On December 11, 2024, the Fifth Circuit, sitting en banc, and by a vote of 9-8, struck down Nasdaq’s board diversity rules. The full Court’s decision overrules an earlier ruling of a three-judge panel that had upheld the Nasdaq rules. The en banc panel held that the SEC exceeded its authority when it approved the rules. The court’s ruling, which can be found here, represents the latest blow against corporate DEI initiatives.
Background
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 at least on Diverse director who self-identifies as an Underrepresented Minority or LGBTQ+.
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.
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 panel rejected the petitioners’ constitutional argument, saying that the Constitution applies only to state actors and that Nasdaq did not qualify as a state actor. The three-judge panel also concluded that the agency was within its authority in approving the rules. The petitioner sought en banc review of the three-judge panels ruling.
The December 11, 2024, Opinion
In a detailed December 11, 2024, opinion written by Judge Andrew Oldham for a 9-8 majority, the Fifth Circuit overturned the ruling of the three-judge panel and struck down the Nasdaq rules.
The Court first concluded that the SEC’s approval of the Nasdaq rules exceeded the agency’s authority. The Court said the Exchange Act existed to “protect investors and the macroeconomy from speculative, manipulative, and fraudulent practices, and to promote competition in the market for securities transaction.” Rules related to these purposes are appropriate under the Act. In making or approving rules for exchanges like Nasdaq, the SEC “may not approve even a disclosure rule unless it can establish the rule has some connection to an actual, enumerated purpose of the Act.” However, the Court said, the Nasdaq rules were not related to these purposes; moreover, the appropriate purposes under the Act have “no relationship to the disclosure of information about the racial, gender, and sexual characteristics of the directors of public companies.”
The court went on to say that the “major questions” doctrine affirms its conclusion. Under the major questions doctrine, an agency must have clearly delegated authority from Congress in order to decide an issue of national significance. The Court said that in its view, this rules challenge is a major questions case, with significant economic and political significance. In noting the political significance, the court referenced what it called the “social justice movement” and widespread efforts to increase “diversity and inclusion” at public companies. The SEC’s exercise in approving the rules was not only novel, the court said, but it also “intruded” into areas (e.g., corporate law) traditionally reserved for the states. The court found that the agency had exceeded its statutory authority in approving the rules.
Judge Stephen J. Higginson, who had written the opinion for the three-judge panel, wrote a dissenting opinion in which seven other judges joined. In his dissent, Judge Higginson emphasized the importance of diversity in corporate governance. He argued that Nasdaq’s board diversity rules were a reasonable effort to address historical inequities and promote a more inclusive and effective corporate environment, and that the SEC, within its limited role in supervising self-regulatory organizations like Nasdaq, acted within its authority in approving the rules. Higginson highlighted that diverse boards can lead to better decision-making and improved company performance. He also expressed concern that striking down these rules could hinder progress toward greater equality and representation in the corporate world.
Discussion
In a number of different ways, this decision is not a surprise. I noted at the time that the three-judge panel upheld the rules that it was very odd that the three-judge panel consisted entirely of among the few Fifth Circuit judges appointed in by a Democratic President. Most of the judges on the Court, I noted, are conservative judges appointed by a Republican President. On that basis, I opined that the petitioners would seek to have the full court review the three-judge panel’s ruling, in their hope that the full court might take a different view than that of the three-judge panel – which is exactly what has happened.
The three-judge panel’s prior ruling was the surprise outcome; that the full Fifth Circuit overturned the three-judge panel and struck down the rules is not a surprise. (It could be argued that it is a surprise that there were eight votes to uphold the rules. I would love to know more about how that happened.)
News reports suggest that Nasdaq has already said it will not seek further review of the appellate court’s decision. The SEC could seek further review, but even if the current SEC leadership were inclined to pursue these issues further, it seems unlikely that the new administration under the incoming Trump administration would continue the appeal.
With the Fifth Circuit’s ruling striking down the Nasdaq board diversity rules, it seems that the board diversity initiatives that were launched to great fanfare just a short time ago are now pretty much dead. Not only have the Nasdaq rules now been struck down, but the California board diversity statute also has been struck down. As discussed here, 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. 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 Fifth Circuit’s decision in this case is merely the latest blow against organized corporate DEI initiatives. At least one news report discussing the Fifth Circuit’s decision called it “the latest defeat for DEI policies across corporate America.” The decision comes after a number of high-profile U.S. companies – including Walmart, Ford, Harley-Davidson, and Lowe’s — have publicly walked back their company DEI policies, in response to a conservative legal movement against ESG generally and DEI in particular.
Just the same, and while DEI initiatives may be in retreat, It is probably worth noting that though the board diversity initiatives have been struck down, corporate boards are in fact significantly more diverse than they were only a short time ago. It may be that these kinds of initiatives, while facing legal challenges, have nevertheless led to cultural changes and changing attitudes.