(This post updates my post of December 12 to add further discussion of the decision.)
In August 2021, the SEC approved a Nasdaq proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. The new listing rules adopted a “comply or explain” mandate for board diversity for most listed companies and required companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. (See this PubCo post.) It didn’t take long for a court challenge to these rules to materialize: the Alliance for Fair Board Recruitment and, later, the National Center for Public Policy Research petitioned the Fifth Circuit Court of Appeals—the Alliance has its principal place of business in Texas—for review of the SEC’s final order approving the Nasdaq rule. (See this PubCo post and this PubCo post.) (Reuters points out that the same pair of challengers “led the successful U.S. Supreme Court challenge against race-conscious college admissions policies.” In October 2023, a three-judge panel of the Fifth Circuit denied those petitions, in effect upholding Nasdaq’s board diversity listing rules. Given that, by repute, the Fifth Circuit is the circuit of choice for advocates of conservative causes, the decision to deny the petition may have taken some by surprise—unless, that is, they were aware, as discussed in the WSJ and Reuters, that the three judges on that panel happened to all be appointed by Democrats. Petitioners then filed a petition requesting a rehearing en banc by the Fifth Circuit, where Republican presidents have appointed 12 of the 16 active judges. (See this PubCo post.) Not that politics has anything to do with it, of course. That petition for rehearing en banc was granted, vacating the opinion of the lower court. In May, the en banc court heard oral argument, with a discussion dominated by rule skeptics. (See this PubCo post.) Last week, the Fifth Circuit, sitting en banc, issued its opinion in Alliance for Fair Board Recruitment v. SEC, vacating the SEC’s order approving Nasdaq’s board diversity proposal. No surprise there—the surprise was that the vote by the Fifth Circuit was nine to eight. The majority of the Court applied a strict interpretation—some might call it pinched—of the purposes of the Exchange Act to hold that the Nasdaq board diversity rules “cannot be squared with the Securities Exchange Act of 1934,” and, therefore, the SEC had no business approving them. Ironically, the dissent also contended that the SEC’s authority was limited—that its statutory authority to disapprove a rule proposed by Nasdaq, cast by the dissent as a “private entity” engaged in private ordering, was constrained by the Exchange Act. In effect, the dissent contended, the majority was advocating that the agency intrude more on this exercise in private ordering. According to Bloomberg Law, a “Nasdaq representative said the exchange disagreed with the court’s decision, but doesn’t plan to appeal the ruling. An SEC spokesperson said the agency is ‘reviewing the decision and will determine next steps as appropriate.’” But if Nasdaq doesn’t appeal, how likely is it that the new Administration would do so?
In summary, the majority reasoned that “an exchange rule is not related to the purposes of the Exchange Act simply because it is a disclosure rule. The Act exists primarily to protect investors and the macroeconomy from speculative, manipulative, and fraudulent practices, and to promote competition in the market for securities transactions. A disclosure rule is related to the purposes of the Act if it has some connection with those purposes, but not otherwise.” Nor, in the Court’s view, did the SEC explain how the Nasdaq board diversity proposal had “any connection with those purposes. All it said was that the Proposal is designed to advance three of the purposes contained in § 78f(b)(5). But those purposes bear no relationship to the disclosure of information about the racial, gender, and sexual characteristics of the directors of public companies.” Further, the majority invoked the major questions doctrine (see this PubCo post) to confirm its “interpretation of the statute’s ordinary meaning.” Quoting Judge Sentelle, the Court concluded that “finding a hidden disclosure mandate in the Exchange Act and its amendments requires concluding that ‘Congress not only had hidden a rather large elephant in a rather obscure mousehole, but had buried [it] beneath an incredibly deep mound of specificity, none of which bears the footprints of the beast or any indication that Congress even suspected its presence.’” Accordingly, the Court held that “no part of the Exchange Act even hints at SEC’s purported power to remake corporate boards using diversity factors.” The Court did not attribute much weight to the SEC’s and Nasdaq’s counterarguments, finding them “unavailing.” Accordingly, the Court vacated the SEC’s order approving Nasdaq’s board diversity proposal.
