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Using the Federal Securities Law to Improve Diversity on Corporate Boards

Francis A Bottini Jr

Using the Federal Securities Law to Improve Diversity on Corporate Boards
Thomas Barwick via Getty Images

Let me make the case for the use of our federal securities laws to improve diversity on corporate boards. Beginning on July 2, 2020, my firm filed complaints on behalf of our shareholder clients against Oracle, Facebook, Qualcomm, Cisco, Gap, NortonLifeLock, and Monster Beverage for violations of section 14(a) of the Securities Exchange Act of 1934 for making false statements about diversity in the companies’ annual federal proxy statements. The cases are brought as shareholder derivative actions, which have long been recognized as important mechanisms to address director misconduct: “The machinery of corporate democracy and the derivative suit are potent tools to redress the conduct of a torpid or unfaithful management.” Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984), overruled in part on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). To some, this is a “liberal” versus “conservative” political issue. Let me attempt to explain why, when properly framed, this is incorrect. While some have asserted that the cases attempt to impose a quota system on publicly traded companies, forcing them to appoint a certain number of historically underrepresented individuals to their boards, the fact is that the cases only seek remedies that have been available since Congress passed the Securities Exchange Act in 1934. While it is true that my clients’ cases ask the companies to voluntarily agree to certain governance changes as part of any settlement, the fact remains that a court presiding over a civil shareholder lawsuit cannot compel a publicly traded company to add an individual to its board over its objection. What shareholders and courts can do is to hold individual directors liable for lying about the role of diversity at their companies. And, as demonstrated below, the origin of the requirement for public companies to disclose the role that diversity plays (if any) in nominating individuals to serve on their boards had its genesis in a rule the U.S. Securities and Exchange Commission (SEC) passed on December 16, 2009.

The Role of Full Disclosure in Our Federal Securities Laws and the Origin of the SEC Rule Requiring the Role That Diversity Plays in Nominating Individuals to Serve on Corporate Boards

To begin with, it is important to remember that the federal securities laws, as opposed to state “blue sky” laws, do not seek to impose a set of substantive rules telling companies how to conduct themselves. Instead, the basic premise of the federal securities laws is to require full disclosure of all material facts by companies and then let the market adjust the price of the securities based on the disclosed facts. If a company discloses that its financial statements should no longer be relied on and that it suspects a violation of generally accepted accounting principles has occurred at the company, then normally the company’s stock will decline on the stock market. The idea is that companies will not want their stock price to decline and thus will voluntarily avoid accounting fraud. Of course, the disclosure rules also have an enforcement mechanism: Shareholders who have been lied to can bring fraud-based claims under the Securities Exchange Act of 1934 for damages and injunctive relief. And if they bought their stocks or bonds in an initial public offering or secondary offering, they can bring strict liability claims under the Securities Act of 1933.

Now let’s turn to the issue of diversity. Historically, diversity was not something companies talked about and generally not something they discussed in their dry, dense public filings. Over time, however, shareholders began to care deeply about diversity, pay equity, and discrimination at companies in which they owned stock. Both individual shareholders and institutional shareholders—including state pension funds that invest their funds to ensure that public employees such as firefighters, teachers, police officers, and other public servants receive their promised pensions—began to demand information about these important issues. Still, absent a duty to disclose such information, companies did not have to include a discussion about diversity in their annual reports or proxy statements. That began to change in 2003 and was given teeth in 2009, in the wake of two major financial crises.

Background of Additional Disclosures Mandated by the SEC in Proxy Statements Relating to the Process by Which Individuals Are Nominated to the Boards of Directors of Publicly Traded Companies

In 2008–2009, the stock market plunged by over 50 percent due to mortgage-related fraud. The Dow Jones Industrial Average hit a market low of 6,469.95 on March 6, 2009, having lost over 54 percent of its value since the October 9, 2007, high. In the ensuing years, the United States suffered a massive recession. Many corporations such as Countrywide, Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, and American International Group collapsed or had to be rescued by the government due to fraud or exposure to the subprime mortgage market. But for a massive governmental intervention to save companies and inject unprecedented liquidity into the market, many commentators at the time believe another great depression would have ensued.

