Over recent months, there has been a series of regulatory, legislative, and litigation measures and actions implemented to try to address perceived concerns about diversity in the corporate boardroom. Prominent among these measures was AB 979, the California board diversity statute for “underrepresented communities.” This California legislative measure was the subject to a legal challenge seeking to prevent the California secretary of state from expending taxpayer funds to enforce the measure, which, the taxpayer plaintiffs claimed, violated the equal protection clause in the California state constitution. In an interesting and detailed April 1, 2022 opinion (here), California Superior Court Judge Terry A. Green, granted the taxpayers’ motion for summary judgment, striking down the legislation on equal protection ground.
AB 979 is actually the second of two California legislative measures designed to address board diversity issues. The first of these two measures was SB 826, the California board gender diversity statute. SB 826 is itself the subject of a separate legal challenge by taxpayer plaintiffs; the gender diversity litigation is awaiting decision following a bench trial.
AB 979 was largely modeled on SB 826. AB 979, which has been codified as California Corporations Code Section 301.4, requires publicly held corporations (regardless of their state of incorporation) with principal executive offices located in California to have minimum specified numbers of directors from “underrepresented communities” according to the statute’s timetable. A director from an “underrepresented community” means 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. The law also requires the State’s Secretary of State to public certain periodic reports documenting the number of corporations in compliance with the bill’s provisions, as well as other information. The statute also allows the Secretary of State to implement regulations providing for the imposition of fines for violations of the law.
Three plaintiffs filed a legal challenge to the law in California Superior Court, in their capacities as California taxpayers, in reliance on California procedures permitting taxpayer challenges to obtain a judgment “restraining and preventing any illegal expenditure of, waste of, or injury to, the estate, funds, or other property” of a state or local agency. The taxpayer plaintiffs’ action seeks injunctive and declaratory relief; their action seeks to enjoin the Secretary of State from “spending public funds on California’s … quotas.” The taxpayer plaintiffs seek a judicial declaration that the diversity mandate is unlawful in violation of the equal protection clause in the California constitution. The taxpayer plaintiffs and the Secretary of State filed cross-motions for summary judgment.
The April 1, 2022 Order
In a thorough and detailed April 1, 2022 order, Judge Green granted the taxpayer plaintiffs’ motion for summary judgment and denied the summary judgment motion of the Secretary of State.
In granting the plaintiffs’ motion, Judge Green held that the statutory provision “violates the Equal Protection Clause of the California Constitution on its face.” The statute, Judge Green said, “treats similarly situated individuals – qualified potential corporate board members – differently based on their membership (or lack thereof)” in specified identity groups. It requires that “a certain specific number of board seats be reserved for members of the groups on the list – and necessarily excludes members of other groups from those seats.”
In reaching this conclusion, Judge Green held that, contrary to the requirements of the constitution to justify the classification in the statute, the Secretary of State had not identified a “compelling state interest” with sufficient specificity (as, for example, the legislature relied on nationwide-based, rather than California-based, statistics). Judge Green also held that, contrary to the constitution’s requirements, the legislative measure was not “narrowly tailored to meet the compelling interest the Secretary offers.” For example, rather than simply obtaining disclosures from California-based companies on their board compositions, the legislature implemented compulsory requirements.
Because the statute “treats similarly-situated individuals differently by race, sexual orientation, and gender identity, because that use of suspect categories is not justified by any compelling interest, and because the statute is not narrowly tailored to serve the interests offered,” the statutory provision “violates the Equal Protection Clause of the California Constitution.” The plaintiffs, Judge Green said, are entitled to a judgment declaring as much and injunction preventing the expenditure of taxpayer funds on implementation of the measure.
I have attempted to summarize Judge Green’s decision in the preceding section, but there is some danger that in telescoping the court’s conclusions I may have minimized the court’s analysis. Judge Green’s opinion is quite detailed and worth reading in full.
As an opinion of a state trial court judge, Judge Green’s ruling may not be the last word on the question of the legality and enforceability of the California statute. According to an April 3, 2022 New York Times article discussing the ruling, the California Secretary of State’s office has not yet said whether it will appeal Judge Green’s ruling.
The California legislation was of course not the only board diversity initiative put in place in recent months. As discussed here, in August 2021, the SEC approved proposed Nasdaq listing guidelines requiring Nasdaq-listed companies to disclose whether or not they are in compliance with Nasdaq board diversity requirements or to explain why they are not in compliance. These requirements continue to apply to Nasdaq-listed companies, whether located in California or elsewhere. However, as discussed here, the Nasdaq listing requirements are themselves subject to legal challenge.
In addition to these various legislative and regulatory measures seeking to address board diversity issues, board diversity also was the subject of several shareholder derivative suits filed against the boards of several public companies. As readers of this blog undoubtedly will recall, these lawsuits have uniformly fared poorly; in every one of these cases that has reached the motion to dismiss stage, the dismissal motions have been granted (as discussed for example here).
With these various board diversity initiatives under challenge, the question may arise whether these initiatives are falling short of their goal to enhance diversity in corporate boardrooms. While the track record for these initiatives is mixed at best, that does not mean that the initiatives have failed. To the contrary, all of these initiatives helped highlight the issue of corporate board diversity; as a result of public attention and scrutiny, diversity in the boardroom is now an issue that no public company can disregard.
Even more significantly, corporate board diversity is an issue that many of the largest institutional investors have taken up. The institutional investor attention to these issues suggests that diversity in the boardroom will remain a high priority issue for publicly traded companies, independently of the question of whether or not the various legislative and regulatory initiatives withstand judicial scrutiny.
As the April 4, 2022 Law360 article discussing Judge Green’s opinion in the board diversity case put it, “experts say the ruling is unlikely to have much of an impact on companies’ actions in California or elsewhere, as shareholders, proxy advisory firms and other stakeholders continue to demand more diversity.”