Background
Nasdaq listing rule. The Nasdaq board diversity rule set a “recommended objective” for most Nasdaq-listed companies to have at least two diverse directors on their boards; if they did not meet that objective, they would need to explain their rationales for not doing so. Companies with five or fewer directors could satisfy the recommended objective with one director from a diverse background rather than two. The rule also required listed companies to provide annually, in a board diversity matrix format, statistical information regarding the company’s board of directors related to the directors’ self-identified gender, race and self-identification as LGBTQ+. Separately, Nasdaq also provided Nasdaq-listed companies with one-year of complimentary access to a board recruiting solution to help identify board-ready diverse candidates. (See this PubCo post.)
To refute potential criticism of the board diversity proposal as a quota in disguise, Nasdaq took great pains to frame its proposals as principally “a disclosure-based framework and not a mandate,” a presentation that the SEC embraced. The SEC observed that the proposal “would mitigate concerns regarding unequal access to information“ among investors and might benefit companies that chose to comply with the diversity objectives. In light of these disclosure benefits, and “given that the studies of the effects of board diversity are generally inconclusive and the costs of the proposal are likely to be comparatively limited,” the SEC found that the proposal was consistent with the requirements of the Act. In approving the proposals, the SEC made clear that it had no discretion to modify the proposals and, if it found the rules to be consistent with the Exchange Act, no real choice but to approve the proposals: under the Act, the SEC “‘shall approve’ a proposal if it finds that the rule is consistent with the requirements of the Act and the rules and regulations applicable to the SRO—including requirements in Section 6(b). The statute does not give the Commission the ability to make any changes to the rule proposal as submitted, or to disapprove the rule proposal on the ground that the Commission would prefer some alternative rule on the same topic.” Because the SEC found both proposals to be consistent with the requirements of the Act and the rules and regulations applicable to Nasdaq, the SEC stated in the Order, “[t]he proposed rule changes therefore are required to be and are approved.”
Three-judge panel opinion. That approach to framing the proposals seems to have been persuasive—right out of the gate, the three-judge panel described the Nasdaq listing rule as a “rule that would require companies listed on its stock exchange to disclose information about their board members, as well as a rule that would give certain companies access to a board recruiting service.”
Petitioners first made several Constitutional claims. The panel, however, concluded that Nasdaq was not a state actor. Although Nasdaq “is heavily regulated by the SEC, the Supreme Court has made clear that a private entity does not become a state actor merely by virtue of being regulated.” Nor did “the SEC’s involvement with and approval of Nasdaq’s Rules render the Rules subject to constitutional scrutiny.” Petitioners also contended (i) that the SEC was prohibited “from considering investors’ subjective beliefs that disclosure would be valuable,” (ii) that the SEC was prohibited “from approving an exchange rule that requires disclosure of information that would not be ‘material’ for purposes of a securities fraud claim, (iii) that Congress did not explicitly authorize the SEC to approve a rule that infringes state sovereignty, and (iv) that Congress did not explicitly authorize the SEC to approve a rule that concerns ‘major policy questions of vast economic and political significance.’” But the panel rejected all of those arguments and concluded that, in approving the Nasdaq rules, the SEC acted within its statutory authority. Notably, the panel rejected the application of the “major questions” doctrine. Citing West Virginia v. EPA (see this PubCo post), the panel explained that “the ‘major questions doctrine’ applies in ‘extraordinary cases’ where the ‘history and the breadth of the authority that the agency has asserted, and the economic and political significance of that assertion, provide a reason to hesitate before concluding that Congress meant to confer such authority.’” This was not one of those cases. Rather, in this instance, “the SEC’s asserted authority is an ordinary exercise of its power to approve exchange listing rules”—“business as usual for the SEC.” Finally, the panel concluded that the SEC’s Approval Order was not arbitrary and capricious under the APA. Based on its analysis, “the SEC decided that the Disclosure Rule contributes to the maintenance of fair and orderly markets” and “reasonably concluded” that the Rule “would not impose a burden on competition between issuers that is not necessary or appropriate in furtherance of the purposes of the Act.” In the end, the panel unanimously decided that “AFBR and NCPPR have given us no reason to conclude that the SEC’s Approval Order violates the Exchange Act or the APA.”
