A U.S. Court of Appeals court ruled that Nasdaq can no longer enforce its board diversity rules, vacating the Securities and Exchange Commission’s approval of a rule that requires disclosure of each board member’s racial, gender, and LGBTQ+ identification. The court found that the SEC went beyond the scope of its authority in requiring board members to disclose such information.
In the case of Alliance for Fair Board Recruitment v. SEC, the Fifth Circuit court held that the SEC’s approval of the Board Diversity Rules was “arbitrary and capricious” and as a result an overreach of power. In reaching its decision, the court found that the SEC did not give adequate reasons as to why such rules were in line with the Securities Exchange Act of 1934. The court held that such Diversity Rules were unnecessary and unimportant within the context of the 1934 Act and overruled the SEC’s approval on a constitutional basis.
Case Analysis
The court consistently noted that the purpose of the 1934 Act is to protect investors from fraud and other similar types of harm. Due to this, the court held that such disclosures are permitted to be required “only if it is related to the elimination of fraud, speculation, or some other Exchange Act-related harm.” Ultimately, the court found that since the Rules (i) did not “promote just and equitable principles of trade” because they are not directed toward the unethical practices this Exchange Act language addresses, (ii) did not “remove impediments to” or “perfect the mechanism of a free and open market” because they are not related to a free and open market in the execution of securities transactions as the Exchange Act intends, and (iii) were not “designed . . . in general, to protect investors and the public interest” they were not related to the more specific purposes states in the 1934 Act.
“SEC has intruded into territory far outside its ordinary domain,” U.S. Circuit Judge Andrew Oldham who wrote for the majority opinion. “It is not unethical for a company to decline to disclose information about the racial, gender, and LGTBQ+ characteristics of its directors,” the ruling stated. “We are 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.”
Under the original rule, companies were required to have at least one woman, racial minority or LGBTQ person on the board or explain why they do not. Additionally, the rule required that companies also disclose how board members identify in those categories.
This case represents the ongoing of court rulings overturning SEC rulemaking such as share repurchase rules and the private fund rules. The Fifth Circuit has, for a while, been known to limit agencies’ authority to make rules as was seen when the court affirmed a case using the Loper Bright approach, also known as the case that overruled the Chevron Doctrine. This case once again indicates that judicial system seems to be leaning away from agency rulemaking and authority. 
Jacob Horowitz is a contributing editor at Compliance Chief 360°