The SEC and Diversity the the Boardroom: The Impact of SEC Disclosure Requirements (Part 4)

We are discussing diversity in the boardroom and the speech given by Commissioner Aguilar on Sept. 16 at the SAIS Center for Transatlantic Relations (at Johns Hopkins), titled "Diversity in the Boardroom is Important and, Unfortunately, Still Rare." 

Corporate boards have continued to struggle with diversity.  Given this apparent example of market failure, the SEC has dipped into the area by proposing and implementing additional disclosure requirements that highlight board practices with respect to diversity.  As Commissioner Aguilar's speech noted, the proposals were popular.     

• Accordingly, in 2009, I worked with SEC staff to seek input through a Commission release as to whether investors and other market participants required greater information regarding diversity in the boardroom. In response to our proposal, we were deluged with letters. These letters were overwhelmingly supportive, with approximately 90% expressing support for disclosure of information related to race and gender diversity on the board.

Moreover, institutional investors supported the efforts.  See Aguilar Speech ("We received letters from persons and organizations representing over $3 trillion in assets and they made it clear that information about board diversity is something they find important in the assessment of companies that they own.").   As a result, the SEC adopted rules that require companies to disclose:  

• whether diversity is a factor in considering candidates for nomination to the board of directors,

• how diversity is considered in that process, and

• how the company assesses the effectiveness of its policy for considering diversity.

Disclosure, as we have noted, can do more than provide investors with material information.  It can also affect substantive behavior.  See Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.  The disclosure requirements in this case had that potential.  See Aguilar Speech ("It is reasonable to expect that the process of focusing on their diversity policy and its effectiveness could likely result in greater diversity.").   

So how have these requirements worked out?  Disclosure requirements will only be effective if they are meaningful.  This means avoiding boilerplate and describing actual practices in specific manner.  The track record so far has been mixed.  On the one hand, as Commissioner Aguilar describes:  

• A review of the filings received indicates that some companies have done a very good job. For many companies, however, there is a great deal of room for improvement. One example that satisfies the disclosure that investors demanded was by a company that disclosed that of the 14 directors on the board, three were women, two were African-American, and two were Hispanic. This disclosure is noteworthy because instead of just talking about the diversity policy and how it is implemented, the company gives investors actual facts that show the results of the company's efforts.

On the other hand, not all of the disclosure has been particularly illuminating. 

• Unfortunately, while some companies provided useful information in the spirit of the SEC rule, many other companies provided only abstract disclosure — often times limiting their disclosure to a brief statement indicating diversity was something considered as part of an informal policy. Many companies did not include any discussion of any concrete steps taken to give real meaning to its efforts to create a diverse board. By leaving out the steps taken and how those efforts are evaluated, these companies fail to provide investors with useful information, and it deprives investors of information they have demanded.

Were matters to stop there, the SEC's disclosure requirements would likely have marginal impact.  Nonetheless, there will apparently be follow-up by the staff.  See Aguilar Speech (staff asked "to follow up with some of these companies and I expect this disclosure to improve.").  Moreover, Commissioner Aguilar has set out some specific points that ought to be considered by companies responding to the disclosure requirements.  Companies should, for example, consider revealing whether they have a policy of:   

• interviewing one or more candidates who are a minority and/or a woman,

• retaining a search firm that has been specifically instructed to seek candidates that are minorities and/or women, and/or

• soliciting recommendations from organizations that have a reputation for identifying candidates with diverse backgrounds.

Similarly, he has indicated a need for hard information. 

• When discussing the effectiveness of the policy and how that effectiveness is assessed, the disclosure could, for example, indicate how many candidates were interviewed that were women and/or minorities. Useful disclosure also could highlight the diversity of the existing board of directors, which would shed light on the effectiveness of the fund's board diversity policy even if the information was provided in the aggregate and did not specifically identify any particular directors.

These efforts are designed to encourage more meaningful disclosure.  This, in turn, may result in the adoption by companies of more specific policies with respect to diversity.  See Aguilar Speech ("For example, a nominating committee should follow policies and procedures that require the proactive development of a diverse slate of candidates in advance of a board opening becoming available.").  

As some companies implement meaningful practices, pressure will build on others to do the same.  This is another example of where transparency is designed to allow the market to function more effectively.