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Game Change - The New Age of Diversity Regulation

June 14, 2019

For multinational companies and the law firms that represent them, regulatory mandates in the EU that target wage inequity and board diversity represent a new era of diversity enforcement. EU countries are not typically regarded as being in the vanguard of leadership on diversity issues. Yet, according to the World Economic Forum’s Global Gender Gap 2018 Report, EU nations lead the U.S. in overall gender parity. [1]

 

The diversity reforms introduced in the last year are an important step forward.  Compelling companies to provide the public with more line-of-sight clarity about wage gaps and governance represents a valuable lever for change.  The policy dialogue around corporate diversity has chiefly focused on gender parity. However, it is now broadening to address problematic workforce trends that impact racial and ethnic minorities. This month, the Financial Times began a compelling video series on diversity focused on the impact of race on employees in the workplace. Delving into such thorny territory is an undeniable reflection of growing public impatience and awareness of workplace equity gaps. 

 

The willingness of state actors to serve as diversity champions that recognize the public’s interest in equitable practices is an important step forward. Sanctioning regulations that activate new standards of transparency and corrective action promises to both rewrite the rules of business conduct and reinforce new workforce norms.

 

Member EU countries share a history of regulatory activism. State engagement in social dialogue, government investment in economic growth, and alertness to labor market dynamics are familiar themes. Flexing state regulatory muscle to initiate legal measures which disrupt gender- gap trends in governance and compensation reflects this history. Government action in the diversity arena also reflects the changing landscape of the international political and business climate regarding equity issues in general. 

 

And the times, they are a’ changing. The election of women to prime minister roles, the selection of women CEOs for global companies, including IBM and Sodexho, increasing public pressure, and emerging research about the business value of diversity have sparked momentum around structural changes. Furthermore, private equity firms are paying increasing attention to diversity as an ESG priority and competitive factor in the investment decisions of institutional investors. In June of last year for instance, the Chicago Teachers Pension Fund passed on Blackstone Corporation and Brookfield Asset Management as managers for a $50 million infrastructure allocation due to concerns about low diversity numbers at both firms.

 

The emergence of a regulatory model for industrialized nations that enables scalable diversity best practices represents a huge development.  Catalyzing next-gen norms for corporate accountability and reporting has implications not only for developed markets, but for emerging markets that will likely follow suit. 

 

Most importantly, these mandates create bright line rules for corporate behavior and key performance indicators regarding diversity. Companies operating on a global scale and their counsel must now consider business risk and liability through a diversity compliance lens. Moreover, from a mergers and acquisitions or investment perspective, the diversity performance of companies will likely represent a due diligence consideration and competitive factor.

 

As a long-standing “hot button” issue in the United States, diversity has been framed primarily in terms of workplace culture and inclusive hiring.  Defined by an HR lexicon of terms such as unconscious or implicit bias and inclusive values or neuroscience ones such as confirmation bias, diversity has typically been linked to talent and workforce issues. The path that connects the dots between D&I principles and corporate decisions about talent, social impact and inclusive engagement is a clear one. However, diversity’s relevance to business priorities within the domains of corporate strategy, capitalization, risk management and economic growth has been far murkier. 

 

Characterizing diversity as a bona fide business imperative has been an open question that has been difficult for senior leaders to address. Even with compelling data from firms like McKinsey which touts the performance success of diverse teams, corporate discussions about reputational risk, and the competitive advantage gained by having diverse voices identify new business opportunities, skepticism abounds.  The business case for diversity has been a hard sell. 

 

The shifting tides of heightened regulatory scrutiny and enforcement of equitable practices promises to change that.

In April 2018, the UK required companies to report on their gender wage gap trends. This past October, UK Prime Minister Teresa May introduced a Race at Work Charter committing employers to standards for improving the recruitment and advancement of ethnic minorities. The charter was signed by major firms such as Norton Rose Fulbright, Lloyds Banking Group, Saatchi & Saatchi, and KPMG. 

 

This year, a UK mandate is being considered that would require companies with 250 or more employees to report on their ethnicity or BAME (Black, Asian, and Minority Ethnics) pay gap data. This development was spurred in part by the pivotal McGregor-Smith Review of Race at Work survey and a study released this year by the Centre for Social Investigation at Nuffield College. The center’s study found that the level of discrimination faced by blacks and South Asians in the UK labor market hasn’t declined since the late 1960’s and 1970’s. Data showed that Blacks and South Asian job seekers needed to send out 80% more applications than their white peers to garner a positive response from prospective employers. In addition, the UK’s Labour Force Survey data confirms significant pay gaps between White employees and BAME employees. A difference that contributes to poverty rates being twice as high for BAME groups.

 

In support of the ethnicity wage gap proposal, several companies have agreed to voluntarily disclose ethnicity wage gap information, including Citigroup, Stella McCartney, KPMG and the Bank of England. A valuable effort, but it’s not enough. In March, PWC released survey results showing that due to apprehensions about legal fallout and GDPR guidelines on collecting data, only 5% of large companies tracked ethnicity-based wage gaps. 

 

Nonetheless, the mandate for this reporting remains intact. UK think tank Resolution Foundation estimates that the income loss for employees impacted by the ethnic salary gap is approximately $4.2billion (£3.2 billion) a year.  In-house counsel should take proactive steps in advance of a reporting requirement regarding ethnic wage gaps to identify data collection processes that comply with legal and regulatory standards. Experts believe strongly that the UK’s strong commitment to improving workplace equity outcomes will result in the passage of an ethnicity wage reporting law.

