United States: Court Concludes That California Board Diversity Statute Is Unconstitutional

On April 1, 2022, the Superior Court of California, County of Los Angeles, granted a summary judgment motion that effectively struck down AB 979, a California statute requiring the boards of public corporations based in the state to include a minimum number of directors from underrepresented communities (as previously discussed here and here ).^1,2 The court determined that the statute violated the Equal Protection Clause of the California Constitution by "treat[ing] similarly situated individuals — qualified potential corporate board members — differently based on their membership (or lack thereof) in certain listed racial, sexual orientation, and gender identity groups." 

With other legal challenges still pending in state and federal court, the fate of board diversity statutes like AB 979 is unsettled. In particular, the same plaintiffs that prevailed here await a posttrial decision in another suit challenging SB 826, California's predecessor statute relating to gender diversity requirements. But regardless of the outcomes of these cases, board diversity will remain a high priority for many companies and stakeholders. 

The Court's Analysis

As a threshold matter, the court determined that the plaintiffs had properly asserted a facial challenge to AB 979 as the statute "clearly applies suspect categories" to the selection of board members. The inquiry therefore focused on the following two issues: (1) whether the state demonstrated a "compelling interest" that justified using these classifications and (2) whether the statute was "narrowly tailored to suit that interest."

Fatally, the court rejected each of the compelling interests offered by the state. First, "remedying discrimination in board selection" was too general an interest in that it "covers the entire nation and all industries," rather than "identify[ing] a specific arena." As the court observed, the regulated companies could range from technology to pharmaceutical to agriculture businesses, each with different pools of qualified candidates. The court found that the state also failed to produce "convincing evidence" of discrimination to justify such remedial action. Anecdotal and statistical evidence, when combined, can support a finding of discrimination — but here, the state improperly used the general population as the comparison group even though it is "manifestly not the qualified talent pool for corporate board seats." Second, the court deemed an interest in "healthy businesses" as "not sufficiently specific or immediate to permit the use of suspect classifications."

Even assuming that the state had demonstrated a compelling interest, the court determined that the statute was not "narrowly tailored to suit that interest" since it was not the "least restrictive means available for accomplishing the goals the Legislature had in mind."³ According to the court, the "most prominent" of these race-neutral and intermediate measures is "a disclosure requirement that would compel corporations to reveal the demographic information of their board members." Notably, this type of disclosure requirement is the basis of Nasdaq's proposed rule that applies to companies voluntarily listed on its exchange, which was approved by the Securities and Exchange Commission (SEC) in August (as previously discussed here).  

Conclusion

The state of California has not yet announced whether it intends to appeal the court's decision invalidating AB 979. Even so, momentum continues to build toward setting and achieving long-term corporate diversity goals. Proxy advisory firms, including Institutional Shareholder Services and Glass Lewis, have released U.S. voting policies for the 2022 proxy season that include specific guidelines relating to board diversity. So, too, have large institutional investors including BlackRock, Vanguard and State Street. No doubt in large part due to the pressures imposed by these and other stakeholders, corporations have recently seen record numbers of board members from historically underrepresented groups.⁴

Notwithstanding the present decision, public companies, believing in the benefits of board diversity and cognizant of these stakeholder interests, continue to have ample incentives to pursue board diversity as an essential governance goal.

Footnotes

1. Robin Crest, et al. v. Alex Padilla (No. 20 ST-CV-37513).

2. The statute defines a "[d]irector from an underrepresented community" as "an individual who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender."

3. Although the state expressed its frustration with previous failed legislative initiatives, including a resolution calling on corporations to increase board diversity, the court explained that "by escalating from somewhat blasé and voluntary requests straight to a numeric mandate, [the Legislature] skipped over several possible intermediate and neutral steps." 

4. See https://www.spencerstuart.com/-/media/2021/july/boarddiversity2021/2021_sp500_board_diversity.pdf.

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