Social unrest currently roiling the U.S. body politic has brought systemic racial inequity and injustice into sharp focus. Why, after decades of public statements and corporate commitments to enhancing racial diversity has so little progress been made? Because, as it's often said, change starts at the top, one avenue to begin to address these issues is to increase the number of African-Americans and ethnic and other underrepresented minorities represented on boards of directors. Yesterday afternoon, California Governor Gavin Newsom signed into law AB 979, designed to do for "underrepresented communities" on boards of directors what SB 826 did for board gender diversity. (See this PubCo post.) As reported in the Sacramento Bee, prior to signing the bill, Newsom said that "[w]hen we talk about racial justice, we talk about empowerment, we talk about power and we need to talk about seats at the table."
The new law requires that boards of public companies, including foreign corporations with principal executive offices located in California, include specified numbers of directors from "underrepresented communities." According to the Assembly analysis of the bill, since
"the beginning of recent social unrest, corporations have publicly messaged their support for diversity and Black lives. However, critics have pointed out this public support does not translate to diversity within a company and will not lead to long-term structural change. AB 979 will serve as a springboard to: address the ethnic pay gap, facilitate employment and outreach opportunities, promote board diversification, establish pipeline creation and upward mobility of diverse technical talent, and retention of that talent through company culture and development."
A number of other states have legislation on the books or in the works that is largely patterned after California's board gender diversity law, SB 826, although the timing and diversity goals may vary. Will other states now follow suit with regard to board diversity for underrepresented communities? Will corporations incorporated in other states observe its provisions or challenge the application of this California law?
Has SB 826, the California board gender diversity legislation, been effective? According to reporting from the WSJ, the answer is a big yes. The WSJ reports that, when the law was signed on Sept. 30, 2018, 93 California-based companies in the Russell 3000 had all-male boards; a little over a year later, only 17 had no women on their boards. During the same period, according to the WSJ, 244 California companies in the Russell 3000 have added at least one female director, and 41 companies added two. Even more surprising, over 90% of companies in the S&P 500 now include two or more women on their boards, compared to 86% in the prior year. And last year a milestone was reached: the elimination of the last all-male board among the S&P 500. (See this PubCo post.) And the non-profit 2020 Women on Boards has announced that it has met its goal of 20% of board seats of companies in the Russell 3000 held by women. Notably, for the second year in a row, California had the largest increase in companies with 20% or more of their board seats held by women, which, WOB observed, "may be a direct result of the historic legislation requiring companies in the state to diversify their boards." In California, 68 more companies met the 20% goal in 2019 than in 2018. (See this PubCo post.) According to data from Bloomberg, women "now hold 28% of all board seats at major corporations."
By comparison, according to Bloomberg, about "a dozen of the largest companies by market value in the S&P 500 Index have no Black board members." What's more, Bloomberg reports, "the number of Black corporate directors has stalled or even declined. Although about 10% of directors at the 200 biggest S&P 500 companies are Black, according to executive recruiting firm Spencer Stuart Inc., the percentage of Black executives joining boards in 2020 fell to 11% from 13% the year before." Similarly, according to Heidrick &Struggles' Board Monitor U.S. 2020, in contrast to significant gains posted for women among newly appointed directors compared to prior years, increases in racial and ethnic diversity have "been disappointing": "nearly half, or 44%, of non-executive director appointments in the United States last year were women, the highest proportion since we began tracking board appointments 11 years ago. People of color also have made some progress on boards in the United States-with appointments increasing from 13% in 2010 to 23% in 2019-although the rate of change has been notably slow, taking 9 years to increase by only 10 percentage points."
What accounts for the difference in gender compared with racial/ ethnic diversity? Some attribute it to the determined push for board gender diversity by institutional holders, such as BlackRock (See this PubCo post) and State Street (see this PubCo post), along with legislative mandates, such as California's SB 826 (see this PubCo post). The California law has meant that companies have needed to look outside of the usual channels-other boards and CEOs-to find female board candidates; the WSJ reports that over 60% of the women who joined the board of a California company in 2019 had never served on a public company board.
