California-Mandated Diversity Measures – An Invalid or Necessary Regulation of Corporate Affairs?

Posted on by Héctor González Medina

Diversity, equity and inclusion has gained substantial traction as a major business and social initiative in the past decade. Organizations committed to the goal of creating more diverse and inclusive workspaces range from private businesses to institutes of higher education to non-profit foundations and engage in a wide array of business activities such as technology, law and business.1 Despite advances in diversity recruitment and retention, especially in technology, media, and telecommunications,2), data collected in a 2020 report by the Alliance for Board Diversity and Deloitte, shows that the boards of Fortune 500 companies consisted of 83.9% White/Caucasian directors, while only 8.6% identified as African American/Black, 3.8% identified as Hispanic/Latinx, and 3.7% identified as Asian/Pacific Islander.3

California Enacts Legislation to Increase Diversity

California is no stranger to flexing its market share to accomplish targeted social and policy goals through legislation.4 In a push for greater diverse representation in business, California Governor Gavin Newsom signed Assembly Bill 979 into law on September 30, 2020.5 The act follows similar legislation adopted in 2018 which sought to increase gender diversity on corporate boards of publicly held California companies.6 The newly signed legislation goes further in amending the California Corporations Code to require minimum numbers of directors from “underrepresented communit[ies]” on the boards of “publicly held domestic or foreign corporation[s] whose principal executive offices . . . are located in California.”7 The act sets two timelines for compliance with minimum underrepresented directors. The first requires boards to have at least one director from an underrepresented background no later than December 31, 2021.8 The second deadline, requiring compliance no later than December 31, 2022, sets standards based on the size of the corporation’s board of directors: i) for boards with nine or more directors, a minimum of three directors from underrepresented communities are required; ii) for boards with five to eight directors, a minimum of two directors from underrepresented communities are required; and iii) for boards with four or less directors, a minimum of one director from an underrepresented community is required.9 For purposes of the act, the legislature defined a director 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.”10 Importantly, these requirements apply to corporations with principal executive offices in California per SEC 10-K filings whether or not such corporations were formed under the laws of the State of California or another foreign jurisdiction.11 The code, however, gives some flexibility in allowing corporations to increase the number of directors in order to comply with this requirement and credits service for a portion of the year as sufficient to satisfy the mandate.12

Remedy Sought by Legislation

As noted, the California Legislature sought to remedy the underrepresentation of certain minority groups and genders on corporate boards through legislation. Research conducted by the Latino Corporate Directors Association (LCDA), released in March 2020, found that of 662 publicly held corporations headquartered in California, only 105 had at least one African American, only 87 had at least one Latinx board member and 281 had at least one Asian or South Asian board member.13 Additionally, LCDA found that as of July 2020, 233 publicly traded California companies had boards containing only White directors.14 Similar research found that despite the awareness of a lack of gender diversity on corporate boards, “[f]ewer than 20% of board seats of S&P 1500 companies [we]re held by women” in 2016.15

Active Litigation Challenges

Though having the potential to trigger strict scrutiny review of race-conscious remedies, California’s diversity requirement for corporate boards has only faced minimal challenges. Currently, both the gender diversity law and underrepresented community law are being challenged under a California taxpayer standing doctrine granting taxpayers the right to sue government officials to prevent the spending of taxpayer funds for unlawful purposes.16 A trial is currently set for 2021.17 A related case with nearly identical claims was filed shortly after the underrepresented community bill was signed into law.18 Another case, Meland v. Padilla, similarly challenged the gender diversity law as a shareholder suit alleging the law was unconstitutional under the Equal Protections Clause of the 14th Amendment. The case was dismissed for lack of standing in the U.S. District Court for the Eastern District of California,19), and is currently on appeal to the U.S. Court of Appeals for the Ninth Circuit.20).

At present, no claims have been brought under the internal affairs doctrine recently affirmed by the Delaware Court of Chancery.21 In Juul Labs, Inc. v. Grove, the court held that a California law expanding access to stockholder inspection rights of a Delaware corporation was in conflict with Delaware’s own law regulating internal corporate affairs.22 The law in question, Section 1601 of the California Corporations Code, applied rights of inspection to all shareholders of both “domestic . . . and of any foreign corporation keeping any such records in this state or having its principal executive office in this state.”23 The Delaware Court of Chancery looked to Edgar v. MITE Corp., in which the Supreme Court of the United States held that the “internal affairs doctrine is a conflict of laws principle which recognizes that only one State should have the authority to regulate a corporation’s internal affairs . . . because otherwise a corporation could be faced with conflicting demands.”24 In deciding Juul Labs, the court ultimately held that “stockholder inspection rights are a matter of internal affairs” and therefore “governed by Delaware law, not by California law.”25 The size and composition of Delaware-incorporated boards of directors are governed by statute.26 Therefore, according to Juul Labs and Edgar, the internal affairs of a corporation, including the functioning and composition of its board, should be regulated by the laws of the state in which it was incorporated. Having competing requirements between the laws of the state of incorporation and the laws of the state in which a corporation conducts business creates conflicting incentives for compliance.

