Nasdaq Board Diversity Rules Vacated by En Banc Fifth Circuit Decision

Court Holds that SEC Approval was Unsupported by Exchange Act

In an en banc decision filed on December 11, 2024, the U.S. Court of Appeals for the Fifth Circuit (Fifth Circuit) vacated the 2021 approval by the U.S. Securities and Exchange Commission (SEC) of rules adopted by The Nasdaq Stock Exchange (Nasdaq) to promote more diverse board membership at Nasdaq-listed companies. The 9-8 en banc decision overturned an earlier ruling by a three-judge panel of the Fifth Circuit that had upheld the SEC’s approval of the Nasdaq diversity rules. An SEC spokesperson was reported (1, 2) as saying that the SEC is “reviewing the decision and will determine next steps as appropriate.” Nasdaq, which filed a brief as an intervenor supporting the SEC’s defense of its decision to approve the Nasdaq rules, has posted interpretive guidance on its website stating that “Nasdaq does not intend to seek further review of that decision.” The Fifth Circuit decision eliminates the last remaining diversity requirements that were broadly applicable to public companies listed on U.S. national stock exchanges, and has several important implications for Nasdaq-listed companies as they prepare for the 2025 proxy season.

Practical Implications of the Fifth Circuit Decision

The Fifth Circuit order means that Nasdaq-listed companies are no longer required to comply with Nasdaq Rule 5606, which required disclosure about board diversity, and Rule 5605(f), which required companies to have, or explain why they did not have, at least the minimum number of directors in specified diversity categories. As a result, Nasdaq-listed companies are once again in the same position with respect to board diversity and board diversity disclosure as companies listed on the New York Stock Exchange, which had not adopted similar diversity rules. For Nasdaq-listed companies, the Fifth Circuit order that vacated the Nasdaq diversity rules will have several impacts on the 2025 proxy season, which is rapidly approaching for companies that have a December 31 fiscal year end.

As a starting point, Nasdaq-listed companies should consider whether they wish to take a different approach to board diversity and board diversity disclosure in their 2025 proxy statements than the approach taken in their 2024 proxy statements. Companies can then determine what disclosure will be appropriate in their 2025 proxy statements under SEC proxy rules.

Board Diversity Considerations. With the Nasdaq diversity rules no longer in effect, the only broadly-applicable diversity requirements that apply to public company boards will be state-level disclosure requirements and private sector inputs, and the substance and format of board diversity disclosure will reflect decisions made by individual companies.

In particular, public company board diversity is likely to remain a concern for certain institutional investors, investment advisors and others. Proxy advisory services and corporate governance ratings services are also likely to continue to consider board diversity when publishing their recommendations and governance ratings. On the other hand, various groups that oppose diversity, equity and inclusion (DEI) initiatives have become active, such as submitting proposals for shareholder approval at annual meetings and initiating litigation. Other factors may also affect board decisions about board diversity, such as relations with a company’s workforce, customer and supplier policies, and comparisons with a company’s industry peers and competitors. In the end, decisions about board diversity will be made on the basis of the factors that are individually relevant to each company.

Proxy Statement Board Diversity Disclosure. Because the Nasdaq diversity rules no longer apply to proxy and information statements filed by Nasdaq-listed companies, these companies will not need to include the board diversity matrix specified by Nasdaq Rule 5606. Further, Nasdaq Rule 5605(f) will no longer require companies to have the specified numbers of diverse directors or explain why they do not. Disclosure about board diversity will therefore need to be tailored to the specific facts and priorities relevant to each company. At a minimum, proxy and information statements must be revised to eliminate any statements that Nasdaq rules require any board diversity disclosure or diverse board membership.

Nominating Committee Disclosure. If there have been any changes to how the nominating committee considers diversity in identifying nominees for director or in its policies regarding the consideration of diversity, companies should review the disclosure required by Item 407(c) of Regulation S-K about the nominating committee of the board of directors and its director nomination process. In addition, any disclosure that relates to the Nasdaq diversity rules should be revised as necessary to reflect the Fifth Circuit order.

Director and Officer Questionnaires. Director and officer questionnaires used by Nasdaq-listed companies for the 2024 proxy season are likely to require revisions to reflect the Fifth Circuit order, even if a company chooses to continue to disclose board diversity information in a format similar to the format that had been required by Rule 5606. At a minimum, director and officer questionnaires used by Nasdaq-listed companies should be revised to eliminate any statements that any questions related to director diversity are necessary to support the diversity disclosure and director diversity requirements of former Nasdaq rules. Beyond that minimum, each company will need to evaluate how it will handle board diversity and revise the company’s director and officer questionnaire accordingly.

The Rationale for the Fifth Circuit Decision

The question at the heart of the litigation in the Fifth Circuit was whether the SEC had the statutory authority under the Securities Exchange Act of 1934 (Exchange Act) decision to approve Nasdaq’s adoption of its diversity rules. SEC approval was necessary to make the Nasdaq rules effective under the federal securities laws. The litigation did not directly challenge the substance of the Nasdaq rules, nor did it challenge Nasdaq’s adoption process, although the subject matter and stated goals of the Nasdaq diversity rules were an essential part of the decision by the Fifth Circuit that the SEC did not have authority under the Exchange Act to approve the Nasdaq rules.

Essentially, the Fifth Circuit ruled that the Exchange Act did not provide any basis for approval of the Nasdaq diversity rules by the SEC. The Fifth Circuit reviewed the SEC’s approval in light of the “major questions” doctrine, which requires a clear Congressional mandate to justify action such as approval of the Nasdaq rules by the SEC. Among other arguments, the SEC and Nasdaq argued that full disclosure is the “core” purpose of the Exchange Act, and that purpose gives the SEC broad authority to adopt its own disclosure rules and to approve stock exchange disclosure rules such as the Nasdaq diversity rules. The Fifth Circuit rejected this argument, stating that under relevant decisions of the U.S. Supreme Court “disclosure is not an end in itself but rather serves other purposes.” In this case, those are the purposes articulated by Congress when it enacted the Exchange Act, and the Fifth Circuit found in each case that the legislative purposes enumerated in the Exchange Act were not sufficiently related to the purposes of the Nasdaq diversity rules to authorize the SEC’s action.

The Fifth Circuit decision vacating the Nasdaq diversity rules is the latest in a series of judicial decisions that have overturned a wide variety of federal, state and stock exchange rulemaking initiatives. Among the most prominent rules currently subject to litigation are the SEC rules intended to enhance and standardize climate-related disclosures and two California state laws that would require new climate-related disclosures. The incoming Trump administration, with majorities in the U.S. House of Representatives and Senate and control or significant influence over federal agencies and commissions, is considered likely to expand efforts to change the U.S. regulatory landscape, including public company disclosure requirements. Public companies should continue to monitor litigation challenging existing disclosure requirements, as well as legislative and administrative developments that could amend or eliminate these requirements.

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.