What the new law requires. Like SB 826, this new law will require, no later than the close of 2021, that a "publicly held corporation" (that is, a corporation with outstanding shares listed on a major U.S. stock exchange) with principal executive offices (according to its Form 10-K) located in California, no matter where it is incorporated, have a minimum of one director from an underrepresented community. A director from an "underrepresented community" means a director who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, Alaska Native, gay, lesbian, bisexual, or transgender. A corporation may increase the number of directors on its board to comply with the new law. No later than the close of 2022, a corporation with more than four but fewer than nine directors will be required to have a minimum of two directors from underrepresented communities, and a corporation with nine or more directors will need to have a minimum of three directors from underrepresented communities. As with board gender diversity, the bill will likely have the effect of compelling companies to look outside their traditional channels to find new directors from underrepresented communities.
The bill will also require, on or before specified dates, that the Secretary of State publish various reports on its website documenting, among other things, the number of corporations in compliance with the bill's provisions, the number that have moved their headquarters in or out of California and the number no longer publicly traded. The legislation also authorizes the imposition of fines for violations in the amounts of $100,000 for the first violation, and $300,000 for each subsequent violation. Failure to timely file board member information with the Secretary of State is also subject to a fine of $100,000. (Note that no regulations have yet been adopted to implement the fines authorized under SB 826, which was signed into law in 2018.)
Two recent surveys have looked at how diverse directors are recruited: "Why Do Boards Have So Few Black Directors?," in the Harvard Business Review, analyzed a survey of a 1,000 directors conducted during 2015 and 2016 to gain an understanding of the institutional and social barriers that "that perpetuate the continuing underrepresentation of Black professionals on boards." And the "Black Corporate Directors Time Capsule Project," a survey undertaken by Barry Lawson Williams, a retired director who has served on 14 corporate boards, sought to "capture the experiences" of 50 seasoned Black directors "for the benefit of the next generation of Black corporate directors."
The HBR study concluded that the racial status quo on boards is reinforced by the process for recruiting new directors. The study found that, when recruiting to fill open board positions, boards that do not include any directors who are racial/ethnic minorities consider almost no candidates who are racial/ethnic minorities (0.2 candidates per open vacancy, on average) and fewer total candidates (2.9, on average). By comparison, boards that include two or more directors who are racial/ethnic minorities consider an average of 1.0 racial/ethnic minority candidate and 3.9 candidates for each open board seat. The authors suggest that even invocation of the Rooney Rule (a policy originally created by the National Football League to increase the number of minority candidates considered for head coaching and general manager positions, which requires that at least one racial/ethnic minority candidate be included in every pool from which nominees for open board seats selected) may not suffice: "studies indicate that these rules often do not go far enough. Finalist pools need to have more than one candidate from an underrepresented group to meaningfully influence hiring outcomes."
But how do prospective candidates gain initial introductions? The Williams survey found that Black directors were nominated to boards primarily "because of business, community or other board relationships"; the author found that 85% of board searches did not involve an executive search firm and only 17% of first board appointments were made primarily through executive search firm contact. Black directors indicated that race played a major role in only 14% of board searches; rather, having the desired skill set and experience as a corporate executive were the most significant factors. An important pipeline, the Williams survey showed, was service on a non-profit board, which provided experience in how boards function, collaboration skills, "how to listen and express their voice," and additional skills and leadership experience as well as access to new, potentially influential, relationships. Civic, industry and government involvement were also mentioned as possible pipelines. In the Williams survey, when respondents were asked what they wished they done differently, although it was important to "avoid being considered a single-issue director," the "primary thing most Black directors would have done differently was to promote diversity more and sooner, including getting off boards that lacked a clear commitment." Most respondents in the Williams survey expected that relationships would continue to be the most important avenue for being nominated for board service over the next five years.
