ESG Investing

Nasdaq Rule Requires a Diverse Board of Directors for Listed Companies

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A more diverse board of directors may be on the horizon for Nasdaq-listed companies.

First proposed by Nasdaq in December 2020 and endorsed by the Securities and Exchange Commission (SEC) the following August, a new rule requires boards to disclose diversity in an unprecedented manner. This follows a similar action by Fortune 500, which introduced a diversity metric earlier this year.

The new Nasdaq rule could prove a boon to long-underrepresented demographics such as women, minorities, and members of the LGBTQIA+ community. However, the response has not been uniform, with pushback from several quarters. Nevertheless, the decision provides ESG investors concerned about diversity and inclusion with one more metric to help make an impact.

Introducing New Diversity Requirements

Approved by the SEC on August 6, 2021, Rule 5605(f) states that all Nasdaq-listed companies must meet the following diversity requirements for their boards of directors:

  • Have at least two board members who meet diversity requirements. One must identify as female and the second must identify as an underrepresented racial or ethnic minority or as a member of the LGBTQIA+ community.
  • Publish statistics on board diversity on a regular basis.
  • Provide a written explanation of any failure to meet diversity goals.

The rule does not impact all companies equally, however. Foreign companies, those that meet the guidelines for smaller reporting companies, and companies with five or fewer board members all have unique requirements. Nevertheless, these three types of companies must still provide a written report of any failures to meet diversity requirements.

The new Nasdaq rule could prove a boon to long-underrepresented demographics such as women, minorities, and members of the LGBTQIA+ community.

Facing Pushback on the Rule

The new rule has invited some criticism. In a piece for Harvard Business Review, YSC Consulting Senior Diversity and Inclusion Advisor Simran Jeet Singh cautions that the change could lead to tokenism if companies are not willing to perform deeper cultural work. “The organizations that will benefit most from Nasdaq’s decision are those that see its recommendations not as tick boxes but as an impetus to achieve thoughtful and purposeful change,” he writes.

The rule has also encountered ongoing legal challenges in court. For example, the Alliance for Fair Board Recruitment has sued the SEC, asserting that the “race, sex and sexual identity board quotas required by Nasdaq are unfair and illegal.”

Addressing Impacts for ESG Investors

For ESG-minded investors, the new Nasdaq rule may offer substantial benefits.

  • Enhanced ESG vetting: As companies roll out required reporting in 2022, ESG fund managers and investment advisors will have even more tools to weigh an investment’s fit for ESG portfolios.
  • Investment options: Investors with an eye toward supporting minority stakeholders, such as Black and LGBTQIA+ people, stand to see their investment choices increase as board diversity data becomes a regular investment assessment tool.
  • Increased returns potential: Emphasizing the governance element of ESG as the intersection of conscious company culture and performance, increasing board diversity could bring about increased returns from companies coming into compliance.
  • Further growth of the ESG sector: According to Morningstar, investors committed $51 million to sustainable funds in 2020. With more opportunities for companies to join the ESG ranks, investment managers could create more funds to offer ESG investors a wider array of investment products.

Although the Nasdaq board diversity rule is still in its early stages, it highlights some of the growing opportunities for investors to reflect America’s changing demographics. Many companies are long overdue in building a diverse board of directors; the potential performance increases that representation can bring highlight the multifaceted benefits of working toward intersectional leadership.

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