For a more detailed discussion of the now-vacated opinion of the three-judge panel, see this PubCo post.
Petition for rehearing. The petition for rehearing opened by observing, speaking of the Nasdaq board diversity rule, that “a rule that facially discriminates based on race and sex now has the imprimatur and backing of the federal government….That discrimination now has this Court’s seal of approval, too.” It’s worth noting here that there were a slew of amicus briefs submitted in this case, including FINRA, the State of Utah and 23 other states, the Buckeye Institute, the Manhattan Institute, the Interfaith Center on Corporate Responsibility, Academic Experts in the Fields of Business, Management, and Economics and various other academics, Ariel Investments, L.L.C., the Council of Institutional Investors, Better Markets, Inc., the NAACP Legal Defense and Educational Fund, and an Ad Hoc Coalition of Nasdaq-Listed Companies.
The two questions identified in the petition for the Court’s en banc review were:
“(1) whether approval of the Rule and its compulsion of discrimination and controversial disclosure requirements are unconstitutional state action; and
(2) whether the Rule is justified under the Exchange Act on the sole basis that select financial activists want to encourage board selection based on race and sex.”
The petition contended that the listing rule violated the Equal Protection clause and, by compelling controversial disclosure, the First Amendment, citing the conflict minerals decision, Nat’l Ass’n of Mfrs. v. SEC. (See this PubCo post.) The petition also challenged the panel’s conclusion that no state action was involved, arguing that “requiring private parties to encourage discrimination that otherwise would not have occurred” is in effect, state action by the SEC. And the “unique relationship between the SEC and national stock exchanges like Nasdaq means exchange rules are subject to constitutional requirements, as well.”
The petition also requested that the Court grant the rehearing
“to remove this Court’s new stamp of approval on race and sex discrimination, to uphold the First Amendment, and to resolve the now-conflicting caselaw on state action. The Court should also grant rehearing to review the panel’s far-reaching determination that the Rule is consistent with the Exchange Act. Most notably, the panel held that even though the SEC found no link between a board’s race/sex breakdown and its corporate performance, the Rule was nonetheless justified because a few financial activists asked for it. Under that circular test, anything is ‘material’ and can be forcibly disclosed if someone wants it. The SEC could authorize compelled disclosures under the Exchange Act about how many firearms a company’s employees own, their political affiliations, what churches they attend, how many abortions they’ve had, etc. No court has ever adopted such an expansive definition of materiality, which will empower the SEC to act as a junior-varsity Congress unconstrained even by the Constitution.”
For more detailed ‘discussion’ of the petition, see this PubCo post.
Oral Argument. [Based on my notes, so standard caveats apply.] Petitioners’ argument fairly tracked the paragraph of the petition quoted above: As a result of its order, the SEC gave its imprimatur to the Nasdaq rule, ultimately constituting state action; the rule imposed a quota, but even if the rule involved only disclosure, it was discriminatory on its face based on race and sex because it was designed to pressure companies to support DEI; and the rule compelled controversial speech about categories of race and sex in violation of the First Amendment.
But that was not the central concern of the Court’s questions. Rather, the discussion initiated by the Court was largely focused on two issues: was the information required by the rule within the parameters of the Exchange Act provisions describing the purposes for which the SEC and Nasdaq may impose rules? And, in that light, were there any limits on what information the SEC could require companies to disclose?
