ISS, Glass Lewis, and Now Nasdaq – Board Diversity Is Here

On December 1, 2020, the Nasdaq Stock Market LLC (“Nasdaq”) proposed to adopt listing rules related to board diversity after determining that the national market and the public interest would benefit from a regulatory framework designed to promote “meaningful and multi-dimensional diversification of their boards.” This news comes following the influx of recent state laws and proposals relating to board diversity[1] and on the heels of announcements from both Institutional Shareholder Services Inc. (“ISS”) and Glass Lewis that they have updated their voting policies related to board diversity. The proposed rule change had met with significant stakeholder interest, with Nasdaq reporting that as of January 9, 2021, it had received more than 150 comment letters. Nasdaq’s proposed rules represent the second largest stock exchange in the world, recognizing mounting pressure from shareholders, institutional investors, and advisory services to proactively address board diversity as part of a public company’s disclosures. Board diversity is a trend that cannot be ignored, irrespective of the state in which a company is headquartered, and California’s headline-grabbing board diversity legislation can no longer be seen as an outlier event, but rather a harbinger—indicative of a larger movement that has now resulted in new initiatives by Nasdaq, ISS, and Glass Lewis.

Nasdaq proposes new rules for listed companies

Nasdaq’s proposed rules are not yet effective and require Securities and Exchange Commission (“SEC”) approval before a company would need to comply. On January 8, 2021, Nasdaq filed a comment letter with the SEC giving its consent to extend the time period for SEC action on the proposed rule change from January 4 to March 11, in order to not only provide the SEC with more time to review the proposal, but also to give Nasdaq time to respond many comment letters it had received in a comprehensive manner. If approved, the new rules would require companies listed on Nasdaq to (i) provide statistical information regarding diversity on their board and (ii) if they fail to meet this threshold, explain why the company does not have at least two “Diverse” directors. For most Nasdaq-listed companies, the proposed rule distinguishes between, and requires the inclusion of, two different categories of Diverse directors. In order to be compliant, a company must have at least one Female director and at least one Underrepresented Minority director. Only foreign issuers and smaller reporting companies could satisfy the requirement with two Female directors.

Under the proposed rule, “Diverse” means a director who “self-identifies as: (i) Female, (ii) an Underrepresented Minority, or (iii) LGBTQ+.” “Female” is defined as a person who “self‑identifies her gender as a woman, regardless of her sex at birth.” “Underrepresented Minority” is defined as a person 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 or Pacific Islander, or Two or More Races or Ethnicities.”[2] “LGBTQ+” means an individual who “self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.”

The proposal provides a phase-in timeline for meeting the requirements with slightly different rules for its separate market tiers: Global Select Market, Global Market, and Capital Market. The requirements set forth in the rule proposal are as follows:

• All Nasdaq-listed companies would need to provide board-level statistical information regarding diversity within one calendar year of the SEC’s approval of the rule;
• All Nasdaq-listed companies would need to have, or explain why such company does not have, one Diverse director within two years following the date of approval; and
• Companies would need to have, or explain why such company does not have, two Diverse directors within:
  
  • Four years following the date of approval for companies listed on the Nasdaq Global Select Market or Global Market tiers; or
  • Five years following the date of approval for companies listed on the Nasdaq Capital Market tier.

A Nasdaq-listed company may also follow a timeframe applicable to a different market tier so long as it publicly discloses the reasoning behind the decision.

The first requirement of all Nasdaq-listed companies would be disclosure of board-level diversity data. Such disclosure would be provided annually in a format substantially similar to a Board Diversity Matrix that Nasdaq provided an example of in its rule proposal—see below in the appendix—which identifies the total number of directors and the number of directors who identify in the various Diverse categories. A company would be required to provide this disclosure in its proxy statement or information statement for its annual meeting or on the company’s website. Then, once the requirement for a certain number of Diverse directors became applicable, if a company did not meet the minimum requirement of Diverse directors, it would have to (i) specify the requirement of the proposed rules and (ii) explain why it has not met such requirement. This explanatory disclosure would have to be provided in the same manner as the Board Diversity Matrix.

ISS updates its voting policy

ISS has also made changes to its voting policies related to diversity that will reach companies in the S&P 1500 and Russel 3000. Under the revised policy, effective for meetings on or after February 1, 2022, ISS will recommend withholding a vote, or voting against, the reelection of any chair of a nominating committee, or other directors on a case-by-case basis, where the company’s board has no apparent racial or ethnic diversity. ISS has said such policy is designed to help investors identify companies with which they may wish to engage and to help foster a dialogue on this topic between companies and investors. ISS’ new policy on racial and ethnic diversity is in addition to its existing policy on gender diversity, pursuant to which ISS will recommend withholding a vote, or voting against, the reelection of any chair of a nominating committee, or other directors on a case-by-case basis, where there are no women on a company’s board.

