Diversity in the Boardroom: Nasdaq’s Diversity Disclosure Rules Struck Down by En Banc Fifth Circuit Court of Appeals

In what will likely mark the final outcome, the U.S. Court of Appeals for the Fifth Circuit, sitting en banc, struck down the Nasdaq Stock Market’s diversity-disclosure framework on Dec. 11, 2024. The Nasdaq rules issue — Rule 5605(f) and Rule 5606 (together, the Diversity and Disclosure Rules) — required most Nasdaq-listed companies to report that they have, or explain why they do not have, racial, gender or LGBTQIA+ diversity among the directors on their boards. The parties have until March to ask the Supreme Court to review the decision, but we’ve seen reports that Nasdaq does not intend to seek certiorari and the Securities and Exchange Commission (SEC) under the new Trump administration seems unlikely to request further review.^[1]

Although the ruling eliminates Nasdaq’s requirements for listed companies to disclose board diversity information, we anticipate that many public companies will voluntarily share such data. Listed companies, however, are no longer tied to Nasdaq’s standardized matrix and can choose when, how and what information to disclose to meet proxy voting and stewardship guidelines, state regulations, and investor expectations. We note that Institutional Shareholder Services (ISS), Glass Lewis and some state initiatives request companies to provide information on the racial, ethnic, gender and LGBTQIA+ composition of their boards.

We also provide an update on California’s board diversity statutes below, and we will continue to monitor developments and requirements in this area.

Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir.)

As we detailed here and here, the nonprofit groups the Alliance for Fair Board Recruitment and the National Center for Public Policy Research (together, Petitioners) sought Administrative Procedure Act (APA) review shortly after the SEC approved the Diversity and Disclosure Rules in 2021. Petitioners argued that the rules were unconstitutional violations of equal protection and free speech, and that the SEC’s approval of the rules violated the APA and the Securities Exchange Act of 1934 (Exchange Act or the Act). In October 2023, a three-judge panel rejected Petitioners’ constitutional arguments and affirmed the SEC’s approval of the rules. See Alliance for Fair Board Recruitment v. SEC, 85 F.4th 226 (5th Cir. 2023), vacated on reh’g en banc (Panel Opinion). Shortly after, the full Fifth Circuit agreed to rescind the panel’s order and reconsider Petitioners’ challenge to the rules.

Decision En Banc

With this en banc decision, the Fifth Circuit vacates the SEC’s approval of the Diversity and Disclosure Rules, holding that the rules could not properly “be squared” with the approval power granted to the SEC by federal securities laws. Alliance for Fair Board Recruitment v. SEC, No. 21-60626, 2024 WL 5078034 (5th Cir. Dec. 11, 2024) (En Banc Opinion). The court reasoned that the SEC may not approve an exchange’s rule “unless it can establish the rule has some connection to an actual, enumerated purpose of the Act.” See id. at *10. From a broader regulatory perspective, the Fifth Circuit’s ruling on the Diversity and Disclosure Rules, along with earlier rulings on the dealer rule and private fund adviser rule, reflects a narrow, textualist view as to the SEC’s regulatory powers.

Writing for a 9-8 majority, Judge Andrew S. Oldham first rejected the SEC’s argument that the Diversity and Disclosure Rules relate to the Exchange Act’s purpose to facilitate “full disclosure of information important to investor decision-making.” See SEC Resp. to Pets. for Reh’g En Banc 14, ECF No. 330. Instead, the court determined that Congress passed the Exchange Act “primarily to protect investors and the American economy” from “fraud, manipulation, speculation, and anticompetitive exchange behavior.” En Banc Opinion, 2024 WL 5078034 at *10, *14 n.6. The majority allowed that there “may be other purposes buried in the Exchange Act’s voluminous text,” but concluded that “the Act’s history makes clear that disclosure of any and all information about listed companies is not among them.” Id. at *10.

The court then reviewed and rejected in turn each of the SEC’s offered enumerated purposes, finding insufficient record evidence that the Diversity and Disclosure Rules were “consistent with” the Act’s designs to “promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system, [or] protect investors and the public interest” to justify the SEC’s approval. See id. at *3, *10; see also Exchange Act § 6(b)(5), 15 U.S.C. § 78f(5). The court reviewed the evidence the SEC used in its approval process and determined that Nasdaq “offered little support for its assertion that there is an empirically established—or even logical—link between the racial, gender, and sexual composition of a company’s board and the quality of its governance.” Id. at *14. In a footnote, however, the court suggested that the SEC “may have” erred by even considering the effects of the rules on firm performance. En Banc Opinion at *14 n.6. “Congress,” Judge Oldham wrote, “did not pass the Exchange Act for the purpose of maximizing shareholder wealth.” Id. He instead emphasized a narrower anti-fraud congressional purpose and, thus, a narrower scope of exchange rules that the SEC may approve.

The dissent — written by Judge Stephen A. Higginson, who penned the 2023 Panel Opinion that this en banc decision replaced — emphasized the limited role the Exchange Act gave the SEC in reviewing the rules proposed by a self-regulatory organization like the Nasdaq Stock Market. “The requirement that the SEC interrogate investors’ motivations [for wanting board diversity information] is nowhere in the Exchange Act,” wrote Judge Higginson, “and is contrary to the SEC’s limited role in reviewing private exchange-proposed rules for consistency with the Act, rather than for adherence to the SEC’s preferred business judgment.” En Banc Opinion at *23 (Higginson, J., dissenting).

