More Potential Flexibility to Address Board Diversity
On December 11, 2024, the United States Court of Appeals for the Fifth Circuit (the “Fifth Circuit”) vacated the Securities and Exchange Commission’s (the “SEC”) order approving Nasdaq’s board diversity rules. The ruling means that Nasdaq-listed companies will no longer be required to meet specified board diversity criteria or make prescribed disclosures regarding their board’s diversity characteristics. Nasdaq has indicated it does not intend to appeal the Fifth Circuit’s decision. The SEC has not yet announced whether it intends to appeal, but that seems doubtful in light of the upcoming change in Administration.
Even without the Nasdaq rules, companies will want to proceed thoughtfully as proxy advisory firms and major institutional investors have expressed interest in diversity on corporate boards and may still expect to see disclosure around board diversity.
Nasdaq Board Diversity Rules
Nasdaq’s board diversity rules were approved by the SEC in 2021 and consist of the following:
- Rule 5605(f) (the “Diversity Rule”) required companies to meet, or explain why they do not meet, certain minimum diversity objectives for their boards of directors, such as having at least two diverse directors. The specific objectives applicable to a company depended on various factors, including the size of the company’s board and the company’s listing tier and issuer status.
- Rule 5606 (the “Disclosure Rule”) required companies to annually disclose information regarding their directors’ self-identified diversity characteristics in a specified matrix format.
In a separate but related order, the SEC also approved Rule IM-5900-9 (the “Recruiting Rule”). That rule set forth a definition of “eligible companies” that could receive complimentary access to a Nasdaq-provided service which assisted companies with identifying and recruiting diverse board candidates.
Fifth Circuit Ruling
In Alliance for Fair Board Recruitment v. SEC the en banc Fifth Circuit, by a 9-8 vote, held that the SEC did not have the authority to approve the Nasdaq board diversity rules. The court ruled that the SEC’s finding that both the Diversity Rule and the Disclosure Rule were “related to” the purposes of the Securities Exchange Act of 1934 (the “Exchange Act”) was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law,” in violation of the Administrative Procedure Act. The Fifth Circuit also held that the challenge to the Recruiting Rule was moot, as the window to request access to the service closed on December 1, 2023. The en banc decision overruled a prior Fifth Circuit panel decision upholding the Nasdaq board diversity rules.
The Fifth Circuit’s majority opinion stated that the SEC’s authority under the Exchange Act to compel disclosure of information must be related to the purposes of the Exchange Act, which the Fifth Circuit identified primarily as “limiting speculation, manipulation, and fraud, and removing barriers to exchange competition.” The Fifth Circuit therefore held that the SEC erred in finding that any disclosure-based exchange rule is related to the purposes of the Exchange Act. The court also rejected the SEC’s arguments that the Nasdaq board diversity rules were related to other enumerated provisions of the Exchange Act, such as the provision that exchanges adopt rules “designed […] in general, to protect investors and the public interest.” Lastly, the Fifth Circuit invoked the major questions doctrine to support its conclusion, characterizing the Nasdaq board diversity rules as changes of sweeping economic and political significance outside of the SEC’s traditional regulatory domain.
Takeaways
As a result of the Fifth Circuit’s ruling, Nasdaq-listed companies are no longer required to meet, or explain why they do not meet, certain minimum diversity objectives for their boards of directors, nor are they required to disclose the board diversity matrix to report the diversity characteristics of their board.
Notwithstanding the Fifth Circuit’s decision, however, proxy advisory firms and large institutional shareholders continue to consider board diversity and related disclosure in such firms’ shareholder voting decisions. A summary of these voting guidelines is included in an appendix to this alert. In light of this continued interest, public companies, whether listed on Nasdaq or the NYSE, will have to consider whether to provide disclosure about board diversity on a voluntary basis.
In the absence of the Nasdaq rules, Nasdaq-listed companies have greater flexibility on how to provide such information in the format and location of their choosing.
If you have any questions concerning the material discussed in this client alert, please contact the members of our Capital Markets and Securities practice.
Proxy Voting Guidelines on Board Diversity and Related Disclosure
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Proxy Advisory Firm or Institutional Shareholder
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Board Diversity Guidelines
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Disclosure Guidelines
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ISS
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Generally recommend against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) at companies where there are no women on the company's board, subject to certain exceptions.
