US Court Strikes Down Nasdaq Diversity Disclosure Rule

News

Published by Stephen Oluwadara at December 15, 2024

A Background to The Litigation Against Nasdaq Diversity Disclosure Rule

The Nasdaq Stock Market LLC first submitted to the SEC in December 20204 a proposal for promoting transparency into the board diversity of Nasdaq-listed companies.

The rule required companies to share board diversity data and include at least one director from underrepresented groups, such as women, marginalized groups, or LGBTQ+ individuals. If companies couldn’t meet the requirement, they had to explain why.

On August 6, 2021, the SEC approved the proposed rule, stating that the disclosure would contribute to the maintenance of fair and orderly markets and “promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national system, and protect investors and the public interest” in accordance with Section 6(b)(5) of the Exchange Act.

However, critics attacked Nasdaq’s rule as a quota system. The Alliance for Fair Board Recruitment and the National Center for Public Policy Research filed suit challenging the rule, claiming that it violated the First and Fourteenth Amendments to the U.S. Constitution and that the rule exceeded the SEC’s authority under the Exchange Act and the Administrative Procedure Act (the “APA”).

On October 18, 2023, a three-judge panel of the Fifth Circuit dismissed the challenge. The panel held that the SEC’s approval of the rule complied with the Exchange Act and the APA and that the Alliance for Fair Board Recruitment and the National Center for Public Policy Research argument that disclosure requirements had to be related to material information within the scope of the Exchange Act did not apply. The panel rejected the constitutional claims because Nasdaq is a private entity, not a government institution or state actor.

Nevertheless, the Alliance for Fair Board Recruitment (led by conservative activist Edward Blum, who sued the Fearless Fund for its Strivers Grant program) and the National Center for Public Policy Research petitioned the Fifth Circuit court to review the case en banc, which the court granted on February 19, 2024.

New-Orleans Based Fifth Circuit Ruling

The Fifth Circuit majority held that the SEC’s approval of the Nasdaq disclosure rule was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law” as the rule was not related to Nasdaq’s role as established by the Exchange Act.

Judge Andrew Oldham argued that the rule exceeded what the Securities Exchange Act of 1934 allowed. While transparency is crucial for markets, he said, the rule wasn’t tied to addressing fraud or market manipulation—the act’s primary focus.

Nasdaq expressed disappointment but stated it would not challenge the court’s decision. “We respect the Court’s decision and do not intend to seek further review,” a spokesperson told Bloomberg.

The exchange denied that its diversity targets were a mandatory quota, citing the provision that let companies provide written explanations if they didn’t meet the targets. Nasdaq argued that its diversity rules benefited investors, pointing to studies that show greater boardroom diversity is associated with better financial performance.

The court battle drew interest from prominent players in business and politics, reflecting national fault lines over affirmative action. A coalition of Nasdaq-listed companies, including Airbnb, Microsoft, and Starbucks, submitted a brief supporting the SEC and Nasdaq, as did the American Civil Liberties Union and NAACP Legal Defense and Educational Fund. On the other side, the Republican attorneys general of two dozen states filed a brief supporting the lawsuit and blasting Nasdaq’s rules as unconstitutional.

Broader Implications of This Ruling on Corporate Diversity

This New Orleans-based Fifth Circuit ruling represents the latest battle in a war between right-wing activists and corporate America. Although cast as a discriminatory suit, like many similar culture-war suits, it was fought over something else: a growing rollback of diversity initiatives.

After myriad legal challenges against internship programs, startup grants, and even ending the use of race in college admissions, many of even the most committed companies have begun to bend — at least in public.

Organizations such as Boeing Co. disbanded its global Diversity, Equity, and Inclusion (DEI) team. Other corporations, such as Tractor Supply Co., Deere & Co., Polaris Inc., and Harley Davidson Inc., have scaled back or changed their DEI policies.