Fifth Circuit Strikes Down Nasdaq “Show or Tell” Diversity Rules

On December 11, 2024, the Fifth Circuit, in a divided opinion following an en banc hearing, struck down the Nasdaq “show or tell” diversity rules. The Court concluded that the rules, some of which the majority described as a “public-shaming penalty for a corporation’s failure to abide by the Government’s diversity requirements,” exceeded the SEC’s Exchange Act rulemaking authority. 

The case, Alliance for Fair Board Recruitment v. SEC, ends (for now) the rule requiring Nasdaq-listed companies to disclose the gender, sexual orientation and racial makeup of their boards, or to explain why the companies were unable to achieve the diversity metrics the rule established. 

The majority for the sharply divided en banc Court rejected the Nasdaq diversity rules as exceeding the purposes of the Exchange Act. After an extensive historical analysis of the 1934 Exchange Act and its 1975 Amendments, the majority concluded that nothing in the Exchange Act required disclosure “for disclosure’s sake” and instead noted the Exchange Act’s purpose was to prevent market abuses. 

The Court rejected the premise of the rules on the Exchange Act’s requirement of the “just and equitable principals of trade”. The Court concluded that this provision simply required exchanges to “promote behavior that is morally right and in conformity with the rules and customs of the securities profession.” The board diversity rules, the Court concluded, is “far removed” from the concept of just and equitable principles of trade. In so concluding, the Court found that it is not unethical for a company to decline to disclose information about the racial, gender and sexual orientation of its directors, noting that “[w]e are not aware of any established rule or custom of the securities trade that saddles companies with an obligation to explain why their boards of directors do not have as much racial gender, or sexual orientation diversity as Nasdaq would prefer.” 

The Court also rejected the SEC’s argument that the diversity rule was designed to remove impediments to a free and open market because a free and open market meant an open market meant reducing transaction costs associated with executing securities trades. “Equipping investors to make investment and voting decisions might be a good idea, but it has nothing to do with the execution of securities transactions.”

The Court also rejected the SEC’s argument that the rules were designed to protect investors and the public interest. It found the “catch all” provision of the Exchange Act was intended to address “speculation, manipulation, fraud, and anticompetitive exchange behavior.” Toward that end, diversity did not implicate the public interest because the SEC failed to establish a “link between the racial, gender and LGTBQ identities of a company’s board members and the quality of a company’s financial reporting, internal controls, public disclosures and management oversight.” Further the Court concluded that no support was provided for the empirical relationship between board diversity and the quality of its governance nor did the Court agree that diversity information important investors demanded was sufficient to justify requiring it. Neither basis supported rulemaking authority under the public interest provision. 

The Court also invoked the “major questions” doctrine (the doctrine that courts will presume that Congress will not delegate to executive agencies issues of major political or economic significance) as further proof of the SEC’s overstepping its authority. The Court noted that diversity was among one of the more politically divisive issues in the nation. Further, the Court found that during the Exchange Act’s existence, which dates back to 1934, SEC had never claimed the authority to impose diversity requirements or anything resembling them, on corporate boards. Instead, the Court noted, the SEC had intruded into an area that is the particular domain of state law. 

While the SEC may appeal this decision, an appeal appears highly unlikely given the change in administration and the limited chances of success. The Mintz ESG Practice will continue to monitor these and other governance issues for further developments.