Nasdaq’s Board Diversity Rule, approved by the Securities and Exchange Commission (SEC) in August 2021, is the subject of an ongoing, high stakes court battle in the United States Court of Appeals for the Fifth Circuit. The attorneys general of 17 “red” states have faced off against the SEC, the ACLU, an “Ad Hoc Coalition of Nasdaq-Listed Companies,” and a group of “Investors and Investment Advisers.” In an amicus filing, the attorneys general argue that the rule violates the Equal Protection Clause of the Constitution, undermines traditional state authority in the area of corporate governance, and forces companies to violate state anti-discrimination laws. The amici supporting the diversity rule have argued that Nasdaq is a private actor, that board diversity is good for corporations and investors, and that the diversity data reported as a result of the rule will be beneficial to academics and society as a whole. Meanwhile, a California judge has struck down a California statute addressing board diversity.
Nasdaq’s Board Diversity Rule
Nasdaq first introduced its board diversity rule in December 2020, and the SEC approved an amended version on August 6, 2021. The rule defines diverse directors as those who self-identify as female, members of underrepresented minorities or LGBTQ+. It requires Nasdaq-listed companies to (1) publicly disclose board-level diversity statistics using a standardized template; and (2) explain, if the company’s board does not have at least two diverse directors, the reason for that lack of diversity in its proxy statement, information statement for its annual shareholder meeting, or on the company’s website. The rule requires companies to make this disclosure on an annual basis. Nasdaq describes the rule as “a disclosure standard designed to encourage a minimum board diversity objective for companies and provide stakeholders with consistent, comparable disclosures concerning a company’s current board composition.”
Challenge to the Board Diversity Rule
Opponents challenge the rule as an unconstitutional racial classification, while supporters say that the rule is constitutional, that diversity benefits corporations and investors, and that it facilitates beneficial transparency for the market. Chief among the rule’s opponents are the National Center for Public Policy Research (NCPPR), a conservative think tank that focuses on “free market solutions to today’s public policy problems,” and the Alliance for Fair Board Recruitment (AFBR), a recently formed nonprofit whose mission is “to promote the recruitment of corporate board members without regard to race, ethnicity, sex, and sexual identity.” The AFBR was formed by Edward Blum, a politically conservative activist who also has challenged affirmative action in university admissions. AFBR has also brought challenges against the board diversity measures in California.
In August 2021, AFBR filed a Petition for Review of the SEC’s approval of the rule in the Fifth Circuit. In its supporting brief, AFBR argues that the rule violates equal protection and the First Amendment’s free speech clause, is an unconstitutional exercise of legislative powers reserved to Congress, is not supported by substantial evidence, and is not designed to accomplish statutorily required objectives. AFBR further asserted that the SEC exceeded its statutory authority by approving the Nasdaq rule that requires disclosure of non-material information on board diversity. NCPPR filed a similar Petition in October 2021, and its supporting brief echoes AFBR’s arguments. AFBR also argued that the Nasdaq rule was state action subject to constitutional scrutiny because “the Rule required SEC approval, the SEC independently justified and made judgments about the Rule, and Nasdaq has an ongoing statutory obligation to enforce the Rule.”
In response, the SEC contended that it acted reasonably in concluding that the rule is consistent with the Exchange Act and that the rule did not involve state action because it was being implemented by a private actor. The SEC further asserted that the rule falls within established standards for compelled speech under the First Amendment, and that the rule does not violate the First Amendment because the rules requires only disclosure and does not dictate what a company may say or who it may hire.
Nasdaq filed a brief as an intervenor, arguing primarily that Nasdaq is a private company and, thus, there is no state action to challenge.
Numerous Groups File Amicus Briefs Supporting the Board Diversity Rule
Several groups of amici filed briefs in support of the rule, asserting points that fall generally into two categories: (i) that the rule is good for companies and investors and (ii) that the rule is good for transparency. In addition, the Financial Industry Regulatory Authority, Inc. (FINRA) filed an amicus brief in support of the rule narrowly focused on the state action issue.
