On December 11, 2024, the United States Court of Appeals for the Fifth Circuit, in a 9-8
en banc decision, vacated NASDAQ’s Board Diversity Rules (the “Rules”) in
Alliance for Fair Board Recruitment v. SEC, finding that the Securities and Exchange Commission (the “SEC”) exceeded its authority under the Securities Exchange Act of 1934 (the “Exchange Act”) when it approved the Rules. The decision reversed an October 2023 decision by a three-judge panel of the Circuit, which had upheld the Rules. As a result, NASDAQ-listed companies are no longer required to disclose information about the racial, gender and sexual characteristics of their directors, nor have (or explain why they do not have) at least two diverse directors, in the manner dictated by the Rules.
Background
In December 2020, NASDAQ submitted to the SEC a proposal for promoting transparency into the diversity of the Boards of Directors of NASDAQ-listed companies. After comment and amendment, the Rules required that NASDAQ-listed companies (1) have at least two diverse directors, as defined by the Rules, or explain why it does not; and (2) disclose information about the voluntary self-identified gender, race, and LGBTQ+ status of the company’s board, in aggregate.
In August 2021, the SEC approved NASDAQ’s proposed Rules, reasoning that the Rules would improve the quality of information available to investors by providing consistent and comparable diversity metrics, and in so doing, contribute to the maintenance of fair and orderly markets and protect investors and the public interest under the Exchange Act.
In October 2023, a three-judge panel upheld the rules after a challenge brought by the Alliance for Fair Board Recruitment and the National Center for Public Policy Research. The panel held that the SEC’s approval of the Rules was, among other things, within its authority under the Exchange Act. The petitioners sought and won
en banc review from the full Circuit, leading to the instant decision.
Rationale of the Majority
The majority held that the SEC’s approval of the Rules was “arbitrary, capricious and an abuse of discretion” because the SEC’s authority under the Exchange Act to compel disclosure must be related to the purposes of the Act, which the majority defined principally as “limiting speculation, manipulation, and fraud.” In the majority view, the Rules were “far removed” from this purpose. Referencing the major-questions doctrine, the majority found that the SEC needed to have clear statutory authority to take action in an area that the majority characterized as having substantial economic significance; and that the political significance of the issue was “likewise staggering.” The Circuit rejected the SEC’s arguments that the Rules were just disclosure rules; rather, the majority wrote, the requirement that listed companies explain their failures to satisfy the diversity standard was a “public-shaming penalty.”
The Dissent
The eight-judge dissent focused on the limited role Congress had given the SEC in reviewing and approving the Rules and concluded that its limited role did not permit the SEC to “displace NASDAQ’s private business judgment” with its own policy views. The dissent pointed to the elimination of information asymmetries regarding board composition as a core concern of the Exchange Act.
Impact
While the Fifth Circuit’s decision removes the requirements set forth in the NASDAQ Rules, it does not directly affect the practice by many listed and not listed companies to provide board diversity data to the public. Indeed, the majority opinion expressly notes that companies can choose to disclose such information to investors.
But the Circuit’s close reading of the SEC’s authority and focus on a relatively narrow purpose, suggests that other SEC rule making may face critical scrutiny in the Circuit in the years to come.
