On December 11, 2024, the US Court of Appeals for the Fifth Circuit ruled that the Securities and Exchange Commission (SEC) lacked statutory authority to approve Nasdaq’s board diversity rules. Subject to certain exceptions, the diversity rules required, among other things, that Nasdaq-listed companies publicly disclose the demographic makeup of their boards of directors, and that boards with five or more directors include at least two “diverse” directors.

Fifth Circuit’s Ruling in Alliance for Fair Board Recruitment v. SEC

In its majority opinion, the Fifth Circuit held that the Nasdaq diversity rules were unrelated to the purpose of the Securities Exchange Act of 1934 and, as such, the SEC had no authority to approve the diversity rules. The court reasoned that US Congress enacted the Exchange Act specifically to protect investors in securities by establishing a regulatory oversight regime. Thus, the authority granted to the SEC under the Exchange Act is limited to the prevention of fraud and misrepresentation or concealment of material financial risks, and to stabilize the market from speculation-driven instability.

The SEC argued that the Exchange Act was also intended to remove barriers to the open market and promote justice and equitable trade principles, but the court held that if Congress intended to grant the SEC authority to impose such demographic regulations, the Exchange Act would have stated so explicitly.[1]

Nasdaq’s Proposed Diversity Rule

Nasdaq filed its proposed diversity rules with the SEC on December 1, 2020, and the diversity rules were approved by the SEC on August 6, 2021. The diversity rules, subject to certain exceptions, required a Nasdaq-listed company with five or more directors to:

1. Establish a board with at least one director who self-identifies as female and one director who self-identifies as Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Hawaiian or Pacific Islander, two or more races or ethnicities, or as LGBTQ+.
2. Submit an explanation for its lack of compliance if a company’s board does not meet such requirements.
3. Submit public disclosures detailing the demographic composition of its board.

What Is Next?

In a December 12, 2024, statement, Jeff Thomas, Nasdaq’s Global Head of Listings, confirmed that Nasdaq will not seek to appeal the decision, and that companies seeking Nasdaq listing or listed on the Nasdaq stock markets will not need to comply with the diversity rules. However, the SEC may seek to appeal the Fifth Circuit’s decision to the US Supreme Court, though it remains unclear whether the Supreme Court would agree to consider the case. Congress could also consider amending the Exchange Act, enabling the imposition of board diversity requirements.

Takeaways

Absent a reversal by the Supreme Court or new legislation passed by Congress, Nasdaq-listed companies will no longer be required to adhere to the requirements of the diversity rules and may establish board compositions at their discretion. However, publicly held corporations should expect ongoing scrutiny related to their diversity, equity, and inclusion initiatives generally.