17 states back court challenge to Nasdaq board diversity rule

By Jim Tyson for CFODive.com

• Seventeen states have supported a lawsuit challenging Securities and Exchange Commission (SEC) approval of a Nasdaq rule that requires race and gender diversity on corporate boards, saying the requirement sets quotas that discriminate on the basis of race, ethnicity and sex.

• The SEC “has blessed explicit race-based requirements for listed corporations, and further threw in overt sex-based and sexual-orientation-based mandates,” the states said in an amicus brief. “None of this is remotely lawful, and [the] SEC has transgressed both constitutional and statutory limitations on its authority.”  

• The SEC in August backed a Nasdaq requirement that listed companies include on their boards at least one woman director and someone who is a racial minority or who self-identifies as lesbian, gay, bisexual, transgender or queer. Companies are required to regularly report on the demographics of their boards, and those that fail to justify non-adherence to the standard in writing would risk delisting.

CFOs and their C-suite colleagues face pressure from the SEC to increase transparency and better measure performance on environmental, social and governance (ESG) issues, including board and workforce composition. The agency plans early this year to propose rules for corporate reporting on carbon emissions.

SEC Chair Gary Gensler has said agency support for the Nasdaq rule aligns with the preferences of investors, who are increasingly focused on ESG goals when committing their capital.

Global ESG investment soared 55% to $35.3 trillion in 2020 from $22.8 trillion in 2016, according to the Global Sustainable Investment Alliance. The total will probably exceed $50 trillion by 2025, making up more than one third of the projected $140.5 trillion in global assets under management, according to Bloomberg.

The Nasdaq mandates “reflect calls from investors for greater transparency about the people who lead public companies,” Gensler said in a statement in August.

The standards “will allow investors to gain a better understanding of Nasdaq-listed companies’ approach to board diversity, while ensuring that those companies have a flexibility to make decisions that best serve their shareholders,” he said. Gensler also wants companies to provide ”human capital disclosure,” or detailed reports on the demographics of their employees.

Only one in four of the 100 largest companies specify the demographic traits of individual board members, according to a study by Shearman & Sterling.

“The vast majority of companies are disclosing aggregate diversity information for the board, but only about a quarter are providing director-specific diversity information, which is data that companies are increasing[ly] being pressured to disclose,” Shearman & Sterling said. Only one in three of the biggest companies provide data on employee diversity.

Attorneys general for the 17 states said that by backing the Nasdaq quotas, the SEC is engaging in unlawful discrimination. “The type of race- and sex-based preferences here are particularly crude and odious: outright quotas rather than any sort of holistic analysis or plus factor.”

“It is unconscionable to see discrimination so blatantly put on display by requiring these companies to hire employees based solely on race, sex and sexuality,” Texas Attorney General Ken Paxton said. “The SEC’s quotas violate the constitution and federal civil rights laws by requiring that companies overlook a person’s relevant qualifications under the guise of promoting diversity.”

The SEC also “seeks to encroach upon an area of traditional state concern: corporate governance,” the attorneys general said in their brief. “Board composition might even be called the quintessential example of the ‘internal affairs of the corporation’ that are outside federal reach without express congressional authorization.”

Looking beyond boardrooms, CFOs have stepped up support for diversity and inclusion (D&I) training and related programs since the murder of George Floyd while in police custody in May 2020.

Three out of five CFOs plan to push D&I programs within their companies through such efforts as leadership mentoring programs for women and minorities, PwC said, citing a survey of financial executives.

“CFOs are putting their money where their mouth is around people, with more than half making investments in D&I training (57%),” PwC said in a report on a survey in August of 128 financial executives at Fortune 1000 and private companies.

Moody’s Investors Service said that the Nasdaq mandate will prove “credit positive” for the more than 3,000 companies listed on the exchange.

“The SEC’s approval of Nasdaq’s listing rules is credit positive for Nasdaq and its listed firms because the rules will improve transparency and disclosure, as well as encourage board-level diversity and inclusive representation,” Moody’s said.

The amicus brief was filed in the federal appeals court in New Orleans in support of a suit brought by the Alliance for Fair Board Recruitment. Alabama, Alaska, Arizona, Arkansas, Florida, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Oklahoma, South Carolina, Texas and Utah filed the brief.