There’s a new case challenging both of California’s board diversity laws. The case, which was filed in a California federal district court against the California Secretary of State, Dr. Shirley Weber, seeks declaratory relief that California’s board diversity statutes (SB 826 and AB 979) violate the Equal Protection Clause of the 14th Amendment and the internal affairs doctrine, and seeks to enjoin Weber from enforcing those statutes. The plaintiff,  the Alliance for Fair Board Recruitment, is described as “a Texas non-profit membership association,” with members  that include “persons who are seeking employment as corporate directors as well as shareholders of publicly traded companies headquartered in California and therefore subject to SB 826 and AB 979.” Will this case be the one to jettison these two statutes? 

You might recall that California has two board diversity statutes.  The first, SB 826 requires that publicly held companies (defined as corporations listed on major U.S. stock exchanges) with principal executive offices located in California, no matter where they are incorporated, include minimum numbers of women on their boards of directors. Under the law, each of these publicly held companies was required to have a minimum of one woman on its board of directors by the close of 2019. That minimum increases to two by December 31, 2021, if the corporation has five directors, and to three women directors if the corporation has six or more directors. (See this PubCo post.) The statute also requires that the office of the California Secretary of State post on its website reports on the status of compliance with the law. Under the statute, the Secretary may impose fines for violations, ranging from $100,000 to $300,000 per violation.  To date, the Secretary has neither adopted regulations regarding fines or imposed fines for violations. Even proponents of the California law recognized the possibility of “equal protection” claims and other legal challenges—when Governor Jerry Brown signed the 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, as discussed in the SideBar below, some litigation has been filed by a group of taxpayers and a shareholder.

AB 979, patterned after SB 826, requires, no later than the close of 2021, that a “publicly held corporation” (defined as above), 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.  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. (See this PubCo post.)

According to the complaint, these statutes require all publicly traded corporations headquartered in California to discriminate based on sex and race in selecting their board members. The complaint alleges that

“[t]hese laws are unconstitutional and patronizing social engineering. The legal regime they institute relies on and perpetuates invidious racial categories and sex stereotypes that the American legal system has rightly discarded. These statutes do not claim to remedy any particular past discrimination. Rather, California says that mandating race and sex discrimination is justified on the pretext that discrimination will be lucrative for California’s corporations and shareholders and thus for the state. That is unconstitutional. If the Fourteenth Amendment and our foundational civil rights laws stand for anything, it is that private moneymaking is no justification for race or sex discrimination.”

To support its argument against the statutes, the plaintiff cites the late Justice Ruth Bader Ginsburg for her explanation that, “while there are ‘[i]nherent differences’ between men and women,’ these differences cannot justify the ‘denigration of the members of either sex’ nor can they support the imposition of ‘artificial constraints on an individual’s opportunity.’…  Thus, while states may use sex classifications in limited circumstances, the state ‘must not’—as SB 826 does—’rely on overbroad generalizations about the different talents, capacities, or preferences of males and females.’”  

As the plaintiff introduces its analysis, “states may not require discrimination on the basis of race without making a convincing showing at the outset that the discrimination is narrowly tailored to advance a compelling state interest. And they may not compel discrimination on the basis of sex without demonstrating that the discrimination is substantially related to achieving an important governmental interest.” 

With regard to SB 826, the plaintiff contends that the statute violates the 14th Amendment’s equal protection clause prohibition on “unjustified discrimination based on sex. The discrimination here is stark: California’s Woman Quota law explicitly bars men from consideration for specific numbers of board director positions.”  As a result, it argues, the law is “subject to heightened scrutiny, meaning [it] must substantially relate to achieving an important governmental interest. Any discrimination based on sex must establish ‘an exceedingly persuasive justification’ for such action.” But SB 826, the plaintiff asserts, “serves no important government interest. To the contrary, it relies on improper gender stereotypes about women having unique ‘working styles’ that will, it claims, improve corporate performance.”  And even if it did serve an important government interest, the plaintiff claims, “forcing corporations to reserve board seats for only female candidates is not sufficiently tailored to be substantially related to achieving this interest.”

