California Court Declares State’s Gender Diversity Board Mandate Unconstitutional
Verdict Follows Similar Ruling Last Month Holding California’s Racial/Ethnic Diversity Mandate for Public Company Boards Unconstitutional; State to Seek Appellate Review
Board Diversity Expected to Remain Key Governance Priority for Many Public Company Stakeholders Despite Legal Setback
- A California trial court has ruled that the state law requiring all publicly traded corporations with headquarters in California to have a minimum number of female directors on their boards violates the Equal Protection Clause of the California Constitution. The California Secretary of State’s office has announced its intention to appeal the ruling.
- This decision follows a similar ruling last month invalidating the state statute requiring California-based public companies to include at least one underrepresented minority director on their boards.
- Notwithstanding this pair of California decisions, corporate board diversity representation and disclosure can be expected to remain a significant governance priority for many key public company stakeholders, including proxy advisory firms, asset managers and institutional investors, as well as stock exchanges, state legislatures and the U.S. Securities and Exchange Commission (“SEC”).
- These additional drivers of boardroom diversification should continue to inform how companies approach incorporating diverse representation into their corporate leadership.
A California judge has struck down the state’s pioneering law that mandates corporate board seats for women.
In a ruling dated May 13, 2022, and publicly released last week, Judge Maureen Duffy-Lewis of the Superior Court of California in Los Angeles County enjoined the 2018 state law known as SB 826—the first in the nation to legally compel the representation of women on public company boards—after determining the statute was unconstitutional because it violated the Equal Protection Clause of the California Constitution. The decision followed a nearly monthlong non-jury trial that concluded in February.
California Secretary of State Shirley Weber subsequently announced that her office plans to appeal the ruling, noting in a statement that “SB 826 was passed not to remove men from the boardroom, but simply to make room for highly qualified women who have been excluded from the corporate board selection process for decades.” The court’s decision, she said, “ignores critical and substantial evidence of discrimination against women in the director selection process and fails to acknowledge the realities that women face when attempting to access corporate boards.” If permitted to stand, she contended, the verdict would “allow systemic gender discrimination to create an impenetrable wall which excludes women from the State’s most influential boardrooms.”
SB 826 required all publicly traded corporations with headquarters in California (regardless of their state of incorporation) to have one to three female directors on their boards, depending on their board size. By the end of the 2021 calendar year, companies with six or more directors were required to have at least three women on their boards, companies with five directors were required to have at least two women on their boards and companies with four or fewer directors were required to have at least one woman on their boards. The statute authorized the imposition of fines of $100,000 for initial noncompliance and $300,000 for subsequent violations, but the California Secretary of State had not yet proposed or adopted implementing regulations, or imposed any penalties for noncompliance.
This decision is the second California trial court ruling in as many months to find that corporate board diversity mandates are unconstitutional under the California Constitution. Last month, a different judge in the same court invalidated the state’s 2020 law known as AB 979 that required California-headquartered public companies to have a minimum number of directors on their boards from certain statutorily specified racial/ethnic/LGBT “underrepresented communities,” as discussed in our previous client alert available here.
Judicial Watch, a nonprofit conservative legal advocacy group, challenged the validity of both board diversity statutes on behalf of several California taxpayers on the basis of reverse discrimination, arguing that the use of taxpayer funds to implement or enforce diversity quotas is illegal under the California Constitution.
The Court’s Reasoning
In a 23-page opinion, Judge Duffy-Lewis first rejected the state’s argument that the lawsuit was premature because the government had not yet implemented or imposed monetary penalties for enforcement of SB 826 and had no plans to do so, writing that “[o]ngoing and/or anticipated expenditures indicated implementation planning was occurring and in its beginning state. Fines to compel compliance [were] anticipated and expected.”
The court then determined that SB 826 failed to withstand constitutional scrutiny because the state did not meet its burden to prove that the law’s use of a gender-based classification (i) meets a compelling state interest; (ii) is necessary to boost California’s economy, improve opportunities for women in the workplace or protect California taxpayers, public employees, pensions and retirees; and (iii) is narrowly tailored.
Compelling State Interest
The state asserted three compelling state interests, arguing that SB 826 was passed to eliminate and remedy discrimination in the director selection process; to increase gender diversity on the boards of publicly held corporations to benefit the public and the state economy; and to increase gender diversity to benefit and protect California taxpayers, public employees and retirees.
With respect to the state’s burden to show a compelling governmental interest, the court explained that:
“[T]here is no compelling governmental interest in remedying societal discrimination. There also is no compelling governmental interest in remedying generalized, non-specific allegations of discrimination…. Generalized assertions of discrimination in a particular region or industry are insufficient to give rise to a compelling governmental interest, as are mere statistical anomalies, and the discrimination must be identified with specificity. The state also must show purposeful or intentional, unlawful discrimination by the entity employing the suspect classification to assert a compelling governmental interest in remedying discrimination.”