But before the 2008–2009 stock market crash, another major stock market crash had occurred in 2001–2002. Between 1995 and its peak in March 2000, the Nasdaq Composite stock market index rose 400 percent, only to fall 78 percent from its peak by October 2002, giving up all its gains during the bubble. During the “” crash, many online shopping companies, such as, Webvan, and, as well as several communication companies, such as Worldcom, NorthPoint Communications, and Global Crossing, failed and shut down. Some companies, such as Cisco, whose stock declined by 86 percent, and Qualcomm, lost a large portion of their market capitalization but survived. The “internet bubble” that preceded the crash was fueled by speculation on new internet companies and by a widespread but temporary abandonment by Wall Street and analysts of “traditional” and allegedly “outdated” analytic tools such as price/earnings ratios, which supposedly were irrelevant to the new-fangled companies (which of course had no profits, such that ignoring price/earnings ratios proved convenient for the analysts touting the companies and the investment banks seeking to profit from bringing the companies public). At the time, there was also a widespread lack of any type of “Chinese wall” between the underwriting and analyst departments at major Wall Street firms. Securities analysts at brokerage firms were frequently influenced by their partners at the firm who were making much more money from the underwriting business and who thus did not want to “alienate” their clients by having their colleagues write negative analyst reports.

When the bubble burst, it had a major negative effect on the economy and the value of Americans’ pension funds, retirement accounts, and investment savings. In light of these devastating effects, Congress and the SEC passed major legislation to try to provide additional protection to investors.

The Sarbanes-Oxley Act of 2002—also known as the Public Company Accounting Reform and Investor Protection Act (in the Senate) and the Corporate and Auditing Accountability, Responsibility, and Transparency Act (in the House) and more commonly called Sarbanes-Oxley or SOX—established new or expanded requirements for all U.S. public company boards, management, and public accounting firms. A number of provisions of the act also apply to privately held companies, such as the willful destruction of evidence to impede a federal investigation. The bill was enacted to protect investors in light of massive fraud at a number of companies, including Enron and WorldCom.

Due to congressional recognition that a company’s board of directors and senior management should bear ultimate responsibility for wrongdoing, the Sarbanes-Oxley Act added responsibilities to a public corporation’s board of directors, added criminal penalties for certain misconduct, and required the SEC to create regulations to define how public corporations are to comply with the law. In addition, the act added a requirement that a company’s chief executive officer and chief financial officer certify the company’s financial results in Form 10-Ks and 10-Qs.

In 2003, the SEC passed a final rule aimed at providing shareholders with additional disclosures in companies’ proxy statements regarding the persons nominated to serve on boards of directors and the process by which they are nominated. The final rule was entitled Disclosure Regarding Nominating Committee Functions and Communications Between Security Holders and Boards of Directors.

In explaining the need for the rule, the SEC stated:

The amendments are designed to address the growing concern among security holders over the accountability of corporate directors and the lack of sufficient security holder input into decisions made by the boards of directors of the companies in which they invest. Currently, companies must state whether they have a nominating committee and, if so, must identify the members of the nominating committee, state the number of committee meetings held, and briefly describe the functions performed by such committees. In addition, if a company has a nominating or similar committee, it must state whether the committee considers nominees recommended by security holders and, if so, must describe how security holders may submit recommended nominees. The amendments are designed to build upon existing disclosure requirements to elicit a more detailed discussion of the policies and procedures of nominating committees as well as the means by which security holders can communicate with boards of directors.

SEC Release Nos. 33-8340; 34-48825 (Nov. 24, 2003).

Six years later, and after the 2008–2009 stock market crash, the SEC passed another set of rules mandating additional proxy disclosures regarding the board nomination process. At an open meeting held on December 16, 2009, the SEC approved a set of proposed rules to enhance the information provided to shareholders in company proxy statements regarding a number of risk oversight, compensation, board leadership and composition, and other corporate governance matters. The SEC released the text of the final rules on the same date they were adopted.