 

The UK is not alone in its commitment to more robust diversity regulation. [2] At the end of last year, Iceland became the first country to mandate that companies pay men and women equally. In the same quarter, Canada’s parliament passed Bill C-86 which fortifies the country’s Labour Code.  The new legislation includes pay equity protections that require employers to establish a pay equity committee and the creation of a federal pay equity commissioner who will have oversight authority. 

 

South Africa, which leads the world in gender wage gap inequality, requires employers to report on wage gap data and information that explains salary differentials for women and men of color under its 1998 Employment Equity Act. In addition, the country’s voluntary King IV Codes and mandatory Johannesburg Stock Exchange governance provisions direct boards to develop a plan of action for addressing wage gap differences within their workforces. 

 

France, which passed a gender neutrality mandate for corporate boards in 2011, now leads the EU in the gender diversity of it corporate boards. According to the 2018 report of European Women on Boards, women represent 44.8% of France’s corporate boards, making the highest-ranking EU country for board diversity. In order to strengthen its gender neutrality mandates, France now plans to fine companies that fail to disclose information related to pay equity gaps. 

 

In the U.S., two developments indicate growing regulatory resolve here as well at both the state and federal levels. In October 2018, the state of California in the U.S. recently passed the widely-heralded and criticized Senate Bill 826. [3] The bill imposes a board quota requirement for any public or foreign company with executive offices in California. By the end of 2019, one woman must be sitting on that company’s board. By the end of 2021, companies with five directors must have two women on the board and those with six directors must have three women in board seats.  Failure to do so will result in fines beginning at $100,000.

 

At the beginning of 2019, the U.S. Securities and Exchange Commission released guidance interpretations regarding corporate proxy statements and disclosures related to the background of board directors. The SEC offers this directive “Item 407(c)(2)(vi) of Regulation S-K requires a company to discuss the nominating committee’s process for identifying and evaluating director nominees, including discussion regarding any director diversity policy and the manner in which its effectiveness is assessed.”  

 

This guidance statement aligns with the transparency provisions that characterize the reporting mandates under the aforementioned EU regulations.It signals the SEC’s alertness to the importance of inclusive board selection processes and accountability that starts at the top. For company leadership, the SEC interpretation of the highlighted Regulation S-K provision signals that companies will need to make their diversity commitment more explicit through leadership selection and a process that bolsters good faith efforts to be inclusive.

 

In sum, the aforementioned developments represent both a new enforcement framework for diversity priorities. These reporting and accountability reforms harness the regulatory leverage of government and codify public expectations of transparency and good faith. More importantly, these new mandates centered on wage-gap deficits and board diversity will facilitate a market-facing and compliance –centered discipline at global companies concerning diversity. This approach places the emphasis on comprehensive, structural change that can shape corporate strategy and executive-level decision-making.

 

Moving forward, it’s critical that executive leaders and their counsel map out an execution strategy that mitigates liability/legal exposure and risk related to these new diversity-driven mandates. The following priorities should frame next steps:

 

  • Development of compliance, compensation, and risk management diversity benchmarks for senior leaders and managers which guides the design of a process and audit pathway that mitigates risk, improves outcomes, and strengthens organizational line of sight re: pay equity and board selection deliberations 

 

  • Completion of a competitive analysis and scoring model that examines the business consequences/financial costs associated with the company’s strategic strengths and weaknesses in the global market place and investor community due to its diversity and inclusion performance

 

  • An assessment of due diligence milestones (assets, liability, transactions), workplace trends, and overall organizational fitness through the lens of diversity, transparency, and “north star” objectives to create greater company equity

 

  • Finalizing an outreach plan for building broader and more diverse pipeline of social and professional connections for the company

 

Multinational companies are on the frontlines of state efforts to address economic inequity. In this new era of diversity enforcement and global attentiveness to problematic corporate behavior, outcomes matter more than ever. 

 

In response to regulatory oversight, companies should work to benchmark progress and accountability with respect to wage gaps and governance decision-rights. Most importantly, in this new regulatory climate, leadership, including corporate directors, should work to create an aligned, virtuous cycle of equitable decision-making, operational integrity, and economic growth to advance impactful solutions for change and compliance. 

 

 

Footnotes:

[1] The three highest ranking countries for gender equity are Lao PDR, Barbados and the Bahamas respectively.

[2] Denmark passed a pay wage gap reporting mandate in 2007, one of the first in the EU.

[3] Senate Bill 826 and its quota-based approach to reform has been subject to concerns about its constitutionality due to the Equal Protection Clause and the internal affairs conflict of laws doctrine. Under the internal affairs doctrine, which directs that one state shall have jurisdiction over a corporate entity, a question arises about California’s jurisdiction over a foreign corporation.

 

Valerie Kennedy is a corporate lawyer and diversity practitioner who practices in New York City.

 

Her legal experience includes both Biglaw roles at the firms of Skadden, Arps, Slate, Meagher & Flom and Cravath, Swaine & Moore and positions in the public sector. She served as the City’s first Diversity Officer at the New York City Economic Development Corporation and as a Senior Mayoral Advisor on diversity matters in the Mayor’s Office of Appointments.  

 

She has spoken about diversity  before New York City’s Gender Equity Commission, Columbia University’s School of International and Public Affairs and at the Womensphere Conference.

 

She is well-versed in diversity and equity issues pertaining to race and gender.

 

 

 

 

 

 

 

 

 

 

 

 

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