Petitioners maintained that the purpose of the rule was not within the purposes cognizable under the Act—specifically Section 6(b)(5), 6(b)(8) and 19(b)—which generally include preventing fraudulent and manipulative acts and practices, promoting just and equitable principles of trade, removing impediments to and perfecting the mechanism of a free and open market and a national market system, and, in general, protecting investors and the public interest. Nor, petitioners maintained, does the rule promote efficiency, competition, capital formation or investor protection. The SEC may not approve rules that are out of bounds. Is it clear that board diversity is beneficial, they asked? Even the SEC, petitioners observed, in approving the Nasdaq rules, found that “the studies of the effects of board diversity are generally inconclusive.”
One judge asked if the purpose needs to be profit-driven: aren’t there other values to protect? Petitioners contended that, unless the rules related to improving corporate performance and shareholder value, there was no basis for their approval. Investor requests for information, especially socially controversial information, outside the purposes of the Exchange Act do not justify the rules, they argued. But, the judge inquired, should the SEC have to interrogate investors like Goldman Sachs about their motivations? Shouldn’t the Court let the markets decide for themselves what information they need? Should the SEC be required to tell investors that they cannot have certain information because it’s controversial, the judge asked. Later, petitioners said that the Court should look through the claims of investor interest to the real intent of the rules—to create a pressure campaign to allocate board seats based on race and sex. When asked how far the SEC needs to inquire into the motives of investors, counsel for petitioners argued that there was no need to look under the hood of the car—this rule was itself a hood ornament. The rule, they said, opens the door to disclosure of religion and political affiliation. Those demanding the information, they contended, are not really representative of the whole investor class, but rather of asset managers and proxy advisors and others with special interests who are not acting to maximize shareholder value, but rather to advance collateral social interests. In the hands of proxy advisors, they said, the information could even be harmful. They contrasted the 2009 SEC disclosure rule, which simply required information about how the nominating committee considers diversity in its director nominations, but did not define diversity. On this new rule, they contended, Nasdaq was “out over its skis.”
But that issue quickly devolved into some amazing hypotheticals from the various judges as to what the rules could require if investors said they wanted to know: Could the rules require disclosure regarding the college degrees of board members? Could information be required about directors’ views on abortion, or attendance at religious services or religious affiliation as indicia of diversity? What about disclosure of directors’ views on Gaza? Whether they are on TikTok? Are they Swifties? In the interests of board integrity, could disclosure be required about spousal infidelity? If investors were interested, could the rules require disclosure of whether board members were “on Team Drake or Team Kendrick Lamar”? (Seriously.)
The SEC and Nasdaq contended that the Nasdaq rule does not involve state action: Nasdaq was a private exchange, and listing on Nasdaq involves a private agreement with each company. The ’34 Act did not federalize the exchanges and gave the SEC only limited oversight authority. To find state action here would upend a system that has been in place for years. In addition, they argued, companies can choose to list anywhere, and there is vigorous competition for listings. Each exchange adopts its own rules that govern the exchange’s relationships with its listed companies, they contended, and Nasdaq’s decision to differentiate itself with this rule was not a basis for the SEC to find the rule was inconsistent with the Act. The Long-Term Stock Exchange, they noted, has a different diversity rule that was also found to be consistent with the Act, a fact that led one judge to question how the Court could find the rule to be arbitrary and capricious here if the LTSE has a similar rule. The Court, they said, should reject the idea of turning private action by the exchange, which the Constitution protects, into public state action, which the Constitution constrains. This rule, they maintained, was consistent with the Act by promoting just and equitable trading by creating transparency and parity of information among large and small investors and protecting investors by providing information they want, and that is hard to collect, in a comparable format.
Several members of the en banc panel continued to pursue the issue of limitations. What is the line? If this rule is consistent with the Act, why doesn’t the NYSE adopt it? Why doesn’t the SEC? The SEC contended that, in this case, the record showed that investors wanted to use the information in decision-making, believing that diversity is a marker of good corporate governance and that it positively affects corporate performance. The SEC also pushed back on the argument that the SEC’s remit was limited to specific financial metrics.
