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California Court Strikes Down Board Diversity Law: Now What?

April 14, 2022, 8:00 AM

A California court struck down California’s groundbreaking law mandating corporate board seats for members of certain underrepresented communities. The April 1 ruling granted summary judgment to the taxpayer challenging the law, finding that the law—known as AB 979 but codified as California Corporation Law § 301.4—violated the Equal Protection Clause of the California Constitution.

The ruling legally and practically implicates board recruitment practices. Despite the ruling, given the heightened interest from government regulators, shareholders, employees, and consumers, boards should nonetheless consider the benefits a diverse board may bring to the corporation’s mission.

The Court Case

Following the 2018 enactment of California’s gender mandatefor corporate boards, which is applicable to California-based public companies, the California Legislature expanded that mandate through AB 979 to require that certain board seats be allocated to members of statutorily specified underrepresented communities.

Immediately following enactment, a taxpayer filed suit, claiming that the law violated the state’s constitution. Following a hearing on the taxpayer’s summary judgment motion, the court declared the law unconstitutional and enjoined the state from enforcing it.

While this ruling does not impact the separate pending legal challenges to the gender mandate (a state court ruling on which is pending), this decision could influence that outcome. The state has not yet indicated whether it will appeal.

The Court’s Reasoning

To withstand constitutional scrutiny, a statute like AB 979 that employs racial and other classifications must be narrowly tailored to address a specifically identified harm that the state has a compelling interest in remediating.

While the court agreed that the state has a compelling interest in eliminating discrimination, the court found the state failed to produce evidence of past discrimination in board selection. The court found the data applicable to corporate board selection for the 600 California companies subject to the law did not show whether specific discrimination had occurred in any industry or geographic region in California.

The court also found the state failed to present adequate statistical evidence showing a disparity between the make-up of the board-qualified talent pool and individuals who hold board seats.

The court rejected the argument that executives who typically fill board seats contributed to systemic discrimination. Data showing that most executive jobs were held by White cisgender males did not, in the court’s view, constitute evidence of discriminatory board selection.

In this regard, the court note that “a person is not necessarily engaging in discrimination when they look at a talent pool full of white people and pick a white person.” The court also rejected as irrelevant evidence that the board selection process is secretive, exclusive, and dependent on personal networks of those holding board positions. Instead, the court found these board refreshment practices to be structural problems unrelated to the problem AB 979 was meant to solve.

The court also concluded that the state had failed to tailor the law narrowly to address the perceived discrimination, including consideration of “race-neutral” steps. The most prominent of these steps, in the court’s view, is a disclosure requirement that would “compel corporations to reveal the demographic information of their board members.”

While the court did not reference the Nasdaq diversity initiative that becomes effective this year, its mention is suggestive of the Nasdaq regulations.

The Nasdaq Diversity Disclosures

Beginning Aug. 8 (or the date the issuer’s 2022 proxy is filed, whichever is later), Nasdaq issuers must file an initial board matrix reflecting board diversity statistics using a Nasdaq template.

The rule also requires (after a transition period) issuers to explain whether or not they have at least two diverse directors and if not, why not. Unlike AB 979, the disclosure rule is not a mandate: companies that fail to meet the diversity objectives may elect to explain the unmet objectives in a proxy statement or through other public disclosures.

The Nasdaq rule is the subject of a pending lawsuit alleging that the SEC overstepped its legal authority when it approved the rule’s implementation.

Impact on Board Refreshment Practices

California-based publicly traded companies are no longer legally obligated to seat underrepresented community members on boards. But that doesn’t relieve the board of its duties to source, identify, and recruit suitable individuals who will provide leadership, expertise and critical viewpoints to the board.

California, while pioneering these initiatives, is not alone in board representation regulation. Washington, Illinois, and New York have passed legislation either mandating board representation or requiring board composition disclosure like the Nasdaq rule.

Given the keen focus on governance—from government regulators, shareholders, employees and consumers—boards should dedicate themselves to a meaningful process for seating the right board, which should include considerations of community representation.

Toward this end, boards might consider:

  • Adopting strategic plans or goals for board representation—whether for diversity of race, gender, or other community representation;
  • Engaging in outreach to non-traditional avenues of board recruitment, such as to professional affinity groups that include credentialed individuals who might lack access to traditional board recruiting networks;
  • Identifying critical strategic skills and subject matter areas—climate risks among them, especially in light of the SEC’s proposed climate-related disclosures;
  • Widening the aperture of expertise beyond the traditional substantive “consumer-based” or “biotech” industry experience to focus on skill sets– experience in marketing to GenY or digitally transforming traditional brick and mortar concerns to meet the needs of the next generation of stakeholders.

In sum, the movement toward disclosure in governance practices (and results) dictates the priority of board diversity—on all spectrums—even in the absence of a legal obligation to do so.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

Jen Rubin is a member with Mintz, practicing bicoastal employment law. She is chair of the firm’s ESG Practice Group.