Background
On September 30, 2018, Senate Bill 826 (SB 826) was signed into law in California, which required publicly held corporations with principal executive offices located in California to have at least one female director on their boards by the end of 2019, and up to three female directors by the end of 2021, depending on the size of the board. Failure to comply with this state law subjected California-based public companies to fines ranging from $100,000 for a company’s first violation to $300,000 for second and subsequent violations, although no fines were known to be levied.
A lawsuit successfully challenged the constitutionality of SB 826, which was overturned on May 13, 2022.
Procedural History
On August 6, 2019, almost one year after SB 826 was signed into law, Judicial Watch, a nonprofit advocacy group, brought a lawsuit challenging the constitutionality of the law (Robin Crest, et al. v. Alex Padilla, known as Crest v. Padilla I). The plaintiff asserted that taxpayer resources should not be used to enforce and implement SB 826 on the basis that it mandated an unconstitutional gender-based quota in violation of the Equal Protection Clause of the California Constitution.
SB 826 preceded Assembly Bill 979 (AB 979), a similar law enacted on September 30, 2020 that required companies to have directors from “underrepresented communities.” Shortly after AB 979 was signed into law, Judicial Watch also challenged its constitutionality on the same basis – that taxpayer resources should not be used to enforce or implement AB 979 and that the law violated the California Constitution. Subsequently, Los Angeles Superior Court Judge Terry A. Green overturned AB 979 on April 1, 2022 (Robin Crest, et al. v. Alex Padilla, known as Crest v. Padilla II). The court opined that AB 979 was rendered unconstitutional by the California Equal Protection clause. Please see our prior blog post on AB 979 here.
SB 826’s Gender-Based Quota Is Ruled Unconstitutional
On May 13, 2022, less than two months after AB 979 was overturned and following a lengthy bench trial, Los Angeles Superior Court Judge Maureen Duffy-Lewis struck down SB 826. The judge agreed with the plaintiff that SB 826 violated the California Equal Protection Clause because it treated similarly situated individuals (men and women) differently based on their gender. According to the opinion, the government failed to establish that the use of a gender-based classification was justified by a compelling government interest, and the law was not narrowly tailored to remedy gender discrimination.
The court stated that “remedying generalized, non-specific allegations of discrimination” does not constitute a compelling government interest. In its opinion, defendant did not “identify any specific, purposeful, intentional and unlawful discrimination” that could be remedied by SB 826. In addition, the court noted that the legislature’s failure to consider “amending existing anti-discrimination laws” or “enacting a new anti-discrimination law focused on the board selection process” before enacting SB 826 demonstrated that SB 826 was not narrowly tailored to the government’s interest.
SB 826 Impact
Before it was overturned, SB 826 was at least partially responsible for increasing the share of women on boards of corporations with headquarters in California. Because of the reporting requirement, there is some quantifiable data since 2019.
- In July 2019, 34% of California-based public companies self-reported having at least one female director on their boards.
- In December 2019, that figure rose to 45%.
- In 2020, 48% of California public companies self-reported compliance with SB 826, and 95% of S&P 500 companies had two or more female directors.
- In 2021, only 26% of California public companies self-reported compliance with SB 826.
- Lower levels of compliance may be attributable to the requirement that by the end of 2021, companies have up to three female directors depending on the overall size of the board.
- This year, 99% of California public companies have at least one female director on their board, and 66% have three or more female directors.
- 70% of California public companies are expected to meet the SB 826 requirement in 2022.[1]
Takeaways
There are no longer state law diversity requirements for California-headquartered companies, although California Secretary of State Shirley Weber announced that the state will appeal the May 13th decision. In light of the lengthy process of appeals, which can be prolonged by further appeals to higher courts, we may not see a resolution for a number of years.
The pressure to increase the number of female and diverse directors remains even absent a state law requirement. Many investors, proxy advisory firms, regulators and other stakeholders continue to advance board-related diversity issues and influence companies (through advocacy, voting, or otherwise) to continue improving boardroom diversity.
- The largest passive institutional investors have all messaged that diverse boards and companies are an ESG priority and have exercised votes against companies without diverse board members, or for failing to make progress on diversity. Each year, additional investors amend proxy voting guidelines regarding diverse director expectations and begin exercising votes against directors on the basis of insufficient board diversity.
- ESG- and values-oriented investors often prioritize diversity considerations and have and are likely to continue to submit shareholder proposals to companies on diversity issues. Support for ESG-related shareholder proposals continues to rise, and many board diversity proposals have passed.
- Shareholder activists have routinely used board composition, including diversity issues, to bolster their thesis that a company’s board is lacking. With the universal proxy rules in effect for the next proxy season, it will be easier and less costly for shareholder activists and those adopting shareholder activist tactics to conduct a proxy contest, including on the basis that the board lacks diversity, and a proxy contest can install diverse directors quickly.
- ISS and Glass Lewis proxy voting guidelines expect companies will have board diversity, including in respect of gender diversity. Failure to comply risks withhold vote recommendations.
- Nasdaq-listed companies are required to: (1) publicly disclose board diversity statistics using a Nasdaq-provided standardized matrix template; and (2) either have at least two diverse directors, including one female director and one director who self-identifies as an underrepresented minority or LGBTQ+, or explain why they do not meet this requirement.
- A company’s failure to have a diverse board has increasingly become a reputational risk, with negative impact to the company’s relationship with its employee base, community and other stakeholders.
[1] Source: CA Secretary of State and California Partners Project