For more detailed discussion of the oral argument, see this PubCo post.
En banc opinion
The majority’s bottom line was that the SEC lacked the authority under the Exchange Act to approve the Nasdaq board diversity rules. First, the Court said, under the Exchange Act, when an SRO, such as Nasdaq, files a proposed rule change, the SEC “must approve the SRO’s proposal if—but only if—‘it finds [the proposal] is consistent with the requirements of’ the Exchange Act…. If SEC does not make that finding, it must disapprove the proposal.” The Court concluded that “before SEC approves a proposed exchange regulation, it must find that the regulation is related to the purposes of the Exchange Act.”
As described by the Court, Nasdaq conducted an internal study about board diversity “[f]ollowing the riots of 2020” in response to “the social justice movement.” In addition, the Court observed that “Nasdaq also recognized that ‘investors and investor groups [were] calling for diversification in the boardroom and legislators at the federal and state level [were] increasingly taking action to encourage or mandate corporations to diversify their boards and improve diversity disclosures.’” As a result, Nasdaq crafted the board diversity proposal comprising the diversity matrix disclosure, aspirational board diversity objectives and the recruiting rule providing complimentary access to recruiting services.
Following submission of these proposals to the SEC and notice and comment, the SEC found that the proposals were related to the purposes of the Exchange Act. However, while Nasdaq purported to have designed its diversity proposals “in part ‘to encourage listed companies to increase diverse representation on their boards,’” the Court observed that the SEC focused instead on the desire of large institutional investors and investment managers for board diversity information on a consistent and comparable basis. The SEC concluded that the diversity proposal was “designed to promote just and equitable principles of trade, remove impediments to and perfect the mechanism of a free and open market and a national market system, and protect investors and the public interest.” The SEC also “found that ‘a better understanding of why a company [had] not [met] the proposed objectives would contribute to investors’ investment and voting decisions.’” In addition, the SEC found that the recruiting component of the proposal was consistent with the requirements of the Exchange Act.
As the majority saw it, the SEC had “found that any disclosure-based exchange rule is related to the purposes of the Exchange Act.” But the majority begged to differ: the purpose of the Act is not disclosing any old information. For the most part, the Court said, the history of the Exchange Act clarifies that it “is primarily about limiting speculation, manipulation, and fraud, and removing barriers to exchange competition…. The obvious implication is that a disclosure rule is related to the purposes of the Act if and only if it has some connection to the ails Congress designed the Act to eradicate.” Although the Exchange Act required listed companies to comply with SEC disclosure regulations, the SEC was vested with a “limited power to compel disclosure of basic corporate and financial information,” such as financial executive comp information—all designed to protect investors and curb the type of speculation and manipulation that fueled the Great Depression. After a lengthy exegesis of the history and development of the Exchange Act, the securities markets and the National Market System, the Court identified nothing suggesting that “disclosure of any and all information about listed companies” is among the purposes of the Exchange Act. Rather, “before SEC approves an SRO rule, it must do more than posit that the rule furthers some ‘core disclosure purpose’ that is found nowhere in the Act….[The] SEC may not approve even a disclosure rule unless it can establish the rule has some connection to an actual, enumerated purpose of the Act.”
According to the majority, the SEC’s efforts to link the board diversity proposal to “some actual purpose of the Exchange Act,” just involved “a few passing citations” to the Exchange Act: the SEC claimed that the proposal was “‘designed to promote [1] just and equitable principles of trade, [2] remove impediments to and perfect the mechanism of a free and open market and a national market system, and [3] protect investors and the public interest’ because it will make available information that some investors want.” In persuading the Court, however, the SEC’s explanation flopped. Quoting the dissent of Commissioner Hester Peirce, the majority determined that the explanation failed “for the obvious reason that ‘the [Proposal] is not actually intended or designed to address any matter relevant to the scope or purposes of’” those provisions of the Exchange Act.
