Emphasis on Diversity Initiatives Broadens in Scope and Focuses on Impact

January 11, 2021

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Diversity has long been a focus for both companies and stakeholders, but 2020 in particular saw diversity come to the forefront of stakeholders’ agendas. Against the backdrop of the ongoing COVID-19 pandemic and its disparate impacts on human capital, alongside increased focus on racial equity and justice and related unrest, we have seen key players across the board push to broaden the scope and impact of diversity issues in the corporate space.

Rapid Expansion of Diversity in Corporate Governance

Looking back only a few years, activists were just starting to focus on increasing the number of women on public company boards. Shareholders primarily drove the initial push by submitting shareholder proposals at companies with a lack of diversity on their boards, prompting initiatives like the NYC Comptroller’s Boardroom Accountability Project, which asked companies to adopt “Rooney Rule” policies for both board and CEO appointments and advocated for disclosure of gender pay gaps. Proxy advisory firms published diversity-related voting recommendation policies, and asset owners, asset managers and institutional investors, including State Street, Vanguard and BlackRock, adopted diversity-related voting policies at the board and management levels and asked companies to disclose workforce diversity through EEO-1 Report data. State legislatures then carried the momentum and implemented board gender diversity requirements and/or board and executive diversity reporting requirements, starting with California in 2018 and followed by Illinois in 2019, with more states in the pipeline considering similar legislation.

Board diversity was the second-highest engagement priority identified by shareholders during the 2020 proxy season,[1] and significant activity has continued in this space. Companies will want to ensure they are well-positioned to engage and communicate on these topics as they head into the 2021 proxy season.

COVID-19 and Social Movements Highlight Diversity Issues in 2020

Through the COVID-19 pandemic, women and racially and ethnically underrepresented workers have been disproportionately impacted by employment and promotion challenges.[2] In September, over 850,000 women left the workforce in the U.S., more than four times as many as men during the same period.[3] At the height of the first wave of the pandemic in the U.S., people identifying as Latinx and Black suffered the highest unemployment rates, approximately 19% and 16.4%, respectively, compared to 13% for people identifying as White.[4] A disproportionate number of these people were racially and ethnically underrepresented female workers; the peak unemployment rates for Latinx women, Black women and White women during the pandemic were approximately 21%, 17.5% and 14%, respectively, compared to approximately 17%, 16% and 11.5% for Latinx men, Black men and White men, respectively.[5] Key stakeholders are well aware of this issue and have responded.

Much of shareholder engagement in 2020 centered around employee welfare and support for members of the workforce who might be more significantly impacted by the economic volatility caused by the pandemic. Similar questions regarding companies’ responses to COVID-19 on its human capital, resources and management echoed at many annual meetings.

The conversations surrounding human capital will continue to be a lively topic in 2021, and public companies should keep in mind that the level of scrutiny placed on a company’s policies and progress in promoting diversity, equity and inclusion at all levels of seniority will continue into the 2021 proxy season.[6] Shareholders are expecting to see progress – regardless of the degree to which the pandemic continues to have an impact. Investor and proxy advisory firm activity in recent months, for example, shows that investors are becoming more active in utilizing their shareholder voting power to promote positive social changes, particularly when it comes to diversity:

  • BlackRock released its 2021 Stewardship Expectations, which includes a reinforced focus on diversity. Citing that “41% of companies where [BlackRock] voted against directors for diversity reasons in 2019 increased their board diversity the following year,”[7] BlackRock plans to use voting against directors as its “most frequent course of action” at any company it believes is not moving with sufficient speed and urgency on gender and racial diversity during the 2021 proxy season.
  • ISS proposed a new policy for U.S. companies, effective February 2022, to recommend against the chair of the nominating committee (or other relevant directors on a case-by-case basis) at any S&P 1500 or Russell 3000 company with no identified racially or ethnically diverse members on its board. ISS’s guidelines already include a policy to recommend against the chair of the nominating committee of any board that has no female directors.
  • Glass Lewis currently has a policy to recommend voting against the nominating committee chair at any Russell 3000 company with no female directors; Glass Lewis will increase the minimum to at least two female directors for shareholder meetings held after January 2022, placing pressure on boards that currently only have one female director. Glass Lewis also announced that it will begin tracking the quality of director diversity and skills disclosure in proxy statements, and, beginning with the 2021 proxy season, its reports for S&P 500 companies will include an assessment of such disclosures.

We expect to see more diversity shareholder proposals in the 2021 proxy season, including board diversity and skills matrices proposals and gender pay gap proposals, and to see continued higher levels of support as more institutional investors beyond the traditional ones like BlackRock, Vanguard and State Street have instituted policies of supporting these and other diversity-related proposals.

