NEW ORLEANS (Legal Newsline) - A closely divided federal appeals court has struck down a rule requiring companies on the Nasdaq stock exchange to recruit women and minority board members, saying the regulation wasn’t authorized under federal securities law and didn’t promote the core goals of eliminating fraud.
While technically private companies, Nasdaq and other securities exchanges are required to clear any rule changes with the Securities Exchange Commission under a law that also prohibits them from enacting rules not consistent with federal securities laws. Nowhere does the law authorize the SEC to approve rules for disclosing the ethnic and sexual makeup of corporate boards, the U.S. Court of Appeals for the Fifth Circuit ruled Dec. 11.
“The history makes clear the Act is primarily about limiting speculation, manipulation, and fraud, and removing barriers to exchange competition,” wrote Judge Andrew Oldham for the nine-judge majority. “There are other, ancillary purposes, but disclosure of any and all information is not among them.”
Eight judges dissented, saying the SEC’s role in overseeing private exchanges is limited and they shouldn’t be constrained from enacting rules their members want. A large number of institutional investors seek standardized information about board diversity, the dissenters said, and the rules were modeled upon similar disclosure requirements by the Equal Employment Opportunity Commission.
A three-judge panel of the Fifth Circuit earlier approved the rules, only for them to be struck down by the larger en banc court.
In 1975, Congress required the SEC to approve rule changes at self-regulated markets like Nasdaq
As part of the approval process, the SEC must determine the proposed rule is consistent with the underlying Exchange Act. That law limits the SEC’s authority to preventing fraud, promoting “just and equitable principles of trade and other mostly investor-related matters." The law says exchanges are not permitted to enact rules that enforce “matters not related to the purposes of this chapter or the administration of the exchange.”
The Nasdaq rule required listed companies to recruit at least one female board member and another from a racial, ethnic or sexual minority group or disclose the reasons they had not done so. The exchange passed the rule in 2020 following widespread racial unrest over the death at police hands of George Floyd in Minneapolis.
Nasdaq concluded “the public interest would best be served by an additional regulatory impetus for companies to embrace meaningful and multi-dimensional diversification of their boards.”
The Fifth Circuit disagreed, saying “we 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.”
“SEC’s efforts `raise an eyebrow’ by stepping outside its ordinary regulatory domain of market manipulation and proxy voting and intruding into the province of other agencies,” the majority concluded.
Attorney Cory Liu, a former assistant general counsel to Texas Governor Greg Abbott, described the ruling on X as “technically complex, but elegant in sticking to just the law.”
“At its core, the opinion reasons that the SEC's legal authority is to ensure a fair and honest marketplace and not to force politically motivated identity politics into corporate decision making,” he wrote.
Under the proposed rules, Nasdaq also would give companies access to a “board recruiting solution,” including board-ready female and minority candidates and benchmarking tools.
The SEC approved the rules without citing the Exchange Act but rather justifying them as necessary for large institutional investors to evaluate public companies. Commissioners Elad Roisman and Hester Peirce dissented at the time, saying the rules didn’t advance any of the SEC’s authorized objectives.
The Alliance for Fair Board Recruitment immediately appealed the rule in the Fifth Circuit.
The Fifth Circuit said “Nasdaq offered little support for its assertion that there is an empirically established—or even logical—link between the racial, gender, and sexual composition of a company’s board and the quality of its governance.”
The dissenters argued the SEC’s role in overseeing private exchanges should be limited, so they can innovate and promote market efficiency. If the SEC had rejected the proposed rule, he said, Nasdaq would have a compelling case that action had been arbitrary and capricious.
“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,” they said.