Lasting Effects of Legislation

Despite the existence of pending litigation challenging both laws, California-based corporations have made significant strides in incorporating these requirements into their board composition. According to The Wall Street Journal, when S.B. 826, mandating gender diversity, was adopted on September 30, 2018, “ninety-three California-based members of the Russell 3000 . . . had all-male boards.”27 A little over a year later, that number had dropped to 17.28 According to the California Secretary of State’s compliance report containing data for calendar year 2019, of 625 impacted corporations, 330 filed a 2019 Corporate Disclosure Statement and of those, 282 reported compliance with state gender diversity requirements.29 In addition, local business groups, such as the highly influential Silicon Valley Leadership Group,30, as well as corporations, including Oportun, Bloom Energy, and HP Inc. have welcomed the push for greater corporate board diversity.31

With no exemption for new or “emerging growth companies,” these requirements are expected to apply to California-based private companies planning an initial public offering (IPO) or direct listing on public stock exchanges.32 Even if an exemption is subsequently granted or A.B. 979 or S.B. 826 are struck down by courts, the effect of industry compliance can have downstream effects with corporations likely subjected to “greater investor and stakeholder scrutiny regarding board diversity.”33 Therefore, between the widespread business support and proactive implementation of private diversity measures to comply with these laws, we are unlikely to see a dip in industry appetite for diverse board representation in the years to come.

  1. See, e.g., Google Diversity Annual Report 2020, Google, https://diversity.google/annual-report/ (last visited Nov. 2, 2020); Diversity, Equity & Inclusion, U. Mich., https://diversity.umich.edu/about/ (last visited Nov. 2, 2020); Diversity, Equity, and Inclusion Annual Report 2020, Ford Foundation, https://www.fordfoundation.org/media/5533/2019-dei-update.pdf (last visited Nov. 3, 2020); Diversity, Equity & Inclusion, Bain & Co., https://www.bain.com/about/diversity-equity-inclusion/ (last visited Nov. 4, 2020). ↩

  2. Missing Pieces: Industry View, Deloitte, https://www2.deloitte.com/us/en/pages/center-for-board-effectiveness/articles/missing-pieces-report-industry-view.html (last visited Nov. 2, 2020 ↩

  3. See id. app. at 6 (reporting the number of Fortune 500 board seats by race/ethnicity). ↩

  4. See, e.g., Cal. Corp. Code § 301.3 (West, Westlaw through Ch. 372 of 2020 Reg. Sess.) (amending the California General Corporation Law to mandate gender diversity on the board of directors of certain California-based corporations); California Consumer Privacy Act of 2018, Cal. Civ. Code § 1798.100-199 (West, Westlaw through Ch. 372 of 2020 Reg. Sess.) (regulating the way businesses collecting California residents’ personal information retain, store, sell or share such information). ↩

  5. Governor Newsom Signs Landmark Legislation to Advance Racial Justice and California’s Fight Against Systemic Racism & Bias in our Legal System, St. of Cal., Off. of Governor (Sep. 30, 2020), https://www.gov.ca.gov/2020/09/30/governor-newsom-signs-landmark-legislation-to-advance-racial-justice-and-californias-fight-against-systemic-racism-bias-in-our-legal-system/. ↩

  6. S.B. 826, 2017-18 Reg. Sess. (Cal. 2018). ↩

  7. A.B. 979, 2019-20 Reg. Sess. (Cal. 2020). ↩

  8. Id. § 3 (adding this provision as Cal. Corp. Code § 301.4(a ↩

  9. Id. § 3 (adding this provision as Cal. Corp. Code § 301.4(b ↩

  10. Id. § 3 (adding this provision as Cal. Corp. Code § 301.4(e)(1 ↩

  11. See id. § 3 (applying provisions to both domestic and foreign corporations). ↩

  12. Id. § 3 (adding these provisions as Cal. Corp. Code § 301.4(a) and 301.4(d)(2)(B ↩

  13. 233 CA-Based Public Company Boards Lack Racial or Ethnic Diversity, Latino Corporate Directors Association (July 1, 2020), https://latinocorporatedirectors.org/ca_public_company_boards.php. ↩

