Lawyers for Nasdaq Inc. and the Securities and Exchange Commission defended the exchange’s plan to require companies to disclose the diversity of their boards Monday, and judges sounded skeptical that the court should overturn the policy.
The SEC last year approved a Nasdaq
policy that asks companies to disclose the demographic makeup of their boards, and questions them if they fail to meet certain standards for diversity. Two conservative groups sued, claiming the rule is discriminatory and unconstitutional, similar arguments to an appeal that struck down California laws on the topic earlier this year, which the state is appealing.
In defending the plan, Nasdaq lawyers said it was a response to investors’ demand for information about board diversity. The rules would set minimum targets of at least two “diverse” board members: one female, plus a member of an underrepresented minority group or someone who identifies as LGBTQ. If companies don’t meet the minimums, which will depend on their size, their board would need to explain why.
Tracey Hardin, an assistant general counsel for the SEC, referred at the hearing to investors who support the Nasdaq rule based on numerous studies showing a link between diversity and positive outcomes for boards and companies.
“This is not just a vocal group of investors,” she said. “We have a broad swath of investors who said this.”
One judge questioned that, directly asking Nasdaq’s lawyer: “So is this Nasdaq’s woke mission to get minorities and gays on boards? Or are investors asking for this?
“It’s absolutely the latter,” lawyer Allyson Ho said on behalf of Nasdaq.
The three-judge panel of the U.S. Court of Appeals for the Fifth Circuit in Louisiana on Monday questioned the petitioners — the National Center for Public Policy Research and the Alliance for Fair Board Recruitment — about their arguments that the rules violate the First and Fifth Amendments because they compel speech and are contrary to equal protection, respectively.
“Compelled explanation deeply offends the Constitution,” said Peggy Little, attorney for the New Civil Liberties Alliance, which teamed up with the National Center for Public Policy Research on the lawsuit, during the hearing.
“If we are going to jump to the Constitution argument, then you’re arguing the [Nasdaq] exchange is a state actor,” Judge Stephen Higginson said.
The SEC and Nasdaq also argue that because Nasdaq is a private entity, its actions don’t amount to state action and are not subject to the constitutional arguments.
“Nasdaq is a private actor, not an arm of the state,” said Ho, a partner with law firm Gibson, Dunn & Crutcher, on behalf of Nasdaq.
Attorneys for the SEC and Nasdaq said at the hearing that courts have found that self-regulatory organizations such as Nasdaq are not state actors, but another attorney for the New Civil Liberties Alliance, Sheng Li, told MarketWatch after the hearing that “Nasdaq exercises quasi-governmental powers.”
“Nasdaq gets protected as a government actor when they’re being sued in other contexts,” Li said, adding that he thought the judges “asked hard and fair questions to both sides.”
Aman George — senior counsel for Democracy Forward, a nonprofit organization that filed an amicus brief supporting the SEC and Nasdaq on behalf of academics and experts who have studied board diversity — said he believed the judges’ questions showed doubts about the constitutional argument.
“The time and tenor of questioning sounded skeptical of the petitioners’ argument that the rule can be challenged on a constitutional argument,” George said.
The groups seeking to appeal the SEC’s approval of the rules also argued that diversity rules fall outside the SEC’s authority. Jonathan Berry for the Alliance for Fair Board Recruitment — a group that is led by Edward Blum, well-known for his political activism against affirmative action — told a judge who asked why disclosures are inherently discriminatory that “they encourage discrimination on basis of race and sex.”
“Enabling investors to discriminate on the basis of race… that is perhaps the most socially inflammatory question we have in America today,” Berry said.
Little, the attorney for the other petitioner, said investors “do not invest their money in order to have their political decisions made for them.”
A judge replied: “Sounds like you’re the one deciding what the information will be.”
The audio of the hearing was streamed live. The other two judges on the panel besides Higginson were Carl Stewart and James Dennis, and it was sometimes hard to tell which judge was speaking.
George, of Democracy Forward, told MarketWatch that the petitioners have tried to “present this rule as untethered from empirical research” into the links between board diversity, corporate decision-making and positive company performance. But he said that “the reality is, effects are very heavily studied… The Nasdaq rule did not come out of nowhere, nor are the calls from investors coming out of nowhere.”
The amicus brief filed by Democracy Forward cited “a substantial number of rigorous, high-quality, peer-reviewed studies” finding a link between diversity on companies’ corporate boards and the performance of companies on corporate governance as well as risk, innovation and protection for investors.
“The results of this research strongly suggest that diversity enhances corporate board decision-making in ways that advance the goals of the [Securities] Exchange Act, by promoting transparency, protecting investors, and reducing fraud,” the brief reads.