Two recent California state court decisions and litigation over Nasdaq’s Rule 5606(f) have increased scrutiny on efforts by states and regulators to increase diversity on public company boards. But investors continue to value board diversity.
First, a bit about those two California cases…
SB 826: On May 16, a California state court judge ruled unconstitutional California’s SB 826 requiring publicly held companies headquartered there to include 1 director who identifies as a woman by year-end 2019 and boards with 5 directors to include 2 women and boards with 6 or more members to include 3 women by January 2022.
AB 979: On April 1, a California state court judge struck down AB 979, California’s more recent effort to mandate inclusion of underrepresented groups on boards. Adopted in 2020, AB 979 required a publicly held domestic or foreign corporation with principal executive offices located in California. The law defined an individual from an underrepresented community 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.”
Notably, legislative efforts to increase board diversity don’t stop at California’s borders…
Other states have adopted varied approaches to encouraging more diverse corporate boards. For example, Illinois requires publicly traded companies headquartered there to report board composition.
Second, Nasdaq Rule 5606(f)…
In August 2021, the SEC approved Nasdaq Rule 5606(f). Nasdaq sees the Rule as setting forth “aspirational diversity objectives.” 5606(f) requires Nasdaq-listed company boards to:
- Include at least 2 self-identified “diverse” board members (a woman and underrepresented minority and/or LGBTQ+ individual) or explain in writing why they are not doing so.
- Starting in 2022, disclose board-level diversity stats using a standardized matrix template. Those stats include the number of directors who self-identify with specified categories: Gender, Race/ethnicity, and LGBTQ+ status.
Plaintiffs have challenged Rule 5606 in federal court.
While the legal challenges continue, the “influencers” are pressing for greater board diversity
Legal challenges to state and regulators’ efforts to increase public company board diversity are likely to go on (and on). In the meantime, the “influencers” are ramping up expectations regarding board diversity and related disclosure. Among key influencers: investors.
Investors are stepping up efforts to influence (and increase) board diversity
Many investors recognize that board diversity contributes to diversity of thought and that contributes to better board decision-making – which can improve company performance. So, investors are paying increased attention and attempting to influence board diversity. Governance policies and voting practices reflect this growing focus. These examples are illustrative (policies abbreviated).
BlackRock urges boards to aspire to 30% diversity, at least 2 female directors, and at least 1director from an “underrepresented group” (which includes individuals who identify as racial or ethnic minorities, LGBTQ+, underrepresented based on national, Indigenous, religious or cultural identity, individuals with disabilities and veterans.). And it wants issuers to disclose:
- How the board’s diversity characteristics, in aggregate, are aligned with a company’s long-term strategy and business model, and
- Whether a diverse slate of nominees is considered for all available board seats.
Vanguard is looking for information about current board composition and related strategy:
- Statements about the board’s intended composition strategy, including expectations for year-over-year progress.
- Policies for promoting progress toward greater board diversity; and
- Current attributes of the board’s composition.
Vanguards looks for diversity disclosure to cover, at a minimum, director gender, race, ethnicity, tenure, skills, and experience.
State Street expects companies to provide board disclosures by gender, race, and ethnicity (at a minimum) at an aggregate or individual level; and also to address efforts to achieve diversity at the board level, including how the governance committee considers ensures diverse candidates are considered during the recruitment process. State Street also encourages companies to consider providing disclosures about other dimensions of diversity (LGBTQ+, disabilities, etc.).
Influencers are having some impact on board diversity and diversity disclosure
Corporate Board Practices in the Russell 3000, S&P 500, and S&P MidCap 400: 2021 Edition (a collaboration amongst Debevoise & Plimpton, KPMG Board Leadership Center, Russell Reynolds Associates, and John L. Weinberg Center for Corporate Governance) includes a comprehensive review of board composition and diversity disclosure. The study notes:
- Women’s representation on Russell 3000 boards increased from 21.9% in 2020 to 24.4% in 2021. Women represented about 38% of 2021’s newly elected directors in both the Russell 3000 and S&P 500.
- However, racial and ethnic diversity among new directors continued to lag.
- African Americans were 11.3% of new directors elected in 2020, 11.5% in 2021.
- Latinx/Hispanics were 6% of the 2020 class, 6.5% in 2021.
- Asian, Hawaiian, or Pacific Islanders were 2.9% of the 2020 class, 3.1% in 2021.
- 78.3% of the 2021 class of new directors were white.
The study also found that more companies are disclosing more board diversity data. Only 24% of the S&P 500 disclosed the racial composition of their boards in 2020; 59% did in 2021. 7.7% of the Russell 3000 disclosed in 2020; 26.9% did in 2021.
Boards should not take much comfort from the two recent California decisions or wait for resolution of the challenge to Nasdaq Rule 5606(f)
The rather slow progress in board diversity is disappointing to many. Companies realize value from diverse boards – as they compete for capital as well as customers. Investors see value in diverse boards and seek to invest in companies with diverse boards and boards willing to share meaningful board diversity data with investors. Companies do well to devote attention to building those boards or risk disappointing investors — and facing the consequences.
More another time about ways to accelerate recruitment of diverse directors.
