Fifth Circuit Strikes Down Nasdaq Board Diversity Rules

The Rules required companies listed on Nasdaq (subject to certain exceptions and phase-in periods) to (1) publicly disclose board-level diversity (race, gender, sexual characteristics) data in a matrix format on an annual basis and (2) have, or explain why they do not have, a certain number of diverse directors on their boards. The New York Stock Exchange never adopted a similar diversity rule.

For many companies already listed on Nasdaq, the deadline to comply-or-explain the inclusion of at least one diverse director occurred on December 31, 2023, and the deadline for having at least two diverse directors would have been on December 31, 2025. Gender diversity at S&P 500 and Russell 3000 companies reached a high-water mark in 2024, with nearly one-third of boards comprised of directors identifying as women. Racial diversity representation on boards has also steadily increased in recent years. While the Rules may have contributed to these trends, other factors, such as voting guidelines from proxy advisors and institutional investors’ expectations, likely also contributed to the recent increases in board diversity.

The Alliance for Fair Board Recruitment (founded by activist Edward Blum, who also led Students for Fair Admissions, Inc. (“SFFA”) at the time of its successful challenge of certain college affirmative action programs in 2023) was joined by the National Center for Public Policy Research in challenging the Rules.

In support of the SEC’s authority to issue the Rules, lawyers for the SEC argued that the Rules promoted full disclosure and “just and equitable principles of trade,” and that the information was “important to” “large institutional investors and investment managers.” In approving the Rules initially, Nasdaq had submitted evidence to the SEC of its belief that encouraging an increase in diverse board representation would “result in improved corporate governance.” Prior to this en banc rehearing, a panel of the Fifth Circuit had found in October 2023 that, among other things, the SEC did not exceed its authority under the Securities Exchange Act of 1934 (the “Exchange Act”) because the diversity rule is a “disclosure rule” and not a “mandatory quota” and that, given demand from investors for this information, the SEC could reasonably conclude that the disclosure obligations for board diversity were within the scope of the SEC’s authority under the Exchange Act.

The Fifth Circuit, in its en banc rehearing, has now rejected the SEC’s argument that the Rules were connected to the purposes of the Exchange Act, which it said exists “primarily to protect investors and the macroeconomy from speculative, manipulative, and fraudulent practices, and to promote competition in the market for securities transactions.” Despite the SEC’s argument that the Rules were designed to advance certain of the purposes of § 78f(b)(5) of the Exchange Act,¹ the court determined that those purposes “bear no relationship to the disclosure of information about the racial, gender, and sexual characteristics of the directors of public companies.” The Fifth Circuit explained, while it is “unethical to violate the law or to disregard a contractual promise,” “[it] is not unethical for a company to decline to disclose information about the racial, gender, and LGBTQ+ characteristics of its directors[,]” and the court is “not aware of any established rule or custom of the securities trade that saddles companies with an obligation to explain why their boards of directors do not have much racial, gender, or sexual orientation diversity as Nasdaq would prefer.”

Nasdaq issued a statement noting that, while the exchange disagreed with the court’s decision, it does not plan to appeal the ruling. It has been reported that an SEC spokesperson said the agency is reviewing the decision and will determine next steps as appropriate. However, given the upcoming transition in presidential administrations, it is unlikely that the SEC would seek to challenge the Fifth Circuit’s decision.

Companies should review their forthcoming annual disclosures to consider whether, and the extent to which, to include diversity-related information. The Fifth Circuit decision does not prevent companies from voluntarily disclosing the information required by the Rules. Furthermore, ISS and Glass Lewis, along with several major institutional investors, continue to consider board diversity in their voting recommendations.

This decision is just one of the numerous challenges currently facing corporations with respect to environmental, social and governance (“ESG”) matters, particularly as they relate to diversity, equity and inclusion (for other recent examples, see our related Securities Update covering the conflicts between ESG and anti-ESG efforts and our Insight on the impact of California’s climate laws in the wake of the SEC’s voluntary stay of its climate-related disclosure rules, as well as the SFFA ruling noted above).

We will continue monitoring developments in this case. Please contact your Vinson & Elkins team to discuss these developments and their potential effects on your business.

¹ “The rules of the exchange are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers, or to regulate by virtue of any authority conferred by this chapter matters not related to the purposes of this chapter or the administration of the exchange.”  15 U.S.C. § 78f(b)(5).