How to make sure your company meets Nasdaq’s board diversity requirements

Starting next year, publicly traded companies on the Nasdaq exchange will be required to annually disclose the demographic composition of their boards “using a standardized template” and have at least two board members that identify as female, LGBTQ, or a member of a racial minority group.

If they don’t have at least two diverse directors, they’ll have to explain why in their report.

“Our goal with this proposal is to provide a transparent framework for Nasdaq-listed companies to present their board composition and diversity philosophy effectively to all stakeholders,” Adena Friedman, president and CEO of Nasdaq, said in a release. “We believe this listing rule is one step in a broader journey to achieve inclusive representation across corporate America.”

Illinois and California have had state-level board diversity laws in place, but this represents the first standard with a scope affecting such a significant portion of the world’s largest companies.

“I think we have seen a lot of improvement in diverse representation at the board level for companies in these states because of these requirements,” Wes Bricker, a vice chair and U.S. trust solutions co-leader at PwC, told Fortune. “Boards that are not prioritizing diversity are doing themselves a disservice, regardless of what the laws and requirements are,” he later added.

The SEC approved the new rule Aug. 6, and the first board diversity reporting will be due via the companies’ annual report on Form 10-K or 20-F filings by August of next year. Friedman previously explained to Fortune how Nasdaq’s reporting requirements sit atop the SEC’s to provide a clearer picture of a company’s health and governance.

“The SEC requires enormous amounts of disclosure around business performance, business risks, operating risks, and financial performance,” she said. “Nasdaq then supplements that with more information we require regarding boards and governance. We examine the independence of board members, the composition of committees; governance has become our domain of expertise.”

The reasons for making this push are clear to Friedman, the SEC, and much of the business community: Investors are demanding greater diversity in leadership, and the long-term benefits of board and corporate diversity are becoming apparent as well.

“There’s a growing amount of evidence that diversity on boards is correlated with improved outcomes in two areas: risk controls—that’s important to us because investor protection is critical—and financial performance,” Friedman said.

Belen Gomez, vice president at Equilar, a company that Nasdaq is partnering with on this initiative, told Fortune that while board members historically have mostly been former CEOs and CFOs, companies looking to fill a board seat are now looking to former general counsels, chief human resource officers, and even technical leaders as well. She added that the GCs and CHROs, in particular, are attractive candidates for their ability to support environmental, social, and governance priorities.

“You don’t necessarily need a boardroom full of CEOs,” Gomez said. “Really thinking about different functional areas that add a lot of value and contribute a lot of great experiences and ideas around the table, the conversation has definitely shifted in terms of the other types of roles, and types of experiences that boards are expanding their scope and really looking at.”

Equilar’s database of over a million diverse board candidates is available to Nasdaq-listed companies and clients at no cost so that they can find people to help meet these new requirements. Gomez said this offering is meant to eliminate the common excuse from board selection committees that they don’t know of any qualified, diverse candidates or have any way of finding them.

Another common reason for the lack of diversity on boards, Bricker said, is poor succession planning at this level.

“Many companies wait for a director to retire before they even think about putting a succession plan in place,” he explained. “This last-minute reactive approach often impedes effective recruitment and hinders diversity progress.”

While it’s not always easy to add a new board member to meet the requirement, Bricker said it can be “a great solution,” even if it’s temporary, to increase the size of the board to allow for additions. “This is especially true if your board does not already have a robust individual director assessment process in place,” he added.

Bricker noted that many companies were already advancing their efforts in this space before it became a regulation, and those were the ones who have had the easiest time meeting this requirement or any other diversity requirements that will come through in the future.

“We have long known that diverse perspectives lead to open collaboration and more equitable, sustainable outcomes,” Bricker said. “Taking steps to diversify your board can deepen trust with your investors and stakeholders—falling short of what’s required may not sit well with them, and they are the ones who will be holding companies accountable.”