It’s not just mandatory climate disclosure that’s on the agenda for Acting SEC Chair Allison Lee. Last week, as reported by Reuters, in remarks to a forum for securities industry professionals, she said that the SEC “should think more ‘creatively and broadly’ about tackling issues of race and gender diversity, including by potentially revisiting public companies’ disclosure requirements.” In the past, Lee has not hesitated to emphasize her concerns about the absence of prescriptive requirements in rulemakings that would have more certainly elicited disclosure regarding diversity. (See, for example, her statement regarding amendments to Reg S-K as well as her remarks to the Council of Institutional Investors, Diversity Matters, Disclosure Works, and the SEC Can Do More.) Now that she has directed Corp Fin to focus on climate disclosure, will diversity be next?

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In her remarks to CII last year, Lee observed that there are a variety of approaches to enhancing diversity, including national and state legislation mandating diversity (see, for example, this PubCo post, this PubCo post, and this PubCo post), disclosure regarding diversity or consideration of diverse candidates (such as the Rooney rule), as well as changes to board refreshment practices. For the SEC, the “most obvious tool in the SEC’s toolkit is disclosure.” Disclosure not only provides decision-useful information to investors, it also “can also drive corporate behavior. For one thing, when companies have to formulate disclosure on topics it can influence their treatment of them, something known as the ‘what gets measured, gets managed’ phenomenon. [Sometimes referred to as “regulation by humiliation.”] Moreover, when companies have to be transparent, it creates external pressure from investors and others who can draw comparisons company to company.”

Although the SEC “has long-recognized that influencing corporate behavior is an appropriate aim of our regulations,” it has thus far been reluctant to require diversity-related disclosure. A 2009 amendment requires companies to “disclose if and how diversity is considered as a factor in the process for considering candidates for board positions,” and subsequent staff guidance has encouraged “disclosure of self-identified characteristics of board candidates.” While these measures are welcome, Lee acknowledged, nevertheless, “given that women of color hold just 4.6% of Fortune 500 board seats and less than one percent of Fortune 500 CEOs are Black, it’s time to consider how to get investors the diversity information they need to allocate their capital wisely.”

The SEC’s recent principles-based approach to regulation allows companies to use their discretion to determine whether information with respect to diversity is material, and, if so, what needs to be disclosed. To Lee, however, this approach “has led to spotty information that is not standardized, not consistent period to period, not comparable across companies, and not necessarily reliable. In addition, I hear complaints about so-called ‘woke-washing’ where companies attempt to portray themselves in a light they believe will be advantageous for them on issues like diversity. A disclosure regime that allows companies to decide if or what to disclose in this area can certainly exacerbate that problem.”

What’s more, she argues, the “shortcomings of a principles-based materiality regime” are revealed in the data: “For example, 72 percent of companies in the Russell 1000 do not disclose any racial or ethnic data about their employees and only four percent disclose the complete information they are required to collect and maintain under EEOC rules. Less than half of all Fortune 100 companies disclose data on the ethnic and gender compositions of their boards. There is room for improvement.” (See this PubCo post.)

What to do? First, Lee advocates that the SEC revisit the recent Reg S-K amendments to “require disclosure of workforce diversity data at all levels of seniority,” and “strengthen” the staff guidance on board diversity disclosure. But, in the end, Lee thinks the question is larger than just disclosure. She believes that there is a “serious lack of diversity among financial regulators.” For example, a recent analysis showed that only 3% of “top financial regulators in the past 106 years were Black.” The SEC and other regulators should work toward opening up opportunities at financial regulators, such as the SEC, as well as among the regulated in the financial services industry.

In her remarks, in addition to revisiting diversity disclosure requirements for public companies, Lee added, the SEC should also consider “strengthening guidance on board diversity in an effort to address a lack of diversity…in corporate boardrooms.” In addition, she suggested that “the SEC could also look at ways to better evaluate the impact of SEC rules on gender and racial discrimination and work to bring more diverse perspectives in their public outreach. ‘We should think more broadly and creatively and pursue every opportunity we have to pursue diversity and inclusion,’ Lee said.” Time will tell whether Lee’s inclination toward more prescriptive diversity disclosure takes the same course as her recent direction to Corp Fin to intensify its focus on climate. (See this PubCo post.) Given the SEC’s recent amendments to Reg S-K adding a principles-based requirement for human capital disclosure (see this PubCo post), it would not be surprising to see Corp Fin staff intensify their review and comment on the most recent round of human capital disclosures as part of the normal disclosure review process. As with climate, that review could be the springboard to additional guidance or rulemaking that the SEC may now view as necessary to elicit the optimal level of diversity disclosure.

