After various legal battles over the past four years, a recent en banc decision by the Fifth Circuit Court of Appeals vacated the Securities and Exchange Commission’s (SEC) approval of the Nasdaq board diversity proposal, holding that the exchange’s reporting requirement went beyond what the Securities Exchange Act of 1934 (Exchange Act) intended.
The case arose from Nasdaq’s attempt to impose new listing standards requiring companies listed on their exchange to disclose information about their directors’ self-identified gender, racial, and LGBTQ+ characteristics, to meet certain diversity objectives, or to explain why they have not met such requirements. The petitioners, the Alliance for Fair Board Recruitment and the National Center for Public Policy Research, argued that the SEC’s finding that the proposal was sufficiently “related to” the purpose of the Exchange Act was arbitrary and capricious, and not in accordance with Congress’ intent when they passed the Exchange Act. The majority opinion, joined by nine Republican-appointed judges, agreed with the petitioners, stating that the Exchange Act is “primarily about limiting speculation, manipulation, and fraud, and removing barriers to exchange competition.”
The majority opinion noted that the Exchange Act was enacted to address early 20th-century market crises, where private exchanges like the New York Stock Exchange (NYSE) set disclosure rules but failed to prevent fraud and manipulation, leading to the Great Depression. To stabilize markets and protect investors, Congress established regulatory oversight over private exchanges like the NYSE and other market participants, aiming to ensure transparency and fairness in securities trading. Building on this historical analysis, the majority invoked the major questions doctrine, a framework increasingly referenced following the Loper Bright decisions, which replaced the Chevron Deference test for Agency Rules. They argued that if Congress had intended to grant the SEC authority to impose demographic disclosures, it would have done so explicitly within the Exchange Act or its subsequent amendment in 1975. Instead, they emphasized the limited scope of the SEC’s authority, asserting it was confined to preventing the concealment of material financial risks and mitigating speculation-driven instability. This limitation, they argued, restricts the SEC’s ability to enforce broader policy objectives, such as corporate diversity initiatives, without explicit congressional authorization.
While the SEC argued that the justification for its approval was based on the Exchange Act’s instruction to “promote just and equitable principles of trade,” “remove impediments” to a “free and open market,” and “protect investors and the public interest,” the court found their arguments and evidence unpersuasive. The majority interpreted “just and equitable” to mean conforming to moral standards of the industry and to established rules, not corporate diversity.
Further relying on the Loper Bright framework, the majority reinforced the importance of statutory language and its ability to effectuate authority onto government agencies. They concluded that the SEC’s investor-protection mandate did not authorize it to approve rules bearing no meaningful connection to preventing fraud, manipulation, or other exchange-related harms. The majority acknowledged that there is a level of investor demand for greater transparency on board demographics, but did not agree that such demand is sufficient to justify the requirements on listed issuers. The SEC’s power to approve exchange rules hinges on whether the rules address the sorts of harm the Exchange Act was written to curb.
Nasdaq argued that greater diversity has historically correlated with better governance, but the court determined there was insufficient evidence to link demographic composition to financial reporting quality, internal controls, or fraud prevention. The court held that the SEC could not approve a rule based solely on investor interest, equating it to compelled disclosures unrelated to statutory authority, and concluded that such approval was unjustified under existing law.
The nine-page dissent, authored by the remaining eight Democrat-appointed judges, took a different approach by arguing in favor of limited government interference and greater reliance on market-driven solutions. While the majority insisted that self-regulation could not circumvent the statutory limits placed on the SEC's authority, the dissent countered that the rejection of Nasdaq’s rule was an intrusion by the government into private dealings and emphasized that experimentation in corporate governance is best managed through private company decisions, market dynamics, and investor preferences. They argued that Nasdaq, as a private business, was free to impose the requirements at issue on the companies who voluntarily listed on their exchange, so long as the proposal did not directly conflict with the Exchange Act.
Despite the split-ruling, Nasdaq issued a statement respecting the court's ruling and separately announced its decision not to appeal. The SEC has not yet commented on its next steps, but it has left open the possibility of appealing to the Supreme Court. Such an appeal could set another significant precedent regarding agency authority and corporate governance under federal securities laws.
This latest ruling highlights the increasing judicial scrutiny of regulatory actions. As the new administration prepares to take office and SEC Chair Gary Gensler is set to step down, the agency’s regulatory priorities and enforcement strategies are likely to shift, signaling that this trend may continue to gain momentum. This means that rather than being mandated by SEC-approved exchange standards, the environment for board diversity disclosures is expected to continue to be voluntary, market-driven, and influenced by investor preferences. Although many organizations' legal duties may be impacted by this rule, the voluntary choice to opt in or out of additional transparency is unaffected.
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