Major Questions: Judicial Scrutiny of Federal Regulation

Judge Oldham cited the “major questions doctrine” in support of the majority’s interpretation of the Exchange Act. The major questions doctrine was brewing in several Supreme Court opinions before it caught national attention in 2022 when the Court used it, instead of the doctrine of agency deference, to limit the Environmental Protection Agency’s ability to regulate greenhouse gas emissions. See generally West Virginia v. EPA, 597 U.S. 697 (2022). According to the doctrine, because an executive agency or regulatory body like the SEC “has no inherent or implied authority” on its own, the agency’s “powers to make major decisions must come only from unequivocal statutory text.” En Banc Opinion, 2024 WL 5078034 at *16. By framing the SEC’s approval of the rules as a significant action outside of the SEC’s “ordinary domain” and, thus, a “major questions case,” the Fifth Circuit signaled broader applications of the doctrine and possible increased judicial scrutiny of regulatory authority.

Petitioners did not emphasize the major question doctrine in their petition for en banc review or subsequent briefing. Nonetheless, the majority stated that “the ‘economic and political significance’ of the SEC’s [approval of the rules] is ‘staggering by any measure.’” Id. The Diversity and Disclosure Rules, Judge Oldham wrote, “attempt to transform the internal structure of many of the largest corporations in the world,” and “come close to regulating ‘the entire economy.’” Id.^[2] Rejecting the SEC and Nasdaq’s argument that the rules merely require disclosure and do not attempt to “remake the boardrooms of America’s corporations,” the court pointed to the requirement that companies explain why they do not have diversity on their boards: “That is not a disclosure requirement. That is a public-shaming penalty for a corporation’s failure to abide by the Government’s diversity requirements.” Id. at *18. The court also expressed skepticism of federal regulation of “diversity in the workplace,” asserting that regulating in this field is primarily the province of the states because corporations are state creations. Finally, the court also described the “social justice movement” of the rules and the “attempt to increase ‘diversity and inclusion’ across ‘public companies’” as two of the most “politically divisive issues in the Nation.” Id. at *16.

Appeals on Hold for California’s Board Diversity Statutes

In 2020, the California Legislature passed its own requirements regarding diversity on the boards of public companies with California headquarters. These statutes, known as Senate Bill 826 (SB 826) and Assembly Bill 979 (AB 979), require minimum numbers of board members from underrepresented racial, gender and LGBT+ groups. Both petitioners from the Nasdaq lawsuit, the Alliance for Fair Board Recruitment and the National Center for Public Policy Research, challenged California’s board diversity laws in federal court; at the same time, taxpayer groups brought suit in state court.

In May 2022, in the taxpayer state-court lawsuit known as “Padilla I,” SB 826 was declared unconstitutional under the California constitution’s equal protection clause. See Crest v. Padilla, No. 19STCV27561, 2022 WL 1565613 (Cal. Super. Ct. May 13, 2022). A month before, in “Padilla II,” AB 979 had also been struck down as unconstitutional under the state constitution’s equal protection clause. See Crest v. Padilla, No. 20 STCV 37513, 2022 WL 1073294 (Cal. Super. Ct. Apr. 01, 2022). The state appealed both decisions. The lawsuits challenging SB 826 and AB 979 in federal court are on hold in the Ninth Circuit Court of Appeals while California pursues its Padilla I and II appeals. See Meland v. Weber, No. 22-15149 (appeal from district court’s denial of preliminary injunction of SB 826); National Center for Public Policy Research v. Weber, No. 22-15822 (appeal from district court’s dismissal of a facial challenge to SB 826); and Alliance for Fair Board Recruitment v. Weber, No. 23-15900 (appeal from summary judgment holding AB 979 unconstitutional). The Padilla appeals have also been stayed, however, as the California Supreme Court considers whether taxpayers can sue state officials over newly enacted statutes, without more specific harms to establish standing. Oral argument in that case, Taking Offense v. State of California, S270535 (Cal., filed Aug. 25, 2021), has not been scheduled. While litigation is ongoing, California is enjoined from implementing or enforcing SB 826 and AB 979 at this time.

Other State Initiatives

Other states continue to request board diversity data from companies. For example, as part of the “Russell 3000 Board Diversity Disclosure Initiative,” the Offices of the Treasurer of Illinois and Connecticut launched an investor coalition that sends letters to companies listed on the Russell 3000 index, requesting each company report board diversity data in their annual proxy statement. The Illinois treasurer recently released the state’s annual report for 2024, summarizing the treasury office’s use of qualified investment firms and contractors owned by minority persons, women, qualified veterans and persons with disabilities.

^[1]_{The presumptive incoming SEC chairman, Paul Atkins, told Congress in 2019 that the SEC “should focus on its mission of regulating capital markets and protecting investors, rather than being tasked with lofty goals it is not equipped to handle.” Testimony of Paul S. Atkins, Hearing Before United States House of Representatives Subcommittee on Investor Protection, Committee on Financial Services (July 10, 2019).}

^[2]_{The dissent stated that the Petitioners abandoned the major-question argument at the en banc stage and referenced the 2023 Panel Opinion’s discussion of the doctrine. Id. at *21 n.4. In that opinion, Judge Higginson wrote that “a disclosure rule for board diversity information is not significant enough to trigger major questions concerns.” Panel Opinion, All. for Fair Bd. Recruitment v. SEC, 85 F.4th 226, 256 (5th Cir. 2023), opinion vacated, No. 21-60626, 2024 WL 670403 (5th Cir. Feb. 19, 2024). Now, the en banc majority, Judge Higginson noted, “seems to suggest that the SEC should have exercised more, not less, of its statutorily limited authority….” En Banc Opinion, 2024 WL 5078034 at *21 n.4 (Higginson, J., dissenting).}