New SEC rules force boards to appoint more diverse candidates
The conventional wisdom is that diversity is good for business and, in an attempt to ensure corporate boards make greater efforts to increase diversity, the SEC has implemented new disclosure rules. In typical SEC style, however, the rules are confusing and ambiguous, and few people believe the commission has solved the problem. The change seems to be a step in the right direction and, in theory, no one seems to have a problem with it – but what is good in theory is not always practical, and many companies know this.
‘The SEC makes the statement that you have to address diversity, but it doesn’t go into a definition of what diversity actually means,’ explains John Nixon, a partner at Duane Morris. ‘It doesn’t define which factors are considered ‘diverse’ other than to say it can be any one of a range, so now we are stuck with a situation of having to define diversity ourselves and then define whether or not it is a consideration.’
Bonnie Gwin, head of board practices at Heidrick & Struggles, actually likes the fact that the SEC was non-specific in its definition. ‘It’s a good thing because diversity has many definitions,’ she explains. ‘To some degree, the diversity of skills, experiences and background that will have most impact on a particular board depends strategically upon where a company is going. I don’t know how that will affect the type of information firms are willing to share about this aspect of governance. In my experience, however, companies take this issue very seriously. I think the new rules will continue the journey boards are already on to make a lot of the aspects of governance more transparent. They will continue to heighten the focus on diversity.’
No firm footing
History shows that whenever the SEC is vague with its rules, companies tend to take a bare minimum approach. Nixon fears this may be the case with the diversity disclosure rules. ‘The nature of the disclosure requirement allows you to basically write as little as you want,’ he points out. ‘If you just want to write that you considered diversity of thought and experience in assembling a board, that would be compliant. You could just write it and walk away.’
Susan Stautberg, co-founder and co-chairman of Women Corporate Directors, is more positive. ‘We hope companies will want to go for extra credit,’ she says. ‘Rather than just complying with the SEC language, they may go out there and show they have really looked beyond the usual list of candidates when selecting new board members.’
It is not unreasonable, says Nixon, to expect a clear separation in diversity quality based on sectors, and this argument is borne out by the data. A recent study from GovernanceMetrics International that examined the level of female representation on boards finds the sectors with the greatest representation to be utilities, retail and media. Bottom of the list are basic resources, automobiles and parts, and construction and materials – hardly surprising, given these sectors’ traditional male domination.
What is likely to happen is that companies will adopt a wait and-see approach. No company will really want to get out in front of this but neither will any firm want to be lagging behind its peers, explains Nixon. Those companies that already have a good story to tell will likely have expansive disclosures, but most will want to write as little as possible.
Embrace the unexpected
One thing the new rules will likely achieve is to force companies to cast a wider net when looking for new directors. ‘Companies need to start looking beyond just having people from their own sectors,’ says Stautberg. ‘Diverse experience and skill sets will help drive companies in the future. There is a danger in having a group of people who all come from the same background and look at things the same way; they may not see potential problems and may miss some opportunities. Just because someone is not a CEO does not mean he or she cannot add value to a board.’
The problem is that there are not many candidates who fit the criteria. ‘The pool of diversity candidates is small,’ says Gwin. ‘Boards need to think very creatively about what they are trying to add to the board dialogue, which requires them to look in new places and consider people who do not have board experience.’
For Nixon, that doesn’t go far enough. ‘This is going to broaden the range of new director candidates,’ he comments. ‘Let’s say you decide to focus on race and ethnicity as the diversity criteria that are important to you. You could draw on minority CEOs, but there are not many of those, so everyone will be going for the same candidates. Additionally, most companies do not want a director to serve on more than three boards at the same time, so this pool will be exhausted very quickly. People are really going to have to start thinking in a non-traditional manner.
‘Even if you have 300 people and put each of them on three boards, that’s only 900 companies, leaving us with approximately 9,000 other firms. This does not mean you throw your hands in the air and say, We can’t do it. It means you start to expand your thinking as to what constitutes qualification for board service.’
One word of caution, however: diverse candidates are, by definition, different. They may not fit in with the rest of the board. This is something that should be prized, but making it work can be extremely difficult. Most people who have ever served on a board will tell you there is a powerful tendency to isolate and exclude those who are different or create dissent. This applies equally to those from different backgrounds and skill sets as it does to the common definition of diversity of ethnicity or gender.
