To Have or Have Not: The Limits of Comply-or-Explain Governance in an American Exchange

In 2020, the National Association of Securities Dealers Automated Quotations (“Nasdaq”) proposed a comply-or-explain governance rule to the Securities and Exchange Commission (“SEC”), aimed at increasing diversity in companies listed on its exchange. The resulting listing rule—approved by the SEC in 2021—was met with a mixed chorus of cheers and jeers from the public and regulated companies. Missing from that chorus, however, was an analysis of the effectiveness of Nasdaq’s approach in using a flexible, predominantly international comply-or-explain governance model to regulate the companies listed on its exchange. Framed as a disclosure code, Nasdaq’s Listing Rule 5605(f)(2) requires listed companies to either have at least two diverse board members or provide an explanation for why the company has failed to do so. Comply-or-explain governance represents an attempt by regulators to meet the needs of companies while also nudging companies in the direction of a best practice—which in Nasdaq’s case is to have two diverse board members. Widely used in Europe, the governance approach toes the line between mandating compliance and allowing companies to adjust the code to their needs. However, inherent in the flexibility allowed for by comply-or-explain governance comes certain flaws prevalent in international jurisdictions that can result in minimal adoption and consequently minimal change. This Comment assesses Nasdaq’s Listing Rule 5605(f)(2) for its likely impact in boardrooms of the more than 3,000 companies listed on its exchange, highlighting critical gaps that could result in the aspirational code. This Comment then proposes a solution to the Rule to fill the gaps through increased Nasdaq monitoring and publication without overextending the exchange beyond its constitutional or statutory limits