Last year, Superior Courts in Los Angeles County invalidated two California statutes requiring specific diversity mandates for California public company boards (Senate Bill 826 “SB 826” and Assembly Bill 979 “AB 979”). The laws allocated a certain number of seats to female candidates and candidates from underrepresented communities. In two separate decisions, the trial courts held that the statutes violate the Equal Protection Clause of the California Constitution by requiring diversity-based “quotas.” While both cases are still on appeal, the Court of Appeals has left the trial courts’ orders in place, enjoining enforcement of either law.
AB 979 encountered another setback in federal court. On May 15, 2023, the United States District Court for the Eastern District of California held that AB 979 violated the Equal Protection Clause of the Fourteenth Amendment of the United States Constitution.2
Outside of California, a rule creating board diversity objectives for Nasdaq-listed companies faces similar constitutional challenges.3
The Statutes
SB 826 mandates that public companies headquartered in California must include at least one individual on their board who self-identifies as female.4
AB 979 requires California public companies to have at least one board member from an “underrepresented community.”5 The statute defines “underrepresented communities” as “Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native” or “gay, lesbian, bisexual, or transgender.”
Both laws require a specified number of diverse directors, which varies depending on the size of the board. Companies that failed to satisfy the requirements of the statute could be fined as much as $300,000.
Our previous alerts discuss AB 979 and SB 826 in further detail.
The Nasdaq Rule
In 2021, the SEC approved a Nasdaq rule change designed to promote board diversity and to provide stakeholders with diversity-related information. This rule requires the boards of most companies listed on Nasdaq to have, or explain why they do not have, at least two diverse directors, including one female and one member of an “underrepresented minority” or who is LGBTQ+.6 The rule defines “Underrepresented minority” as “Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or two or more races or ethnicities.” More information about this Nasdaq rule can be found in our previous alert.
The Court Cases
The plaintiffs challenged the California statutes in the state court cases by arguing that California’s use of taxpayer funds to enforce diversity-based board “quotas” violated the Equal Protection Clause of the California Constitution. These lawsuits, Crest v. Padilla (Padilla I) (attacking SB 826) and Crest v. Padilla (Padilla II) (attacking AB 979), are discussed in more detail in this alert.
Alliance for Fair Board Recruitment, the plaintiff in the federal case, challenged the validity of AB 979 under the United States Constitution. It argued that the law violated the Equal Protection Clause of the Fourteenth Amendment by requiring a minimum number of directors from a select racial and ethnic pool, which constituted a race-based “quota” and unlawfully created preferred classes based on diversity characteristics.
California countered that these racial classifications are permissible because the law aims to remedy past discrimination. California further asserted that the law did not create preferred classes as each candidate must go through an individualized consideration process and boards can expand to accommodate any number of directors who do not self-identify as diverse. The court, however, held the law is facially unconstitutional because it requires “a certain fixed number of board positions to be reserved exclusively for certain minority groups,” which, in the court’s view, amounts to a racial “quota.”7
In August 2022, the Fifth Circuit heard oral arguments in the Alliance for Fair Board Recruitment’s challenge of the SEC’s approval of the Nasdaq board diversity rule. Plaintiffs alleged the Nasdaq rule violated the First and Fifth Amendments by encouraging discrimination against potential board members who do not identify as diverse. Plaintiffs’ arguments also included that the SEC lacked statutory authority to issue the order, which seeks to regulate demographics through the guise of “financial disclosures.”
The SEC and Nasdaq questioned whether constitutional scrutiny applies given that Nasdaq is a self-regulatory organization, not a state actor. The SEC contends that the rule withstands constitutional scrutiny because it does not require any particular board composition. Rather, a company that does not meet the specified diversity objectives need only provide investors an explanation of why it does not meet the stated objectives. The Fifth Circuit’s decision is pending.
Despite the recent court rulings, public and investor pressure to increase board diversity will likely remain for the foreseeable future. For example, Goldman Sachs stated it will only take a U.S. based company public if it has at least two diverse board members, including one woman.8 More impactfully, the “Big Three” institutional investors implemented proxy voting policies designed to foster increased board diversity. BlackRock believes boards should aspire to at least 30% diversity of membership, including at least two women directors and one director from an underrepresented community.9 State Street Global Advisors may vote against a nominating committee chair when a board does not meet State Street’s stated diversity objectives.10 And, Vanguard will generally vote against a nominating committee if the board is making insufficient progress toward Vanguard’s diversity objectives.11
Notes:
Snell & Wilmer 2023 summer associate Libby Brown provided material assistance in the production of this article. Libby Brown is not a licensed attorney.
Alliance for Fair Board Recruitment v. Weber, No. 2:21-cv-01951-JAM-AC, 2023 WL 3481146 (E.D. Cal. May 15, 2023).
Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. filed Aug. 10, 2021).
Cal. Corp. Code § 301.3.
Cal. Corp. Code § 301.4.
Nasdaq Rule 5605(f).
Alliance for Fair Board Recruitment v. Weber, No. 2:21-cv-01951-JAM-AC, 2023 WL 3481146 at *2 (E.D. Cal. May 15, 2023).
Corporate Board Engagement, Goldman Sachs, https://www.goldmansachs.com/our-commitments/diversity-and-inclusion/board-diversity/2022-update/index.html (last accessed June 14, 2023).
BlackRock, BlackRock Investment Stewardship 8-9 (Jan. 2023), https://www.blackrock.com/corporate/literature/ fact-sheet/blk-responsible-investment-guidelines-us.pdf.
State Street Global Advisors, Proxy Voting and Engagement Guidelines 5 (Mar. 2023), https://www.ssga.com/ library-content/pdfs/asr-library/proxy-voting-and-engagement-guidelines-us-canada.pdf.
Vanguard, Proxy voting policy for U.S. portfolio companies 7 (effective Feb. 1, 2023), https://corporate.vanguard.com/content/dam/corp/advocate/investment-stewardship/pdf/policies-and-reports/us_proxy_voting_2023.pdf