For example, the majority explained, the “just and equitable” provision “requires exchanges to promote ethical behavior”; that is, “behavior that is morally right and in conformity with the rules and customs of the securities profession.” As “applied in practice,” it has meant rules that require Exchange members “to abide by just and equitable principles of trade.” But these ordinary applications of the concept, the Court maintained, are “far removed” from the board diversity proposal: “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. 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.”
The Court marched through similar analyses with respect to the other provisions of the Exchange Act cited by the SEC. According to the majority, the protection of “free and open” markets was one of the reasons underlying the creation of the NMS; the proposal had nothing to do with “free and open” markets—a “condition of unrestricted competition” or, in the context of the NMS, “a free and open market for securities transactions,” such as an Exchange rule that reduced transaction costs of a securities trade. While “[e]quipping investors to make investment and voting decisions might be a good idea, but it has nothing to do with the execution of securities transactions.”
Likewise, as to the “public interest” or “investor protection” provision, the majority invoked a lot of Latin to explain that the term should be interpreted in the context of the neighboring terms. That means that, here, the question is whether the proposal “protects investors or the public from the kinds of harms that the Exchange Act explicitly lists as its targets—that is, speculation, manipulation, fraud, anticompetitive exchange behavior, &c.” To illustrate, the Court cited the Nasdaq requirement that listed companies have majority-independent boards, designed to “guard against financial malfeasance.” But the Court refused to find a public interest here. Nasdaq referred to a link between board diversity and “the quality of a company’s financial reporting, internal controls, public disclosures, and management oversight.” But, the Court maintained, Nasdaq did not provide much support for that proposition, and even the SEC, after examining Nasdaq’s evidence, “concluded it was ‘mixed.’” While “an exchange need not produce conclusive empirical evidence” to support a proposal, the Court viewed Nasdaq’s evidence as “only the barest speculation to support the proposition that there is any link between investor protection and racial and sexual diversity.” The SEC, the Court asserted, “cannot approve a rule simply because an exchange declared the existence of some fact.” But, even if Nasdaq did prove a link between investor protection and diversity, the majority suggested, that might justify the disclosure component of the diversity proposal, but it would not justify the mandate to provide an explanation for failure to achieve the Nasdaq diversity objectives. Rather, the Court indicated, there would need to be “some link between the reason for the lack of … diversity on a company’s board and the quality of its governance.” The SEC sought to justify its finding that the diversity proposal would satisfy a public interest or investor protection by arguing that it “would satisfy the demand of some important investors for board diversity information.” However, the Court reasoned, “the public interest provision must be interpreted in light of the more specific purposes Congress listed prior to the general catch-all purpose.” In the view of the majority, the SEC failed to do so and thus failed to show that the public interest provision was satisfied.
The Court also took comfort in the application of the major questions doctrine. You’ll recall that in 2022, in West Virginia v EPA, SCOTUS put its imprimatur on that judicially created doctrine, which holds that courts must be “skeptical” of agency efforts to assert broad authority to regulate matters of “vast economic and political significance,” requiring, in those instances, that the agency “point to ‘clear congressional authorization’ to regulate.’” (See this PubCo post.) The majority traces the doctrine back to the 19th century, attributing its modern formulation to the “principle that administrative agencies have no independent constitutional provenance. They ‘are creatures of statute. They accordingly possess only the authority that Congress has provided.’”
