By Lisa Silverman, Senior Managing Director

In 2020, real-world social justice issues dovetailed with corporate governance, as investors demanded reform at the highest level of public company boards. Diversity took center stage, as institutional and activist investors, individual states, and even stock exchanges weighed in. According to Activist Insight Governance data, in 2020, 23.5% of Russell 3000 directors were female, up from 18% in 2018. In the wake of the Black Lives Matter protests, attention is now turning to racial and ethnic diversity. As corporations scramble to meet new diversity requirements, and activist investors reevaluate their own criteria for dissident slates, unique opportunities and challenges arise.

As has been widely reported, in recent years investors have adopted proxy voting policies aimed at promoting more women on boards, which has helped to ensure record levels of female directors. In fact, in 2018, California was the first state to pass a law requiring all public companies headquartered in California to have at least one woman on their board. Since then, Colorado, Illinois, Maryland, Massachusetts, Michigan, New Jersey, New York, Ohio, Pennsylvania, and Washington have also introduced or passed legislation or resolutions related to board diversity. In 2020, a lack of female representation on boards was a key reason investors opposed board candidates.

Recently, diversity requirements have expanded beyond women. Notably, California and Illinois have expanded these requirements. By the end of 2021, all California boards must have one underrepresented minority; by the end of 2022, boards with nine or more members must have three underrepresented members, while boards with five to eight members must have two underrepresented members. Illinois also requires disclosure of underrepresented groups on boards.

Until recently, board diversity requirements had been limited to actions by individual states. However, in December 2020, Nasdaq filed a proposal with the Securities and Exchange Commission (SEC) for new listing rules regarding board diversity and disclosure. If adopted, they would require a “comply or explain” mandate for board diversity for most listed companies and would also require companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding their board composition. Although Nasdaq amended its proposal in March 2021, the rules would have a significant impact as most companies fall short of these requirements. The SEC could decide on the proposal by summer.

Additionally, under the Biden administration the SEC is expected to move away from its current position of “principles based” disclosure, adopting specific disclosure mandates particularly relating to diversity, climate change, and other ESG-focused areas. In February 2021, acting SEC commissioner Allison Herren Lee said the U.S. securities regulator should think more “creatively and broadly” about tackling issues of race and gender diversity, by, among other things potentially revisiting public companies’ disclosure requirements.

The Practical Impact on Boards

While few dispute diverse boards benefit companies overall, companies have struggled with this initiative, which in part stems from a lack of diversity in the C-suite. Many of America’s largest companies prohibit employees outside their topmost ranks from joining external boards, which leads to intense competition for qualified board candidates. Both corporations and boards find themselves considering in the position of vying for the relatively small number of individuals who meet diversity requirements and have board experience. 

As diversity requirements continue to grow, board candidates with less traditional experience are being considered, requiring a heightened level of scrutiny in preparation for SEC disclosure requirements and assessment by investors. While a lack of board or executive experience should not be disqualifying, those considering potential nominees should take time to ensure a candidate is not being nominated just to fill a diversity requirement but has the experience, perspective, and insights that will make them an asset to the board. A potential candidate can develop experience in a multitude of ways over the course of a career, and close scrutiny benefits both the candidate and the company. A forgotten exaggeration in a LinkedIn profile can become a material misstatement in an SEC bio.Likewise, a newly unearthed tweet from ten years ago can wreak havoc for a newly minted board member. As a result, close analysis of nominees’ backgrounds allows companies and activists alike to develop a full understanding of the strengths of their candidates, and prepare for possible criticisms, setting them up for successful election to a board.

It is easy to get caught up in the excitement of the times as boards begin more closely to resemble their employees, shareholders, and customers. However, these advances risk being eradicated if appropriate diligence is not undertaken, and companies find themselves in the headlines for less than stellar choices.