For companies in the Russell 3000 or S&P 1500 indices, generally recommend against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) where the board has no apparent racially or ethnically diverse members, subject to certain exceptions.
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No specific policies regarding the disclosure of board members’ self-identified personal characteristics.
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Glass Lewis
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Generally recommend voting against the chair of the nominating committee of a board that is not at least 30 percent gender diverse, or all members of the nominating committee of a board with no gender diverse directors, at companies within the Russell 3000 index, subject to certain exceptions. For companies outside the Russell 3000 index, the policy requires a minimum of one gender diverse director.
Generally recommend against the chair of the nominating committee of a board with fewer than one director from an underrepresented community on the board at companies within the Russell 1000 index, subject to certain exceptions.
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Expects disclosure regarding: (i) the board’s current percentage of racial/ethnic diversity; (ii) whether the board’s definition of diversity explicitly includes gender and/or race/ethnicity; (iii) whether the board has adopted a policy requiring women and minorities to be included in the initial pool of candidates when selecting new director nominees. At companies in the Russell 1000 index that have not provided any disclosure in any of the above categories, will generally recommend voting against the chair of the nominating and/or governance committee. Further, when companies in the Russell 1000 index have not provided any disclosure of individual or aggregate racial/ethnic minority board demographic information, will generally recommend voting against the chair of the nominating and/or governance committee.
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BlackRock
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Believes that boards should aspire to at least 30% diversity of membership, and encourages large companies, such as those in the S&P 500, to lead in achieving this standard. An informative indicator of diversity for such companies is having at least two women and a director who identifies as a member of an underrepresented group. BlackRock recognizes that companies with smaller market capitalizations and in certain sectors may face more challenges. Among these smaller companies, BlackRock looks for the presence of diversity and takes into consideration the steps that companies are taking to ensure diversity on their board.
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No specific policies regarding the disclosure of board members’ self-identified personal characteristics.
Expects boards to disclose (1) the process by which candidates for board positions are identified, including whether professional firms or other resources outside of incumbent directors’ networks are engaged to identify and/or assess candidates, and whether a diverse slate of nominees is considered for all available board nominations, and (2) how diversity, including professional characteristics and demographic factors, is considered in board composition, given the company’s long-term strategy and business model.
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Fidelity
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Fidelity will evaluate board composition and generally will oppose the election of certain or all directors if (1) there is no gender diversity on the board, or if a board of ten or more members has fewer than two gender diverse directors, or (2) there are no racially or ethnically diverse directors on the board.
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No specific policies regarding the disclosure of board members’ self-identified personal characteristics.
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State Street
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Expects boards of all listed companies to have at least one female board member. If a company does not meet the applicable expectation for three consecutive years, State Street may vote against all incumbent members of the nominating committee or those persons deemed responsible for the nomination process.
In addition, expect the boards of companies in the following indices to be composed of at least 30-percent female directors: Russell 3000, TSX, FTSE 350, STOXX 600, ASX 300. If a company does not meet the applicable expectation, State Street may vote against the chair of the board’s nominating committee or the board leader in the absence of a nominating committee, subject to certain exceptions.
May withhold support from the chair of the nominating committee when a company in the S&P 500 or FTSE 100 does not have at least one director from an underrepresented racial/ethnic community on its board, subject to certain exceptions.
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Expects disclosure of board diversity characteristics, including racial, ethnic, and gender makeup (at minimum) of the board of directors.
Expects companies to articulate goals and strategy related to diverse representation at the board (including race, ethnicity, and gender, at minimum), including how the board reflects the diversity of the company’s workforce, community, customers, and other key stakeholders.
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Vanguard
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No specific objectives or minimum thresholds, but look for boards to be “fit for purpose” by reflecting sufficient diversity of skills, experience, perspective, and personal characteristics (such as gender, age, race, and ethnicity) resulting in cognitive diversity that enables effective, independent oversight on behalf of all shareholders.
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Expects disclosure of directors’ personal characteristics (such as race and ethnicity), which should occur on a self-identified basis and may occur on an aggregate level or individual director level.
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