Diversity Matters, Disclosure Works, and the SEC Can Do More: Remarks at the Council of Institutional Investors Fall 2020 Conference

Thank you, Amy [Borrus], for the introduction and for the invitation to speak at your conference. I’m pleased to be here with you all today, and want to take this opportunity to thank you and your members for your engagement in our rulemaking process. Your comment letters are unfailingly thorough, analytical, and insightful. They provide a critically important investor perspective on our policies. I’m very grateful for your efforts.

Today I want to talk you about a topic that has dominated my thoughts recently, and I’m sure many of yours as well: diversity and inclusion. I know that many of you have long advocated for greater diversity on corporate boards and elsewhere. Recent events have triggered an unprecedented national conversation on racial injustice that also highlights the urgency of ensuring diverse perspectives and representation at all levels of decision-making in our country. At the SEC, a number of recent rulemakings have also pushed this issue to forefront. Our recent adoption of amendments to Regulation S-K, for example, took a step forward by adding human capital as a broad topic for possible disclosure, but declined to require, among other things, disclosure of diversity data—even data that most companies are already required to keep under Equal Employment Opportunity Commission (EEOC) rules. Our pending proposal under Rule 14a-8 also has implications for promoting diversity and inclusion because it affects shareholder proposals which often cover this topic. The topic has also been prominent on the agenda of recent SEC advisory committee meetings, including last week’s Asset Management Advisory Committee meeting during which participants urged the SEC to require diversity disclosure for public companies and registered entities.[1] And I’m pleased to see that the topics of diversity and inequality are on your agenda for this conference as well.

In recent months, we’ve heard the topic of diversity and inclusion referred to as “timely.” Although there is truth in that, I balk a bit at the description because it suggests that somehow its importance is new or trendy. Unfortunately, it is almost an evergreen topic. One my grandmother talked to my mother about, my mother to me, me to my daughters, and now them to theirs. And I know that Black, Indigenous, and other people of color understand this dynamic likely better than I. So, yes, the topic is timely in that it is currently capturing the nation’s attention, but the issue has long been a problem, and so today I want to share my thoughts on the extent of that problem with respect to our capital markets.[2] I would also very much like to hear from your membership on this issue, during today’s Q&A or at any future point. Please consider my door—virtual though it is these days—always open to you.

Diversity Matters

As a threshold matter, it has often been argued that advocating for corporate diversity is about equality for equality’s sake, and that corporate decision-making by contrast has to be about maximizing shareholder value. In other words, don’t inject social ideals into the boardroom or the management suite. I could never quite buy in to the view that some 40 percent of the population in our country (if we’re talking about minorities) or over half the country (if we’re talking about women)[3] must rationalize their inclusion in corporate boardrooms and elsewhere in economic terms instead of the reverse. How can one possibly justify—in economic terms—the systematic exclusion of a major portion of our talent base from the corporate pool? That is about as economically irrational as it gets. Nevertheless, to the extent one seeks economic support for diversity and inclusion (instead of requiring economic support for the lack of diversity and exclusion), the evidence is in.

There is an increasing body of research showing that diversity correlates with enhanced performance. For example, one recent study on board diversity, using a definition that encompassed director age, gender, race, financial expertise, and number of directorships, had compelling findings:  board diversity corresponds to lower stock volatility due to the adoption of less risky financial policies, and firms with more diverse boards invest more in research and development and therefore are better at fostering innovation.[4]

As another example, a recent study by McKinsey, which has long studied this subject, found that companies with the greatest ethnic diversity on executive teams outperformed those with the least by 36 percent in profitability.[5] The same report found that companies with more than 30 percent women on their executive teams are significantly more likely to outperform those with fewer or no women executives.

Fortune 500 firms with the highest proportion of women on their boards outperform those with the lowest.[6] Companies with higher than average diversity on management teams report higher revenue from new products and services.[7] More women in senior positions is associated with higher return on assets.[8] The list of tangible performance benefits goes on. That’s why we see so many investors, asset managers, proxy advisors, and others incorporating diversity into their proxy voting decisions. I’ve even talked to analysts at quant firms who pull diversity metrics into their algorithms because they have learned that it increases alpha.

In addition, there is growing recognition that a lack of diversity represents a significant reputational risk for companies and may hamper their ability to recruit and retain top talent.[9] Indeed research has shown that employee perceptions about their employer’s commitment to diversity strengthens their own commitment to the companies where they work. For example, a report from last year found that when employees understand that their companies are committed to gender diversity, they plan to stay with those companies longer.[10] This is equally true for men and women.

