In a 9-8 ruling issued Wednesday, the U.S. Court of Appeals for the Fifth Circuit reversed a panel’s October 2023 ruling and axed Nasdaq rules requiring certain diversity disclosures about directors of companies listed on the exchange.
The rules, which were approved by the U.S. Securities and Exchange Commission in 2021, had previously been upheld by a three-judge panel in October 2023 that found the rules were in compliance with the law. But after en banc review, nine judges determined Wednesday that the diversity rules “cannot be squared with the Securities Exchange Act of 1934.”
The 41-page majority opinion was authored by Judge Andrew S. Oldham. The Trump appointee was joined by eight other Republican appointees — Chief Judge Jennifer Walker Elrod and Judges Edith H. Jones, Jerry E. Smith, Priscilla Richman, Don Willett, Stuart Kyle Duncan, Kurt D. Engelhardt and Cory T. Wilson.
The court’s judges who were appointed by Democrat presidents were joined in dissent by two George W. Bush appointees. Judge Stephen A. Higginson authored the 10-page dissent, joined by Judges Carl E. Stewart, James L. Dennis, Leslie H. Southwick, Catharina Haynes, James E. Graves Jr., Dana M. Douglas and Irma Carrillo Ramirez.
Judge James C. Ho — whose wife, Allyson Ho of Gibson, Dunn & Crutcher, argued the case on behalf of Nasdaq — recused himself from the case and did not participate in the decision.
Judges Stewart, Dennis and Higginson had been on the panel that OK’d the SEC’s approval of the Nasdaq rules last year.
The rules at issue in this case, proposed by Nasdaq and approved by the SEC, had required that companies listed on its exchange disclose the racial, gender and sexual makeup of its directors; and to have at least two directors who identify as female or as members of a minority group. Companies that did not have at least two diverse board members were also required to provide an explanation for why it did not meet the criteria.
Nasdaq said it proposed the rule in response to requests from investors and listed companies (including Microsoft, the U.S. Chamber of Commerce, Goldman Sachs and Vanguard) who said the diversity data wasn’t “standardized or efficient to procure.”
The SEC approved the rule, but two commissioners dissented from the decision, arguing that the diversity rule did not “advance any … purposes” of the Securities Exchange Act, which is to regulate securities transactions and to “protect interstate commerce and the financial system by ensuring the maintenance of fair and honest markets in securities transactions.”
The Alliance for Fair Board Recruitment appealed the SEC’s approval decision to the Fifth Circuit in August 2021, and Nasdaq intervened the next month. The National Center for Public Policy Research had appealed the rules to the Third Circuit, which transferred the petition to the Fifth Circuit where the appeals were consolidated.
Judge Oldham and the majority focused their decision on a requirement in the Securities Exchange Act dictating that the SEC must first find that any proposed regulation “is related to the purposes of the Exchange Act” before approving it.
“The Act exists primarily to protect investors and the macroeconomy from speculative, manipulative, and fraudulent practices, and to promote competition in the market for securities transactions,” the majority held. “A disclosure rule is related to the purposes of the Act if it has some connection with those purposes, but not otherwise. We conclude that SEC did not explain how the board diversity proposal has any connection with those purposes. All it said was that the proposal is designed to advance three of the purposes contained in § 78f(b)(5). But those purposes bear no relationship to the disclosure of information about the racial, gender, and sexual characteristics of the directors of public companies.”
Judge Higginson wrote that the explanation requirement in the rule for companies without two diverse board members “would never be assessed for substance” and would not be evaluated by Nasdaq.
“For example, a company might state that it ‘doesn’t consider the information useful to investors’ or ‘prioritizes diversity of thought or geography,’” he wrote. “With that, the company has complied with Nasdaq’s disclosure rule.”
Judge Higginson focused his dissent on the “limited reviewing role” Congress carved out for the SEC as it relates to its ability to approve rules proposed by “self-regulatory organizations” like Nasdaq.
Lawmakers did not permit the SEC “to displace business judgment with its own policy priorities,” he wrote. And the role of the courts is “even more limited,” he wrote, explaining judges are supposed to only consider whether the SEC’s approval of such a proposed rule was “arbitrary, capricious, or an abuse of discretion.”
The dissent accuses the majority of wrongly equating “the SEC’s federal government disclosure-mandating authority with private sector SRO self-regulating authority.”
“Congress created a unique, limited role for the SEC that didn’t permit it to reach a different conclusion here, regardless of whatever good faith disagreement might exist in policy debates about disclosure of corporate board leadership composition,” the dissent reads. “If Nasdaq misapprehended investor appetite for this information and the willingness of the listed companies it contracts with to provide it, the marketplace of competing exchanges — and not the policy preferences of this court or a federal agency — will resolve that.”
Alliance for Fair Board Recruitment is represented by Jonathan Berry and R. Trent McCotter of Boyden Gray.
The National Center for Public Policy Research is represented by Margaret A. Little and Sheng Li of the New Civil Liberties Alliance.
The SEC is represented by its own Daniel Matro, Tracey A. Hardin and John Rady.
Nasdaq is also represented by Bradley G. Hubbard, Amalia Reiss and Amir Tayrani of Gibson, Dunn & Crutcher
The case number is 21-60626.