The briefs arguing that the rule benefits companies and investors were filed by an “Ad Hoc Coalition of Nasdaq-Listed Companies” and a group of “Investors and Investment Advisers.” Those briefs rely on empirical research. The “Nasdaq-Listed Companies” brief also argues that diverse boards further the public interest and that the rule is not burdensome because it provides significant flexibility and autonomy. The “Investors and Investment Advisers” brief makes the additional point that investors and advisers consider board diversity when making investment decisions and therefore want the information the rule requires listed companies to disclose.
The briefs praising increased “transparency” resulting from the rule include one filed by the ACLU and one by a group of “Academic Experts In The Fields of Business, Management, and Economics.” These briefs emphasize the public’s interest in receiving corporate board diversity information. The ACLU brief specifically notes that the public has a First Amendment interest in receiving this information and that Nasdaq has a First Amendment interest in requiring its disclosure.
Seventeen States File Amicus Brief Opposing the Board Diversity Rule
On the other hand, 17 states, through their attorneys general, together filed an amicus brief in support of the NCPPR. The 17 amici are Arizona, Alabama, Alaska, Arkansas, Florida, Indiana, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Oklahoma, South Carolina, Texas, and Utah.
According to the 17 states, the rule exceeds the SEC’s authority under the Securities Exchange Act because corporate board composition is “a traditional state concern,” noting that several states have already enacted or adopted policies related to board diversity. They assert that “the choice to have such laws—or not to have them—is a matter for the states, subject to constitutional and statutory limitations.” They also argue that the Rule would require listed companies to violate civil rights laws in several of the amici states, including Arizona’s prohibition against classifying employees or applicants based on race, color, religion, sex, age or national origin.
One Challenge to a State Diversity Initiative Has Succeeded At The Trial Court Level, And Others Are Pending
California’s statute goes a step beyond the Nasdaq disclosure rule by requiring all publicly traded companies headquartered in California to include at least one director from an underrepresented community on its board by December 2021 or face fines. The statute also requires the state to report on compliance by affected companies. Last month, Judge Green of the Los Angeles County Superior Court in Crest v. Padilla held that the statute violated the equal protection clause of California’s constitution because it resulted in disparate treatment of qualified candidates for corporate boards on the basis of their race, sexual orientation, or gender identity, and the state could provide no evidence of a compelling government interest justifying such disparate treatment. The court emphasized that to assess the alleged disparate impact it had to compare the demographics of current board members to the population of qualified board candidates, rather than to the population as a whole. The court found the state had failed to present statistical evidence to demonstrate such a discrepancy. The court also concluded that California’s claim that increased board diversity led to “healthier businesses” and higher profits was not a sufficiently compelling interest to justify its use of suspect classification to further that goal. Any appeal by the state must be made by June.
 The companies are 2U, Inc., Adobe, Inc., Airbnb, Inc., Allbirds, Inc., Brightcove, Inc., Brighthouse Financial, Inc., Change Healthcare Inc., Comcast Corporation, FactSet Research Systems, Inc., Henry Schein, Inc., Ideanomics, Inc., Kraft Heinz Co., Lyft, Inc., Microsoft Corporation, Morningstar, Inc., Sleep Number Corporation, Starbucks Corporation, United Therapeutics Corporation, and WW International, Inc.
 The listed investors and investment advisors are Council of Institutional Investors, Investment Adviser Association, Northern Trust Investments, Inc., Ariel Investments LLC, Boston Trust Walden Co., Lord, Abbet & Company LLC, Gaingels, Inc., and the Robert F. Kennedy Center for Human Rights.
 Interestingly, according to the Delaware Secretary of State, while 67% of all publicly traded corporations are incorporated in Delaware, Delaware did not weigh in.
 This argument could be interpreted as somewhat disingenuous in suggesting that board diversity can be addressed or mandated by the states, since the brief argues elsewhere that board diversity requirements of the kind reflected in the Nasdaq rule are, on their face, unconstitutional. Indeed, such arguments have been raised against state board diversity rules, including by AFBR.
This post comes to us from Arnold & Porter Kaye Scholer LLP. It is based on the firm’s memorandum, “Caught in the Culture Wars Crossfire: Board Diversity Initiatives Under Attack,” dated May 3, 2022, and available here.