Here, the majority, well, let’s loose. The majority is unequivocal in finding that this case falls within the major questions doctrine: “Put simply, the ‘economic and political significance’ of SEC’s action is ‘staggering by any measure.’… [The] SEC ‘claimed to discover in a long-extant statute an unheralded power’ that it ‘located . . . in the vague language of an ancillary provision of the Act.’…In doing so, SEC has intruded into territory far outside its ordinary domain.’” Because Nasdaq is the second largest exchange in the world, the Court attributed tremendous economic significance to the rules, given that “they attempt to transform the internal structure of many of the largest corporations in the world.” The majority also found the political significance to be “staggering,” in light of the origin of the rules in response to “the social justice movement,” one of the most “politically divisive issues in the Nation.” In addition, the Exchange Act is a “long-extant” statute that the SEC has never before claimed was the source of its “authority to impose diversity requirements, or anything resembling them, on corporate boards. Further, SEC’s efforts ‘raise an eyebrow’ by stepping outside its ordinary regulatory domain of market manipulation and proxy voting and intruding into the province of other agencies.” Typically, the issue of diversity is more properly the province of the DOJ or EEOC, or more often, the States, given that corporations are creations of the States (although the Court does acknowledge that corporate governance is not exclusively the province of state regulation). In this context, the Court concluded, “the major questions doctrine ‘counsels skepticism’ toward SEC’s exercise of this unprecedented power….’To overcome that skepticism, the Government must . . . point to “clear congressional authorization” to regulate in that manner.’… And that clear authorization is sorely lacking. All SEC can do is point to ‘a vague statutory grant’ in the Exchange Act.”
The Court gave short shrift to the contrary arguments presented by the SEC and Nasdaq. To their contention that “exchanges have long imposed substantive corporate governance rules, even after the 1975 Amendments,” the Court distinguished between Exchange requirements for independent boards and corporate governance rules that are not related to the purposes of the Exchange Act. And, although the SEC had violated the 1975 amendments in the past by approving diversity requirements adopted by another exchange, that doesn’t make these violations appropriate. Importantly, the majority did not buy the contention of the SEC and Nasdaq that the rules are just disclosure rules that do “not actually remake the boardrooms of America’s corporations.” The Court maintained that the administrative record did not support that contention: “Nasdaq described the Board Diversity Proposal to impose ‘aspirational diversity objectives.’… And corporations that do not meet those objectives must explain why they failed. That is not a disclosure requirement. That is a public-shaming penalty for a corporation’s failure to abide by the Government’s diversity requirements.” Finally, the Court disagreed that “full disclosure is the ‘core” purpose of the Exchange Act.” Rather, the Court maintained, SCOTUS has acknowledged that disclosure is not an end in itself but rather serves other purposes, such as the purpose of promoting ethical behavior or “the purpose of avoiding frauds.” And, if the core purpose is just full disclosure, what’s to stop the exchanges from requiring disclosure of religious or political affiliation or whether directors recycle.
In conclusion, the majority held that the SEC’s finding regarding the diversity proposal was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law,“ meaning that the “SEC failed to justify its determination that Nasdaq’s Board Diversity Proposal is consistent with the requirements of the Exchange Act.” Accordingly, the Court vacated the SEC’s order approving Nasdaq’s board diversity proposal. As to the recruiting rule, since the benefits under that rule have all expired, the Court decided that the question was moot.
Dissenting opinion
The eight dissenting judges had quite a different take on the board diversity rule— concluding that the roles of the SEC and the courts in this context should be markedly less intrusive into the decisions of Nasdaq, a private entity. They appeared to accept the SEC’s finding that “substantial evidence supported the conclusion that investors sought this information in the face of inaccuracies, inefficiencies, and asymmetries (while carefully noting that Nasdaq had not offered substantial evidence to support a conclusion from the SEC that boardroom diversity improved corporate performance).” The SEC expressly concluded that this was not a hiring quota, but rather a disclosure-based rule, modeled after an EEOC form. According to the dissent, the “SEC approved the Rule because the reviewing scheme that Congress created doesn’t permit the SEC to displace Nasdaq’s private business judgment—informed by investor behavior—with agency policy priorities.” Under the Exchange Act, “the SEC ‘shall’ approve a rule proposed by an exchange ‘if it finds’ that the rule is ‘consistent with the requirements’ of the Act.” To the dissent, this was an example of “private ordering” through rules proposed by an SRO: Congress gave the SEC a very limited role in this oversight of private ordering and “does not permit the SEC to displace business judgment with its own policy priorities.” This corporate governance system encourages private experimentation and in “this system, the even more limited role of courts is to ask whether the SEC’s decision not to intervene in this private ordering—and thus to approve the SRO-proposed rule—was arbitrary, capricious, or an abuse of discretion.”