The rules had been proposed in July 2009. However, based on the more than 130 comment letters that the SEC received on the proposals, the final rules reflect a number of changes that result in clearer and more precisely defined, but in some cases broader, disclosure standards than what the SEC had initially proposed. Among the more significant changes from the rule proposals are the following:

Director qualifications. The final rules require disclosure concerning the specific experience, qualifications, attributes, or skills of directors and director nominees that led to the conclusion that the person should serve as a director. The proposed rules would have required this disclosure to, in addition, address how these factors related to directors’ service on board committees.
Compensation Practices and Risk Management. The proposed rules would have required disclosure in the Compensation Discussion and Analysis of any compensation policies and compensation practices applicable to employees (whether or not they are executive officers) if they created risks that “may have a material effect” on the company. The final rule requires disclosure of employee compensation policies and practices that create risks only if they “are reasonably likely to have a material adverse effect on the company.” Further, pursuant to the final rule, this disclosure will not be part of the Compensation Discussion and Analysis, but instead will be a new and separate disclosure requirement.
Diversity Considerations in the Director Nomination Process. In the rule proposals, the SEC asked whether it should amend its rules to require disclosure of additional factors that a nominating committee considers when selecting someone for a position on the board, such as diversity, and whether it should amend the rules to require additional or different disclosure related to board diversity. The rules as adopted require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for directors. Moreover, in what may be a regulatory first for disclosure of the inner workings of a board, if a nominating committee has a policy with regard to consideration of diversity, the rules require disclosure of how the policy is implemented, as well as how the nominating committee assesses the effectiveness of the policy.

SeeSEC Adopts Final Rules on Enhanced Proxy Statement Disclosures,” Harvard Law School Forum on Corporate Governance, Dec. 21, 2009 (emphasis added).

As this brief history demonstrates, in the wake of the two major stock market crashes of this century, Congress and the SEC passed important laws requiring significant additional responsibilities and disclosures by corporate boards. These additional board-level responsibilities and potential criminal liability were needed because of the devastating effect corporate fraud has on the livelihood and retirement savings of Americans.

The additional disclosures required in proxy statements regarding the qualifications and nominating process of persons nominated to serve on boards of directors were necessary because, as the ultimate decision-making body of a company, the board bears ultimate responsibility for corporate decisions. Congress and the SEC rightfully determined that shareholders needed additional information about the qualifications of director nominees and the process by which a company’s nominating and corporate governance committee identifies and selects persons to serve on corporate boards.

And beginning in 2009, additional specific disclosures were mandated requiring

disclosure of additional factors that a nominating committee considers when selecting someone for a position on the board, such as diversity, and whether it should amend the rules to require additional or different disclosure related to board diversity. The rules as adopted require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for directors.

Id. (emphasis added).

In passing the 2009 rule, the SEC stated:

In the Proposing Release, we also requested comment on whether we should amend our rules to require disclosure of additional factors considered by a nominating committee when selecting someone for a board position, such as board diversity. A significant number of commenters responded that disclosure about board diversity was important information to investors. Many of these commenters believed that requiring this disclosure would provide investors with information on corporate culture and governance practices that would enable investors to make more informed voting and investment decisions. Commenters also noted that there appears to be a meaningful relationship between diverse boards and improved corporate financial performance, and that diverse boards can help companies more effectively recruit talent and retain staff.
We agree that it is useful for investors to understand how the board considers and addresses diversity, as well as the board’s assessment of the implementation of its diversity policy, if any. Consequently, we are adopting amendments to Item 407(c) of Regulation S-K to require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director. In addition, if the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees, disclosure would be required of how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy.

SEC Release Nos. 33-9089; 34-61175 at 38 (Dec. 16, 2009) (emphasis added).

In further expanding on the importance and materiality to investors of the new diversity disclosures mandated by the 2009 rule, the SEC stated:

Required disclosure of whether, and if so, how a nominating committee (or the board) considers diversity in connection with identifying and evaluating persons for consideration as nominees for a position on the board of directors may also benefit investors. Board diversity policy is an important factor in the voting decisions of some investors. Such investors will directly benefit from diversity policy disclosure to the extent the policy and the manner in which it is implemented is not otherwise clear from observing past and current board selections. Although the amendments are not intended to steer behavior, diversity policy disclosure may also induce beneficial changes in board composition. A board may determine, in connection with preparing its disclosure, that it is beneficial to disclose and follow a policy of seeking diversity. Such a policy may encourage boards to conduct broader director searches, evaluating a wider range of candidates and potentially improving board quality. To the extent that boards branch out from the set of candidates they would ordinarily consider, they may nominate directors who have fewer existing ties to the board or management and are, consequently, more independent. To the extent that a more independent board is desirable at a particular company, the resulting increase in board independence could potentially improve governance. In addition, in some companies a policy of increasing board diversity may also improve the board’s decision-making process by encouraging consideration of a broader range of views.

