Faculty of law blogs / UNIVERSITY OF OXFORD

The Attack on Nasdaq’s Board Diversity Rule


John Livingstone
Research Fellow at Case Western Reserve University School of Law
Darren Rosenblum
Professor of Law, McGill University
Anat Alon-Beck
Assistant Professor at Case Western Reserve University School of Law
Michal Agmon-Gonnen
Judge of the Tel-Aviv District Court and a Professor of Law at Tel Aviv University School of Law

The recent pushback by conservative legal groups against equality and diversity on corporate boards has accelerated to new levels in the past few months. The latest example is a challenge to Nasdaq’s board diversity rule, which was approved in August 2021.

Beginning in 2025, the rule will require companies to disclose the level of gender and ethnic diversity on their boards of directors and to explain the lack thereof. On August 29, the US Court of Appeals for the Fifth Circuit heard arguments in a case seeking to vacate the SEC’s order approving the rule.

The petitioners, the Alliance for Fair Board Recruitment and the National Center for Public Policy Research, are challenging the rule on constitutional grounds, arguing that it violates both the Fifth Amendment equal protection clause and the First Amendment freedom of expression clause. According to the two groups, the rule requires companies to engage in self-condemnation and encourages discrimination on the basis of sex and race. If successful, the challenge would significantly curtail the SEC’s administrative powers and the powers of private actors. 

The lawsuit is also being pursued at a time when academics, policymakers, institutional investors, activists, proxy advisors, and the public at large are pressuring corporations to increase diversity, equity, and inclusion at corporations. Adopting diversity and equality norms is widely recognized as a way to improve corporate governance, reduce the risk of groupthink, and increase a board’s independence and objectivity.

In a prior article, we argued for a fiduciary duty of diversification based on gender and discussed the benefits of using private ordering to advance diversity, equity, and inclusion more broadly. We offered a novel approach to this question, asking whether all firms, but especially institutional investors, should bear a fiduciary duty to push for gender equality and ethnic diversity. In a new article, titled ‘Duty to Diversify,’ we argue that corporate law allows, encourages, and perhaps even requires that such a duty be imposed on corporate leaders.

The Rule

Nasdaq first proposed the diversity rule in December 2020, and it consists of two parts. The first, which recently went into effect, requires each Nasdaq listed company to disclose whether they had at least one director who identified as a woman and at least one director who identified as either an underrepresented minority or a member of the LGBTQ+ community. The second part, which takes effect over the next four years, requires companies to explain to their shareholders any failure to have a director in either category and to do so on their website or in their annual proxy statement.

The rule does not mandate the extent to which companies should explain their lack of diversity and emphasizes that the SEC would not evaluate the substance or merit of a company’s explanation. This type of rule, known as ‘comply or explain’, is common in both self-regulatory organizations (‘SRO’) like Nasdaq and in federal regulations. In a review prior to the proposal, Nasdaq found more than 75 percent of the nearly 3,000 corporationslisted on its exchange would have fallen short of the requirements. Nasdaq added, however, that delisting was unlikely for any company that fell short.

As a private organization, Nasdaq must have SEC approval before changing its own rules. As part of the process, the SEC addressed constitutional questions by pointing out that this was not a government action.

The Argument

The two petitioners challenging the rule argue that it discriminates against everyone involved: shareholders, current directors, potential directors (whether or not women or minorities), and the corporation itself. For its part, the SEC takes the position that the rule does not force diversity upon companies but instead simply gives investors more information, which is a ‘fundamental goal of the [Exchange] Act.’

The SEC further argues that the petitioners ignore 50 years of precedent holding that exchange listing standards are not subject to constitutional scrutiny. The commission also reiterates that government approval of an SRO’s rule change ‘does not convert private conduct into state action.’

The Alliance for Fair Board Recruitment, in its brief, lays out an argument often used to challenge diversity disclosure requirements: the rule might pressure a shareholder with enough votes to determine the outcome of a board election to discriminate on the basis of ethnicity or sex.

In 2021, the U.S. Court of Appeals for the Ninth Circuit found a shareholder challenging a similar requirement under California law had a sufficient injury to gain standing because it was plausible the law required him to discriminate on the basis of sex, even if it would advance a protected class. According to the Ninth Circuit, a reasonable shareholder could not assume that his fellow shareholders would vote to elect the requisite number of female board members to avoid a violation of the law and therefore would be forced to vote in a way contrary to how they would have otherwise voted.

But that misses the point of this rule, which is not to force shareholders to undertake an action but instead to provide them with more information to make decisions. The companies are not faced with financial or legal penalties. Instead, they are given a choice to comply or explain, with no one except their own shareholders left to determine if their explanations are sufficient.

In arguments on August 29, Nasdaq’s lawyers emphasized that this is a ‘classic disclosure rule,’ while lawyers for the National Center for Public Policy Research argued that the rules imposed ‘unprecedented demographic quotas and disclosure requirements regarding race, sexual preference and sex’ on Nasdaq listed companies.

Our Take

In our view, Nasdaq’s proposal simply requires disclosure and an explanation for any lack of board diversity, which could include reasons for why a company takes a different approach. According to Nasdaq, ‘the company can choose to disclose as much, or as little insight into the company’s circumstances or diversity philosophy’ as they like. This includes statements such as ‘The Company does not (…) believe Nasdaq’s listing rule is appropriate.’Besides, public companies are already required to disclose whether they consider diversity in identifying nominees to their boards of directors. Yet, there is no mandate that the disclosure include identity-based diversity factors, such as gender (or race or ethnicity).

At the moment, public companies have the flexibility to define diversity as they see fit, and according to previous studies, such definitions typically include a wide range of factors, including the director’s prior professional experience. The Nasdaq rule, which more narrowly defines diversity into specific classes, makes sense. By allowing companies to define diversity for themselves, no company is ever going to choose a definition that would result in themselves being not diverse. 

Specifically defining the type of diversity these companies are required to strive for is necessary to make information provided actually meaningful. It should be noted that this does not add any significant additional costs for public companies because most of this data is already collected by such companies and is already required by other agencies, but is not otherwise made public.

Investors will no doubt continue to demand more information from companies and support more board diversity.The new Nasdaq rule meets that demand and may prompt changes that prove revolutionary, for companies and investors alike by making diversity requirements actually meaningful.

Darren Rosenblum is Professor at McGill University School of Law

John Livingstone is Research Fellow at Case Western Reserve University School of Law

Anat Alon-Beck is Assistant Professor at Case Western Reserve University School of Law

Michal Agmon-Gonnen is a Judge of the Tel-Aviv District Court and a Professor of Law at Tel Aviv University School of Law.

A version of this piece has first been posted on the Columbia Blue Sky Blog.


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