California’s Statutory Efforts to Achieve Board Diversity
POMERANTZ MONITOR | JULY AUGUST 2022
Women—Black and Latina women in particular—remain vastly underrepresented in corporate boardrooms. While studies repeatedly show that an increase in board diversity leads to better business outcomes, progress has been frustratingly slow: As of 2020, women account for around 20% of corporate board rooms, and only 5% of CEOs are women. People of color represent only around 15% of directors on Fortune 500 boards. A lack of diversity at the board level affects corporate governance, as the board establishes a corporation’s vision and mission. Research has shown that diversity of thought and perspective leads to better investment returns, better business strategies, and stronger organizations overall. Companies with diverse boards may have profits 43% higher than those that do not, and compared to individual decision makers, diverse teams make better decisions 87% of the time. In recent years, state lawmakers have increasingly focused on improving workplace diversity through legislation that encourages or requires diversity on corporate boards.
A number of state laws require corporations to disclose the total number of directors on their board and total number of female directors and/or individuals from “underrepresented communities” in their Annual Reports. These “show or tell” laws are built to withstand legal challenges by requiring transparency rather than mandating specific quotas. Only two states—Washington and California— have enacted laws mandating the number of women and individuals from “underrepresented communities” on the boards of directors of publicly traded corporations based in their respective states. The futures of such mandate laws remain up in the air following a pair of recent legal defeats in California state courts.
In 2018, California lawmakers enacted SB 826, requiring publicly held companies with executive offices in California to include minimum numbers of women on their boards of directors by the close of 2019, no matter where they are incorporated. The California Secretary of State has the authority to impose fines up to $300,000 per violation for noncompliance.
In 2020, lawmakers approved a similar bill, AB 979, requiring covered California corporations to have a minimum of one director from an underrepresented community by the close of 2021. The bill defines a director from an “underrepresented community” as “an individual who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian or Alaska Native; or who selfidentifies as gay, lesbian, bisexual or transgender.” Additional requirements apply by the close of 2022, depending on the size of the board.
In April and May, two California state judges struck down the laws in separate decisions, finding SB 826 and AB 979 to violate the Equal Protection Clause of the California Constitution.
To withstand constitutional scrutiny, a statute employing racial and other classifications must be narrowly tailored to address a specifically identified harm that the state has a compelling interest in remediating. In California, if the state wants to create classifications based on sex, it must also have a compelling interest and its action must be necessary to achieve that purpose. In striking down the laws, both courts found SB 826 and AB 979 unconstitutional on their faces. Both laws unconstitutionally treated similarly situated individuals–qualified potential corporate board members–differently based on their racial, sexual orientation, and gender identity groups, requiring that a specific number of board seats be reserved for members of a group, thereby excluding members of other groups from those seats.
The courts found the state failed to show a compelling government interest by failing to produce evidence of specific past discrimination in board selection. In doing so, the courts stressed that while rectifying specific and intentional discrimination can be a compelling government interest, remedying generalized, non-specific allegations of discrimination is not. For example, the state cited only statistics about the number of women on corporate boards as compared to men but failed to identify specific instances of women being discriminated against by a specific corporation in the corporation’s board process. The courts also concluded that the state failed to show the statute was narrowly tailored to address the perceived discrimination in light of available gender-neutral alternatives, such as amending existing anti-discrimination laws or enacting a new anti-discrimination law focusing on the board selection process. The courts did not criticize the goal of the California legislature in enacting the statute, but the specific means it had taken to serve the state’s commitment to equal treatment and opportunity.
It now appears that California’s statutory efforts to achieve board diversity through mandated seats for women and individuals from underrepresented communities is on hold. Despite the setback, public pressure on companies to advance board diversity remains strong. At least a dozen other states have drafted or passed board diversity legislation. As mentioned above, the vast majority of these laws differ drastically from California’s in that they do not mandate a specific number of individuals on any corporate board, but merely require disclosure, which the California state courts’ rulings seemingly deem permissible. While a similar law in Washington requires a specific percentage of female board members, no penalties are given for compliance failures. The California rulings also have no effect on a rule adopted by Nasdaq and approved by the Securities and Exchange Commission (SEC) requiring most companies listed on the Nasdaq to have at least two self-identified “diverse” board members or explain in writing why they do not. Nasdaq has emphasized that the rule establishes a disclosure-based framework, and not a mandate or quota. Nasdaq’s Listing Rules currently face a challenge in the Fifth Circuit, where the Court will review the SEC’s approval of these rules and determine whether they violate the Equal Protection Clause of the U.S. Constitution.
However, legislation is only one of the driving forces behind diversifying corporate boardrooms. As shareholders elect the board, institutional shareholders have shown a willingness to utilize their leverage to apply pressure to influence companies to improve diversity at the board level. A lack of diversity at the board level is considered a risk for institutional investors. Stakeholders may act against companies lacking board diversity by voting against or withholding votes from existing directors or otherwise exerting public pressure. Institutional investors have made bold public statements on their commitments to pressure companies to increase board diversity and be more transparent on their current diversity practices. Large investors like Blackrock, State Street, and Vanguard have publicly expressed a desire to see corporate boards diversify their ranks and have advocated for board diversity through their proxy voting policies.
Concurrently, shareholder groups, employees, and consumers have also been challenging the lack of diversity on corporate boards. Amid escalating battles over diversity, activist shareholders are demanding change. Shareholder derivative lawsuits have recently begun targeting major public and private companies. Alleging that boards have breached their fiduciary duties in creating an “old boys’ club” corporate culture, these activist shareholder lawsuits unequivocally focus on the board’s apparent disinterest in promoting diversity. Through litigation and subsequent settlements, companies have been forced to overhaul their policies, procedures, and oversight functions as well as change the composition of their boards.
Even if legislation to diversify boardrooms remains in question, investors may wield their power and influence to continue to pressure companies to make progress. Investors may emphasize that companies that fail to address this important issue do so at their own peril. In response, companies may choose to adopt corporate governance codes or strategic plans to diversify, such as engaging in outreach to non-traditional avenues of board recruitment, for example. While efforts to diversify boards are long overdue, the gains being made, however slow, are bound to have a positive impact on company culture, corporate performance, and shareholder value.