SEC Diversity Requirements
For the past several years, increasing board diversity has been a pressing item for public companies—and not without good reason.
In 2018, a Boston Consulting Group study found that companies, with diverse leadership, had higher revenues from new products and services (an indicator of successful innovation) as well as higher EBIT margins. That same year, McKinsey & Co. found that “diverse companies are 33% more likely to have greater financial returns than their less-diverse industry peers.”
Logically, one would expect a homogenous entity composed of individuals, with almost indistinguishable backgrounds, to be less than perfect at governance, a role which benefits from wider perspectives and the occasional respectful disagreement. In addition, public opinion favors boards that better reflect the American public.
Despite these actualities, progress has been slow. The New York Times finds that the share of board seats, filled with directors who were Hispanic, Black, Asian-American, Pacific Islander or Native American, only increased by 2.5% in the last five years. The ending percentage, 12.5% in 2020, heavily under-represents the 40% of the U.S. population who are a part of those minorities. Similarly, women make up only 21% of board directors.
Certain institutional investors have decided to take the diversity matter into their own hands, reports Kellogg Insight. Goldman Sachs, for example, announced in 2020 that they would refuse to take a company public if their board did not contain at least one diverse board member. The following year, Goldman Sachs increased that figure to two.
States have also acted. In 2018, California passed a bill requiring at least one female director on the board of every publicly traded company, whose chief executive resided in the state. Prior to this mandate, only 293 of 625 applicable companies fulfilled the requirement.
A week ago, the SEC approved the Nasdaq proposal for board diversity requirements. The rule stipulates that boards must have one person who identifies as female and another who is a member of an underrepresented minority group or is LGBTQ+, reports BBC News. The rule isn’t binding companies who don’t meet the objective can explain why they were not able to do so, says Forbes. Despite this leniency, the proposal was a big step. Even if companies decide not to meet diversity quotas, there will still be increased transparency into the board selection process and the company’s rationale behind the lack of diversity in their boardroom. This is especially important because the board positions in question are highly influential due to the size and finances of public companies.
In a survey, Nasdaq found that 75% of its over 3,000 listed companies would not meet the objectives. They decided to pass the diversity regulations anyway. With an average board size of nine members, requiring two diversity members means that upwards of 4,500 board seats will need to be filled with diverse members within the next year.
What does this mean for women and members of underrepresented minorities? It means that now, more than ever, is the best time to search for board positions.
Boards of directors used to be almost entirely composed of former Chief Executive Officers and other C-Suite executives. This has changed over the years—in 2018, 65% of new board directors were not part of the C-Suite, Egon Zehnder reports. However, this does not mean that the skills and experience necessary to become a board director have diminished. Companies are still looking for highly qualified individuals, especially those with significant P&L experience.
Do I qualify to be on a Board of Directors?
An ideal candidate would be a leader in their field who has closely worked with boards before. The individual should also understand the inner workings of a company, both financially and operationally. In the 2020 Annual Corporate Directors Survey, PwC found that 89% of board members found financial expertise to be a plus. The remaining 11% found the skill somewhat important. The second most sought-after skill was operational expertise, which 53% marked as very important. This does not necessarily mean that you have to be a Chief Financial Officer or a Chief Operating Officer in order to attain a board directorship – Deloitte states that any experience with reforming compensation plans, assessing and retaining talent, or innovating new strategies are all valuable to a board table. In particular, high level roles in risk, compliance, M&A, and crisis management, product development, marketing, sales and digital technology are all items that stand out to a company looking for a board director.
In fact, anything that stands out is a good attribute for anyone seeking board positions. Research continues to show that diversity on boards has been on the rise, in terms of both inclusion as well as breadth of expertise. Board directors of disparate ages, varying professional or economic backgrounds, and dissimilar industries bring differing perspectives into the board room. Not only does this help companies get ahead of public scrutiny of leadership, says The Harvard Law Forum on Corporate Governance, but a variety of contributions allows companies to better anticipate challenges and creatively address issues.