Id. at 80 (emphasis added).

As a result of the 2009 rule enacted by the SEC, Item 407 of Regulation S-K now requires all companies in their proxy statements to

[d]escribe the nominating committee’s process for identifying and evaluating nominees for director, including nominees recommended by security holders, and any differences in the manner in which the nominating committee evaluates nominees for director based on whether the nominee is recommended by a security holder, and whether, and if so how, the nominating committee (or the board) considers diversity in identifying nominees for director. If the nominating committee (or the board) has a policy with regard to the consideration of diversity in identifying director nominees, describe how this policy is implemented, as well as how the nominating committee (or the board) assesses the effectiveness of its policy.

Companies Begin to Make the Required Disclosures about Diversity, But Some Lie about It

In the wake of the December 2009 SEC rule requiring companies to disclose the role, if any, that diversity plays in their board nomination process, companies began making the required disclosures in their proxy statements. Here, it is important to remember that the SEC rules do not require a company to adopt affirmative action programs or to assign any role for diversity in the board nomination process. Instead, they simply have to disclose whether diversity plays any role and, if so, to make full disclosure of the role played by diversity. Thus, if a company does not consider diversity in any way when nominated directors, it can simply so state.

To be sure, the majority of companies appear to have complied with the 2009 SEC rule. However, there clearly are offenders and such companies should be held accountable for lying about the role that diversity plays in their board nomination process. As the history of the 2009 rule demonstrates, both individual and institutional shareholders have made it clear that diversity, equity, inclusion, and a lack of discrimination are very important to their investment decisions. At the same time, no publicly traded company wants to appear to be opposed to these important issues. The problem arises when a company makes false statements about its commitment to diversity. Under those circumstances, the company appeases shareholders who either would not invest in the company in the first instance or who might sell their stock if the truth was disclosed. By lying about the issue, offending companies and their directors both violate the federal securities laws and avoid corrective action in the stock market that the disclosure-based system of the federal securities laws is designed to provide as a free-market enforcement mechanism.

Let’s take a few examples and you can render your own verdict. Oracle is one of the largest publicly traded companies in the United States. There are no African Americans on its board and very few minorities among its executive officers. There have been at least two congressional inquiries into the lack of diversity on Oracle’s board. On Friday, November 22, 2019, over 30 members of Congress slammed Oracle’s lack of diversity, sending a letter to company co-founder Larry Ellison and the board asking for answers to questions about the company’s lack of efforts to diversify its leadership.

The congressional letter to the board stated, “The fact that African Americans make up 13% and Asian Americans make up 5.6% of the US population but 0% of Oracle’s board and leadership team is inexcusable.” The letter went on to state:

As a company that has expressed a commitment to diversity and rejected claims of intentional discrimination, you should recognize the optics of Oracle working doggedly to sell software and technology systems to businesses and congressional districts, historically black colleges and universities and minority serving institutions, and communities of color—but not work to remedy the lack of diversity on your board.

The letter, organized by the Congressional Black Caucus and the House Tech Accountability Caucus, noted a February 2019 commitment by the company to not “intentionally discriminate against women and people of color.” According to the November 22, 2019, letter, the company ignored similar questions in 2018 about the board’s lack of African American representation.

Yet, seeking to placate shareholders and create a veneer of being a good corporate citizen, Oracle, in its 2019 proxy statement, signed by Directors Ellison, Berg, Boskin, Catz, Chizen, Conrades, Fairhead, Garcia-Molina, Henley, James, Moorman, Panetta, Parrett, and Seligman,  made the following representation:

Director Tenure, Board Refreshment and Diversity. The Board and the Governance Committee value diversity of backgrounds, experience, perspectives and leadership in different fields when identifying nominees. As set forth in our Guidelines, the Governance Committee, acting on behalf of the Board, is committed to actively seeking women and minority candidates for the pool from which director candidates are selected.

(Emphasis added.)

Despite this affirmative statement in its proxy statement, Oracle does not have a single African American on its board or among its 41 senior executive officers. Oracle has been accused of paying women and minorities less than men and has opposed publishing information about the ethnic composition of its workforce, which other companies have voluntarily provided in order to ensure transparency. Oracle’s directors have also voted against shareholder proposals calling for the company to publish a pay equity report.