The HBR study also found that social networks were the primary method of introduction. Over half (54%) of Black directors were known to a fellow board member prior to being appointed (33% known to the CEO), while that was the case for only 35% of white directors (31% known to the CEO). Executive search firms were used to recruit 33% of Black directors, but only 25% of white directors. According to one Black director, in selecting board members, "people tend to go to people that they're familiar with [and] have grown to know and trust. Often, people don't have very diverse circles of people that have that level of trust and confidence." Accordingly, recruiting through social networks can have the negative effect of "perpetuat[ing] long-standing racial inequities." And the internal pipeline does not seem to be an effective springboard for Black directors: none of the Black directors in the HBR study were current or former executives of the company, while 12% of white directors had occupied those positions. (See this PubCo post.)
Why did the legislature believe this bill was necessary? The findings set forth in the bill establish the case that there is a deep underrepresentation of Black and other minority communities in industry. Among the bill's findings:
- only 31% of African-Americans and 22% of Latinos worked in management, professional and related occupations, while 54% of Asians and 41% of whites worked in the same occupations.
- according to data from Deloitte and the Alliance for Board Diversity, at Fortune 500 companies, only 8.6% of directors identified as African American/Black, 3.8% as Hispanic/Latino(a), and 3.7% as Asian/Pacific Islander.
- data from the Latino Corporate Directors Association showed that, of 662 publicly traded companies headquartered in California, 233 had all white boards as of May 2020, only 13% had at least one Latino board member, 16% at least one African-American board member, 42% at least one Asian board member, and 6% at least one non-white or other board member.
- in 2019, 90% of CEOs were white, according to the Bureau of Labor Statistics
- since the enactment of Senate Bill 826, data shows that out of 511 director seats filled by women in California publicly traded companies, 77.9 percent are white. In comparison, 3.3 percent of female directors hired are Latina, 5.3 percent are African American, and 11.5 percent are Asian.
- more racially and gender diverse boards also further the independence of boards, a goal of SOX, "which pushed for more independent boards that decrease the likelihood of corporate fraud."
- directors who "hold numerous board seats exert considerable influence over United States corporations and broader society. As directors gain seats on more boards, they gain influence over the creation of policy in more companies and rise in corporate status amongst the corporate elite, which in turn enhances their influence on the creation of policy."
The bill found that underrepresentation of racial and ethnic minorities is especially pronounced in high tech. The bill found that about one quarter of U.S. professionals and about 5% to 6% of the total labor force are employed in high tech. The EEOC reports that "employment in computer science and engineering is growing at twice the rate of the national average. These jobs tend to provide higher pay and better benefits, and they have been more resilient to economic downturns than other private sector industries over the past decade. In addition, jobs in the high tech industry have a strong potential for growth." Nevertheless, relative to private industry overall, "the high tech sector employs more White and Asian-American employees and fewer African-American and Hispanic employees," especially executives. In particular, the bill finds that
- "highly ranked universities graduate African American and Latino computer science and computer engineering majors at twice the rate that leading technology companies hire them."
- less than 1% of Silicon Valley executives and managers are African-American.
- according to McKinsey, "for every 10 percent increase in racial and ethnic diversity on the senior-executive team, earnings before interest and taxes rise 0.8 percent.
- according to Dalberg Global Development Advisors, "the high tech industry could generate an additional $300-$370 billion each year if the racial or ethnic diversity of tech companies' workforces reflected that of the talent pool."
In September, over 40 companies signed the Board Challenge, an effort to increase the number of Black directors "by challenging companies to take the pledge to appoint a Black director within the next year." According to the Board Challenge,
- "Diverse boards of directors are 43% more likely than non-diverse boards to achieve financial performance above the national industry medium for companies in the top quartile vs. bottom quartile, according to McKinsey & Company's 'Delivering Through Diversity' 2018 report.
- More than nine in 10 directors (94%) agree that board diversity brings unique perspectives to the boardroom, according to PwC's 2019 Annual Corporate Directors Survey. Additionally, 87% said board diversity enhances board performance and 76% said it enhances company performance.
- More than half (53%) of investors say board diversity should be a top focus, according to a 2019 report from the EY Center for Board Matters."