The court found that a compelling state interest was lacking:
“During trial the Court found that Defendant was unable to present specific evidence of actual, unlawful discrimination against any specific woman by any specific corporation subject to SB 826. Discrimination experts…could not identify [a] specific instance of [a] specific woman being discriminated against by a specific corporation in the corporation’s board process. Legislature cited only statistics about the number of women on corporate boards as compared to men, not any specific discrimination…. Defendant offered after-the-fact supplementation to the Legislature’s statistics with claims of societal and structural discrimination and general social phenomena of ‘like stereotyping,’ ‘affinity bias,’ ‘like picking like’ and ‘gender matching.’ These are not unique to nor associated with any particular, publicly held corporations headquartered in California.”
Moreover, the court continued:
“Defendant’s witnesses…attributed the differences in the numbers of men and women on corporate boards to reasons other than actual discrimination, including the lack of open board seats, women’s networking issues, board propensity to select persons that they already know, and boards’ preference for choosing CEOs to fill open board positions.”
With respect to the state’s burden to prove that SB 826 was necessary to boost California’s economy, the court found that the state failed to show a connection between women on corporate boards and improved financial performance, noting that academic research on the subject was inconclusive. The court was persuaded by evidence that “[e]mpirical research has been inconclusive in showing positive benefits related to company performance, corporate decision-making, or beneficial effects on the representation of women in senior management” and that “the overall impact…of diversity on corporate performance has yet to be established.” Similarly, the court agreed with the plaintiffs that academic studies “do not support the existence of a causal relationship between women on boards and improved corporate performance and corporate governance,” despite the existence of some correlative evidence.
The court also noted that “[i]n support of women in the board room, the Defense offered the testimony of stereotypical virtues of women such as ‘consensus builders’ and ‘less risky behavior in investments,’” but the court was “unpersuaded by this offer of stereotypes for a justification of [the law].”
Finally, with respect to the state’s burden to show that SB 826 was narrowly tailored, the court determined that the state:
“failed to show the Legislature considered gender-neutral alternatives to remedy specific purposeful or intentional, unlawful discrimination against women by private-sector corporations in the selection of board members or that gender-neutral alternatives were not available. The Legislature did not consider amending existing anti-discrimination laws or enacting a new anti-discrimination law focusing on the board selection process before enacting SB 826…. Defendant did not sufficiently prove that SB 826’s use of a gender-based classification was limited in scope and duration to that which is necessary to remedy specific, unlawful discrimination against women in the selection of board members.”
Based on the foregoing reasoning and analysis, the court concluded that “SB 826 violates the Equal Protection Clause of the California Constitution and is thus enjoined.”
Federal Court Challenges to California Laws and Nasdaq Board Diversity Rules
Lawsuits against both board diversity statutes remain pending in the U.S. District Court for the Eastern District of California, a federal court in the Ninth Circuit, arguing that the California mandates violate the federal Equal Protection Clause and antidiscrimination statutes.
Federal litigation is also pending in the Fifth Circuit Court of Appeals challenging the SEC’s August 2021 approval of Nasdaq’s board diversity listing rules, effective this year, that require most listed companies, after a transition period, to have, or explain why they do not have, at least two “diverse” directors—at least one of whom self-identifies as female and at least one of whom self-identifies either as a member of an underrepresented ethnic or racial minority or as LGBTQ+—and to publish annually, in a prescribed matrix format, aggregated diversity data about their boards.
The lawsuit contends that Nasdaq’s rules violate federal antidiscrimination laws and the U.S. Constitution’s Equal Protection Clause. Oral arguments are tentatively scheduled to begin in August, but it is unclear whether a decision will be handed down this year.
In contrast to the California laws, which were legal mandates to include a minimum number of diverse directors, the Nasdaq board diversity requirement takes a comply-or-explain approach, which its proponents believe may facilitate wider acceptance and make it less vulnerable to legal challenge. More information about Nasdaq’s board diversity rules can be found in an earlier Gunderson client alert available here.
Focus on Board Diversity Continues
Although California-based public companies may no longer have a legal obligation to seat female and underrepresented community members on their boards (pending the ultimate outcome of the appeals), corporate board diversity representation and disclosure are—and can be expected to remain—a significant governance priority for many key stakeholders, including proxy advisory firms, asset managers and institutional investors, as well as stock exchanges, state legislatures and the SEC. Stakeholder pressure to diversify corporate boardrooms shows no sign of abating.
The list below provides just a few notable examples of the multiple varied stakeholder policies, plans, views and expectations helping to drive momentum behind board diversification that will likely result in board diversification remaining a critical focus area, notwithstanding the invalidation of California’s board diversity mandates. These additional drivers of board diversity should continue to inform how companies approach incorporating diverse representation into their corporate leadership:
- Proxy Advisory Firms. Leading proxy advisory firms ISS and Glass Lewis recently expanded the coverage of their board diversity policies with respect to both gender and race/ethnicity:
- ISS. Beginning in 2023, the existing ISS policy to recommend voting against the nominating committee chair (or other directors on a case-by-case basis) for companies with no women on the board will be extended beyond the Russell 3000 and S&P 1500 indices to all companies. Effective this year, ISS will generally recommend voting against the nominating committee chair (or other directors on a case-by-case basis) at companies in the Russell 3000 and S&P 1500 indices that do not have at least one racially or ethnically diverse director.
