SEC approves Nasdaq’s new diversity requirements for public company boards

For eight months, the New York exchange operator has been seeking the Securities and Exchange Commission’s sign-off on a plan to require many of its listed companies to have at least one or two “diverse” board members, or explain in writing why they do not. Nasdaq has also been pushing to be able to require its issuers to disclose the diversity breakdown of their boards.

And after some tweaks were made about who must comply, how, and when, Nasdaq finally got its wish Friday when the SEC approved the proposals.

“Investors are looking for consistent and comparable data when making decisions about their investments,” SEC Chair Gary Gensler said in a statement following the decision. “I believe that our markets work best when investors have access to such information.”

Under the proposal’s structure, the majority of Nasdaq-listed issuers that are based in the U.S. will need to have at least one woman on the board and another who self-identifies as Black, Hispanic, Asian, Native American, LGBTQ+, or as part of another underrepresented minority, by certain deadlines over the coming years. If the companies do not meet those benchmarks, though, Nasdaq is not threatening to delist their stocks. The exchange instead wants the company to explain in writing why that is, which could amplify public and investor pressure on the company to diversify. Nasdaq is even offering to cover the cost of board recruiting services for some of its listed companies.

Issuers will also need to begin disclosing the statistical diversity breakdown of their boards’ structures by next year under the rule, a requirement that some have already fulfilled. LPL Financial, for instance, disclosed earlier this year that its board included six men, one of whom identifies as Black or African American, and three women, all of whom are white. Stamps.com said in an April proxy statement that it had four men on its board and one woman, while another director’s gender was not disclosed. Of the four men, one of Stamps.com’s directors identifies as Asian.

The ruling marks a historic moment for advocates and investors who have been pushing for more women, people of color, and members of the LGBTQ+ community to have a seat in corporate America’s higher ranks, something that Nasdaq has continually touted as being paramount to better financial returns and risk controls. As Rusty O’Kelley III, who is a co-leader of board and CEO advisory partners at executive search firm Russell Reynolds Associates, told Fortune, the rules will “spur discussions in the nominating committees of every Nasdaq listed company about gender and ethnic diversity, which will ultimately lead to conversations about board composition, skills, experiences, and whether they have an inclusive culture.”

For years, a campaign to bring new voices to corporate America’s white-and-male-dominated boardrooms has been gaining steam among investors, executives, and academics. Wall Street—perhaps surprisingly considering the financial sector’s historical lack of diversity—has been one of the most active in the effort as of late, with many institutions wielding their power at the nexus of the financial markets to effect change. Goldman Sachs, for example, works to bring public only companies that have a certain level of diversity on their boards. Others like BlackRock and State Street have used their sway as some of the world’s biggest public-market investors to try to persuade companies to diversify their C-suites and boards.

Change has been gradual, nonetheless. A recent study from Deloitte in partnership with the Alliance for Board Diversity found that men occupied nearly 75% of board seats among Fortune 500 companies in 2020. White directors represented 82.5% of the Fortune 500’s board seats.

“There is a continued, harmful disparity in the representation of a wide range of communities in our capital markets,” SEC Commissioners Allison Herren Lee and Caroline Crenshaw, both of whom voted in support of the proposal, said in a joint statement. “Because enhanced diversity is critically important for investors, the markets, and our economy, we hope this is a starting point for initiatives related to diversity, not the finish line.”

Led by Adena Friedman, Nasdaq sees its proposal as a sort of opening salvo toward promoting diversity in the boardroom. “We are pleased that the SEC has approved Nasdaq’s proposal to enhance board diversity disclosures and encourage the creation of more diverse boards through a market-led solution,” Nasdaq said in a statement following the SEC’s decision.

Stock exchanges have historically acted as the financial markets’ gatekeepers, often cracking down on bad corporate governance practices in the name of better functioning markets and investor protections. And now, with a growing body of research showing how board diversity can improve shareholders’ returns, investors have begun clamoring for more transparent diversity data themselves—helping pave the way for the Nasdaq proposals. Nasdaq, in one instance in its proposal, pointed to a 2020 report from the Carlyle Group, where Friedman was formerly CFO, highlighting that companies in its portfolio with at least two diverse directors posted average earnings growth of 12.3% over the prior three years, versus 0.5% among those with no diversity on their boards.

“What gets measured, gets done,” Ariel Investments co-CEOs John Rogers Jr. and Mellody Hobson wrote in a December 2020 letter to the SEC in support of the proposal. “In the annual reports that we read regularly, diversity is often stated as a ‘strategic imperative.’ It is impossible to measure progress without data. As such, when it comes to board diversity disclosures, clarity and uniformity are needed.”

However, questions have still arisen as to whether the exchange itself should even be able to ask for such information. No group has arguably been more critical of the proposal than congressional Republicans, a dozen of whom led by Sen. Pat Toomey wrote to the SEC in February to raise their concerns over the rule. In a statement following the ruling, Toomey called Nasdaq’s rule a “one-size-fits-all quota” that “misses the mark.”

“By defining diversity by race, gender, and sexual orientation, Nasdaq’s mandate will inevitably pressure companies to subordinate crucial factors such as knowledge, experience, and expertise when selecting board members,” the Pennsylvania Republican said.

SEC Commissioners Hester Peirce and Elad Roisman voted against the bulk of the Nasdaq proposal. In a statement, Peirce said the rule will have the inverse influence it purports to focus on, adding that it will raise “new arbitrary barriers.” Said Peirce: “Unfortunately, the Proposal will not help to achieve greater opportunity for all members of society to exercise their talents. Nor will it advance the Exchange’s stated objectives of more accurate and comparable board diversity data and less ‘groupthink.’ It is more likely to do the opposite because it relies on crude categorizations of people into racial, gender, ethnic, and LGBTQ+ status boxes that deprive the people being categorized of their individuality and their professional, educational, experiential, and personal complexity.”

Others have criticized the Nasdaq proposal for not going far enough.

In June, Ted Kennedy Jr., the chairman of the American Association of People With Disabilities, for one, wrote in Fortune that people with disabilities should have also been considered as diverse under the Nasdaq proposal—considering Congress, the judicial system, and government agencies have long recognized the “history of unequal treatment and marginalization” those with disabilities have faced historically. Meanwhile, National Urban League president and CEO Marc Morial and Patrick Bradford, a partner at Bradford Edwards & Varlack LLP, took issue with the proposal’s structure to allow a company to comply by having either a Black person on its board or a member of the LGBTQ community. “This is unacceptable,” the two wrote in Fortune. “It suggests that potential Black directors and white LGBTQ directors are interchangeable. To pit these differently situated diverse groups against each other is poor public policy.”

Nasdaq acknowledged many of those concerns in February, but did not amend its proposal to widen the scope of what classifies as a “diverse” director. Instead, the exchange said that the proposal does allow companies “to consider additional diverse attributes when identifying director nominees, such as nationality, disability, or veteran status, and [companies] are free to disclose information related to diverse attributes of board members beyond those highlighted in the rule.”

Update, August 6, 2021: This article has been updated with a statement from SEC Commissioner Hester Peirce and a comment from executive search firm Russell Reynolds Associates.