Fifth Circuit Vacates Nasdaq’s Board Diversity Requirements

In another setback for the corporate diversity movement in the United States, a 9-8 panel decision of the U.S. Court of Appeals for the Fifth Circuit has vacated the U.S. Securities and Exchange Commission’s (the “SEC”) approval of Nasdaq rules requiring certain board diversity thresholds be met (or an explanation be provided if not) and statistical disclosures regarding the diversity of corporate board members. 

Nasdaq’s rules, adopted in 2021, required a listed company to have, or explain why it does not have, at least two members of its board of directors who are diverse (i.e., female, an underrepresented minority or LGBTQ+), including (i) at least one female director; and (ii) at least one underrepresented minority or LGBTQ+ director; and to disclose annual numerical data on the diversity of its board of directors (the “Board Diversity Rules”). Nasdaq also adopted a rule offering companies who did not meet its “aspirational diversity objectives” complimentary access to a board recruiting solution providing access to a network of board-ready diverse candidates. Nasdaq-listed foreign issuers were given some flexibility in complying with the Board Diversity Rules.

The Fifth Circuit vacated all of the rules, holding that the SEC’s approval “cannot be squared with the Securities Exchange Act of 1934.” Nasdaq is a self-regulatory organization (“SRO”), and it must file any proposed rule changes with the SEC. After a notice-and-comment period (and additional proceedings, if deemed necessary), the SEC must approve an SRO’s proposal if it finds the proposal is consistent with the requirements of the Exchange Act.

The panel held that a stock exchange rule is not related to the purposes of the Exchange Act simply because it is a disclosure rule; the disclosure rule must have some connection to the Act’s purposes of protecting investors from speculative, manipulative and fraudulent practices and promoting competition in the securities market. The panel flatly rejected all of the SEC’s and Nasdaq’s arguments attempting to connect the rules to the Act’s purposes as “wrong,” concluding that the Act’s purposes bear no relationship to the disclosure of information about the racial, gender, and sexual characteristics of the directors of public companies. 

The panel also concluded that the rules violated the “major questions” doctrine, which requires that when an agency asserts the power “to substantially restructure” the American market, it must point to “clear congressional authorization for the power it claims.” While noting that not everything the SEC does to regulate Nasdaq – the world’s second-largest stock exchange – automatically implicates a major question, the diversity rules, “which attempt to transform the internal structure of many of the largest corporations in the world,” come close to regulating “the entire economy.”

The dissent focused on the SEC’s limited review role, arguing that the SEC approved the rules because the reviewing scheme that Congress created does not allow the SEC to displace Nasdaq’s private business judgment —informed by investor behavior, in a competitive market with other exchanges — with the SEC’s policy priorities. 

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The ruling means that Nasdaq-listed companies do not need to comply with the Board Diversity Rules, including the disclosure requirements, which were due at the calendar year end. Nasdaq has said it will not appeal the ruling, and while the SEC is considering an appeal, it seems unlikely that the SEC under the Trump administration will do so. 

We will continue to monitor developments in this area and welcome any queries you may have.