Lawsuit Challenges Nasdaq Diversity Rule: How Should Boards Respond?

Every board of a Nasdaq-listed company will need to decide how it will respond to the Nasdaq rule before the 2022 proxy season—or risk being accused of tacitly agreeing with the lawsuit’s contention.

The predictable pushback against board diversity has been taken to the next stage as the Alliance for Fair Board Recruitment has filed a Federal lawsuit last month seeking to overturn the SEC’s approval of Nasdaq’s rule requiring companies listed on its exchange to diversify their boards or explain why they won’t.

The Nasdaq rule requires Nasdaq-listed companies to have at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+, or provide an explanation for not doing so. The rule further states that, “Nasdaq will verify that the company has provided an explanation, but will not assess the merits of the explanation. There is no right or wrong reason that a company may give for not having at least two directors.”

In a press release from AFFBR, president Edward Blum said: “The race, sex and sexual identity board quotas required by Nasdaq are unfair and illegal. This rule violates our nation’s civil rights laws and Constitution and should be struck down by the courts without delay.”

The release also states, “AFFBR has members who, because of their race, sex and sexual orientation are forced to compete on an uneven playing field because of Nasdaq’s quota requirements.”

So although it may be left up to the courts to decide whether Nasdaq’s remedy for what some people felt was an uneven playing field has created an uneven playing field for other people, boards must decide where they stand on the issue now. Every board of a Nasdaq-listed company will need to decide how it will respond to the Nasdaq rule before the 2022 proxy season. Here are some things to consider:

• Prepare a public statement that clearly defines the company’s position on the rule. In the current politically charged atmosphere, a court case putting the Nasdaq rule on trial could generate high public interest. Boards will need to respond to shareholders and employees if the situation arises. This may be one circumstance where not having or refusing to make a statement will be interpreted as making a statement.

• Understand the risks associated with the position taken regarding the Nasdaq board diversity rule. The Nasdaq rule has been debated since it was first proposed late last year. Now that it has been approved by the SEC, companies are bound to comply. Nasdaq has gone out of its way to say the rule is not a mandate, but the lawsuit challenges that, calling the rule a quota.

Boards should know that the lawsuit could add a level of risk to Nasdaq-listed companies that resist complying with the rule. If companies do nothing, they may be accused of agreeing with the lawsuit’s contention that the rule is unconstitutional. There’s no way of knowing how that will play with customers, employees and on social media. Coming out against the rule might invite heightened scrutiny and reputational damage. However, complying with the rule by providing an explanation why the company has not diversified its board might decrease stakeholder scrutiny on something many feel the SEC has already settled.

• Engage with investors to head off potential shareholder proposals in 2022. By now Nasdaq-listed boards should know if they have shareholders who are sensitive to the issue of board diversity. With the Nasdaq rule approved by the SEC, it might be a good time to have discussions with shareholders who may have been very vocal on the issue. If shareholders have lobbied for more board diversity over the last few years and the board resists diversifying now, it may trigger withhold voting campaigns against certain board members, including the chair of the nom gov committee. Boards could instead use the approval of the Nasdaq rule to ask shareholders for potential candidates to fill future board seats, which could build good will with investors and find qualified diverse board candidates.

• Comply with the rule—and evaluate. Boards will be able to do whatever they want regarding the rule; bring on new diverse board members or explain why they do not have to. Transparency on board diversity is what Nasdaq is after because that’s what investors have been asking for. After boards comply, they can assess the impact of their response to shareholders and make adjustments if necessary.