It now appears—at least until the appellate dust settles—that California’s statutory efforts to mandate board seats for females and individuals from underrepresented communities is on hold.
The recent defeats that two trial courts handed California suggests now may be an opportune time to rethink (and possibly reframe) statutory board diversity efforts to focus on disclosure, not mandates. The first ruling, on April 1, involved California’s law mandating corporate board seats for underrepresented communities, while the second ruling, on May 13, dealt with the state’s landmark requirement that corporate boards include women.
Both California courts rejected the evidence supporting the state’s board diversity mandates. While the procedural avenues to these rulings differed slightly, their legal premises rested on the same failure of the state to prove these laws were narrowly tailored to address specific harms that the state had a compelling interest to address.
In sum, both courts concluded that California failed to meet its evidentiary burden to justify state-imposed penalties for missing statutorily mandated gender and race milestones for public company boards.
While the state indicated it intends to appeal the May 13 ruling overturning the gender mandate, it faces a high bar on appeal. Now would be an appropriate time to pursue a statutory solution to inclusive board representation that will withstand legal challenge. A starting point for a solution may be found in longstanding precedents requiring transparency and disclosure rather than imposing penalties for not achieving statutorily-fixed representation goals.
The EEO Model
The notion of diversity disclosure is not new. In 1966, the Equal Employment Opportunity Commission adopted mandatory diversity reporting for employers of 100 or more as a data gathering method to understand the scope and impact of employment discrimination.
The EEO-1 reporting mandate has remained largely unchallenged (except for recent legal skirmishes about pay data reporting). The report requires employers to identify racial, ethnic, and gender categories for each employee.
This requirement goes well beyond the small group of Russell 3,000 companies (the top 3,000 U.S. publicly traded companies as ranked by market capitalization) that represent most public companies in the US—nearly 75,000 corporate employers representing 56 million employees filed EEO-1 reports in 2018 alone, the last year for which such data is available.
The SEC-Nasdaq Approach
More than a decade ago, the SEC adopted a rule requiring issuers to disclose how diversity impacts the board nomination process. This rule instructs boards to treat diversity as one of many important factors in board selection, such as seating board members with disparate viewpoints, professional experience, education, skill, and other qualities and attributes, among them gender, race, and national origin.
These nominating committee disclosures for identifying and evaluating candidates and policies for board refreshment generally have never been seriously challenged or significantly modified—at least until the 2021 Nasdaq diversity rule becomes effective this year.
Building on the EEO-1 model, and consistent with the SEC disclosure rules, effective Aug. 8 (or the date the issuer’s 2022 proxy is filed, whichever is later), Nasdaq issuers must file an initial board matrix showing the issuer’s board diversity makeup through a Nasdaq template. The rule also requires (after a transition period) issuers to explain whether they have at least two diverse directors, and if not, why not.
This “show or tell” rule is not a mandate. Issuers who fail to provide or meet the stated diversity objectives may elect to explain the unmet objectives in a proxy statement or through public disclosures. The Nasdaq rule is the subject of a pending lawsuit that challenges the SEC’s authority to implement this rule.
Other State Law Models
Several states, such as Washington, Illinois, and New York have enacted laws similar to the EEO-1 and Nasdaq show or tell rules, requiring mandatory board representation reporting.
While the Washington law facially requires a specific percentage of female board members, no penalties are assessed for compliance failures. In fact, the Washington statute operates like the Nasdaq initiative in requiring transparent reporting through a board diversity discussion and analysis that provides the diversity makeup of the board, information about proposed candidates, and other board refreshment disclosures.
These disclosure models are firmly built to withstand legal challenge because instead of mandates for legally-protected classifications that trigger heightened constitutional analyses, the reporting models are administrative vehicles to transparency, much in the same way financial reporting keeps shareholders informed as to whether a corporation is meeting its financial and other goals.
Show or Tell Meets ESG Goals
Inclusive board representation is not just good governance, it reflects principles of purposeful and transparent governance that stakeholders demand—key underpinnings of the ESG movement. Transparent diversity information, while non-monetary, might be material to the corporate mission. Board refreshment practices implicate the movement toward a keen focus on social justice, community representation, and the value (including monetary value of increased shareholder returns and corporate profits) diverse representation brings to corporate boards.
A “show or tell” method ultimately serves important ESG demands for meaningful governance processes. In sum, statutory governance initiatives might accomplish more inclusive board representation if they are legally aimed at transparently informing shareholders that the boards reflect the communities the corporations serve.
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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Jen Rubin is a member with Mintz, practicing bicoastal employment law. She is chair of the firm’s ESG Practice Group.