Consumers are watching too, and companies understand this.[11] For example, we all received a flood of emails from companies in the wake of the George Floyd protests stating various commitments to racial justice. I’m not casting doubt on their sincerity, but I do think those companies understand that it may matter to their bottom line whether we as consumers perceive them to have a sincere commitment to racial justice. Consider for example Amazon’s decision in June to place a one-year moratorium on law enforcement use of its facial recognition software. [12] This occurred amidst criticism from civil rights groups that such technology produces inaccurate results for people with darker skin. Consider also companies who pulled their ads from certain shows that offered particularly offensive criticism of recent protests.[13] Consumer perception matters.  

One might have thought that diversity would fade in significance during an economic crisis like we are enduring this year. But the recent proxy season reflected a continued commitment to diversity, with diversity-related proposals garnering significant support.[14] That is likely due in part to the fact that, alongside the economic downturn, we have an equally pressing national concern over racial injustice. But it may also reflect a growing understanding that a commitment to diversity makes good business sense as a strategy for weathering a difficult economy.[15] Evidence shows, for instance, that banks with more women on their boards were more stable during the 2008-09 financial crisis.[16] I note also some commentary and data suggesting that women leaders are better guiding their countries through the current COVID crisis.[17]

The value of diversity for our nation and for our capital markets is clear. I’m often asked “how much diversity is enough?” This calls to mind the inimitable Justice Ginsburg’s response to the question of when there will be enough women on the Supreme Court. “When there are nine,” she said. No one ever questioned the wisdom of having nine men.[18] Why should women and minorities be any different? But, in any event, we are not where we need to be when diversity levels fall so far short of representation in the population, when too often women and minority executives and board members are the only ones of their type in the room.[19] There is work to do to avail ourselves of the full base of talent in this country. So, let’s talk about what that work should look like.

Disclosure Works

There are many different approaches to promoting diversity. Some countries and states have mandated certain levels of representation on boards.[20] Pending legislative efforts would require disclosure of the diversity characteristics of board members and senior executives [21] and consideration of diverse candidates for certain positions, along the lines of the NFL’s Rooney Rule.[22] Still other efforts have focused on board refreshment to encourage diversity.[23]

The most obvious tool in the SEC’s toolkit is disclosure. This gets investors the information they need to make investment decisions based on their own judgment of what indicators matter for long-term value. Importantly, it can also drive corporate behavior. For one thing, when companies have to formulate disclosure on topics it can influence their treatment of them, something known as the “what gets measured, gets managed” phenomenon.[24] Moreover, when companies have to be transparent, it creates external pressure from investors and others who can draw comparisons company to company.[25] The Commission has long-recognized that influencing corporate behavior is an appropriate aim of our regulations, noting that “disclosure may, depending on determinations made by a company’s management, directors and shareholders, influence corporate conduct” and that “[t]his sort of impact is clearly consistent with the basic philosophy of the disclosure provisions of the federal securities laws.”[26]

So far, however, we have largely declined to require diversity-related disclosure. In 2009, we adopted a requirement for companies to disclose if and how diversity is considered as a factor in the process for considering candidates for board positions, including any policies related to the consideration of diversity.[27] In 2018, we issued guidance encouraging the disclosure of self-identified characteristics of board candidates.[28] While I appreciate these measures, given that women of color hold just 4.6% of Fortune 500 board seats[29] and less than one percent of Fortune 500 CEOs are Black,[30] it’s time to consider how to get investors the diversity information they need to allocate their capital wisely.

It is often argued that, if information, including with respect to diversity, is material, it must be disclosed under our broad, principles-based regime. We should, therefore, leave it to companies to determine whether diversity information is material, and, if so, what specifically to disclose. This approach, however, has led to spotty information that is not standardized, not consistent period to period, not comparable across companies, and not necessarily reliable. In addition, I hear complaints about so-called “woke-washing” where companies attempt to portray themselves in a light they believe will be advantageous for them on issues like diversity. A disclosure regime that allows companies to decide if or what to disclose in this area can certainly exacerbate that problem.

And the current state of disclosure reveals the shortcomings of a principles-based materiality regime in this area. For example, 72 percent of companies in the Russell 1000 do not disclose any racial or ethnic data about their employees and only four percent disclose the complete information they are required to collect and maintain under EEOC rules.[31] Less than half of all Fortune 100 companies disclose data on the ethnic and gender compositions of their boards.[32] There is room for improvement.

