Nasdaq Board Diversity Rules Struck Down by Fifth Circuit (2)

A federal appeals court on Wednesday scrapped Nasdaq rules intended to increase representation of women and minorities on corporate boards, withdrawing its previous support for an SEC order that had allowed the regulations to move forward.

The Securities and Exchange Commission lacked the power in 2021 to approve the requirements for Nasdaq-listed companies to have diverse boards or explain why they don’t, the US Court of Appeals for the Fifth Circuit ruled in a 9-8 vote.

All nine of the judges in the majority were appointed by Republican presidents. The eight judges voting against the decision included three Democratic-appointed judges who backed the SEC in a 2023 ruling that led to the full court’s review.

The challenge came from conservative groups that argued the SEC overstepped its authority under federal securities law. One of the organizations, Alliance for Fair Board Recruitment, is led by Edward Blum, who helped bring the case behind the 2023 Supreme Court decision limiting the use of race in college admissions.

The rules have required thousands of public companies that trade on Nasdaq Inc. exchanges to have at least one woman, minority, or LGBTQ+ member on their boards since 2023, unless they disclose why they can’t comply. Companies also have had to report director diversity information annually.

The regulations are “far removed” from the 1934 Securities Exchange Act, which requires the SEC to approve stock exchange rules that promote “just and equitable principles of trade,” Judge Andrew Oldham wrote in an opinion for the majority. He was joined by judges Jennifer Walker Elrod, Edith Jones, Jerry Smith, Priscilla Richman, Don Willett, Kyle Duncan, Kurt Engelhardt, and Cory Wilson.

“It is obviously unethical to violate the law or to disregard a contractual promise,” Oldham wrote. “It is not unethical for a company to decline to disclose information about the racial, gender, and LGTBQ+ characteristics of its directors. We are not aware of any established rule or custom of the securities trade that saddles companies with an obligation to explain why their boards of directors do not have as much racial, gender, or sexual orientation diversity as Nasdaq would prefer.”

A Nasdaq representative said the exchange disagreed with the court’s decision, but doesn’t plan to appeal the ruling. An SEC spokesperson said the agency is “reviewing the decision and will determine next steps as appropriate.”

Jonathan Berry, Boyden Gray PLLC’s managing partner who represents the Alliance for Fair Board Recruitment, praised the decision, saying the group is “grateful that the court has vindicated fair treatment under the law.”

Dissenting Judges

The ruling came more than three years after the Democratic-led SEC voted along party lines to endorse the Nasdaq regulations. The Alliance for Fair Board Recruitment and National Center for Public Policy Research sued to kill the rules soon after they arrived in 2021. But the Fifth Circuit didn’t reach its initial decision in support of the regulations until October 2023.

Judges James Dennis, Stephen Higginson, and Carl Stewart ruled then that the SEC acted appropriately when it concluded that a reasonable investor may find use in board diversity information. The Exchange Act allows the SEC to back requirements for disclosures important to shareholders’ investment and voting decisions, the panel ruled.

Dennis, Higginson, and Stewart all voted against tossing the Nasdaq rules in the Fifth Circuit decision on Wednesday. They were joined by judges Leslie Southwick, Catharina Haynes, James Graves, Dana Douglas, and Irma Carrillo Ramirez. Graves, Douglas, and Ramirez are Democratic appointees, while Southwick and Haynes are Republican picks.

“If Nasdaq misapprehended investor appetite for this information and the willingness of the listed companies it contracts with to provide it, the marketplace of competing exchanges—and not the policy preferences of this court or a federal agency—will resolve that,” said Higginson, writing for the minority in a dissent.

The case is Alliance for Fair Board Recruitment v. SEC, 5th Cir. en banc, No. 21-60626, opinion issued 12/11/24.