Board Diversity Shareholder Suits: Diverging Materiality Tests Under Rules 10B-5 and 14A-9

Abstract

Environmental, social, and governance (ESG) investing has grown significantly as an investment strategy over the past decade, leading to intensified demands among investors for more ESG disclosures from publicly listed companies. Perhaps the most high-profile example of this trend is the recent widespread demand among institutional investors, proxy advisory firms, and exchanges for more disclosure and compliance as it relates to board and workplace diversity. Given these efforts and the signals coming from the SEC that it intends to take a more proactive approach to ESG disclosure and compliance, issuers can expect an environment of more specific and detailed diversity disclosures. These increasingly comprehensive disclosures implicate the anti-fraud provisions of the federal securities laws, particularly Rules 10b-5 and 14a-9. While the Supreme Court has held that the materiality requirement under each of these rules is identical, this note argues that, in the case of securities fraud claims related to diversity disclosures, they require distinct evaluations and lead to different outcomes. Specifically, Rule 14a-9, with its focus on what is important to a reasonable investor’s voting decisions, is more favorable to plaintiffs than Rule 10b-5, which regulates information important to a reasonable investor’s buying and selling decisions. The divergent outcomes are due, in large part, to the combined effects of ownership concentration, passive investing, and the preference among investors for addressing ESG and diversity by voting their shares rather than by selling them. As a result, this note finds that Rule 14a-9 is an increasingly viable option for claims against issuers for false or misleading statements related to board diversity. Consequently, Rule 14a-9 may constitute a mechanism by which plaintiffs can motivate compliance with board diversity standards by making noncompliance too costly.