The court has come to the rescue once again! On December 11, 2024, the 5th Circuit held that the SEC exceeded its authority in approving Nasdaq’s board diversity rule finding the rule was far removed from the purposes of the Securities Exchange Act’s regulatory regime. Rumor has it that the Nasdaq does not intend to appeal, meaning the board diversity rule may be DOA.
Background
On August 6, 2021, the SEC approved Nasdaq’s board diversity listing standards proposal adding new listing Rule 5606(a) (see HERE).
Nasdaq Rule 5606(a) requires Nasdaq listed companies to publicly disclose, in an aggregated form, to the extent permitted by law (for example, some foreign countries may prohibit such disclosure), information on the voluntary self-identified gender and racial characteristics and LGBTQ+ status of the company’s board of directors as part of the ongoing corporate governance listing requirements. Each company must provide an annual Board Diversity Matrix disclosure, including: (i) the total number of directors; (ii) the number of directors based on gender identity (female, male or non-binary); (iii) the number of directors that did not disclose gender; (iv) the number of directors based on race and ethnicity; (v) the number of directors who self-identify as LGBTQ+; and (vi) the number of directors who did not disclose a demographic background.
Foreign issuers may elect to use an Alternative Board Diversity Matrix format. Foreign issuers using the Alternative Matrix are required to disclose: (i) the total number of directors; (ii) its country of principal executive offices; (iii) whether it qualifies as a Foreign Private Issuer; (iv) whether disclosure is prohibited under its home country law; (v) the number of directors based on gender identity and the number of directors who did not disclose gender; (vi) the number of directors who self-identify as underrepresented individuals in its home country; (vii) the number of directors who self-identify as LGBTQ+; and (viii) the number of directors who did not disclose a demographic background.
Although not required, the rule encourages disclosure of other diverse attributes such as nationality, disability or veteran status. Failure to provide the disclosure will result in a listing deficiency with the ability to submit a plan within 45 days that would provide for cure within 180 days. For a review of both the Board Diversity Matrix and Alternative Board Diversity Matrix see HERE.
Court Challenge
The Nasdaq Diversity Rule was almost immediately challenged in an administrative proceeding by the Alliance for Fair Board Recruitment and National Center for Public Policy Research claiming the Rule violated both the first and fourteenth amendments to the Constitution and violated the SEC’s statutory obligations under the Exchange Act and the Administrative Proceedings Act (APA). The challenge to the Rule was originally denied. At the time a 5th Circuit panel contended that the constitutional challenges failed because Nasdaq is a private company, and only state or governmental parties are subject to constitutional challenges. The plaintiff’s had argued that the Nasdaq acts as a governmental entity and that its rules, which are approved by the SEC, are attributable to a governmental entity.
At that time, the Court also rejected the claims that the Rule extended beyond the Exchange Act and violated the APA. The Court agreed with the SEC’s position that the purpose of the Exchange Act is full disclosure, even if such disclosure is not material to investment decisions or potential fraud.
Despite what appeared to be a win for the Nasdaq and SEC, the Plaintiff’s noted that the panel was comprised of entirely democratic appointed judges and an appeal to the full 5th Circuit would provide a much different judicial body – comprising of 12 republicans out of 16 total judges. The Plaintiff’s appealed and they were not wrong.
As noted above, on December 11, 2024, the 5th Circuit held that the SEC exceeded its authority in approving Nasdaq’s board diversity rule finding the rule was far removed from the purposes of the Securities Exchange Act’s regulatory regime. The Court found that the disclosure obligations in the Exchange Act are not the fundamental purpose of the Act, but rather a method of achieving the fundamental purpose which in turn is to promote ethical behavior and avoid fraud. Accordingly, a disclosure rule must be related to the purpose of the elimination of fraud, speculation or some other Exchange Act related harm (including related to fair competition among market participants, brokers and dealers).
When the SEC approved the Board Diversity Rule, Commissioner’s Roisman and Peirce dissented, finding the Rule did nothing to further the Exchange Act but rather was an attempt to remedy a societal challenge. The 5th Circuit agreed, finding that the Rule did nothing to prevent fraud, manipulation, speculation or other market harm.
The 5th Circuit flat out rejected the SEC’s claim that the rule was “designed to promote just and equitable principles of trade.” The Court notes that “just and equitable” in turn means morally right and in conformity with the rules and customs of the securities profession. The Nasdaq Diversity Rule is far removed from this standard – it is not unethical for a company to decline to disclose an individual’s racial, gender or LGTBQ+ characteristics. Likewise, the Court notes that it is “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.”
The SEC also argued that the Rule is “designed to remove impediments to and perfect the mechanism of a free and open market and a national market system.” The Court found that too is just wrong. The purposes of the NMS are to promote: (i) economically efficient execution of securities transactions; (ii) fair competition between brokers, dealers and markets; (iii) information with respect to quotations for transactions and securities; (v) best execution of customer orders; and (v) opportunities to execute certain orders without the participation of a dealer. The Nasdaq Diversity Rule cannot explain any correlation to these purposes, nor did the SEC try to do so. Similarly, a free and open market is one open to all buyers and sellers. Again, the Diversity Rule does nothing related to this standard nor did the SEC provide any arguments to suggest it did.
The last SEC point in favor of the Rule was that it was “designed in general to protect investors and the public interest.” Once again, the Court found this to be “wrong.” Rather these words must be interpreted in association with the content of the neighboring words and context of the list or other words in which they are associated. It is ludicrous to assert that the SEC has the power to enact any rule it believes would protect investors and the public interest without reference to or regard to the Exchange Act provisions themselves and statutory purpose. As the Court notes, the SEC could not enact a rule designed to protect investors or the public from the perils of tobacco. In this case, the SEC failed to present any real correlation between the Board Diversity Rule and the protection of investors.
The Court found that the SEC’s approval of the Nasdaq Rule violated the “major questions doctrine.” The major questions doctrine provides in essence that a government agency cannot enact a rule that is a “major question” that could affect a vast and comprehensive swath of American life without clear and express authorization from Congress. Administrative agencies have no independent constitutional power but are merely creatures of statute possessing only the authority Congress grants to them.
The Court found that the question of board diversity is a “major question.” Nasdaq is the second largest stock exchange in the world, with aggregate company valuations greater than the US GDP. By prescribing rules such as these, which attempt to transform the internal structure of many of the largest corporations in the world, and come close to regulating “the entire economy,” the SEC has implicated a major question. Similarly, the topic of diversity is staggering on a political level – and a divisive issue. Certainly, beyond the power of the SEC.
Furthermore, the Court found the SEC improperly attempts to regulate corporate law by influencing a board’s make up – an area firmly within the constitutional authority of state governments. Raising yet another major question.
The 5th Circuit opinion is worth a read, thoroughly laying out the background of the Exchange Act, its purposes, and changes along the way supporting that purpose, including the 1975 amendments and creation of the National Market System (NMS).
The Author
Laura Anthony, Esq.
Founding Partner
Anthony, Linder & Cacomanolis
A Corporate and Securities Law Firm
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony, Linder & Cacomanolis, PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALC legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including the American Red Cross for Palm Beach and Martin Counties, Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others.
Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.
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