And some companies are providing enhanced diversity disclosure. According to the WSJ, large U.S. companies “are giving a more detailed picture of diversity in their ranks, with dozens of them publicly sharing gender or race breakdowns, many for the first time.” In addition to a “nudge” from the new SEC rule, the disclosures “also reflect a new focus among many companies on workforce diversity following last summer’s protests over discrimination, racial inequity and the death of George Floyd while in police custody.” According to a study by the WSJ of over 160 annual reports for 2020 filed by companies in the S&P 500, although about 100 companies “chose to say little about demographics,” still, “about a third included diversity disclosures, though the details varied widely. Most provided a tally of women in their workforces. Almost three-quarters disclosed at least some information on racial and ethnic diversity—often a combined count of nonwhite employees. A few provided data on veterans, younger or older workers, people with disabilities and those who identify as gay, lesbian or transgender. Some provided figures only for their corporate boards.” The article observes that, in addition to the SEC rule, some workforce diversity disclosure was made in response to pressure from institutional investors, some of which use the data to develop their rankings or to make investment decisions. In support, some investors cite “data collected by McKinsey showing [that] 25% of companies with the least diversity by gender and race are more likely to financially underperform industry averages.” A number of companies have also committed to make public the diversity data they privately report to the EEOC. One commentator cited in the article indicated that the enhanced disclosures “help add substance to pledges by many executives last year to give priority to diversity….’Transparency leads to greater accountability,’” she observed. The article also notes that, if approved by the SEC, the new Nasdaq diversity proposal, which includes a disclosure component, could accelerate a move toward increased diversity disclosure.

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In this recent Op-Ed in the WSJ, the CEO and President of Nasdaq indicates that, in response to public comments, Nasdaq is amending its proposal for new listing rules regarding board diversity and disclosure (see this PubCo post) to lighten some of the requirements, especially for smaller companies. You might recall that the Nasdaq diversity proposal would impose new “expectations” regarding diversity. Companies would need to have at least two diverse directors on their boards or explain their rationale for not meeting that objective. The rule would also require listed companies to provide annually, in a proposed Board Diversity Matrix format, statistical information regarding the company’s board of directors related to the directors’ self-identified gender, race and self-identification as LGBTQ+. In her op-ed, Nasdaq’s CEO emphasizes that the new Nasdaq diversity rule would not impose a quota: it establishes a “recommended objective,” but “[m]ost important, it is not a quota: the only requirement for companies that don’t meet this new objective is to provide an explanation to shareholders. During the SEC comment period, the vast majority of commenters spoke in favor of our proposal. Some criticized it for not going far enough, and some felt that Nasdaq shouldn’t get involved in boardroom diversity at all.” (One group that offered criticism consisted of several Republican Senators on the Senate Committee on Banking, Housing, and Urban Affairs who questioned the propriety of Nasdaq’s acting “as an arbitrator of social policy or forc[ing] a prescriptive one-size-fits-all solution upon markets and investors.” See this PubCo post.) To address the feedback, Nasdaq is “making some changes to strengthen our proposal in response. For example, we heard from companies with smaller boards, as well as from several small-cap investors, that meeting the diversity objective would be more challenging for them. As a result of that feedback, we’re now proposing that companies with five or fewer directors may satisfy the recommended objective with one director from a diverse background rather than two. We’re also providing a one-year grace period in the event a vacancy on the board brings a company under the recommended diversity objective.” The Nasdaq proposal, she said, “seeks to demonstrate that, with proper disclosure and clear objectives, companies and investors can create momentum toward an approach to capitalism that offers more opportunity to more people. We believe this can be accomplished through a market-driven solution—rather than government intervention.