Fifth Circuit Vacates Nasdaq Board Diversity Rule

On December 11, 2024, the full Fifth Circuit Court of Appeals vacated (by a 9-8 vote) the approval by the Securities and Exchange Commission (SEC) of Nasdaq Listing Rule 5605(f) and Nasdaq Listing Rule 5606(a) (together with Nasdaq Listing Rule IM-5900-9, the Board Diversity Rule). The Board Diversity Rule, which was approved by the SEC in August 2021, consisted of three separate provisions:

• Nasdaq Listing Rule 5606(a) (the Diversity Rule) imposed board diversity requirements on Nasdaq-listed companies (or required companies to disclose their reasons for failing to comply with the requirements);
• Nasdaq Listing Rule 5605(f) (the Disclosure Rule) mandated annual disclosure of a company’s board diversity statistics on a standardized template; and
• Nasdaq Listing Rule IM-5900-9 (the Recruiting Rule) provided listed companies access to a third-party board recruiting platform to help them meet their board diversity objectives.

Shortly after the SEC approved the Board Diversity Rule, the Alliance for Fair Board Recruitment and National Center for Public Policy Research petitioned the Fifth Circuit to review the SEC’s approval, arguing that the SEC lacked statutory authority to approve the Board Diversity Rule and that the Board Diversity Rule violated the Fifth Amendment’s equal protection principles and the First Amendment’s free speech clause.

In October 2023, a three-judge panel of the Fifth Circuit found that the SEC acted appropriately when it approved the Board Diversity Rule.¹ The advocacy groups then petitioned the Fifth Circuit for a rehearing en banc, which was granted in February 2024. Oral arguments before the full Fifth Circuit were held on May 14, 2024.

In its December 2024 ruling, the Fifth Circuit held that the SEC acted arbitrarily and capriciously when it approved the Diversity Rule and the Disclosure Rule without “adequately” explaining how the rules were consistent with the primary purpose of the Securities Exchange Act of 1934, which in the Fifth Circuit’s view is to “protect investors and the macroeconomy from speculative, manipulative, and fraudulent practices, and to promote competition in the market for securities transactions.” The majority of the Fifth Circuit also held that the SEC did not have clear and unequivocal statutory authority to approve the Board Diversity Rule, as required by the “major questions doctrine,” which applies to politically and economically significant agency actions.²

The dissent disagreed with the majority opinion, noting that the SEC acted reasonably when it found substantial evidence to support the conclusion that investors sought board diversity information in the face of inaccuracies, inefficiencies, and asymmetries.

The challenge to the Recruiting Rule was dismissed as moot.

The Diversity Rule had already undergone implementation as part of the phased-in effectiveness structure, with the first phase (requiring listed companies, subject to certain exceptions, to have at least one director meeting Nasdaq’s definition of “diverse”) effective on December 31, 2023. Nasdaq-listed companies had also already been complying with the requirements of the Disclosure Rule. With this ruling and expectations that it will not be appealed, Nasdaq will no longer require that companies collect diversity information from their board of directors and report the statistics on their Form 10-K, proxy statement, or on their website. However, companies may still voluntarily collect and report on this information, either to comply with separate state law requirements, internal board composition goals, or to respond to requests from institutional or other investors.

¹ Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. Oct. 18, 2023).

² According to the majority, the Board Diversity Rule was both economically and politically significant: (i) economically significant because it was attempting “to transform the internal structure of many of the largest corporations in the world” and (ii) politically significant because it was doing so in response to the “politically divisive” social justice movement and related push to increase diversity and inclusion across public companies.

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