State AGs Challenge Nasdaq’s Diversity Disclosure Rule as Discriminatory

On October 3, 2024, a group of twenty-two state attorneys general sent a letter to Nasdaq Chair Adena Friedman inquiring into the listing company’s “commitment to ensuring federal and State anti-discrimination laws are followed.”[1] The letter, penned by Iowa Attorney General Brenna Bird, stems from a rule change Nasdaq promulgated in 2020 in an effort to increase diversity within boardrooms.

On December 1, 2020, Nasdaq first proposed its diversity rule in a U.S. Securities and Exchange Commission (SEC) filing.[2] The proposed rule would have required Nasdaq-listed companies, subject to certain exceptions, to have two diverse members of its board, including one director who self-identifies as female and one director who self-identifies as an underrepresented minority or as LGBTQ+, or to explain why the company does not have at least two board members who self-identify in those categories.[3] The proposed rule also included a recruiting component, where Nasdaq would provide certain Nasdaq-listed companies with one year of complimentary access to a board recruiting service, which would provide access to a network of board-ready diverse candidates for companies to identify and evaluate.[4]

On February 26, 2021, Nasdaq amended its proposed rule in response to comments that had been filed with the SEC.[5] Notably, Nasdaq amended the proposed rule so that the diversity thresholds noted above would be considered “objectives” rather than “requirements.”[6] It also provided companies with boards of five or fewer directors the ability to satisfy the objective by having one diverse director.[7]  On August 6, 2021, the SEC approved Nasdaq’s amended proposed rule.[8] In response to certain concerns raised during the comment period, the SEC noted that the rule “would establish a disclosure-based framework and not a mandate or quota.”[9] It further stated that the proposal “would balance the calls of investors for companies to increase diverse representation on their boards with the need for companies to maintain flexibility and decision-making authority over their board composition.”[10]

In their October 3, 2024 letter, the coalition of Republican state attorneys general asserted that the rule is an improper quota system, particularly in light of the U.S. Supreme Court’s 2023 SFFA ruling that race-based admissions policies in universities are unconstitutional.[11] The letter alleges that “[f]or more than three years, Nasdaq has defended as something other than a quota a policy that looks like a quota and acts like a quota.”[12] Specifically, the attorneys general requested “documentation of Nasdaq’s rules and policies requiring its listed companies to follow federal and State anti-discrimination laws and any legal analysis explaining how those laws comport with Nasdaq’s purportedly aspirational quotas[.]”[13] They have demanded a response from Nasdaq by October 23, 2024.[14]

Almost one year ago, on October 18, 2023, a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit upheld the SEC’s order approving Nasdaq’s rule.[15] In doing so, the Fifth Circuit held that the SEC’s approval order complies with the Securities Exchange Act of 1934 (the “Exchange Act”) and the Administrative Procedure Act (“APA”).[16]

When the SEC approved Nasdaq’s rule, it explained that a company can choose to list on an exchange other than Nasdaq if it objected to providing an explanation as to why its board was not diverse.[17] Petitioners in the Fifth Circuit litigation challenged the SEC’s approval order as unconstitutional under the First and Fourteenth Amendments, in exceedance of the SEC’s authority under the Exchange Act, and as arbitrary and capricious under the APA.[18] However, the panel rejected these arguments, holding that petitioners’ constitutional claims failed because Nasdaq is a private entity and not a state actor bound by the Constitution, and the SEC’s action was not in exceedance of its authority or arbitrary and capricious because it properly considered all relevant evidence in its decision-making.[19]

Shortly thereafter, petitioners filed a petition for en banc review, and on February 19, 2024, the Fifth Circuit granted the petition. The Fifth Circuit vacated its October 18, 2023 decision and reconsidered it en banc.[20] On May 14, 2024, the en banc panel heard oral argument and their decision is pending. If the SEC’s order is upheld, Nasdaq’s board diversity rule will go into effect in December 2026.

Attorneys in Crowell’s State Attorney General practice group will remain apprised of developments related to this litigation, as well as related actions by state attorneys general regarding diversity in corporate and financial services.