Companies should note that this new voting policy would be implemented as follows:

• In 2021, during a “one year transition period,” ISS research reports will identify company boards that lack racial and ethnic diversity.
• Starting in 2022, ISS will generally recommend withholding a vote, or voting against, the chair of any nominating committee, or other directors on a case-by-case basis, where the company’s board has no racial or ethnic diversity. Mitigating factors will include the presence of a racial and/or ethnic minority on the board at the preceding annual meeting and a firm commitment to appoint at least one racial and/or ethnic diverse member.

Glass Lewis updates its voting policy

Glass Lewis has also weighed in on the board diversity topic with its own set of voting policy updates. Starting January 1, 2021, Glass Lewis now assesses companies listed in the S&P 500 on their disclosure of board gender diversity in their proxy statements—noting companies with boards that have fewer than two female directors as a factor for concern. It will also assess board diversity based on race and ethnicity and a company’s disclosure of such data in its proxy statement. Glass Lewis’ guidelines also reference the new state laws on diversity. The advisory service states that its own recommendations will align with composition requirements under applicable state laws, providing an example of pressure from an advisory proxy service firm strengthening the mandate of a state law that is applicable to a company.

In order for a company to comply with Glass Lewis’ updated guidelines, it should prepare for the services’ diversity assessment, which will center around:

• A board’s current composition based on race and ethnic diversity;
• Whether the board’s definition of diversity explicitly includes gender and race;
• Whether the board has implemented policies pertaining to women and minorities in the candidate pool; and
• Board skills disclosure.

Note that Glass Lewis has proposed the following timeline for the changes to its voting policy:

• As of January 1, 2021, Glass Lewis will be flagging deficiencies as areas of concern for a company in 2021 but will continue to make voting recommendations based on its current requirement of at least one female board member.
• As of January 1, 2022, Glass Lewis will begin acting solely upon the results of its updated diversity assessment—planning to generally vote against the nominating committee chair of a board whenever such board has less than two female directors.
• As of January 1, 2021, Glass Lewis will begin tracking the quality of racial and ethnic board diversity in proxy statements—focusing on the board’s current percentage of racial and ethnic diversity, the board’s definition of diversity, and whether the board has adopted a policy that requires the inclusion of women and minorities in the initial pool of candidates for director nominees.

Preparing for expanded disclosure and increased shareholder engagement on diversity

While Nasdaq is focused on providing additional disclosure without imposing mandated diversity standards for boards, this disclosure proposal is ultimately reflective of the interest of shareholders in board diversity. ISS and Glass Lewis’ voting policies are evidence of shareholders’ increasing likelihood of voting on the basis of perceived shortcomings in a company’s diversity profile. As can be seen from their recent updates, both proxy advisory service firms are implementing voting policies that ask for minimum levels of female and minority representation on boards. However, both services are also implementing policies that call for (i) company disclosure and (ii) formal written policies from companies designed to address diversity issues. Though these two proxy advisory services cannot enforce or mandate certain disclosures, their combined pressure carries enormous weight—this, added with the applicable state changes that these services seem inclined to enforce, creates a web of guidance and mandates to navigate in order to attract both high-end investors and employees.

Company disclosures under the proposed Nasdaq rules and meeting the diversity targets under ISS and Glass Lewis should be viewed as just a starting place, and companies should use the exercise of reviewing such rules as a first step in a more holistic assessment of the board’s current diversity profile and the board’s and company’s diversity goals. Such goals should consider not only board composition, but also diversity and inclusion for management and employees. As shareholders increasingly engage on this topic, companies and their boards will be well served by considering the messaging and goals on diversity proactively and not merely being reactive to stock exchange and proxy advisory firm developments.

Appendix:
Board Diversity Matrix

[1] See our client alert titled: New California Law to Require Representation from “Underrepresented Communities” on Boards of Public Companies Headquartered in California, available at: https://www.mofo.com/resources/insights/200831-new-california-law.html.

[2] Foreign issuers may satisfy the diversity requirement by having an individual who self identifies as an underrepresented individual based on national, racial, ethnic, indigenous, cultural, religious, or linguistic identity in the company’s home country jurisdiction.