Serving on a board is not a decision to be made lightly—directors will be leading the company through major corporate events such as litigations, mergers, bankruptcies, and crises of all kinds. As such, companies will also be looking for someone with integrity and loyalty as well as dedication. Furthermore, as board directorships are closely tied to company and stock performance, companies will not accept any individual who is only available for a short period of time.
Finally, those looking to become board members should reflect on whether or not they have the wherewithal to participate in governance. The National Association of Board Directors states that the average amount of time spent on board matters per director was 245 hours per year—just over six work weeks. Employees who wish to continue their full-time job while serving on boards will have to inform their employers of the arrangement and confirm that they have the go-ahead as well as the ability to carry out both roles.
In May of 2021, Colonial Pipeline, the largest pipeline system for refined oil products in the United States, was targeted by a yet untraced hacker group. The firm’s billing system and internal business network were both compromised, causing a shortage of gas on the east coast. Eventually, Colonial Pipeline paid the hackers a ransom of $4.4 million in Bitcoin to cease the attack. Months later, the company is still paying— Colonial Pipeline is being sued for lax cybersecurity by a class-action lawsuit consisting of hundreds of gas stations hurt by the hack, reports the Washington Post. Ransoms (even ones paid in Bitcoin) can be recovered by law enforcement; much of Colonial Pipeline’s has been recuperated. But settlements in the tens of millions of dollars for cybersecurity lapses are irreversible, not to mention devastating to the company’s reputation.
Colonial Pipeline was only one of numerous companies that experienced an attack this year. Cybersecurity attacks have been on the rise, and the situation has only worsened after COVID-19 prompted a nationwide shift towards working from home. In addition, hackers have been deploying sophisticated new tactics, such as ransomware equipped with artificial intelligence that spreads without human intervention. Due to these factors, PwC reports that the global annual cost of cybercrime is expected to increase to $6 trillion in 2021. What can boards do to ensure their companies are fully prepared for a cyber-attack?
Harvard Law School’s forum on Corporate Governance advises that boards carefully consider with executive-level managers the avenues through which the company monitors cyber risk. In particular, the forum warns against delegating the entire burden to the Audit Committee given the magnitude of the responsibility. According to PwC, boards must direct their company to take a close inventory of valuable digital assets, screen third parties before the company releases sensitive data to them, patch system vulnerabilities, minimize the usage of IoT (due to its wide attack surface), and train employees to practice cyber hygiene and maintain security on the digital front. Boards should also leverage new technology in the space, such as blockchains or distributed ledger technologies, which provide security through decentralization and constant data validation. While implementing a blockchain solution, IBM states that management has to provide a secure, resilient infrastructure as well as the willingness to truly understand blockchain networks and how to manage them. That way, companies can truly minimize the risk of data vulnerabilities.
Beyond preventing cybersecurity incidents with appropriate measures, boards should also devise contingency plans consisting of detection, mitigation, and business continuity. The contingency plans should encapsulate a range of scenarios and provide extra detail on when the situation should be escalated or communicated to stakeholders and customers.
To summarize, Boards should prioritize with the tools of prevention and mitigation, creating a cybersecurity framework for their company that guarantees both safety and service to their employees and clients.
When the COVID-19 pandemic first broke out in March 2020, millions of workers were forced to relocate their workplaces to their bedrooms, living rooms and kitchens. Fifteen months later, as mask mandates and other restrictions loosen amidst the vaccination of adult Americans, companies are faced with the task of transitioning their workers back to the physical workplace. As they do so, their boards of directors should keep the impact of the COVID-19 pandemic and the social unrest it wrought, at the forefront of the conversation.
