intended to facilitate access to a network of board candidates that companies can identify and evaluate.

The Nasdaq Diversity Rule

Nasdaq’s diversity rule establishes a disclosure-based framework intended to make consistent and comparable statistics widely available to investors regarding the number of diverse directors serving on a company’s board. The diversity rule is established in Nasdaq Rules 5605(f) and 5606. As adopted, the diversity rule will require Nasdaq-listed companies to:

• Have, or explain why they do not have, at least two “Diverse” members on their board, including at least one member who self-identifies as “Female” and at least one member who self-identifies as an “Underrepresented Minority” or as “LGBTQ+”; and
• Publicly disclose on an annual basis specified diversity statistics regarding their board of directors. An example of the prescribed format of this disclosure can be found here. This matrix will need to be provided in the company’s proxy statement or information statement for its annual meeting of stockholders, or if the company does not file such statements, in its annual report on Form 10-K. The required matrix requires aggregated disclosures instead of identifying individual directors by name, and directors will not be compelled to identify as a member of any group as the matrix includes a “did not disclose” option.

The above requirements generally apply to all Nasdaq-listed companies, except as follows:

• Smaller Reporting Companies must have, or explain why they do not have, at least two members on their board who are Diverse, including at least one Diverse director who self-identifies as Female and for the second director, who self-identifies as one or more of the following: Female, LGBTQ+, or an Underrepresented Minority.
• Companies with smaller boards (five or fewer members) must have, or explain why they do not have, at least one member on their board who is Diverse.
• Foreign Issuers must have, or explain why they do not have, at least two members on their board who are Diverse, including at least one member who self-identifies as Female and for the second director, who self-identifies as one or more of the following: Female, LGBTQ+, or an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the country of the company’s principal executive offices.
• The only Nasdaq-listed companies exempt from the new diversity rule are: pre-business combination special purpose acquisition companies, asset-backed issuers and other passive issuers, limited partnerships, management investment companies, issuers of non-voting preferred securities, debt securities and certain derivative securities that do not have equity securities listed on Nasdaq, and certain issuers of certain securities other than common or preferred stock and warrants.

If a company does not comply with the diversity objectives described above following the implementation periods discussed below, the company must specify the particular aspect or aspects of the diversity objectives that it fails to comply with and explain the reasons for its non-compliance. Nasdaq did indicate that it does not intend to scrutinize the substance of this disclosure (i.e., the explanation as to noncompliance). Where a company has failed to comply with the diversity objectives and must explain its failure, such disclosure must be provided in advance of the company’s next annual meeting of shareholders in: (i) its proxy statement or information statement; or if it does not file such statements, its annual report on Form 10-K or (ii) on its website.¹ If a company fails to provide the required disclosure or fails to provide an explanation as to why it cannot satisfy Nasdaq’s diversity requirements, it could be subject to delisting.

Definitions

“Diverse” means an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority, or LGBTQ+.

For Foreign Issuers, “Diverse” means an individual who self-identifies as one or more of the following: Female, LGBTQ+, or an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the country of the company’s principal executive offices.

“Female” means in individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.

“Underrepresented Minority” means an individual who self-identifies as one or more of the following: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian, Pacific Islander, or two or more races of ethnicities.

“LGBTQ+” means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.

“Two or More Races or Ethnicities” means a person who identifies with more than one of the following categories: White (not of Hispanic or Latinx origin), Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander.

Implementation and Transition Dates

Diversity Statistical Information Matrix

The required board-level disclosures regarding diversity must be provided by Nasdaq-listed companies by the later of: (i) August 6, 2022, or (ii) the date the company files its proxy statement or information statement, or if the company does not file such statements, its annual report on Form 10-K, for its first annual stockholder meeting after August 6, 2022.

Diversity Objectives Compliance Disclosure

For the disclosure requirements regarding compliance with the diversity objectives (i.e., the comply or explain disclosure), Nasdaq provided for a phased approach based on a company’s Nasdaq market tier. A summary of the compliance and transition dates follows.

• Each Nasdaq-listed company (other than a Nasdaq-listed company with a small board) must have one, or explain why it does not have, at least one Diverse director by the later of: (i) August 6, 2023, and (ii) the date the company files its proxy statement or information statement, or if the company does not file such statements, its annual report on Form 10-K, for its first annual stockholder meeting after August 6, 2023.
• Each Nasdaq-listed company listed on the Global Select Market or Global Market must have, or explain why it does not have, at least two Diverse directors (as delineated above) by the later of: (i) August 6, 2025, and (ii) the date the company files its proxy statement or information statement, or if the company does not file such statements, its annual report on Form 10-K, for its first annual stockholder meeting after August 6, 2025.
• Each Nasdaq-listed company listed on the Nasdaq Capital Market must have, or explain why it does not have, at least two Diverse directors (as delineated above) by the later of: (i) August 6, 2026, and (ii) the date the company files its proxy statement or information statement, or if the company does not file such statements, its annual report on Form 10-K, for its first annual stockholder meeting after August 6, 2026.
• A Nasdaq-listed company that has a small board (five or fewer members) must have, or explain why it does not have, at least one Diverse director before August 6, 2025 or August 6, 2026, depending on its market tier.

Our Perspective

Nasdaq’s new diversity rule amplifies the continued focus on diversity and inclusion issues for public companies as proxy advisors, institutional investors, customers, and other stakeholders call for change. Nasdaq believes its new rule promotes diverse leadership while giving listed companies flexibility under a comply or explain framework.

To be sure, regulating our way to a more diverse corporate culture will face legal challenges as evidenced by the Fifth Circuit Petition for Review filed by Alliance for Fair Board Recruitment (“AFBR”) challenging the new Nasdaq diversity rule² and the current Ninth Circuit challenge to California’s law, SB 826 (see our previous client alerts on this topic here and here), which requires companies with principal executive offices in California to have a certain number of women directors on their Board.

Despite these legal challenges, we expect that most companies will lean more towards complying with the new diversity rule before the final phase in of the diversity objectives is required, as a number of companies have made recent strides on diversity and inclusion issues, particularly as it relates to board gender diversity.

For companies that are struggling with board diversity inclusion efforts, 12 months of free access to a network of board-ready diverse candidates is available through NASDAQ’s relationships with Equilar’s BoardEdge Platform and Equilar Diversity Network, Athena Alliance’s community of women leaders, and the Boardlist’s premium talent marketplace.