Diversity Efforts Spread Beyond Investors

Historically, many of the diversity-focused efforts in the governance space have been led by investors, including institutional investors, smaller investors (Arjuna Capital, As You Sow, Trillium Asset Management and other “ESG investors”), state pension funds and comptrollers and proxy advisory firms (ISS and Glass Lewis). In 2020, however, there was a sharp increase in activity originating from parties not traditionally in this group.

Much like the state-led legislative efforts in the last few years, these new efforts from market makers, regulatory bodies and stock exchanges will likely prompt even more rapid progress in the coming years. Unlike previous initiatives in this space, these new initiatives target not only public companies but also private companies that are thinking about going public – sending a clear message that the market no longer views diversity as an option.

  • Private companies planning their initial public offerings now face pressure to have diversity on their boards as they go public. Goldman Sachs, one of the leading underwriters of IPOs both domestically and internationally, announced that, as of this past summer, it would no longer underwrite IPOs of any company in the U.S. or in Europe that did not have at least one director “from a traditionally underrepresented group based on gender, race, ethnicity, sexual orientation or gender identity.”[8] Despite the estimated $101 million in lost fees from up to 18 U.S. IPOs if the policy had been effective in 2019,[9] Goldman Sachs further announced plans to increase the threshold to two diverse directors in 2021. While other major Wall Street investment banks have not yet announced similar policies, the takeaway for private companies is that the traditional grace period for newly public companies to increase board diversity is quickly disappearing and diversity issues need to be a priority for both the board and management earlier in the process.
  • At the beginning of December, Nasdaq submitted new listing requirements for board diversity to the SEC for approval.[10] Under the new listing requirements, Nasdaq-listed companies would be required to (i) publicly disclose transparent board diversity statistics and (ii) have at least two diverse directors by a certain date, including one self-identified female director and one self-identified underrepresented minority or LGBTQ+ director, or disclose why they do not. The diversity disclosure requirements include a board diversity matrix, which identifies a breakdown of the number of directors who identify as male, female and non-binary, and the number of directors who identify as LGBTQ+ and/or a number of different race and ethnicity categories.[11] This proposed listing requirement would apply to both companies already listed on Nasdaq (and continued noncompliance may result in delisting, if a company does not publicly disclose the reason for failure to comply) and companies that are preparing for their initial public offering and have decided to list on Nasdaq. Although the New York Stock Exchange currently does not have any such listing requirement, it would not be surprising if it followed with a similar proposal to the SEC, assuming the Nasdaq proposal is approved.
  • This fall, the SEC adopted amendments to Item 101 of Regulation S-K, explicitly writing into the rule a requirement to include more detailed human capital disclosure in Exchange Act reports.[12] While the rule is largely principles-based and does not outline a definitive list of topics that are required for disclosure, many companies that have filed reports in compliance with the new rule have taken the position that human capital disclosure should include diversity, equity and inclusion statistics for the company’s general employee workforce – in a similar vein to the disclosure of certain self-identified diversity characteristics of board directors and nominees pursuant to the C&DIs that the SEC staff published last year.[13] As companies prepare their year-end Form 10-K reports and proxy statement disclosures, boards should carefully consider whether diversity statistics, policies and other related disclosures are warranted as being material to an understanding of a company’s business and, if so, how best to present such disclosures.
  • Following its 2018 legislation requiring at least one female director on all boards of companies headquartered in California, California enacted a law (AB 979) in September 2020 that requires public companies headquartered in California also to elect at least one racially/ethnically underrepresented director by the end of 2021. By the end of 2022, the law requires these companies to have at least two racially/ethnically underrepresented directors on boards with five to eight members, and three racially/ethnically underrepresented directors on boards with nine or more members. While we may see similar legal challenges brought against AB 979 as we did against the 2018 gender diversity law, we may also see other states following suit and proposing similar legislation, much like they did in 2018 and after.

Looking Ahead to Engagement in 2021

The message behind these initiatives is clear – the fact that a critical mass of companies in the Fortune 500 now have at least one female director on the board is not a sufficient demonstration of diversity at the senior levels of a company. Key stakeholders are calling for more kinds of representation on the board and beyond the board, and particular attention is being paid to employees and the broader workforce. For example, this summer the NYC Comptroller sent letters to the CEOs of 67 S&P 100 companies, asking them to reaffirm their commitments to racial diversity, equity and inclusion and requesting disclosure of their annual EEO-1 Report data. Companies that did not respond to the letter are seeing related shareholder proposals submitted by the NYC Comptroller for their upcoming annual meetings. Stakeholders increasingly want to engage with companies and know what the company is doing to improve the status quo, from the board to management and employees.

