How can California public companies prepare for new requirements for diversity on boards of directors and the growing emphasis on transparency in disclosing diversity considerations when selecting board members? We briefly summarize the current board diversity landscape and offer several recommendations for next steps.
Current Board Diversity Landscape
Some important recent initiatives by the Securities and Exchange Commission (“SEC”), state legislatures and proxy advisory firms include:
Item 407(c)(2)(vi) of Regulation S-K requires disclosure of whether, and if so how, the nominating committee (or the board of directors) considers diversity in identifying nominees for director. In February 2019, the SEC provided additional guidance on preparing disclosure relating to qualifications of directors under Item 401 of Regulation S-K and evaluating director nominees under Item 407 of Regulation S-K.
The SEC expects any description of diversity policies to include a discussion of how the company considers the self-identified diversity attributes of nominees as well as any other qualifications its diversity policy takes into account. Under this new guidance, companies are still not required to make a diversity disclosure where the company does not consider the self-identified diversity characteristics in assessing a director’s qualifications to serve on the board.
- California Senate Bill 826:
Signed in September 2018 and now in effect, SB 826 requires public companies with shares listed on a major U.S. stock exchange (e.g., NASDAQ or NYSE) and whose principal executive offices are located in California to have one woman on their board by the end of 2019. By the end of 2021, SB 826 requires at least two women on boards with five total directors, and at least three women on boards with six or more total directors.
While SB 826 is vulnerable to attack for various reasons, as long as it remains in effect, companies subject to the statute will need to immediately take action to identify and appoint qualified female director candidates or risk significant civil penalties. According to analysis by Columbia Law School's The CLS Blue Sky Blog, as of January 2019, "one-third of California-based companies (217) lack any female director representation and will have to appoint at least one female on their board by the end of 2019."
- Proxy Advisory Firms:
Institutional Shareholder Services (“ISS”). While ISS will not make adverse vote recommendations due to a lack of gender diversity for 2019 annual meetings, it will highlight in the company report if the board has no female directors. For companies in the Russell 3000 or S&P 1500 indices, effective for meetings on or after February 1, 2020, ISS will generally recommend voting against the chair of the nominating committee (or other directors on a case-by-case basis) at companies when there are no women on the board.
ISS has also added two new factors relating to gender diversity to its proprietary Governance QualityScore. As part of its new “Board Diversity” subcategory, in addition to considering the number and proportion of women on a board, it will now factor into the calculation how many women serve in leadership roles on the board and how many women are named executive officers of the company.
Glass Lewis. As detailed in its 2019 Board Gender Diversity guidelines, for meetings held after January 1, 2019, Glass Lewis will generally recommend voting against the nominating committee chair (and in some cases, the nominating committee members) of a board that has no female members.
- Stock Exchange Guidance:Neither NASDAQ nor the NYSE has directly addressed gender diversity within its continued listing rules. However, in light of the current diversity landscape, it is possible that they will propose listing rules regarding board diversity and related disclosures in the future.
Six Steps California Companies Can Take Now
Given the rapidly evolving board diversity considerations, we recommend several actions for California companies to take now:
Note SB 826's requirement to include one woman on the board by the end of 2019, which is only six months away. Contact counsel for guidance on immediate actions to take to begin the process of identifying qualified candidates. Begin formulating a plan on how to include additional women on the board by the end of 2021.
- Consider adding disclosure to your proxy statement to provide additional detail surrounding any consideration the board gives to diversity as part of the director nomination process.
- Review company policies and board committee charters in order to assess your current commitment to board diversity and any related disclosures in your public filings.
- If your company has certain practices in place that are not addressed in the policies and charters, we recommend adding detail on those practices.
- If your company is not currently engaged in any practices related to increasing gender and other diversity on the board, you should discuss the situation with legal counsel and consider the level of commitment that the company is ready to undertake and the public disclosures it is willing to make.
- Consider formalizing the board’s current view on board diversity in anticipation of the possible receipt by the company of communications from institutional investors or other stockholders, which will help in the preparation of talking points to address investors’ concerns.
- Monitor the disclosures of peer group companies to ensure that the company stays on pace with its peers both in terms of its governance policies and public disclosures.
On the Horizon
The call for diversity is expanding, and cultural shifts in America's workplaces have accelerated the pace of change in recent years. While opposition to SB 826 continues, no lawsuits challenging the statute have emerged yet. A similar measure passed the Illinois House of Representatives just last week. Several other states are considering following California's "sea change" legislation, according to Bloomberg Businessweek. The Bloomberg article also includes a handy tool to search a company's status for compliance with the California rule.
SB's first deadline—appointing one woman to the board—must be met by the end of this year. For further insights on navigating the complexities of changing board composition and related impacts on company policies and disclosures, we suggest you contact experience legal counsel.