The SEC Can Do More

What should the SEC do? To start with we could consider re-visiting our amendments to Regulation S-K to require disclosure of workforce diversity data at all levels of seniority. We could likewise strengthen our 2018 guidance on disclosure of board candidate diversity characteristics. But there are broader considerations than just corporate diversity disclosures.  

First, there is a serious lack of diversity among financial regulators. Georgetown Law Professor Chris Brummer recently undertook a detailed analysis of the issue and found that just three percent of top financial regulators in the past 106 years were Black.[33] As he noted, currently “[t]here are no Black Commissioners at the Securities and Exchange Commission (SEC). Or at the Commodity Futures Trading Commission (CFTC). There has never been a Black Chairman of the Federal Deposit Insurance Corporation (FDIC), SEC, or CFTC. And today, the staffs of political appointees—whether Democrat or Republican—are, with few exceptions, almost devoid of African Americans.” Those are grim statistics, and we should all be working to open opportunities in financial regulation. 

In addition, diversity intersects with our regulatory mission in the financial services industry. There is a noteworthy lack of diversity, most pointedly at senior levels, at SEC-registered entities.[34] Particularly disturbing is a finding from a 2017 GAO report on financial services firms that showed only marginal increase in minority representation and no increase for women at the management level from 2007 through 2015.[35]

Significantly, we also see substantial disparities in access to capital for women and minorities due in part to a persistent wealth gap between minority and non-minority communities that can prevent minority entrepreneurs from investing their own capital in their businesses or using it as collateral.[36] We see disparities in lending practices that can hinder or discourage minority and women founders from seeking or obtaining loans,[37] and unconscious bias in investment behavior,[38] which may also contribute to disparities in capital raising.

The challenges associated with diversity are broader than just corporate disclosures; our solutions should be broader as well. We should reflect on how the SEC could more systematically consider gender, racial, and other representation disparities in its policymaking.

First, we could consider tasking our Division of Economic and Risk Analysis with assessing the extent to which our rules will have an impact on underrepresented communities. I have noted that in our rulemaking, particularly those relating to capital-raising, the economic analyses often claim that our rules will benefit minority- and women-owned businesses simply because we are loosening restrictions that are equally applicable to all businesses.[39] This mindset fails to recognize the unique reasons for disparity of opportunity. We could instead take a more rigorous approach to the question by isolating and analyzing whether and how a proposed rule addresses the particular challenges faced by minority- and women-owned business, or otherwise affects underrepresented communities. It is insufficient to expect changes in our rules to affect all businesses in the same way.  

Second, we could consider better integrating our Office of Minority and Women Inclusion (OMWI) into our policymaking. We have a tremendous resource in OMWI. More so now than ever, that office is doing important work helping the agency to examine its own diversity policies and practices. We could consider how better to leverage that resource in efforts aimed outside of the agency.

I note that part of OMWI’s mandate relates to assessing diversity at SEC-regulated entities. To that end, OMWI has implemented a voluntary diversity self-assessment for regulated entities to use in assessing their diversity policies and practices. Voluntary submission rates of those self-assessments to the SEC, however, have been low—only four percent of those entities that were asked to submit a self-assessment responded.[40] We could solicit comment on ways to encourage voluntary submission, or on whether to incorporate such disclosures into those already made by regulated entities.

Beyond that, we could consider utilizing OMWI in an expanded or more formal role in our rulemaking process, ensuring that they have an opportunity to review and comment on draft rulemaking materials.  Specifically, OMWI could help us understand how our rulemaking may affect existing racial, gender, and other disparities, or otherwise affect diversity concerns.

Finally, are there ways we could better work with other agencies, such as the Consumer Financial Protection Bureau and the Small Business Administration, in their efforts to combat discrimination and support women and minority-owned small businesses. Can we coordinate with the banking regulators in addressing the finding of a House Financial Services Committee Staff Report that large banks are not giving opportunities to minority-owned firms when they select asset managers?[41]

I do not purport to have all the answers here on what specific measures we could or should take. I ask for your help in thinking through these issues. Because diversity in capital markets matters. It matters for fairness, it matters to consumers, and it matters in realizing the full potential of our talent base. All of that translates to performance and matters to investors. We should consider better corporate disclosure, but we should do more. We should think more broadly, more creatively, and consider every opportunity we have to promote diversity and equality of opportunity in our economy. Thank you.