Nasdaq's board diversity rules struck down by Fifth Circuit

Background

In August 2021, following the United States Securities and Exchange Commission (“SEC”)’s approval, by a 3-2 vote, Nasdaq implemented amendments to its listing standards aimed at increasing board diversity among boards of Nasdaq-listed companies (the “Diversity Rules”). The Diversity Rules required Nasdaq-listed companies to:

• Provide statistical information on the gender, race, and LGBTQ+ status of their directors in a “Board Diversity Matrix” (Rule 5606) and
• Either (a) have at least one director who identifies as female and one director who identifies as an underrepresented minority or LGBTQ+, or (b) explain why they do not meet these diversity objectives (Rule 5605(f)).²

The New York Stock Exchange does not have a comparable listing standard.

Summary of the case

The parties’ arguments

Alliance for Fair Board Recruitment (AFBR) and the National Center for Public Research (NCPR) challenged the Diversity Rules in the Fifth Circuit, arguing that (a) the SEC lacked statutory authority to approve the Diversity Rules and (b) the Diversity Rules were inconsistent with the requirements and aim of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which is intended to “protect investors and the macroeconomy from speculative, manipulative, and fraudulent practices, and to promote competition in the market for securities transactions.”³

The SEC argued that the Diversity Rules satisfied the requirements of the Exchange Act because the disclosure of board diversity information would “promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system, and protect investors and the public interest,”⁴ consistent with the goals of the Exchange Act. The SEC also noted that the disclosure of board diversity information was important to large institutional investors and investment managers, such as Blackrock, Vanguard, and State Street, and that the Diversity Rules would establish a disclosure-based framework that would make board diversity information available to investors on a consistent and comparable basis.

The Court’s ruling and reasoning

In a 9-8 ruling, the Fifth Circuit ruled in favor of AFBR and NCPR and vacated the SEC's order approving the Diversity Rules. 

Applying the “major questions” doctrine, which requires clear congressional authorization for an agency to exercise significant regulatory power, the Fifth Circuit held that the SEC lacked statutory authority under the Exchange Act to approve rules that compel disclosure of board diversity information or impose diversity objectives on listed companies. It also found the SEC's reasoning that the Diversity Rules would satisfy investor demand for board diversity information was insufficient. For the Fifth Circuit majority, the fact that investors may want disclosure of certain types of information is irrelevant if mandating such disclosure would be unrelated to the purposes of the Exchange Act, which purposes the Fifth Circuit construed narrowly.

Takeaways

• Nasdaq stated that it does not intend to seek further review, and with new leadership about to take over at the SEC and a coming Republican majority on the Commission, the SEC is not expected to appeal this decision.
• Nasdaq-listed companies should prepare for the next proxy season. Some companies adopted Nasdaq’s Board Diversity Matrix as a base for their overall board diversity disclosures, while others added it to supplement their own board skills and demographic matrices, so companies should begin to plan how they will present this information going forward. Companies could continue to use the Board Diversity Matrix and remove references to the Nasdaq requirement.
• This ruling does not mean board diversity information is no longer relevant. Most public companies have presented information related to board diversity long before Nasdaq implemented this listing standard and the breadth of these disclosures has only been increasing. As noted in our 22nd Annual Corporate Governance & Executive Compensation Survey, the number of the top 100 companies that presented director-specific diversity information increased from 61 companies in 2023 to 73 companies in 2024.
• Additionally, prominent shareholder advisory firms, such as ISS and Glass Lewis, maintain their own policies on diversity disclosure, which include expectations for diverse board representation. Similarly, many institutional investors want to see board diversity disclosures and have expectations regarding actual diverse membership on the board and commitments to seek diverse directors.
• Ultimately, each issuer will need to determine, based on its own internal policies and objectives, as well as the views of proxy advisory firms, its stockholders, and other stakeholders, whether, to what extent, and in what format it will continue to provide diversity disclosures.

Footnotes

1. Alliance for Fair Board Recruitment v. SEC, No. 21-60626, (5th Cir. 2024).

2. The Diversity Rules also included a third component that provided listed companies that did not meet the diversity objectives with access to a board recruiting service to help identify diverse candidates (Rule IM-5900-9).

3. Alliance for Fair Board Recruitment v. SEC, No. 21-60626, at 10 (5th Cir. 2024).

4. Alliance for Fair Board Recruitment v. SEC, No. 21-60626, at 22 (5th Cir. 2024).