- Glass Lewis. Starting this year, for Russell 3000 companies, Glass Lewis will generally recommend voting against the nominating committee chair of a board with fewer than two gender diverse (defined as women and non-binary) directors, and against the entire nominating committee of a board with no gender diverse directors. For companies outside of the Russell 3000 index, and all boards with six or fewer total directors, Glass Lewis generally recommends voting against the nominating committee chair of a board without at least one gender diverse director. Beginning with shareholder meetings held after January 1, 2023, Glass Lewis will transition from a fixed numerical approach to a percentage-based approach and will generally recommend voting against the nominating committee chair of a board at a Russell 3000 company that has less than 30% gender diversity.
Additionally, Glass Lewis will recommend voting against the nominating committee chair of S&P 500 companies that provide insufficient board diversity disclosure. Beginning in 2023, Glass Lewis will generally recommend voting against the nominating committee chair of S&P 500 companies that do not provide any disclosure of individual or aggregate racial/ethnic minority board demographic information.
- BlackRock. BlackRock, the world’s largest asset manager with approximately $10 trillion of total assets under management, believes boards should aspire to 30% diversity and encourages companies to have at least two directors who identify as female and at least one director who identifies as a member of an underrepresented group. Although the policy is framed as aspirational, BlackRock last year voted against nearly two thousand directors globally because of a lack of diversity.
- Vanguard. Vanguard, the world’s second largest asset manager, will generally vote against the nominating committee chair (or other director if needed) if a company’s board is making “insufficient progress” in its diversity composition or in addressing its board diversity-related disclosures. The factors Vanguard will consider include applicable market regulations and expectations, along with additional company-specific context.
- State Street. State Street, which completes the “Big Three” asset management firms, currently expects all boards to have at least one female director and, starting in 2023, will expect Russell 3000 boards to have at least 30% female directors, and may vote against the chair of the nominating committee if these objectives are not satisfied. Moreover, if a company fails to meet these diversity expectations for three consecutive years, State Street may vote against all incumbent members of the nominating committee. In addition, if a company in the S&P 500 does not disclose the racial and ethnic composition of its board (either at the aggregate or individual level), or does not have at least one director from an underrepresented racial or ethnic community, State Street will vote against the nominating committee chair.
- Goldman Sachs. In 2020, Goldman Sachs, one of Wall Street’s biggest IPO underwriters, announced that it would only underwrite IPOs of private companies in the U.S. and Europe that have at least one diverse board member and, starting in 2021, at least two diverse board members, asserting that “[g]etting [diverse leadership] right—before the IPO—is the right thing for all companies going public.”
- Nasdaq. As noted above, Nasdaq’s board diversity and disclosure listing rules, which are currently effective, require most listed companies, after a transition period, to have (or explain why they do not have) at least two diverse directors—at least one of whom self-identifies as female and at least one of whom self-identifies either as a member of an underrepresented ethnic or racial minority or as LGBTQ+. Nasdaq-listed companies must also publish annually, as early as this year, aggregated diversity data about their boards in a standardized matrix format.
- SEC. The SEC is expected to propose rules requiring enhanced and standardized disclosures about the diversity of public company board members and nominees later this year. Proposed rulemaking on human capital management disclosure, also anticipated this year, could include requirements to disclose diversity metrics more broadly, including for senior management and the general workforce.
- State Legislatures. Following California’s lead, a number of other states, including New York, have enacted or proposed legislation either mandating minimum levels of diverse board representation, or requiring disclosure by companies of the demographic composition of their boards and the processes they use to identify diverse directors. It is possible that California will pursue additional legislative efforts.
The momentum created and sustained by the kinds of collective stakeholder efforts and initiatives described above has enabled meaningful progress in recent years toward expanding female, racial and ethnic representation on public company boards. This evolution is reflected in the following director diversity data and trends compiled in the latest U.S. corporate board surveys published by executive recruiting firm Spencer Stuart (S&P 500 Board Index; Technology Board Index):
S&P 500 Companies
- In 2021, among S&P 500 companies nationally, every board included at least one female director, and just 4% of boards had only one woman. 96% of boards included two or more female directors (compared with 58% a decade earlier), and 72% of boards included three or more female directors.
- Women represented 43% of new independent directors in the S&P 500 in 2021. Overall, about 30% of S&P 500 directors were women (up from 16% a decade ago).
- Directors from historically underrepresented racial and ethnic groups made up 47% of new independent directors in the S&P 500 in 2021. Overall, about 21% of S&P 500 directors were from underrepresented backgrounds.
200 Largest U.S. Public Technology Companies
- In 2021, among the 200 largest U.S. public technology companies, 98% of boards included at least one female director (up from 85% in 2018). 48% of technology boards included three or more female directors.
- Women represented 49% of new independent directors on technology boards in 2021. Overall, about 28% of directors on technology boards were women (continuing a steady rise from 17% in 2017).
- Directors from historically underrepresented racial and ethnic groups made up about 37% of new independent directors on technology boards in 2021. Overall, about 16% of directors on technology boards were from underrepresented backgrounds.