Diversity being at the forefront of governance issues, especially given the experience of 2020, should not come as a surprise to anyone; however, we expect stakeholders to have a certain degree of patience, understanding that progress in this area does not happen overnight. Engagement with stakeholders will continue to be crucial in this respect, and company boards, management and investor relations teams should be prepared going into the 2021 proxy season to address diversity topics when meeting with investors and other stakeholders.

Action and progress metrics will be a key part of engagement discussions with stakeholders, as stakeholders are no longer content with just reading diversity commitments without seeing results. In 2020, shareholders filed three separate derivative lawsuits in California federal court against the directors and officers of Facebook, Inc., Oracle Corporation and Qualcomm, Inc., respectively, alleging that the boards and management teams of these companies failed to deliver on their commitments to diversity, despite public disclosures made by the companies about the importance of diversity within their respective organizations.[14] A number of other similar suits have risen since then, and while the initial lawsuits were filed in California, one of the latest in this string of derivative suits was filed in the U.S. District Court for the District of Columbia.

Whether or not these complaints are successfully sustained, they show that the trend of shareholders stepping into courts to hold companies accountable will most likely continue. Stakeholders throughout 2020 made it clear that they increasingly expect companies to follow through on their commitments and are more than willing to take proactive steps to ensure that measurable improvements and progress are being made.

Given these shareholder actions, companies should be thoughtful about crafting a narrative that provides some transparency into target goals and updated progress made toward such goals with stakeholders in the coming proxy season. Before announcing any goals and commitments to investors and the market, companies should consider their ability to adequately measure progress and how they propose to identify milestones that will spotlight the ways in which they are acting on and achieving these commitments.

While companies should move thoughtfully, the key to effective communication in these dialogues is to avoid a repeat of prior conversations and public statements on this topic – investors want to know how the company is thinking about diversity issues, what the short-term and long-term goals are and how a company is going to follow through on those goals within a defined period of time. As a starting point, company boards should routinely review their own membership, the composition of management and data at the broader workforce level to see what diversity profile the company has as a whole, and what plans are in place to further promote and advance diversity, equity and inclusion.

Moving forward, companies should think about diversity issues holistically: it is important to see more representation of female and racially/ethnically underrepresented directors, management and employees at a company, but equally important are adequate training and professional development initiatives, retention and promotion pipeline structures and other forms of support that ensure the long-term success of these advances. Taking a broader view will help companies meet stakeholders’ expectations, now and in the future.

[1] Harvard Law School Forum on Corporate Governance, “Four ESG Highlights from the 2020 Proxy Season” (August 23, 2020), available here.

[2] See, e.g., id.; Centers for Disease Control and Prevention, “Health Equity Considerations & Racial & Ethnic Minority Groups” (July 24, 2020), available here; and Economic Policy Institute, “Black workers face two of the most lethal preexisting conditions for coronavirus—racism and economic inequality” (June 1, 2020), available here.

[3] Michael Madowitz and Diana Boesch, “The Shambolic Response to the Public Health and Economic Crisis Has Women on the Brink as the Job Recovery Stalls” (Washington: Center for American Progress, October 22, 2020), available here.

[4] Rogelio Saenz & Corey Sparks, “The Inequities of Job Loss and Recovery Amid the COVID-19 Pandemic” (August 11, 2020), available here.

[5] Id.

[6] For additional information on developments relating to human capital management, see Fulfilling the Board’s Expanded Oversight Role in Human Capital Management in this memo.

[7] BlackRock, “2021 Stewardship Expectations” (2020), available here.

[8] Washington Post, “Goldman Sachs CEO says it won’t take a company public without diversity on its board” (January 23, 2020), available here.

[9] Bloomberg Law, “Analysis: IPO Diversity Plan May Cost Goldman $101M in Lost Fees” (January 28, 2020), available here.

[10] Nasdaq, “Nasdaq proposed new listing requirement rule change, filed with the SEC pursuant to Rule 19b-4 of the Securities Exchange Act of 1934” (2020), available here.

[11] Nasdaq, “Nasdaq Board Diversity Matrix instructions”, available here.

[12] SEC Release No. 33-10825, Final Rule: Modernization of Regulation S-K Items 101, 103 and 105, available here.

[13] SEC Division of Corporation Finance, Compliance and Disclosure Interpretations 116.11 and 133.13, available here.

[14] See Cleary’s alert memo on this topic for more information, available here.