Nasdaq Diversity Rule Deemed Unenforceable By 5th Circuit
On December 11, 2024, the U.S. Court of Appeals for the 5th Circuit, sitting en banc, ruled that The Nasdaq Stock Market LLC (Nasdaq) cannot enforce previously adopted listing rules requiring Nasdaq-listed companies to have women and minority directors on their boards or explain their absence (the Nasdaq Diversity Rule). In a 9-8 ruling, the court determined that the Nasdaq Diversity Rule, which was approved by the U.S. Securities and Exchange Commission (SEC) in August 2021, exceeded the SEC’s authority and, therefore, violated the Securities Exchange Act of 1934, as amended (the Act). We first wrote about the Nasdaq Diversity Rule here.
Supporters of the Nasdaq Diversity Rule, which previously had been upheld by a three-judge panel of the 5th Circuit in October 2023, argued that the Nasdaq Diversity Rule is a “commonsense measure intended to ensure greater consistency and uniformity in companies’ disclosures, to the benefit of investors and other stakeholders” and that, given the flexible disclosure-based regime, compliance with the rule is not burdensome. Additional information may be found here and here.
Regardless, by a narrow margin, the U.S. Court of Appeals for the 5th Circuit found that the “SEC ha[d] overstepped its bounds and ventured into areas far beyond its usual jurisdiction.” In addition, citing 5 U.S.C. §706(a)(2), the court also opined that the SEC’s approval of the Nasdaq Diversity Rule was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The court noted that the Nasdaq Diversity Rule also was challenged on constitutional grounds. However, because the court found the rule unlawful on statutory grounds, it did not weigh in on constitutional arguments.
Nasdaq announced that, despite believing that the Nasdaq Diversity Rule benefits both companies and investors, it does not intend to appeal the ruling. The SEC has stated it will review whether to challenge the court’s ruling, which, if appealed, would next be reviewed by the U.S. Supreme Court. In light of the imminent change in presidential administrations and the current composition of the U.S. Supreme Court, we believe that any such appeal is unlikely.
From a practice perspective, we note that while the Nasdaq Diversity Rule is no longer enforceable, voting guidelines and policies published by shareholder advisory groups, as well as the major institutional investors and asset managers, continue to include boardroom diversity considerations. Accordingly, irrespective of the 5th Circuit’s decision, issuers should confer with their legal and financial advisors about including publicly available information about director skill sets and backgrounds, including in relation to diversity.
