US Appeals Court Upholds Nasdaq Board Diversity Rule … For Now

On Wednesday, the United States Court of Appeals for the Fifth Circuit upheld Nasdaq’s board diversity rule, which encourages greater board diversity from companies listed on the exchange, in Alliance for Fair Board Recruitment v. SEC, 5th Cir., No. 21-60626. Subject to certain phase-in periods, Nasdaq requires listed companies to (i) annually disclose board-level diversity statistics using the standardized matrix in Nasdaq Rule 5606 and (ii) have, or disclose why they do not have, a minimum of two diverse board members, including at least one female and at least one underrepresented minority or LGBTQ+ member, in each case as defined in Nasdaq Rule 5605(f). In contrast, the New York Stock Exchange does not require disclosure regarding board diversity.

As part of the litigation, the Alliance for Fair Board Recruitment and the National Center for Public Policy Research argued that the Nasdaq diversity rule violates federal securities laws and the U.S. Constitution’s prohibition of discriminatory laws and restraints on free speech, as it unconstitutionally conferred preferential status on minorities, women and members of the LGBTQ+ community. Both groups have been involved in recent anti-ESG activism, as the Alliance for Fair Board Recruitment is a non-profit organization that has challenged other board diversity requirements, and the National Center for Public Policy Research opposed a wide range of ESG orthodoxy including DEI efforts, corporate financing of the radical gender ideology, companies weighing in on the national abortion debate and companies’ support of decarbonization during the last proxy season through shareholder resolutions. 

However, the three judge Fifth Circuit panel found that the constitutional challenge was unfounded, as Nasdaq is not a state actor so that such a challenge under the First Amendment’s protection of free speech would be appropriate, nor does the SEC’s involvement with and approval of Nasdaq’s rules render such rules subject to constitutional scrutiny. The Court acknowledged that while “Nasdaq must register with and is heavily regulated by the SEC… a private entity does not become a state actor merely by virtue of being regulated.” The Court also concluded that the SEC acted within its statutory authority in approving Nasdaq’s rules. The panel generally agreed that the rule is a disclosure requirement that provides standardized information on board diversity, not a demographic quota.

This is not the first time board diversity requirements have been challenged.  In 2022, California state superior courts invalidated board diversity statutes that required California-based public companies to have directors from an “underrepresented community” and female directors. We previously summarized these key decisions and takeaways in the following links, respectively: here and here.

The Fifth Circuit decision was issued by a panel of three Democratic-appointed judges and further review is likely to be sought. The groups can petition for rehearing by the full Fifth Circuit, where the majority of judges have been Republican nominees. This case may continue to have critical implications for human capital management disclosure, which is expected to come under increased focus as the SEC is expected to propose a more expansive rule on human capital management disclosure as early as this year.