PricewaterhouseCoopers says that the health and safety of the workforce should be management’s top priority. To achieve this end, cleaning crews should be hired for strict and frequent sanitization. This may also mean implementing hybrid models of three days a week in the office and two from home, or distancing cubicles and offsetting schedules. Not only will these measures decrease exposure risks for the employee, but they will mitigate potential liability risks for the employer.
To maximize the value addition of returning to the physical workplace, boards must deliberate on which employees are demonstrably underproductive outside of the physical workplace in order to prioritize them for return. It will be one of the “hard questions” that all good board directors are used to asking: do our employees really need to return to the workplace? While executives may be making haste to return to pre-COVID normalcy in the hopes of achieving pre-COVID balance sheets, boards should not write off the productivity of remote work. Instead, Deloitte advises that boards take the time to fully consider all opportunities for business and workforce strategies.
Given the vast array of considerations to take, companies should take careful note of board composition, and form multi-disciplinary teams that do not lack external advisors in the public health area. It would also be prudent for boards to stay on top of global, federal, state and local guidelines, especially publications from the U.S. Centers for Disease Control and Prevention and the Occupational Safety and Health Administration. Boards should also schedule hearings with professionals in the legal, human resources, information technology, operations and health and safety areas, as well as representatives from employee constituent groups.
Many employees will have difficulties reacclimating to onsite work and addressing these problems will smooth the process. While being understanding to each employee’s situation, Ernst and Young suggests putting into place a flexible reward framework that incentivizes return. Another way to make return more attractive to employees is to work on building a strong work culture. Shearman & Sterling proposes a phased approach to employee returns, in which employees who want to work in the office could volunteer themselves.
Finally, boards of directors should remember that current conditions are still unstable. While the majority of adult Americans have been fully vaccinated against COVID-19, a resurgence is not impossible. As such, every board director should work to maintain flexibility in return-to-work plans as employees make their way back.
Which is the biggest risk to business: Climate change, ESG or Sustainability?
The terms can be confusing, exacerbated by overlapping usage.
What do they mean in plain terms? ESG refers to environmental, social and governance principles, as most of us know. Social includes matters such as labor disputes, product liability, shifting regulations and demographics, among others. Governance includes diversity issues, oversight of corporate risks, strategic directions and growth opportunity maximization. Sustainability refers to ESG generally.
The “E” in ESG includes climate change, among other environmental risks such as toxic releases. Climate change, most would contend, is the greatest risk at the macro-level for our planet and brings risks to corporate assets and profits that are often not assessed.
Climate risks are different from most social and governance concerns because they can impact physical assets and cause business disruption. According to Barron’s, 60 percent of companies in the S&P 500 Index “hold assets that are at high risk of at least one type of climate-change physical risk.”
Asset manager directives usually combine climate change with important—but less existential—social and governance issue risks, such as board quality and executive compensation. The potential devastation of climate change makes this combination questionable.
Initiatives to address climate change:
- On Earth Day, April 22, 2021, President Biden set ambitious new targets to address the climate crisis, committing the U.S. to cut its greenhouse gas emissions in half, relative to 2005 levels, by the end of the decade—double the target set by President Barack Obama in 2015. More details of his initiatives and their impacts on business will be forthcoming over the next few weeks.
- Organizations such as The World Economic Forum have developed climate change governance principles for boards of directors. For example, see www.weforum.org/whitepapers/how-to-set-up-effective-climate-governance-on-corporate-boards-guiding-principles-and-questions.
- Companies should conduct a comprehensive assessment via a multi-disciplinary team including engineers, risk managers, climate scientists and business strategists, to assess projected climate risks such as those from rises in water levels, turbulent weather events such as hurricanes, temperature changes, infrastructure damage and supply and customer disruptions. Mitigation strategies should be developed. Not to be overlooked are potential competitive opportunities from climate change, such as impacted competitors, technology innovations and supply chain differentiation.
Denise Drace-Brownell, JD, MPH
Science and technology innovation executive, Author
CEO, DDB Technology, LLC New York, NY