Fifth Circuit overturns SEC’s approval of Nasdaq’s diversity rules

On December 11, 2024, the Fifth Circuit Court of Appeals decided that the Securities and Exchange Commission (SEC) overstepped its bounds in endorsing Nasdaq’s diversity regulations. These rules mandated Nasdaq-listed firms to reveal the diversity makeup of their board members publicly. The core of the regulations was that boards with five members or more had to include a minimum of two “diverse” directors.

The Fifth Circuit based its ruling on the case called Alliance for Fair Board Recruitment v. SEC. The court concluded that the SEC did not have the authority to approve the Nasdaq diversity rules because they did not align with the original goals of the Securities Exchange Act of 1934. The Exchange Act was designed by the US Congress to safeguard investors’ interests in securities by setting up a regulatory oversight framework. Accordingly, the SEC’s powers under this act are limited to preventing fraud, material risk concealment, and speculative market instability.

While the SEC argued that the Exchange Act also aimed to eliminate market barriers and foster fairness, the Fifth Circuit held that if Congress intended to grant the SEC the authority to establish demographic regulations, it would have done so explicitly in the Act.

Nasdaq submitted its diversity rules proposal to the SEC on December 1, 2020, and on August 6, 2021, the SEC approved these rules. The rules obliged Nasdaq-listed corporations with five or more directors to:

– Form a board including a female director and a Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Hawaiian or Pacific Islander, LGBTQ+, or two or more races or ethnicities-identifying director.
– Provide an explanation for non-compliance if a board does not meet these demands.
– Disclose the board’s demographic composition publicly.

Jeff Thomas, Nasdaq’s Global Head of Listings, announced on December 12, 2024, that Nasdaq had no plans to challenge the court’s decision, meaning companies no longer had to abide by the diversity policies. However, the SEC could decide to appeal the Fifth Circuit’s ruling to the Supreme Court, although the outcome is uncertain. Congress might also think about amending the Exchange Act to introduce board diversity mandates.

Unless the Supreme Court reconsiders or Congress enacts new laws, Nasdaq-listed entities can now determine their board makeup as they see fit. Nevertheless, publicly traded corporations should be prepared for continued scrutiny regarding their diversity, equity, and inclusion efforts.

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