Yesterday, yet another complaint was filed in federal district court charging that California’s board diversity statutes, SB 826 and AB 979, are unconstitutional under the equal protection provisions of the 14th Amendment.  This complaint was filed by The National Center for Public Policy Research, which, you may recall, has also filed a petition challenging the Nasdaq board diversity rule (see this PubCo post and this PubCo post).  The NCPPR describes itself as “a non-profit 501(c)(3) organization that supports free market solutions to social problems and opposes corporate and shareholder social activism that detracts from the goal of maximizing shareholder returns.” The case is National Center for Public Policy Research v. Weber, and the initial scheduling conference for this case isn’t set to occur until March of next year.

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, litigation has been filed by a group of taxpayers and by various shareholders.

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.)

In the complaint, the NCPPR states that it has invested in at least 14 companies subject to the California diversity statutes. While the plaintiff states that it “supports diversity of thought and experience on corporate boards,” it “believes that quotas based on immutable characteristics are offensive and contrary to this goal, as well as to the Constitution. It believes that shareholders should vote for board members based on their individual talents, capacities, and other characteristics, and that it should be able to vote free of government compelled discrimination.” To that end, the NCPPR has submitted various shareholder proposals that would prohibit “consideration of characteristics such as race, sex, and sexual orientation in the selection of directors.”

The plaintiff asserts that its injury arises out of the laws’ impact on the behavior of shareholders, who elect directors to the board. The NCPPR observes that many of the companies in which it has invested have adopted majority voting for directors, which means, the plaintiff contends, that these companies are “particularly responsive to shareholder voting and demands.” (Note, however, that some of them also have multi-class share structures with unequal voting rights, which, some contend, could have quite the opposite effect.) The complaint also observes that shareholders may also submit names of candidates for election to the board of directors. The diversity statutes, the NCPPR claims, “therefore impose a race, sex, and sexual orientation-based quota directly on shareholders, and seek to force shareholders to perpetuate race, sex, and sexual orientation-based discrimination.”

The plaintiff states that, in the future, it intends to vote and to nominate candidates for director.  However, it contends, the “diversity quotas injure Plaintiff’s right to vote for the candidate of its choice, free of a government-imposed race, sex, and sexual orientation quota.“  The plaintiff contends that these diversity quotas “harm individual shareholder voting rights directly, separate from any injury to the corporation,” and “directly undermine” its efforts to submit shareholder proposals that would prohibit consideration of race, sex and sexual orientation in the selection of directors. The plaintiff notes that some of the companies of which it is a shareholder do not yet satisfy the statutory minimums. 

With regard to the statutes’ unconstitutionality under the equal protection provisions of the 14th Amendment, the plaintiff asserts that diversity statutes “facially discriminate on the basis of race, sex, and sexual orientation [and] serve no important nor compelling government interest”; just increasing the proportion of directors that are women or underrepresented minorities “for its own sake is not an important nor compelling government interest,” the plaintiff contends.  And even if there were a compelling governmental interest, the use of a “rigid and arbitrary quota” is “not sufficiently tailored to that interest”: it applies across the board to all publicly traded companies in all industries, “regardless of the hiring pool or the company’s historical hiring patterns,” and imposes the quotas “in perpetuity regardless of changes in representation in future years.”  In addition, the NCPPR contends, the California Secretary of State does not “have specific evidence of discrimination against racial minorities, women, or sexual minorities, sufficient to justify the diversity quotas.” Just showing that there is a disparity in board membership “is not sufficient evidence of discrimination,” the plaintiff contends. The plaintiff further argues that the Secretary “may not rely on societal, rather than government sponsored discrimination, to justify a quota based on immutable characteristics.” Moreover, the Secretary’s interest in enforcing the statutes is “undermined by the fact that racial and sexual minorities and women are increasingly being appointed to corporate boards even without a government mandate.”

The NCPPR seeks a declaratory judgment that the diversity statutes are unconstitutional under the 14th Amendment and a permanent injunction prohibiting the Secretary from enforcing or otherwise taking further action to enforce the diversity statutes.

Happy Thanksgiving!!

Posted by Cydney Posner