And the evidence, in the plaintiff’s view, is not exceedingly persuasive: the California legislature does not justify the legislation with a “claim that California companies discriminate against female director candidates. Nor does it  suggest that the quota is necessary to remedy specific, past instances of discrimination. Instead, the California legislature cites a handful of reports from investment firms,  consultancies, and advocacy groups that claim that female directors may improve a corporation’s financial performance or governance.” What’s more, the plaintiff maintains, the empirical evidence cited in support of the legislation “is extraordinarily weak,” “not credible,” not based on “sound statistical analyses,” demonstrates correlation, not causation, and is “contradicted by robust empirical analyses showing that the ‘diversity’ California seeks to require has, at best, no impact on corporate performance and may even hurt investors.”

With regard to AB 979, the complaint asserts that the statute violates the 14th Amendment prohibition against discrimination based on race or ethnicity, which is prohibited “in all but the narrowest circumstances. Laws that discriminate based on race are subject to strict scrutiny, meaning they must be narrowly tailored to serve a compelling government interest.” By requiring “corporations to give substantial preferences to board candidates who self-identify as members of these favored racial and ethnic groups,” the complaint maintains, the law “creates an unequal playing field for candidates who do not self-identify as members of California’s favored racial and ethnic groups, which is itself a constitutional violation unless California can satisfy strict scrutiny.”  But, the complaint contends, the law fails both prongs of the strict scrutiny test: there is no compelling state interest—the law neither remedies past discrimination nor fosters the educational benefits of diversity in a college setting.  Rather, the plaintiff argues, California views the statute as an appropriate tool to increase diversity “as a means of increasing the performance of corporations headquartered in California and, thus, increasing the state’s wealth. This is insufficient.” 

In addition, the complaint claims that AB 979 is not narrowly tailored: once again, the statute provides no “convincing evidence that requiring corporations to engage in racial discrimination will in fact achieve its goal of improving firm performance.”  According to the complaint, the California legislature cites two reports “suggesting that racial diversity—on senior executive teams or in the general high tech workforce—may benefit corporate earnings….But the legislature does not provide any evidence that racial diversity on corporate boards improves firm performance or governance, likely because academic studies have failed to establish that link.”  Moreover, it alleges, “the available social science research shows that there is at most no correlation between the racial makeup of corporate boards and the firm’s performance, let alone any causal relationships.”

The plaintiff also contends that the statute violates the prohibition in 42 U.S.C. § 1981 against discrimination on the basis of race in the making and enforcing of contracts by hindering those who do not identify as members of the favored class from securing contracts for board positions at corporations headquartered in California.

Finally, the plaintiff contends that both statutes “trample on the sovereign rights of other states to regulate corporate governance for entities incorporated under their laws. SB 826 and AB 979 apply to all corporations headquartered in California, even if the corporation in question is incorporated under the laws of a different state. This policy is illegal because California lacks jurisdiction to regulate the internal affairs of entities incorporated under the laws of other states.”  The internal affairs doctrine provides that the law of the state of incorporation governs matters that pertain to the relationships among or between the corporation and its officers, directors and shareholders. According to the complaint, the internal affairs doctrine is “mandated by constitutional principles, except in the rarest situations.” But the two statutes at issue purport to apply to the exclusion of the laws of the state of incorporation. Accordingly, the complaint contends, “California’s ‘diversity’ laws violate the internal affairs doctrine.”

To support its claim of “associational standing,” the plaintiff alleges that one of its members was directly harmed by the statutes: a member who is a former corporate board director “was ousted from his position not because of a lack of skills, judgment, connections, integrity, or talent, but because he is not a woman and does not self-identify as an underrepresented minority. He is now deprived of an equal playing field on which to compete for board positions at corporations headquartered in California.”  Similarly, some of plaintiff’s members are alleged to have been injured by a  violation of the internal affairs doctrine that has forced them “to compete on an unequal playing field for board of director positions of corporations headquartered in California.”

In addition, both statutes, the complaint claims, affect the behavior of plaintiff’s members who are voting shareholders and intend to vote on board member nominees at annual meetings. SB 826 “impairs their right to vote for the director candidates of their choice, free from the threat of fines imposed on the corporation (which would reduce the value of their holdings).” AB 979 injures plaintiff’s members by “requiring  them to discriminate against potential board candidates based their race, ethnicity,  sexual orientation, or gender identity, which impairs these members’ right to vote for the director candidates of their choice.”  The plaintiff also claims that these are all live controversies and that the alleged injuries to its members “are directly traceable” to the statutes and would be redressed by an order enjoining enforcement.

For litigation questions, you can contact Jessica Valenzuela SantamariaKoji FukumuraLuke Cadigan or Sarah Lightdale.

Posted by Cydney Posner