The bill's findings also address the legislation in the context of affirmative action plans, presumably, to fend off potential future constitutional challenges based on equal protection. According to the San Francisco Chronicle, a senior attorney at the conservative legal organization that has a challenge to California's board gender diversity legislation pending in the 9th circuit said that the organization "would consider bringing or supporting a legal challenge over the bill if it becomes law." (Notably, however, while there were multiple official opponents of the board gender diversity legislation-including a coalition of over two dozen organizations that comprised every variety of Chamber of Commerce in California-no major business groups, such as the California Chamber of Commerce, were identified as formal opponents of this new law, reports CalMatters.) According to the Senate analysis, a "statute that draws a distinction based upon race or ethnicity in this fashion-whether remedial or punitive in intent-is suspect and only passes constitutional muster if it can meet the strict scrutiny test: that the statute is narrowly drawn to meet a compelling government interest.. Remedying past discrimination can be a sufficiently compelling government interest to withstand strict scrutiny." The analysis also acknowledges that the bill may run afoul of the "internal affairs doctrine," enunciated by SCOTUS in Edgar v. Mite. Under that doctrine, only the state of incorporation may impose requirements on companies that determine how a corporation conducts its internal affairs.
Even proponents of SB 826, the California board gender diversity law, recognized the possibility of "equal protection" claims and other legal challenges-when Governor Jerry Brown signed that bill into law, he acknowledged that "serious legal concerns" had been raised. (See this PubCo post.) And many expected a flood of legal challenges to frustrate efforts to implement the bill. Nevertheless, California's businesses appear to have accepted the requirements of the legal mandate-perhaps also feeling the pressure from large asset managers such as BlackRock and State Street-and have not filed suit.
However, two conservative legal groups did file complaints. The first, Crest v. Alex Padilla (as amended), filed in California State Court, was framed as a "taxpayer suit" that sought to enjoin Padilla, the California Secretary of State, from expending taxpayer funds and taxpayer-financed resources to enforce or implement the statute, claiming violations of the equal protection provisions of the California constitution. (See this PubCo post.)
In the second case, Meland v Padilla, a conservative legal organization filed a complaint in the U.S. District Court for the Eastern District of California on behalf of a shareholder of a publicly traded company that is incorporated in Delaware and headquartered in California. The case sought a declaratory judgment that the statute was unconstitutional under the equal protection provisions of the 14th Amendment and a permanent injunction preventing implementation and enforcement of the statute. At the time the complaint was filed, the company had an all-male board and, the plaintiff asserted in the complaint, was required under the statute "to add a female member by the end of 2019 and two more female board members by the end of 2021 or face fines for failing to comply with the Woman Quota."
The Court dismissed the complaint, finding that none of the provisions of SB 826 affected the plaintiff's 14th amendment rights to an extent sufficient to establish standing under Article III. The plaintiff had argued that the statute was compelling him, as a shareholder, to vote in a way that perpetuated sex-based discrimination and, therefore, that he had standing to challenge the requirement. However, the Court contended, the plaintiff's argument "misse[d] the mark" and "ignored and/or distorted the plain language of SB 826." Rather, SB 826 "places a requirement and a possible penalty on publicly held corporations, but Plaintiff is not a publicly held corporation. He is a shareholder. And that is a distinction with a difference." Under SB 826, neither the requirement nor the penalty is imposed on the plaintiff, the Court maintained.
In addition, the Court reasoned, the plaintiff is not being forced to vote for any particular director: "notwithstanding SB 826, Plaintiff, as a shareholder, can vote in shareholder elections as he pleases. If, at future shareholder meetings, Plaintiff prefers a male board member nominee, there is nothing in SB 826 preventing him from casting a vote in favor of that nominee." The plaintiff was not affected in any "personal or individual way." For the same reasons, the Court held that the plaintiff did not have prudential standing. Only the company faced fines under SB 826; the impact on the plaintiff was "merely incidental." Because the Court held that the plaintiff lacked standing, the Court did not address whether the plaintiff had otherwise adequately stated a claim. Accordingly, the Court dismissed the complaint without prejudice. This case has, however, been appealed to the 9th Circuit. (See this PubCo post.)
Originally published by Cooley, October 2020
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