On December 11, 2024, in a 9-8 decision, the United States Court of Appeals for the Fifth Circuit ruled that in approving the Nasdaq Stock Market’s (Nasdaq) board diversity rules (the Rules), the Securities and Exchange Commission (SEC) had exceeded its authority under the Securities Exchange Act of 1934, as amended (the Exchange Act) and vacated the Rules. Subject to limited exceptions, the Rules required Nasdaq-listed companies to (i) publicly disclose, in a standardized matrix format, the total number of company board members and how those board members self-identify regarding gender, predefined race and ethnicity categories, and LGBTQ+ status; and (ii) have at least two diverse board members or to explain the company’s reasons for not meeting this diversity objective.¹

Background

In August 2021, in a 3-2 vote, the SEC approved Nasdaq’s proposal to amend its listing standards. The SEC stated that the Rules “should improve the quality of information available to investors for making investment and voting decisions by providing consistent and comparable diversity metrics.” Following the SEC’s approval, the Alliance for Fair Board Recruitment (AFBR) and the National Center for Public Policy Research (NCPPR) challenged the Rules on a number of grounds, including that the SEC’s approval violated the First and Fourteenth Amendments and that the SEC lacked the statutory authority for approval.

In October 2023, a three-judge panel on the Fifth Circuit ruled in favor of the SEC, upholding the Rules. The Fifth Circuit panel rejected AFBR and NCPPR’s arguments, stating that Nasdaq is a private entity rather than a government institution or state actor, and that the SEC’s approval of the Rules complied with both the Exchange Act and the Administrative Procedure Act. In response, AFBR and NCPPR requested that the full Fifth Circuit review the case.

Court Ruling

On December 11, 2024, in a split decision, the Fifth Circuit rejected the Rules, holding that the SEC had exceeded its authority under the Exchange Act. The Fifth Circuit reasoned that providing diversity information to investors who demand it is irrelevant to the purposes of the Exchange Act. The majority opinion noted, however, that companies are not prevented from voluntarily disclosing their directors’ social, demographic, political or any other characteristics, and if particular investors seek such information, “companies can choose to disclose it.” The majority opinion also rejected the SEC’s finding that the Rules relate to the purpose of protecting investors and the public interest.

Dissenting Opinion

Eight judges dissented, concluding that the SEC’s “unique, limited role” in reviewing the Rules did not allow it “to displace business judgement with its own policy priorities” and reach a different conclusion. In their view, if the SEC had disapproved the Rules, “Nasdaq would have had a compelling case that the SEC had acted arbitrarily and capriciously.”

Heightened Scrutiny of DEI Initiatives Continues

The Fifth Circuit’s decision to vacate the Rules represents another win for opponents of corporate diversity, equity and inclusion (DEI) policies. One of the challengers in this case, AFBR, was founded by Edward Blum, the president of Students for Fair Admission, which successfully challenged race-conscious college admissions policies at the Supreme Court.² As discussed in prior client alerts, litigants opposed to DEI initiatives are expected to continue to challenge these initiatives in the private sector.³

Next Steps

Nasdaq announced that it does not plan to appeal the Fifth Circuit’s ruling. The SEC is reviewing the decision and plans to determine next steps as appropriate. Given the upcoming change in SEC leadership in 2025, the SEC is not expected to challenge the decision.

Notwithstanding the ruling, board diversity disclosure has become customary practice even among companies that are not listed on Nasdaq. Although Nasdaq-listed companies are no longer required to comply with the Rules, we anticipate that many public companies will continue providing some level of board diversity data on a voluntary basis. For example, companies may want to provide board diversity-related disclosure to align with investor expectations and the voting guidelines of proxy advisory firms or significant shareholders.

Nasdaq-listed companies that choose to voluntarily disclose board diversity data will now have more flexibility in its presentation and can deviate from a standardized matrix template. Specifically, Nasdaq-listed companies may take a variety of approaches to the format and categories of board diversity data, including (i) how the company defines diversity and (ii) the presentation, location and timing of such disclosure.

ENDNOTES

1 See our August 10, 2021, client alert “SEC Approves Nasdaq Board Diversity Listing Standards.”

2 See our September 2023 Insights publication “Corporate DEI Policies Face Scrutiny Following SCOTUS Affirmative Action Decision.”

3 See our December 2023 Insights publication “The Supreme Court’s Affirmative Action Opinion Continues To Spawn Challenges to DEI Programs.”

This post comes to us from Skadden, Arps, Slate, Meagher & Flom LLP. It is based on the firm’s memorandum, “Nasdaq Board Diversity Rules Vacated by the Fifth Circuit,” dated December 16, 2024, and available here.