California is First State to Mandate Public Company Board Diversity

By Greg Gautam, Josh Schneiderman and Kevin Zen

With the issues of social justice, systemic racism, bias and inequality drawing heightened attention since George Floyd’s killing, the passage of AB-979 makes California the first state to require public companies with their principal executive offices located in California to have at least one or more directors be from an “underrepresented community.” According to data cited in the bill, there are 662 publicly traded companies headquartered in California and 35 percent of these companies currently have all white boards of directors. This new law builds on California’s existing law SB-826, which requires public companies headquartered in California to meet minimum requirements for female board representation.

AB-979 applies to any corporation, whether incorporated within or outside California, with principal executive offices located in California (as disclosed in the corporation’s Annual Report on Form 10-K filed with the Securities and Exchange Commission) and with shares listed on a major U.S. stock exchange. The law requires such a corporation to, no later than December 31, 2021, have at least one director from an “underrepresented community” on its board of directors. A director from an “underrepresented community” for purposes of AB-979 means 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.  According to data cited in the bill from Deloitte and the Alliance for Board Diversity, the percentages of Fortune 500 company board seats held by people identified as African American/Black, Hispanic/Latino(a) and Asian/Pacific Islander were 8.6 percent, 3.8 percent and 3.7 percent, respectively, and according to Department of Labor statistics, in 2019, 90 percent of chief executives were white.

AB-979 applies a sliding scale for board diversity for future years based on the size of the board.  By no later than December 31, 2022, AB-979 will require board representation as follows: (i) corporations with four or fewer directors must have a minimum of one director from an underrepresented community; (ii) corporations with more than four but fewer than nine directors must have a minimum of two directors from an underrepresented community; and (iii) corporations with nine or more directors must have at least three directors from an underrepresented community.

The bill authorizes the California Secretary of State to impose fines for noncompliance, including a fine of $100,000 for the first violation and $300,000 for subsequent violations.  Corporations are also subject to an additional $100,000 fine for failure to timely file board member information with the California Secretary of State.  In addition, no later than March 1, 2022, and annually thereafter, the Secretary of State is required to publish a report identifying the number of corporations that were in compliance with AB-979, the number of publicly held corporations that moved their U.S. headquarters to California from another state or out of California into another state and the number of publicly held corporations that were subject to AB-979 whose shares are no longer publicly traded.

While it is unclear as to whether AB-979 will result in more diverse representation more generally in the California business community (and corporate culture more broadly), we note that according to Bloomberg, women have made real gains on corporate boards since the passage of SB-826. Women accounted for almost half of new board seats for California public companies in 2020.

AB-979’s gender oriented predecessor SB-826 is currently facing legal challenges in the courts. In April of this year, a federal district court ruled in Meland v. Padilla that a plaintiff who challenged SB-826 as unconstitutional under the equal protection clauses of the 14^th Amendment lacked standing. That matter is currently pending appeal before the Ninth Circuit. More generally, some have speculated that both SB-826 and AB-979 violate the U.S. Constitution, the California Constitution and various other civil rights laws by effectively creating a quota system. Theories have also been advanced that the laws violate the Internal Affairs Doctrine (a doctrine that says the laws of the state of a corporation’s incorporation should govern issues relating to the internal affairs of a corporation) insofar as they purport to apply to California-headquartered corporations that were incorporated in another state.

While it is unclear whether AB-979 will withstand these legal challenges, institutional investors demand for increased gender and board diversity (as explained by Blackrock in its 2020 Annual Stewardship Report, it voted against 1,569 directors globally due to board diversity concerns), shareholder derivative lawsuits over director diversity concerns and our country’s changing demographics, seem to indicate that there may be desire for change.