Fifth Circuit Court of Appeals Upholds Nasdaq Board Diversity Disclosure Rule – What it Means for Corporate Boards


In August of 2021, it was announced that the U.S. Securities and Exchange Commission (SEC) approved a proposed Nasdaq rule to encourage board diversity in the companies that use the platform for trading. Though criteria are not difficult to meet, Nasdaq and the SEC have faced backlash regarding this new rule, including the recent effort in the Fifth Circuit Court of Appeals by the Alliance for Fair Board Recruitment (AFBR) and the National Center for Public Policy Research (NCPRR).

The labor and employment attorneys at MehaffyWeber have heard passionate voices on both sides of the argument. Some appreciate the push to prioritize a diverse and innovative group, and others see it as an attack and an attempt to push an agenda. However, Nasdaq touts this as an attempt to encourage diversity and, at a minimum, increase the transparency of diversity efforts within companies.

What is the Board Diversity Disclosure Rule?

The Board Diversity Disclosure rule requires companies trading on the exchange to have a member on their board of directors who identifies as female, is a member of an underrepresented racial or ethnic minority, or is a member of the LGBTQ+ community. One person can satisfy multiple criteria, but this rule means that companies will likely need two directors identifying as ‘diverse’ in some way to meet the requirements. A company with a board of directors under five people can satisfy the guidelines with one person who meets the requirements.

The company must publish this information annually, by December 31, on its website using a standardized matrix or something functionally similar. If they have not met the diversity requirement, the company is required to post the matrix and explain why the standards haven’t been satisfied. If board composition changes the same year after the data has been published, an update can wait until the following reporting year.

Research Supporting Diversity on Corporate Boards

Research has shown that diversity in a board of directors is helpful for innovation. Particular benefits result from companies having individuals with 2-D diversity, defined as at least three inherent diversity traits, or traits they are born with, and three acquired diversity traits, or things learned through experience.

In reports on various studies demonstrating the benefits of diversity in business, the Harvard Business Review states that companies exhibiting 2-D diversity are 45% more likely to report growth in market share compared to the previous year and 70% more likely to have captured a new market.

Nasdaq Diversity Disclosure Controversy

In the face of this rule with relatively little consequence to Nasdaq-listed companies, many are less than thrilled with the decision. The research is clear, but many disagree with the Nasdaq requirements. Of those dissenting to the rule, the Alliance for Fair Board Recruitment (AFBR) and the National Center for Public Policy Research (NCPRR) are among the loudest. In 2022, both groups were in the middle of litigation in the Fifth Circuit Court of Appeals, arguing that the rule was unconstitutional.

The lawsuit’s premise was that this requirement defies the Constitution’s proscription of discriminatory laws and restraints on free speech. As these are restrictions of government, they argued that these restrictions were extended to Nasdaq because they are regulated by the SEC, a government entity. The SEC and Nasdaq argued that being regulated by a government agency does not make a company an agent of the state. Therefore, the same restrictions do not apply, and the rule does not violate the Constitution.

Many are expecting and hoping for an En Banc review, which will have the appeal presided over by the entire Fifth Circuit instead of just three of the judges pulled for a standard review. However, those opposing the rule would benefit because the three judges who presided over the review happened to be appointed by Democratic presidents. In contrast, Republican presidents appointed the majority of the appeals court justices. This gives opposition to the rule a hope that it may be overturned.

How Will the Nasdaq Board Diversity Rule Affect Companies?

With the opposition to the Board Diversity Disclosure rule shot down, many companies wonder about the next steps. First, the listing center website has several resources available to guide companies through the process and answer questions. This includes examples of what appropriate and inappropriate disclosures may look like.

Companies that are listed in Nasdaq’s Global or Global Select market tiers should meet the standards of having at least two ‘diverse’ directors by December 31, 2025. Smaller companies listed on the capital market tier will have until December 31, 2026 to have diversified their board of directors.

The goal of the Nasdaq rule is simply to make their diversity makeup more transparent, as this may affect how investors choose to invest. The companies only need to disclose the makeup and, if they haven’t met standards, explain why. There are some concerns about forcing marginalized populations to self-identify. However, all disclosure is optional for the individual, and the company should indicate that members did not disclose in the posted matrix.

The Nasdaq announcement explicitly states that the merits of an explanation will not be investigated, but it should be posted where investors can see it. If a company declines or fails to follow the guidelines, there is a grace period of their next annual meeting or 180 days, whichever is later. This is based on the date that the company fell out of compliance. If the company hasn’t gotten back into compliance at this time, they will be notified of being delisted.

What Does The Nasdaq Ruling Mean Moving Forward?

Diversity is a hot topic right now, and people from all backgrounds have opinions on it. Inviting people with diverse backgrounds to work together can only give us a wider variety of ideas. While the decision of the Fifth Circuit is a win for the SEC, Nasdaq, and innovation, an En Banc review might change the ruling.

However, this may encourage more companies and agencies to further their DEI efforts, even if it isn’t mandated. This transparency will empower investors to be better informed regarding the companies they invest in or with. Contact the Texas business attorneys at MehaffyWeber to see how we can help your business.