As I have noted in prior posts, one of the follow-on effects of the recent racial justice movement has been increased scrutiny of racial diversity within corporate management, and in particular on corporate boards. The boards of several publicly traded companies have been hit with shareholder derivative lawsuits alleging that the directors breached their fiduciary duties by failing to include African-American individuals on the boards, while at the same time the companies were touting their diversity and inclusion efforts.
In addition to the recent litigation, efforts to advance board racial diversity have included legislation. Earlier this year, the California legislature passed a bill mandating the inclusion on boards of California headquartered companies of representatives of “underrepresented communities.” On September 30, 2020, California Governor Gavin Newsom signed the bill into law. As discussed below, even though the law has only been in place for a few days, a lawsuit challenging the bill has already been filed.
California Assembly Bill 979, a copy of which can be found here, requires that no later than the end of 2021, the approximately 625 companies with securities listed on U.S. exchanges and that are headquartered in California, must, regardless of where the companies are incorporated, have a minimum of one director from an “underrepresented community.”
The statute defines “underrepresented community” to mean a director who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual or transgender. A corporation may increase the number of directors on its board to comply with the new law.
The statute provides further that by the end of 2022, a corporation with more than four but fewer than nine directors will be required to have a minimum of two directors from underrepresented communities, and a corporation with nine or more directors will need to have a minimum of three directors from underrepresented communities.
Under the statute, California’s secretary of state is to monitor and report progress on the bill and also to report on a number of other items (including, for example, the number of companies moving out of the state to avoid compliance). The law also authorizes the Secretary of State to impose fines for violations of the statute’s requirements, $100,000 for the first violation, and $300,000 for each subsequent violation. Failure to timely file board member information with the Secretary of State is also subject to a $100,000 fine.
As noted on the Cooley law firm’s PubCo blog (here), AB 979 is “patterned” upon California State Bill 826, the California board gender diversity bill that was enacted in 2018. SB 826 requires all publicly-traded California companies to have at least one female on their board of directors by the end of 2019. SB 826 was the subject of a pair of lawsuits challenging the statute. As discussed here, in April 2020, the Eastern District of California granted the state’s motion to dismiss the federal court lawsuit. The dismissal is now on appeal to the Ninth Circuit. The state court action challenging the gender diversity statute remains pending.
The latest development is that a set of taxpayer claimants has now filed a lawsuit challenging the racial diversity statute.
On September 30, 2020 (that is, the same day as Governor Newsom signed AB 979 into law) three California residents claiming standing as taxpayers filed an action in California (Los Angeles County) Superior Court seeking declaratory and injunctive relief. A copy of the complaint can be found here. The October 5, 2020 press release of Judicial Watch, the group that filed the lawsuit, can be found here.
The complaint notes that AB 979 specifies a number of actions that the California Secretary of State is required to take, including documenting compliance with the statutes and providing annual compliance reports. The complaint quotes a report from a General Assembly Appropriations Committee report that the actions required of the Secretary of State “will result in ongoing costs in the hundreds of thousands of dollars to gather demographic information and compile a report on this data on its internet website.” The complaint notes further that the Secretary of State “will expend taxpayer funds or taxpayer-financed resources performing the above-referenced tasks in furtherance of and to ensure compliance with the racial, ethnicity, sexual preference, transgender quotas required by AB 979.”
The complaint alleges that the expenditure of taxpayer funds “is illegal under the California Constitution.” The statute’s requirement that the companies in California appoint a specific number of directors based on race, ethnicity and sexual preference is “immediately suspect and presumptively invalid and triggers strict scrutiny review.” The statute’s classifications by race, ethnicity and sexual preference “can only be justified by a compelling governmental interest, and its use of race and ethnicity must be narrowly tailored to serve that compelling interest.” The complaint alleges that the defendant (the California secretary of state) “cannot make this difficult showings,” and the statute therefore “unconstitutional” and any expenditure of taxpayer funds in support of the statute is “illegal.”
The complaint seeks a judicial declaration that any expenditure of taxpayer funds in furtherance of and in compliance with AB 979 “to be illegal.” The complaint also seeks a permanent injunction enjoining the Secretary of State from expending taxpayer funds in furtherance of and in compliance with AB 979.
With the enactment of the California legislation, and the growing number of lawsuits against companies lacking African-American directors, it is clear that publicly traded companies – particularly those with headquarters in California – are under increasing pressure to address issues of diversity on their boards of directors. To be sure, the California legislation faces a legal challenge. The lawsuit challenging the statute has only just been filed and it remains to be seen if it will succeed; however, the dismissal of the earlier lawsuit challenging the gender diversity statute does suggest that the latest lawsuit against the new racial diversity statute will likely also not be successful.
The bottom line is that companies, particularly those in California, are under pressure to address board diversity issues. The likelihood is that the scrutiny and pressure will continue.
One interesting question is what the impact of the statute will be on the board diversity lawsuits that are currently pending against a number of California-based companies. The statute seems to mandate one of the major components of relief that the plaintiffs in these cases seeking – that is, the agreement of the defendant companies to add African-American directors to their boards. To be sure, the claimants in these cases are seeking other relief pertaining to diversity and inclusion goals, but the primary objective of their lawsuits – that is, the addition of African-Americans to their boards – is required by and should be accomplished by the statute’s mandate.
In an interesting development that underscores how tricky these issues may be for some companies, in the past few days the U.S. Department of Labor has sent letters to a number of companies with federal contracts, including Microsoft and Wells Fargo, advising the companies that the agency is investigating whether the companies have included specific numerical goals in their pledges to hire more diverse staff, arguing that these measure could represent illegal quotas and could potentially discriminate against white applicants and other groups. The Department of Labor’s investigation has been reported in a number of media article (e.g., here). According to some press reports, the DOL is questioning whether Microsoft’s June 2020 pledge to double the number of Black managers and leaders in its U.S. workforce by 2025 violates federal laws prohibiting discrimination based on race.
The DOL’s investigative initiative underscores how challenging many of these issues may be for some companies and how many of these issues may cross political or legal lines. Undoubtedly, these issues will continue to develop and evolve, and could be substantially affected by the outcome of the November election.