On December 11, 2024, in an en banc decision, the U.S. Court of Appeals for the Fifth Circuit ruled that Nasdaq cannot implement its board diversity rules approved by the Securities and Exchange Commission (SEC) because the SEC lacked the authority to approve such rules. In a 9–8 ruling, the Fifth Circuit vacated the diversity rules, finding that they violate federal securities law and that the regulators failed to explain how the rules have any connection to the Exchange Act’s purpose of protecting investors and the public interest while further promoting competition in the market. In its opinion, the Fifth Circuit concluded that the importance of diversity information to investors is irrelevant to the purposes of securities law.
Background
On December 1, 2020, Nasdaq revealed its proposal for the board diversity rules, which required companies listed on Nasdaq to have at least two diverse directors (or explain why they do not) and to disclose board diversity data. On August 6, 2021, the SEC approved Nasdaq’s board diversity rules, finding that the rules would allow investors to gain a better understanding of Nasdaq-listed companies’ approach to board diversity while also providing flexibility to make decisions that best serve their shareholders. Depending on a company’s market cap and the date it was listed on Nasdaq, this rule was to become effective between December 31, 2023 and December 31, 2026. For most companies, the reporting requirements of Nasdaq’s board diversity rules went into effect starting in December 2023.
On October 18, 2023, a three-judge panel of the Fifth Circuit held that the SEC acted appropriately in approving Nasdaq’s board diversity rules. The Alliance for Fair Board Recruitment and the National Center for Public Policy Research sued the SEC, rather than Nasdaq, alleging that the board diversity rules violated constitutional rights of equal protection by discriminating against white men while stigmatizing members of certain demographics. The panel refused to entertain the lawsuit, ruling that the exchange is a private entity so it is not subject to constitutional scrutiny and the board diversity rules in question cannot be attributed to a government actor. The panel found that although Nasdaq must register with and is heavily regulated by the SEC, Nasdaq is still a private limited liability company, not created by the government.
On February 20, 2024, the full Fifth Circuit agreed to rehear the lawsuit challenging Nasdaq’s board diversity rules that the SEC had approved. During oral arguments, the Fifth Circuit expressed doubts on the board diversity rules, with some judges wondering whether the rules requiring board diversity information would open the door to investor questions on other information such as religious or political beliefs. The Fifth Circuit stated that even if investors seek such information, there is nothing preventing companies from voluntarily disclosing their board diversity information, so companies maintain the choice to disclose. Furthermore, the Fifth Circuit was unpersuaded by Nasdaq’s assertion that there is a link between the racial, gender, and sexual composition of a company’s board and the quality of its governance.
In the dissenting opinion, the eight dissenting judges argued that the SEC acted appropriately when it approved Nasdaq’s proposal because the review process created by Congress does not permit the SEC to disregard Nasdaq’s private business judgment. They believe that a reasonable investor may find use in board diversity information. The dissenting judges further noted that the lawsuit concerns rules proposed by a private company that contracts with other companies to facilitate the listing and trading of securities, which is not an action by the government.
Next Steps
Nasdaq notified its listed companies that although it believes the board diversity rules would benefit companies and investors, it will respect the Fifth Circuit’s decision and does not intend to appeal. A spokesperson for the SEC, on the other hand, stated that the SEC is reviewing the ruling and will determine its next steps as appropriate. In the meantime, while no longer technically required, companies should consider continuing to provide diversity disclosures voluntarily since major institutional investors and proxy advisors (like ISS and Glass Lewis) continue to request information regarding board diversity and consider diversity as a factor in their voting decisions and recommendations. Alston & Bird will be monitoring the SEC’s position on the Fifth Circuit’s ruling and the impact on companies’ board diversity disclosures.
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