Nasdaq’s Board Diversity Win Invigorates SEC Disclosure Plans

An SEC plan to bolster corporate board diversity has found a clearer path forward after Nasdaq rules aimed at boosting women and minority directors secured court support.

The Securities and Exchange Commission has considered requiring public company disclosures on board member and nominee diversity since at least 2016, according to agency rulemaking agendas. The plans garnered new attention after Democrats took the commission’s helm in 2021 and blessed regulations for Nasdaq-listed companies to have diverse boards or explain why they don’t, as companies increasingly emphasized the importance of diversity.

The US Court of Appeals for the Fifth Circuit last month let Nasdaq Inc. keep its rules, which needed SEC approval to take effect. A conservative group is challenging the decision. But the victory for Nasdaq and the commission helps support the agency’s plans to bring board diversity rules to more public companies and boosts its odds of surviving a court challenge, said Jena Martin, a West Virginia University College of Law professor who studies securities regulation and human rights.

“If they stick to: ‘This is disclosure, and we’re just doing this as a disclosure initiative, like all the other disclosure initiatives that we’ve done before,’ I think they’d win,” Martin said.

An SEC representative said the Fifth Circuit decision pleased the agency, but declined to comment on its board diversity rulemaking plans. The commission is looking to release a proposal around April 2024, according to the agency’s most recent rulemaking agenda.

Quota v. Disclosure

A panel of three Fifth Circuit judges appointed by Democratic presidents ruled on Oct. 18 that the SEC had the power to endorse Nasdaq’s rules, which cover thousands of companies. Conservative groups sued the agency in 2021, saying the regulations disregarded federal securities laws and directors’ and companies’ First Amendment rights.

One of the organizations, the Alliance for Fair Board Recruitment, asked the full Fifth Circuit to review the decision. The court, where Republican-appointed judges hold the majority, has yet to decide whether it will consider the appeal. The alliance is led by conservative legal strategist Edward Blum, who also heads Students for Fair Admissions, which won a Supreme Court case in June against Harvard University’s affirmative action use.

The Alliance for Fair Board Recruitment and National Center for Public Policy Research, which also sued over the rules, have said the SEC approved a diversity quota, overstepping its rulemaking authority. The three-judge Fifth Circuit panel disagreed, saying the SEC endorsed disclosure regulations that are within its purview.

The ruling came after California state court judges struck down its laws for companies based there to have women and minority or LGBTQ+ board members. A federal judge also ruled that the state’s statute requiring board members from underrepresented groups employs an unconstitutional quota system. California has appealed the decisions.

The SEC “can’t really make proposals that mandate diversity on boards,” said Sarah Solum, head of US capital markets and managing partner of the Silicon Valley office of Freshfields Bruckhaus Deringer LLP. “I’m not sure what they’re going to require that goes beyond the Nasdaq rule.”

Nasdaq’s regulations, unlike the California rules, don’t explicitly require diverse boards. Nasdaq-listed companies generally must have at least one woman and at least one minority or LGBTQ+ member on their boards, unless they disclose why they can’t, under the rules that are starting to take effect in December.

Scott Shepard, a National Center for Public Policy Research fellow, said he’s hopeful judges eventually will see that Nasdaq is implementing what he says is an illegal quota, regardless of whether some think the regulations have permissible disclosure requirements. The SEC may face litigation over any board diversity rules it adopts, even if the word “quota” is absent from the regulations, he said.

“They can call it broccoli if they want,” Shepard said. “But if it works as a quota, it’s a quota.”

Encouraging Diversity

SEC officials have said little about what the agency would require under its board diversity rules.

The agency’s most recent rulemaking agenda says only that the commission is considering proposing “rule amendments to enhance registrant disclosures about the diversity of board members and nominees.” When asked in 2021 about the shape of potential regulations, SEC Chair Gary Gensler said the agency is a “disclosure-based regime.”

The SEC has adopted board diversity regulations before. During the Obama administration in 2009, the agency approved rules requiring companies to report how they consider diversity when nominating board members.

The California Public Employees Retirement System and other pension funds pushed for the rules at the time and have since called for more board diversity disclosures.

The Council of Institutional Investors, which represents CalPERS and other pension funds, urged the Fifth Circuit to back Nasdaq’s rules, and the court noted in its decision that shareholders find board diversity information useful. Diverse boards help companies perform better, the group and other supporters of the regulations said in an amicus brief filed with the Fifth Circuit in 2022.

Michael Hyter, president and CEO of The Executive Leadership Council, a non-profit that advocates for opportunities for Black executives, said he hopes the Fifth Circuit ruling “will encourage all companies to increase diversity on their boards.”

“It is clear that the SEC has acknowledged the importance of this effort,” he said.

Behavior Changing

Diversity continues to be an important factor in board hiring, according to a report from consulting firm Spencer Stuart. The August report, based on proxy statements from 489 companies between May 2022 and April 2023, said 67% of new directors during that time are diverse and self-identify as female, underrepresented minorities, or LGBTQ+. But that’s down from 72% in 2022 and 2021, the report said.

The percentage of women on S&P 500 boards has continued to rise over the years, the report said. Forty-six percent of new independent directors are women, a 92% increase in the past decade. Last year the percentage of new female directors was also 46%, and overall, 33% of all S&P 500 directors are women, the report said.

The survey also said that 20% of companies are prioritizing recruiting women and underrepresented minorities. But the portion of new directors that are underrepresented minorities is down 10 percentage points—from 46% last year to 36%— according to the report.

Solum of Freshfields said director diversity rules aren’t controversial for most of the boards she advises.

“The train left the station,” she said. “Some of this stuff is hitting the courts, but the actual change in behaviors has happened already.”