The majority, the dissent contended, disputed this restricted role, creating instead a “new, mandatory and enlarged role for SEC intervention, ordering the SEC to displace largely private ordering with alternate policy priorities.” The majority, the dissent continued, finds no authority unless the SRO demonstrates “some connection to the ails Congress designed the Act to eradicate,” but those ails apparently “do not include the elimination of information asymmetries regarding corporate board leadership—the very leaders entrusted with investors’ money and whose identity investors across the full spectrum of our economy seek. This conclusion does not find support in well-established caselaw.”
The dissent distinguished between SEC disclosure rulemaking and rulemaking by Nasdaq, a private entity. After all, “this case concerns a rule proposed by Nasdaq, a private company that, in a competitive market with other exchanges, contracts with other companies to facilitate the listing and trading of securities.” Under this Congressional framework, “the SEC’s authority to impose its own judgment on exchanges and the companies that list on them is, unlike that of the exchanges themselves, extremely limited.” If certain requirements are met, the SEC must approve the rules that Nasdaq devised. In essence, the dissent contended that the majority conflated “the SEC’s federal government disclosure-mandating authority with private sector SRO self-regulating authority.” While the dissent did not discuss the majority’s major questions argument at any length—instead adverting to the panel opinion, the dissent noted that petitioners actually abandoned the major questions argument at the en banc stage. As the panel opinion explained, “this is not a major questions case…. Moreover, throughout its opinion, the majority seems to suggest that the SEC should have exercised more, not less, of its statutorily limited authority to disapprove Nasdaq’s Disclosure Rule.”)
The SEC’s decision to allow “this private ordering disclosure rule about corporate leadership composition,” as consistent with the purposes of the Exchange Act, was not arbitrary or capricious, the dissent asserted. The SEC concluded that the Disclosure Rule was “designed to . . . remove impediments to and perfect the mechanism of a free and open market and a national market system,” among other objectives, because the Disclosure Rule would “contribute to the maintenance of fair and orderly markets.” And the dissent contended that there was substantial evidence to support that conclusion, such as comments from market participants about the importance of board diversity statistics and the limited availability of that data on a consistent and comparable basis. Moreover, it was “unrebutted in this administrative record, or in this litigation, that a wide range of investors seek corporate board composition information.” Nor did petitioners contest the SEC’s assertion that major investors sought the information or that inefficiencies and asymmetries resulted from the absence of the information, particularly between small and large stakeholders, who may be positioned to obtain the information directly from companies. Not to mention that some of the information is already required by existing SEC rules, and much of the data is already required by the EEOC with regard to employees; the dissent asserted that Nasdaq just applied substantially the same categories to directors. And other competing SROs have already been permitted by the SEC to enact similar rules.
The dissent asserted that petitioners “argue that the Exchange Act requires the SEC to question whether investors should have wanted that information.” But where is the “requirement that the SEC interrogate investors’ motivations?” That “is nowhere in the Exchange Act and is contrary to the SEC’s limited role in reviewing private exchange-proposed rules for consistency with the Act, rather than for adherence to the SEC’s preferred business judgment.” According to Professor Joseph Grundfest, quoted in the dissent, “[s]etting aside the SEC’s approval of Nasdaq’s Rule is ‘effectively asking this [c]ourt to rule as a matter of law that managers with more than $18 trillion under management are behaving irrationally.’”
The dissent concluded that “Congress created a unique, limited role for the SEC that didn’t permit it to reach a different conclusion here, regardless of whatever good faith disagreement might exist in policy debates about disclosure of corporate board leadership composition. If Nasdaq misapprehended investor appetite for this information and the willingness of the listed companies it contracts with to provide it, the marketplace of competing exchanges—and not the policy preferences of this court or a federal agency—will resolve that.”