As another example, let’s examine Qualcomm. Qualcomm’s directors, wishing to avoid public backlash, have repeatedly made misrepresentations in the company’s public statements by claiming to have a policy of “demanding” diversity and inclusion at the company. In reality, though, Qualcomm’s board and senior executive officers remain devoid of Blacks and other minorities. Even Qualcomm’s chief diversity officer, Vicki Mealer-Burke, is white.

Qualcomm’s workforce and board remain conspicuously devoid of any meaningful percentage of Black and minority individuals. At Qualcomm, only 1.5 percent of the workforce is African American, despite the fact that African Americans make up over 13 percent of the U.S. population. Qualcomm has made no progress in increasing the hiring of African Americans since 2017—the percentage has remained flatlined at 1.5 percent, after dipping to 1.4 percent in 2018. Qualcomm has three times more Hispanic than Black workers, Hispanics comprising 4.6 percent of its workforce.

Qualcomm has repeatedly represented that it effectively promotes and achieves diversity and inclusion at the company. For example, the company’s website states:

Inclusion and Diversity
Qualcomm aims to build an inclusive environment where everyone feels like they’re part of the team.
We further innovation and accelerate progress by fostering a diverse workforce. We cultivate innovators who bring varying backgrounds, ideas, and points of views.
We are committed to building a pipeline of diverse talent. Qualcomm is present at many diversity conferences and partner with many universities and organizations dedicated to building diversity and creating more opportunities for professional development and engagement. We proudly focus on developing leaders and shaping future talent pools to help us meet the needs of our customers worldwide.

(Emphasis added.)

In its 2020 proxy statement, Qualcomm stated:

The qualifications and criteria considered in the selection of director nominees have the objective of assembling a Board that brings to the Company a reasonable diversity and variety of backgrounds, perspectives, experience and skills derived from high quality business and professional experience, with the Governance Committee also giving consideration to candidates with appropriate non-business backgrounds. As part of its efforts to create a diverse Board, including with respect to race, ethnicity and gender, the Governance Committee will include, and instruct any search firm it engages to include, women and racially/ethnically diverse candidates in the pool from which the Governance Committee selects director nominees.

(Emphasis added.)

My client’s lawsuit against Qualcomm alleges that these statements were highly misleading. By representing that “the Governance Committee will include, and instruct any search firm it engages to include, women and racially/ethnically diverse candidates in the pool from which the Governance Committee selects director nominees,” the company suggested that it is actively seeking to achieve racial and ethnic diversity in its board membership. Despite allegedly requiring racially and ethnically diverse candidates to be included in the director nominee pool, the fact remains that Qualcomm has no African Americans on its board and that no African American or other minority candidate has been elected to the Qualcomm board in the last six years. The undisclosed truth therefore appears to be that Qualcomm may have a policy of attempting to include racially and ethnically diverse candidates in its director nominee pool, but it either has no intention to actually nominate such persons to its board or it engages in efforts to thwart the nomination of such persons and prefers non-diverse applicants in the pool.

The complaint alleges that Qualcomm has made misleading statements about its efforts to promote diversity on its board and among its senior executives. Qualcomm was recently called out for being among the 20 largest companies in the United States without a single Black individual on its board. “Companies need to be intentional about increasing the diversity of their executive leadership teams,” says Crystal Ashby, president and chief executive officer of the Executive Leadership Council, an organization of Black senior executives that works to increase inclusivity in business leadership. “The culture of an organization is cultivated by its leaders.” Id.

The shareholder proxy lawsuits already seem to be yielding results. On November 20, 2020, Qualcomm announced that it has appointed two new directors to its board—an African American and a Hispanic. Nasdaq has also announced an initiative that would encourage companies listed on its exchange to increase diversity at the board level.


Shareholder lawsuits under the Securities Exchange Act of 1934 for false statements in a company’s proxy statement are well established. The lawsuits cannot force a company to add underrepresented individuals to its board. However, directors can be held liable for lying about a company’s commitment to diversity. By holding directors liable for making misleading statements about diversity, companies will be deterred from lying about diversity. Companies that lack a true commitment to diversity will therefore be required to tell the truth; and companies that want to appear to be committed to diversity will have to take action, not just include empty platitudes in their proxy statements. Institutional and private investors can then make investment decisions based on accurate information. In the end, one can expect a greater commitment to diversity from this enforcement of the federal securities laws.