SEC-backed Nasdaq rule on diversity faces court challenge

By Randolph Walerius
Posted September 9, 2021 at 7:00am

An organization formed by conservative legal activist Edward Blum is asking a federal court to overturn the Securities and Exchange Commission’s approval of a Nasdaq Inc. rule that requires companies listed on its exchange to meet certain board diversity goals or explain why they don't.

Blum has previously backed legal challenges to affirmative action policies in university admissions as well as a California law on board diversity. His group, the Alliance for Fair Board Recruitment, argues that Nasdaq's diversity rule itself amounts to illegal discrimination and that the SEC's approval violates the constitutional guarantee of equal protection.

The case sets up a head-on courtroom collision between the growing numbers of investors in the environmental, social, and governance movement who want to consider factors such as leadership diversity in assessing a company’s projected long-term financial performance and traditionalist investors who focus on quarterly earnings. 

ESG-minded investors are asking for more information on diversity and other non-financial factors that can affect a company’s bottom line, and the outcome of this case could have far-reaching effects on the contours within which companies can promote diversity without running afoul of anti-discrimination laws.  

“The race, sex and sexual identity board quotas required by NASDAQ are unfair and illegal,” Blum said in a statement after filing the petition for review in the U.S. Court of Appeals for the 5th Circuit last month. “This rule violates our nation's civil rights laws and Constitution and should be struck down by the courts without delay."

Blum is president of the AFBR, which was formed in February. It brought the case before the federal appeals court under a procedure that allows appellate courts to directly review SEC actions. In cases involving race, federal courts apply a legal standard known as strict scrutiny, requiring the government to prove there is a compelling state interest and its actions are narrowly tailored to achieve that objective. 

AFBR’s members are confidential, Blum said in an interview.

"We have dozens of members, some of whom have served on corporate boards and recognize that the chances of them continuing to serve on boards because they are white and male have been greatly diminished by this new quota rule,” he said.

The AFBR's own directors have experience in business finance, Blum said, adding that two of the nonprofit's board members are men and one is a woman. All are white, he said. 

ESG proponents including Julie Gorte, senior vice president of sustainable investing at Impax Asset Management LLC, a U.S. subsidiary of London-based Impax Asset Management Group PLC, panned the move.

“We have an unequal society that has been reinforced by decades of discrimination and policies are needed to remedy it,” Gorte said in an interview. “I’m not sure how a ‘comply-or-explain’ requirement for a company to be listed on a private exchange could violate the law. A commitment to diversity promotes equality under the law, it doesn’t undermine it.”

In December, Nasdaq unveiled its proposal to require the more than 3,300 companies listed on its exchange, including Apple Inc., Facebook Inc., and Amazon.com Inc., to provide an explanation if they don't have at least one female director and at least one person from an underrepresented racial minority or LGBTQ+ group. It defines minorities as Black or African American, Hispanic, Latinx, Asian, Native American, Alaska Native or Pacific Islander.

The SEC approved Nasdaq’s rule on Aug. 6 and it is supposed to take effect within one year. AFBR, which submitted a 115-page comment letter to the SEC in opposition to the proposal in April, filed the petition for judicial review less than a week after the rule was approved.

AFBR argues Nasdaq's framework forces companies to choose between engaging in race- or sex-based discrimination in director recruitment efforts or face reputational and legal risks over a perceived lack of diversity.

The Nasdaq rule has been "controversial since the day it was announced," Blum said in the interview. "A handful of U.S. senators questioned its constitutionality, members of the investment community questioned its legality and most Americans question its fairness.”

Sen. Patrick J. Toomey of Pennsylvania, the ranking Republican of the Senate Banking Committee, said the policy is full of "prescriptive requirements" that may "ultimately harm economic growth and investors by pressuring companies to select directors from a narrower pool of candidates and discouraging others from going public."

Toomey was among a dozen Senate Republicans who urged the SEC to disapprove of Nasdaq's proposal. Meanwhile, Democrats in both chambers have introduced bills to make all public companies report diversity data.

Admissions challenges

Blum was behind a case brought by the group Students for Fair Admissions against Harvard University, which argued that the school discriminated against Asian American applications. In 1996, Blum was a plaintiff in Bush. v. Vera, in which the U.S. Supreme Court struck down a Texas congressional redistricting plan as impermissible racial gerrymandering.

In the Harvard case, Blum's group argued the school held Asian applicants to a higher standards than Black or Hispanic applicants. Ultimately, U.S. District Judge Allison Burroughs ruled that Harvard's admissions criteria, which considered race among several factors but didn't impose a quota, was sufficiently narrow to pass constitutional muster. 

In 2020, the U.S. Court of Appeals for the 1st Circuit affirmed that ruling. Blum's group has petitioned the U.S. Supreme Court to review the case, which remains pending.

The Supreme Court was asked in briefs to overturn a 2003 case, Grutter v. Bollinger, which upheld the admissions framework at the University of Michigan's law school that considered race among several factors. The high court held in that case that narrowly tailored considerations of race in admissions can legitimately further a school's compelling interest in fostering educational benefits that come from diversity and don't violate equal protection.

AFBR distinguished the admissions policies that survived judicial scrutiny from Nasdaq's rule, which the group said goes beyond those permissible, narrow considerations of diversity and instead imposes an unlawful quota.  

Blum, 69, who spoke from Maine where he lives part of the year, is not an attorney. His organization also filed a separate federal lawsuit in July challenging two California laws that mandate gender diversity for public companies based in the state.

Those who sit on corporate boards, however, are increasingly touting the value of having diverse leadership that mirrors the company's employees, customers, and other stakeholders.

“I'd rather have diverse perspectives around the board table in this world of constant change versus a homogeneous group of people who think alike with similar backgrounds and life experiences,” said Nora Denzel, a retired Silicon Valley executive who served as interim CEO of video retailer Redbox. Denzel has also held seats on boards including at NortonLifeLock Inc. and Swedish telecommunications company Ericsson. She became a board member of the National Association of Corporate Directors in July.

“Serving on both California-based and non-U.S. boards where diversity mandates have been underway for a while, my experience is it feels odd at first, and then once the board is more diverse you can't imagine it any other way,” Denzel said.

The dominant corporate philosophy has now shifted from “should we diversify” to “how fast can we diversify” as business leaders are recognizing that diverse boards can drive better outcomes for shareholders and make companies more sustainable in the long run, according to Denzel.

“I don't think it's an onerous ask, but I do think it's good for business.”

Nasdaq declined to comment.

Sarah Wynn contributed to this report.