From Nasdaq’s board diversity rules to D&O insurance

I saw this article from a US law firm on the US Securities and Exchange Commission’s (SEC) recent approval of Nasdaq’s diversity rules for boards and thought this may have a broader impact than just in the US.

Is board diversity a novel idea?

Board diversity has been under close scrutiny for some time. For example, in 2011 in the UK,  former trade minister Lord Davies launched an independent review, The Davies Review, into women on boards and set a target of 25% women in the 100 largest companies listed on the London Stock Exchange (FTSE) by 2015. The Parker Review report (also from the UK) published in 2017 also set the ‘One by 2021’ target to have at least one person with ethnic minority background on the board of all FTSE100 companies. In its report published in March 2021, 74% of FTSE 100 companies achieved that. While in Canada, starting from January 2020, diversity disclosure for boards and senior management cames into force, requiring all distributing corporations governed by the Canada Business Corporations Act to comply or explain according to Bill C-25.

So having diverse representation on a board is not a new phenomenon, but Nasdaq’s latest rules on race and gender disclosure are perhaps the most demanding move in creating diversity across boards.

Nasdaq’s latest board diversity rules

Starting next year, listed companies on the Nasdaq exchange will be required to disclose the demographic composition of their boards in a prescribed tabular format, and have at least two diverse directors on the board – one self-identified as female and one self-identified as a member of an underrepresented minority or LGBTQ+ community. Companies that do not meet these targets will be required to explain in a public disclosure why they have failed to do so.

These rules, according to the Chair of SEC Gary Gensler, will allow investors to gain a better understanding of the companies’ approach to board diversity, while ensuring that those companies have the flexibility to make decisions that best serve their shareholders.

Under the ‘comply or explain’ framework, continued failure to do either could ultimately result in delisting which would have significant impact for the company, not least of which could be securities litigation.

The rules apply not only to US domiciled companies but also to foreign issuers under Rule 5605 (f) (1), so it is important that all companies with US exposures take these regulations seriously and seek legal advice if necessary on what action to take.

Implications on directors and officers (D&O) liability insurance

So how does this impact D&O insurance? It is perhaps too early to tell whether this will result in increased levels of litigation. If the company is subject to censure and delisting from Nasdaq, then there is a strong possibility of investors bringing actions.  There is also the spectre of increased pressure from the community and other interest groups asking why a board has chosen not to comply, especially if their industry peers are complying.  Failure to comply could also create unfavourable media coverage leading to bigger reputational risks such as loss of financing or loss of business – as financial institutions and other sectors are under greater pressure to integrate environmental, social and governance (ESG) aspects into their business, operation, and investment.

From an underwriting perspective, insurers may consider non-compliance with diversity rules to be a material fact, and either refuse to write, or to impose more stringent, and expensive terms because of a perceived increase in the risk of a claim.

From a corporate governance perspective, this is an additional consideration for company directors and executives to take into account in fulfilling their duties as a leader. Even though these regulations only apply to companies listed on Nasdaq, a pro-active board should look at this emerging trend on the basis that diversity is here to stay and consider how to address this in advance of any compulsory requirement.

The ESG journey continues

SEC’s endorsement on Nasdaq’s board diversity rules was said to be among the agency’s most substantial actions taken to encourage diversity and inclusion since ESG becomes one of the top policy agenda issues.  

Back in Asia where Peak Re is based, the Stock Exchange of Hong Kong has also put forth a consultation paper on review of corporate governance that includes new diversity requirements where all new listing candidates need to have at least one woman on their boards at the time of going public. Meanwhile, the Financial Services Agency in Japan is taking a similar path, proposing revision to its corporate governance code to promote diversity among Japan’s listed companies.

With increasing attention and focus on ESG among companies and investors, it is not surprising to see that more exchanges are moving in the same direction to include gender diversity requirements.