In a lengthy and detailed opinion, the Fifth Circuit has rejected two petitions challenging the SEC’s approval of Nasdaq’s board diversity rules. The rules require most Nasdaq-listed companies to have women and minority directors on their boards or explain why they don’t. The petitioners had argued that the rules violated constitutional free speech and equal protection provisions and also violated the SEC’s obligations under the Exchange Act and under the Administrative Procedures Act (APA). A unanimous three-judge panel rejected these arguments, in effect upholding the rules. The Fifth Circuit’s opinion can be found here.
Nasdaq is private company that operates a securities exchange. In December 2020, Nasdaq submitted to the SEC proposed rules directing its listed companies to add women and underrepresented minorities to their boards. As discussed here, in August 2021, following a public comment period, a divided SEC approved the rules by a vote of 3-2.
Under the Nasdaq rules, each Nasdaq company (other than foreign issuers, smaller reporting companies, and companies with smaller boards) is require to have, or to explain why it does not have, at least two board members of its board of directors who are “Diverse,” including at least one Diverse director who self-identifies as Female and alt least on Diverse director who self-identifies as an Underrepresented Minority or LGBTQ+. Reporting companies are to report their compliance or non-compliance with the diversity requirements using a Board Diversity Matrixv. The rules also make complementary board recruiting services available to exchange-listed companies, to provide access to a network of diverse candidates for companies to identify and evaluate.
The Petitions Challenging the Rules
Just days after the SEC approved the rules, a nonprofit group called the Alliance for Fair Board Recruitment (AFBR) filed a petition with the Fifth Circuit challenging the rules on constitutional and statutory grounds. AFBR is headed by Edward Blum, the conservative legal activist who spearheaded the legal challenge brought against Harvard’s and the University of North Carolina’s affirmative action admissions policies; in June 2023, the U.S. Supreme Court entered an opinion striking down the admissions practices. A second petitioner, the National Center for Public Policy Research (NCPPR), filed a separate petition challenging the rules on similar grounds. The two proceedings were later consolidated in the Fifth Circuit.
The petitioners argued that the rules imposed an impermissible quota on companies that violates the equal protection clause of the Fourteenth Amendment by encouraging discrimination against potential board members. The petitioners also argued that the ruled compel disclosure of controversial information in violation of the First Amendment. In addition, the petitioners further argued that the SEC lacked statutory authority to issue the order approving the rules, and that the SEC’s approval also violates the APA.
The October 18, 2023, Decision
On October 18, 2023, in an opinion written by Judge Stephen Higginson for a unanimous three-judge panel, the Fifth Circuit rejected the petitioners’ challenge to the Nasdaq rules.
The appellate court first considered the petitioners’ constitutional arguments, beginning the analysis by noting that the Constitution “only applies to state action.” The petitioners had argued that Nasdaq qualifies as a state actor; the appellate court rejected all of the grounds on which the petitioner sought to rely to try to establish this point, specifically noting that the SEC’s involvement with and approval of the rules did not subject the rules to constitutional scrutiny, and further that Nasdaq does not become a state actor merely because it is regulated.
The appellate court also rejected the petitioners’ argument that the SEC’s approval of the rules exceeded its statutory authority and violated the APA, saying that the petitioners have “given us no reason to conclude that the SEC’s Approval Order violates the Exchange Act or the APA.” The appellate court concluded that the agency was within its authority in approving the rules.
The Fifth Circuit’s decision in effect upholding the Nasdaq rules stands in interesting contrast to the outcome of the earlier proceedings challenging the validity of the California board diversity statute. As discussed here, earlier this year, a federal court struck down the California board diversity statute as unconstitutional; indeed, a state court had previously stuck down the California statute on state law grounds. There is of course an important difference between the Nasdaq rules and the California statute, as the action of the California legislature in enacting the statute obviously involves state action. Interestingly, the federal court challenge to the California board diversity statute was also led by an organization affiliated with Edward Blum, the legal activist who heads AFBR.
The outcome of the Fifth Circuit proceedings is also interesting on another level; it could be argued that the court’s rejection of the petitions challenging the rules is a surprise outcome. AFBR had filed its petition challenging the Nasdaq board diversity rules in the Fifth Circuit because the appellate court is widely perceived as one of the most conservative circuit courts in the country. 12 of the 16 active judges on the Fifth Circuit bench were nominated to the court by Republican presidents. Yet somehow the three judges on the panel that decided the challenge to Nasdaq’s board diversity rules were nominated for the appellate court by Democratic presidents. Given the composition of the three-judge panel as compared to the overall Fifth Circuit bench, the petitioners could well conclude that they would be well-advised to seek en banc review of the three-judge panel’s decision.
Whether or not there is en banc review of the decision, we almost certainly have not heard the last of the petitioners’ challenges to Nasdaq’s board diversity rules. Blum, the legal activist who led the challenge to Harvard and UNC’s affirmative action admissions policies, is steering the challenge to Nasdaq’s board diversity rules; with the benefit of financial backing from numerous conservative groups and think-tanks, Blum undoubtedly is prepared to pursue the legal challenge to the Nasdaq’s rules all the way to the U.S. Supreme Court. Notwithstanding the financial wherewithal to pursue the continued legal challenge, he is going to face an uphill battle trying to establish sufficient “state action” to support the constitutional challenge.