Nasdaq Stock Market's board diversity reporting requirements - introduced through listings rule 5606 - were quashed by a New Orleans-based appeals court last week (11 December).
In a 9-8 decision, the US Court of Appeals for the 5th Circuit ruled that the New York exchange cannot enforce the rule as the US Securities and Exchange Commission (SEC) did not have the statutory authority to approve the obligations.
Rule 5606 was approved by the SEC in 2021. It came into force in 2022 and required all Nasdaq-listed companies to annually disclose statistics, using a standardised matrix, on their board members' ethnicities, gender identities and sexual orientations.
It also mandated that listed organisations had to provide explanations, if applicable, for why they had not met the diversity objective of having at least one female board member and one board member that self-identifies as "an underrepresented minority or LGBTQ+".
SEC chair Gary Gensler commented back in 2021 that the requirements "will allow investors to gain a better understanding of Nasdaq-listed companies' approach to board diversity, while ensuring that those companies have the flexibility to make decisions that best serve their shareholders."
The Alliance For Fair Board Recruitment - a conservative non-profit membership corporation which aims to remove diversity considerations from board member recruitment requirements - challenged Nasdaq's listings rule back in 2023. A three-judge panel opted to uphold the rule, however, that decision has been overturned by last week's verdict.
The Fifth Circuit cited the 'Major Question Doctrine' and ruled the SEC did not have the authority to approve rule 5606 without a clear mandate from Congress.
In its majority opinion, the court argued that the Exchange Act permits the SEC to regulate companies on issues relating to misconduct or fraud, but does not allow the Commission to require disclosures on topics such as diversity.
The court conclusion reads: "It is obviously unethical to violate the law or to disregard a contractual promise. It is not unethical for a company to decline to disclose information about the racial, gender, and LGTBQ+ characteristics of its directors."
It added that the SEC had "overstepped its bounds and ventured into areas far beyond its usual jurisdiction", and that the approval of the rule was "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law."
The fifth circuit also argued that the transparency obligation on the predefined board diversity targets was no long a "disclosure requirement" but rather a "public-shaming penalty for a corporation's failure to abide by the government's diversity requirements".
While, maintaining that the rule provides benefits for both companies and investors, Nasdaq has announced that it will not appeal the ruling. Meanwhile, the SEC said it will review the decision.
The SEC could challenge the verdict in the Supreme Court, however Corporate Disclosures understands this is unlikely due to political considerations of the imminent Trump administration and the change in leadership at the Commission.