Client Alerts
Oct. 30, 2023

Diversity in the Boardroom: Fifth Circuit Rejects Challenge to the SEC Nasdaq Board Diversity Rules; En Banc Petition Quickly Filed

The U.S. Court of Appeals for the Fifth Circuit (Court) recently rejected challenges to Nasdaq’s “Board Diversity” framework. Those rules require Nasdaq-listed companies to report that they have, or explain why they do not have, diverse directors on their boards. In an Oct. 18 unanimous opinion, the court held that the Securities and Exchange Commission (SEC) acted within its authority to approve the rules. The three judges who heard the case were all appointed by Democratic presidents. On Oct. 25, the groups opposing the rules, the Alliance for Fair Board Recruitment and the National Center for Public Policy Research (together, Petitioners), filed a petition for a rehearing en banc before the full Fifth Circuit, whose overall membership is more conservative leaning.

The Board Diversity Rules 

Nasdaq’s board diversity framework does not mandate specific diversity quotas, but, instead, requires companies to disclose the current composition of their board of directors if those companies want to participate in the Nasdaq exchange. As we have previously discussed here and here, the diversity-disclosure framework is multipart. 

  • Rule 5605 requires a listed company to “have, or explain why it does not have, at least two members of its board of directors who are Diverse, including (i) at least one Diverse director who self-identifies as Female; and (ii) at least one Diverse director who self-identifies as an Underrepresented Minority or LGBTQ+.” The rule defines “Diverse” as “an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority, or LGBTQ+. “Underrepresented Minority” means an individual who self-identifies as Black or African American; Hispanic or Latinx; Asian; Native American or Alaska Native, Native Hawaiian or Pacific Islander; or more than one race or ethnicity. See Rule 5605(f), Nasdaq Rulebook, 5600. Corporate Governance Requirements.
  • Rule 5606 requires companies listed on the U.S. exchange to publicly report board-level diversity data using the Nasdaq’s “Board Diversity Matrix” template or a substantially similar matrix. A company can choose to provide this disclosure in the company’s proxy statement or information statement, or publish the matrix on the company’s website. See id. at Rule 5606.

The framework provides transition periods and additional flexibility for smaller companies, nonoperating companies and foreign issuers. Nasdaq also provides free resources for listed companies looking to recruit from a diverse pool of candidates. More information on Nasdaq’s diversity disclosure requirements and recruiting resources is available here.

The Court’s Decision in Alliance for Fair Board Recruitment v. SEC

Petitioner groups Alliance for Fair Board Recruitment and National Center for Public Policy Research sued the SEC after it approved the board diversity framework; Nasdaq intervened to defend the rules. Petitioners argued that the disclosure rules were unconstitutional violations of equal protection and free speech, and that the SEC’s approval of the rules violated the Securities Exchange Act of 1934 (Exchange Act) and the Administrative Procedure Act.

The Court rejected Petitioners’ arguments. First, the Court found that Nasdaq’s rules were not unconstitutional government action because Nasdaq is not a “state actor” and no “sufficiently close nexus” existed between Nasdaq, a private entity, and the government agency. See Alliance for Fair Board Recruitment v. SEC, No. 21-60626, at 21 (5th Cir. Oct. 18, 2023). Second, the Court held that the SEC acted within its lawful authority, relied on substantial evidence and conducted the appropriate analysis to find the framework consistent with the Exchange Act’s fundamental purpose.

Petition for Rehearing En Banc

The Alliance for Fair Board Recruitment filed a petition for en banc review only seven days after the three-judge panel issued its decision dismissing the case. Most of the petition addresses the dismissed constitutional claims. Petitioners repeat their arguments that the framework is unconstitutional under the 1st Amendment’s free speech and 14th Amendment’s equal protection clauses. They also argue that the disclosure rule requires Nasdaq-listed companies “to participate in or encourage race and sex discrimination to which they are adamantly opposed, and to engage in controversial speech about discrimination, under the threat of penalties mandated by the Exchange Act.” Petition for Rehearing En Banc, ECF no. 297, at 5. The Oct. 18 decision dismissed this argument as misdirected, emphasizing that the SEC has authority under the Exchange Act to sanction Nasdaq — not listed companies — for failure to enforce the disclosure rules.[1]

Petitioners also ask the court to review the sufficiency of the evidence the SEC relied on in its approval. They argue that the Oct. 18 decision will allow “the mere say-so of a few well-placed financial activists [to be] enough to invoke the SEC’s disclosure power” for “anything and everything … e.g., what churches a company’s board members attend, how many firearms they own, how many abortions they’ve had, how much greenhouse gas their suppliers emit, etc.” Id. at 15.

***

Once the petition is filed, any active member of the court may request a poll of the other active judges on whether rehearing en banc should be granted. Rules and Internal Operating Procedures of the U.S. Court of Appeals for the Fifth Circuit, at 35 (April 2023). A response to the petition is only filed if the court requests one. Id. As we wait for a ruling on this petition, certain companies listed on the Nasdaq exchange on or before Dec. 31, 2022, will need to comply with modified rules by the end of the year.

[1] The opinion, however, left open the question of whether such sanctions from the SEC would be state action, writing that it “is not a question presented by this petition, and so we will not touch it today.” Alliance for Fair Board Recruitment v. SEC, No. 21-60626, at 21 (5th Cir. Oct. 18, 2023).

Authors and Editors

Related Practices

We use cookies on this website to optimize user experience and site functionality and to give you the best possible experience. We do so with your approval. The choice is up to you. Learn more.