Divided Fifth Circuit Strikes Down Nasdaq Board Diversity Rules
Commentary by Steven Lofchie
The Fifth Circuit Court of Appeals, by a 9-8 vote, vacated the SEC's approval of the Nasdaq board of directors' diversity rules.
As previously covered, the SEC approved two Nasdaq Stock Market LLC rule proposals on board diversity: one requiring disclosure of diversity statistics ("Board Diversity Proposal") and one offering free access to a board recruiting service ("Board Recruiting Service Proposal"). The rules required companies listed on the exchange "to disclose information about the racial, gender, and sexual characteristics of their directors, and to have (or explain why they do not have) at least two directors who meet Nasdaq's definition of 'diverse.'"
The Court majority found that:
- the SEC's approval of the diversity rules was "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law" under the Administrative Procedure Act.
- Nasdaq failed to demonstrate a sufficient connection between the Board Diversity Proposal and the stated purposes of the Exchange Act, such as preventing fraud, manipulation, or other Exchange Act-related harms.
- the SEC lacked clear statutory authority to approve rules aimed at remaking corporate boards based on diversity. The Court held that such a significant change required a clear congressional mandate, which was absent.
- the rule was not genuinely intended to disclose matters of economic interest, but rather to impose a "public-shaming penalty."
- satisfying "investor demand for Board diversity" was insufficient to align the rule with the purposes of the Exchange Act.
- it did not have to address the constitutional arguments because it resolved the case on statutory grounds.
The Court minority concluded that Nasdaq demonstrated that investors wanted information as to board diversity, and did not deem it significant that there was no demonstration that board diversity was linked to financial performance. The minority also pointed out that the US Government requires the collection of a great deal of demographic information from corporate employees.
Commentary
This is a case worth reading.
Leaving aside the specific disclosure that was at issue—a very important aspect of the decision that could have relevance to other rules recently adopted by the SEC—a majority of the Court rejected the view that securities regulators could "require disclosure for disclosure's sake." That is, the majority held that a disclosure requirement could not be imposed unless the SEC can "establish the rule has some connectional to an actual, enumerated purpose of the [Securities Exchange] Act." In other words, the fact that a rule might "contribute to some investors' investment and voting decisions" was not justification for imposing a requirement that was unrelated to the purpose of the Act.
This logic could very likely serve as a basis for overturning other actions of the SEC, including its disclosure requirements as to greenhouse gases, which the SEC substantially justified on the basis that investors were interested in the information, whether or not it was economically useful.
Related Articles
-
Senate Republicans urged the SEC to reject a Nasdaq Stock Market LLC proposed listing rule that would require that Nasdaq-listed companies take detailed steps to "advance board diversity and enhance transparency of diversity statistics."
-
The SEC approved two Nasdaq Stock Market LLC rule proposals on board diversity: one requiring disclosure of diversity statistics and one offering free access to a board recruiting service.