Companies frowning at California’s mandatory board diversification requirement found a legal wrinkle in their efforts to undo the new law—shareholders now being emboldened to sue the state.
The U.S. Court of Appeals for the Ninth Circuit ruled June 21 that a shareholder of OSI Systems Inc. has standing to pursue his claim that the law forces shareholders to possibly violate the 14th Amendment by discriminating based on sex when they’re voting for corporate board directors.
The Ninth Circuit’s “extraordinarily expansive” ruling on the law’s harm to an individual shareholder could result in shareholders challenging more board diversification policies, said Ann Lipton, a business law professor at Tulane University Law School.
“It’s very difficult for companies themselves to challenge this law because it means taking a public position against diversifying their boards, at a time when public company shareholders are agitating for more diversity,” Lipton said in an email. “So even if a board privately disliked the law, the board might prefer that a shareholder do the challenging for them.”
California will now have to defend in court S.B. 826, a 2018 law intended to accelerate board diversification. It requires publicly traded corporations based in California to have at least one woman on their boards of directors. By the end of 2021, corporations with six or more directors must have at least three female directors.
Failure to comply results in fines from $100,000 to $300,000 per violation.
Other Diversity Laws
Now that the issue of standing has been firmed, California’s other significant board diversity law could face a similar challenge through a shareholder derivative suit. That law requires companies to install, by the end of 2021, at least one board director from an underrepresented minority community.
But such litigation will depend on finding shareholders willing to take on that battle, said Lisa Bugni, a partner in King & Spalding LLP’s securities and shareholder litigation practice.
“If a plaintiff does want to challenge it on constitutional grounds, this decision lays a groundwork to do that,” she said.
The case now continues to face the constitutionality question, but companies will still need to comply with the statute, Bugni said.
Companies and other state legislatures will want to follow the case once it returns to the district court for its potential impact on board diversity policies, Bugni said.
Even absent a legal mandate, companies aren’t likely to halt board diversification efforts, said Charles Elson, a professor of finance and corporate governance at the University of Delaware’s Alfred Lerner College of Business and Economics.
“Companies will continue to add diversity to boards but not because the California legislature told them to do it but because it makes sense in producing a better board,” he said.
The Ninth Circuit, even as it sided with shareholder Creighton Meland, acknowledged that the law already has had an impact on increasing the number of women on boards.
“The legislative conclusion that most shareholders would comply with SB 826’s mandate was reasonable, as early results have shown,” the court said, citing a May 2021 news report that women now make up more than 1 in 4 board directors in California.
“For companies that are invested in moving the needle on female board representation, they may see SB 826 as a sanctioned opportunity to do so,” said Rae Vann, a shareholder at Carlton Fields, P.A., who specializes in labor law.