As reported recently in the Wall Street Journal, “a left-leaning panel of judges appointed by Democratic presidents at the New Orleans-based Fifth U.S. Circuit Court of Appeals” has ruled that the Securities and Exchange Commission (SEC) “acted properly when it allowed Nasdaq to implement its diversity rules.” What follows are some initial criticisms of the opinion – but they are hardly the only problems with the decisions. (The case is AFBR v. SEC, and my employer – the National Center for Public Policy Research – is a plaintiff in the case, for which plaintiffs are currently seeking en banc review.)
As set forth in the opinion, Nasdaq’s diversity rule provides in relevant part that each Nasdaq-listed company shall “have, or explain why it does not have, at least two members of its board of directors who are Diverse, including at least one director who self-identifies as female and at least one director who self-identifies as an Underrepresented Minority or LGBTQ+.”
The court rejected plaintiffs’ arguments that the rule violates the First and Fourteenth Amendments to the U.S. Constitution, as well as the argument that the SEC’s approval of the rule violated its statutory obligations under the Exchange Act and the Administrative Procedure Act.
The court rejected the constitutional challenges to the rule because it found a lack of state action, despite the fact that (1) at least some SEC commissioners arguably signaled Nasdaq to adopt the rule, (2) the rule required SEC approval, and (3) the SEC can enforce the rule once adopted. (The court left open the possibility that sufficient state action might be present if the SEC in fact did try to punish Nasdaq for not enforcing the rule once adopted.)
As to the argument that the SEC exceeded its statutory authority in approving the rule, it’s worth noting that the court repeatedly pointed out that the “fundamental purpose” of the Securities Exchange Act is to enforce “a philosophy of full disclosure … in the securities industry.” But what counts as full disclosure?
One good answer is that a corporation has made full disclosure once it has disclosed all material information reasonably available, with material information being that which a reasonable investor would consider important in deciding whether to buy or sell the corporation’s stock. Assuming that’s a good standard (though the court declined to adopt it), it’s further worth noting that the SEC admitted that “studies of the effects of board diversity are generally inconclusive.” This leads us to ask: Do reasonable investors care about information that has no conclusive impact? Or is it just investors with idiosyncratic interests like virtue signaling or advancing ideological agendas?
It’s also worth noting that the court accepted the SEC’s conclusion that Nasdaq’s diversity rule was necessary to correct a market failure – specifically in the form of a lack of standardized diversity disclosures. But we should always be skeptical of claims of market failure because they are grounded on two propositions very much in tension: (1) that a proposed change provides value to the market, but (2) that this alleged value is somehow insufficient to motivate any of our greedy capitalists to implement the change themselves.
But all of this arguably pales when compared to the substantive absurdity of the rule itself. You see, the express terms of the rule allow men who identify as women to be counted as females, and even relies on self-reporting to identify a director as black or otherwise representing an “Underrepresented Minority.” This appears to mean that a corporation with a board consisting entirely of white men could “inform” the market that it is a diverse board so long as two of its directors provided the necessary self-report.
Perhaps some readers are sympathetic to the argument that the compliance costs of a legitimate diversity rule would in fact be justified by the asserted market demand, market failure, and lack of “full” disclosure. But the Nasdaq’s diversity rule is arguably so easily manipulated as not to constitute a legitimate diversity rule at all.
And we haven’t even mentioned the problems with a diversity rule that presumably attempts, among other things, to address the issue of women’s equality – but does so by effectively simply replacing women with men who identify as women. (Comments asserting that “trans women” are women should include a supporting non-circular definition of “woman.”)
After reading the fine print of this rule, at least some women will be tempted to conclude: With friends like Nasdaq, who needs enemies?
Stefan J. Padfield on October 31, 2023