  14. Id. ↩

  15. Women on Corporate Boards, Robbins Geller Rudman & Dowd LLP (Feb. 16, 2017), https://www.rgrdlaw.com/news-item-Women-on-Corporate-Boards-050417.html. ↩

  16. Crest v. Padilla, No. 19STCV27561 (Cal. filed Aug. 6, 2019). ↩

  17. Report: California Sees Significant Increase in Female Directors After SB 826, but More Needed, JD Supra (Oct. 28, 2020), https://www.jdsupra.com/legalnews/report-california-sees-significant-85194/. ↩

  18. See Cydney Posner, Crest v. Padilla Redux – Conservative Activist Group Challenges AB 979, California’s Board Diversity Law for “Underrepresented Communities,” Cooley PubCo (Oct. 6, 2020), https://cooleypubco.com/2020/10/06/crest-v-padilla-redux/. ↩

  19. Meland v. Padilla, No. 2:19-cv-02288-JAM-AC, 2020 WL 1911545, at *2-4 (E.D. Cal. Apr. 20, 2020 ↩

  20. Report: California Sees Significant Increase in Female Directors After SB 826, but More Needed, JD Supra (Oct. 28, 2020), https://www.jdsupra.com/legalnews/report-california-sees-significant-85194/; Meland v. Padilla, No. 2:19-cv-02288-JAM-AC (E.D. Cal. 2019), appeal docketed, No. 20-15762 (9th Cir. Apr. 23, 2020 ↩

  21. See Cydney Posner, Conservative Activist Group Challenges California’s Board Gender Diversity Law, Cooley PubCo (Aug. 11, 2019), https://cooleypubco.com/2019/08/11/group-challenges-californias-board-gender-diversity-law/. ↩

  22. Juul Labs, Inc. v. Grove, No. 2020-0005-JTL, 2020 WL 4691916, at *7 (Del. Ch. Aug. 13, 2020). ↩

  23. Cal. Corp. Code § 1601(a)(1) (West, Westlaw through Ch. 372 of 2020 Reg. Sess.). ↩

  24. Edgar v. MITE Corp., 457 U.S. 624, 645 (1982) (citing Restatement (Second) of Conflict of Laws § 302 cmt. b (Am Law Inst. 1971). ↩

  25. Juul Labs, 2020 WL 4691916, at *10. ↩

  26. General Corporation Law, Del. Code Ann. tit. 8, § 141(b) (West, Westlaw through Ch. 292 of 150th Gen. Assemb. (2019-2020). ↩

  27. Rachel Feintzeig, California Law Spurs Companies to Add Female Directors, The Wall St. J. (Dec. 18, 2019, 5:30 AM), https://www.wsj.com/articles/california-law-spurs-companies-to-add-female-directors-11576665000. ↩

  28. Id. ↩

  29. Women on Boards March 2020 Report: Corporations Code Section 301.3, St. of Cal. Secretary of St. Off. 1, 3 (2020), https://bpd.cdn.sos.ca.gov/women-on-boards/WOB-Report-04.pdf. ↩

  30. Silicon Valley Leadership Group Supports AB 979, a Landmark Bill to Diversify Corporate Boardrooms, Silicon Valley Leadership Group (Aug. 25, 2020), https://www.svlg.org/silicon-valley-leadership-group-supports-ab-979-a-landmark-bill-to-diversify-corporate-boardrooms/ ↩

  31. Opportun Applauds the Passage of California AB 979, Oportun (Aug. 31, 2020, 4:05 PM), https://investor.oportun.com/news-releases/news-release-details/oportun-applauds-passage-california-ab-979; Allison Levitsky, Bloom Energy, HP Execs Push California Bill that would Require Diverse Boards, Silicon Valley Bus. J. (Aug. 19, 2020, 5:49 PM), https://www.bizjournals.com/sanjose/news/2020/08/19/ab-979-panel-bloom-hp.html. ↩

  32. New California Law Will Require Increased Diversity on Public Boards, Goodwin Procter LLP, https://www.goodwinlaw.com/publications/2020/10/10_14-new-california-law-will-require (last visited Nov. 3, 2020). ↩

  33. Id. ↩

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