On December 11, 2024, the Court of Appeals for the Fifth Circuit, sitting en banc, struck down Nasdaq rules requiring listed companies to report certain board of director diversity statistics, and to have, or explain why they do not have, at least two directors that Nasdaq considered diverse. The Fifth Circuit held that when approving the rules, the SEC failed to demonstrate they were consistent with the requirements of the Securities Exchange Act of 1934 (the “Exchange Act”).
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At issue in Alliance for Fair Board Recruitment v. SEC were three Nasdaq diversity-related rules which required Nasdaq-listed companies to: (i) disclose statistical information regarding the diversity composition of their boards of directors; (ii) have at least two directors that Nasdaq considered “diverse” or, alternatively, explain why they did not; and (iii) offer companies who did not meet these “aspirational diversity objectives” complimentary access to a “recruiting solution” which “provid[ed] access to a network of board-ready diverse candidates.”
Under the Exchange Act, before Nasdaq can adopt a new rule, it must file the proposed change with the SEC. The SEC, in turn, must approve the proposal only if “it finds [the proposal] is consistent with the requirements of” the Exchange Act.
The Fifth Circuit, however, held that Nasdaq’s diversity rules “cannot be squared with” the language of the Exchange Act. In doing so, the Court rejected the SEC’s contention that “any disclosure-based exchange rule is related to the purposes of the Exchange Act.” Rather, a disclosure rule is related to the purposes of the Act “only if” it has some connection to the “ails” the Act was “designed . . . to eradicate,” such as protecting the economy from “speculation, manipulation, and fraud,” or “removing barriers to exchange competition.” But “disclosure of any and all information about listed companies” is not related to the Act’s purposes, according to the Court. The Court also rejected the SEC’s arguments that the diversity rules were consistent with the Exchange Act because they: (i) promoted “just and equitable principles of trade”; (ii) removed “impediments to and perfected the mechanism of a free and open market and a national market system”; and (iii) “protected investors and the public interest” by making available information that some investors wanted.
Additionally, the Court explained that the “major questions doctrine”—which the Supreme Court has increasingly relied on in recent years to strike down agency actions—“confirms our interpretation of the statute’s ordinary meaning.” The Court said that the economic and political scope of the SEC’s approval of the Nasdaq rules was “staggering by any measure,” in addition to being an unprecedented and novel interpretation of longstanding statutory language. The Court wrote that, until recently, the “SEC has never claimed the authority to impose diversity requirements, or anything resembling them, on corporate boards.”
The Fifth Circuit’s decision comes in the wake of increased scrutiny of employers’ diversity initiatives and practices. After the decision was announced, Nasdaq released a statement explaining that it “respect[s] the Court’s decision and do[es] not intend to seek further review. As a result, companies will no longer be required to follow Nasdaq’s board diversity disclosure rules.” Given the upcoming change in administration, it seems unlikely that the SEC will seek further review.