Fifth Circuit Strikes Down Nasdaq’s Board Diversity Rules | Image Source: Nasdaq.com
NEW ORLEANS, December 11, 2024 - In a landmark decision, the U.S. Court of Appeal for the Fifth Circuit invalidated Nasdaq’s diversity requirements for boards of directors, a decision that could significantly change corporate governance standards across the United States. The court found that Nasdaq and the Securities and Exchange Commission (SEC) exceeded their regulatory authority under the Securities Exchange Act of 1934 when they carried out these mandates.
The contested rules, adopted by the SEC in 2021, required companies on Nasdaq’s list to disclose the racial, sexual and sexual orientation composition of their boards of directors and to meet specified diversity thresholds or provide public explanations of non-compliance. Supporters argued that the rules promote inclusion and better governance, aligning themselves with the increasing transparency and diversity requirements of investors. However, the fifth circuit considered that the rules were incompatible with the legal framework governing exchanges.
Nasdaq’s drive for diversity
Nasdaq introduced the rules in 2020 in a context of increased awareness of social justice issues. The rules required companies to have at least two different board members, one of whom was a woman and another from an underrepresented racial, ethnic or LGBTQ+ group. Companies that fail to meet these objectives must publicly explain their reasons. Nasdaq described the measures as “inspiring,” noting that they were not quotas, but tools to promote better representation in corporate leadership.
The SEC approved these proposals, arguing that they are consistent with the objectives of the Change Act to promote fair markets and protect investors. The Commission stressed that transparency on board diversity can help investors make informed decisions. Large institutional investors such as BlackRock and Vanguard have been cited as supporting greater dissemination of diversity measures.
Decision of the Court
The Fifth Circuit disagreed with the rationality of the SEC. For the most part, Justice Andrew S. Oldham stated that the rules were not linked to the fundamental objectives of the Change Act, which focused on fraud prevention, market equity and investor protection. The Court pointed out that Congress never wanted scholarships to regulate broader social issues, such as the diversity of boards of directors.
“The exchange law has been designed to protect investors from speculative and manipulative practices,” wrote Justice Oldham. “It does not allow exchanges to impose obligations that are not related to these objectives, such as establishing the diversity of boards of directors. The Court also criticized the SEC for not sufficiently justifying the alignment of the rules with statutory objectives, noting the lack of clear evidence linking the diversity of advice to market stability or investor protection.
The doctrine of major issues
The decision invoked the “major doctrine of issues”, a legal principle that required the explicit authorization of Congress for regulations with significant economic or political consequences. The Court found that the imposition of requirements for diversity of councils constituted a profound policy change, which warranted clear legislative support. “This is not a minor procedural rule; It is an attempt to reformulate corporate governance at its heart,” said the decision.
Doctrine has been increasingly used in recent years to challenge radical regulatory initiatives. The implementation of the fifth round of this principle underlines its growing importance in the judicial review of agency actions.
Impact on corporate governance
The decision marks a significant setback for Nasdaq and advocates of diversity initiatives in corporate leadership. Critics of the decision argue that it undermines efforts to promote inclusion and may discourage companies from taking similar measures voluntarily. The defence of the court’s judgment affirms that it reaffirms the importance of respecting the legal limits of the regulatory authority.
Some legal analysts predict that the decision will have radical effects beyond Nasdaq, which may limit other exchanges and regulators to implementing societal policies. The case also highlights tensions between federal courts and administrative bodies over the scope of the regulator.
Challenges ahead
Nasdaq and SEC have not yet announced their intention to appeal the decision to the Supreme Court. Meanwhile, companies that navigate the rapidly changing corporate governance landscape must assess the benefits of the reputation of diversity over the absence of regulatory mandates.
This decision focuses on Congress to determine whether diversity objectives should have a legislative basis. In the absence of clear legal guidance, the balance between promoting diversity and respecting regulatory limits may remain controversial.
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