Investors keep up diversity pressure after California law tossed

California judge says statute treats qualified board members differently

California Gov. Gavin Newsom signed the board diversity requirements into law in 2020.  (Aric Crabb/MediaNews Group/East Bay Times via Getty Images)
California Gov. Gavin Newsom signed the board diversity requirements into law in 2020. (Aric Crabb/MediaNews Group/East Bay Times via Getty Images)
Posted April 7, 2022 at 7:00am

Shareholder groups say they'll keep up pressure on board diversity during this year's proxy season after a judge invalidated a California state law requiring companies to have directors from underrepresented backgrounds that has inspired similar laws across the country.

Terry Green, a judge for the Superior Court of California, County of Los Angeles, granted a motion for summary judgment from conservative activist group Judicial Watch challenging the constitutionality of Assembly Bill 979.

AB 979 mandated that public companies with principal executive offices in the state incrementally add people from various racial, ethnic and LGBTQ backgrounds to their boards of directors. The law, signed in 2020 by Democratic Gov. Gavin Newsom, was in the second phase during which corporations were required to have at least two people from an underrepresented background on boards with five to eight members, and three for those with at least nine people, by the end of this year.

Judicial Watch sued on behalf of Robin Crest, Earl De Vries and Judy De Vries, California taxpayers who argued the law violated the state's constitutional equal protection clause and that the secretary of state should not use taxpayer money to implement the statute. 

Green agreed with the plaintiffs, noting in his written opinion that the statute treats qualified corporate board members differently based on their racial, ethnic or sexual identity.

California “has not identified a compelling interest to justify this classification. The broader public benefits produced by well-run businesses do not fit that bill,” Green said in the ruling. While the state could justify such actions on the basis of remediation of discrimination, it has to be specific and localized rather than be broad, he said.

"Healthy businesses are obviously a good thing. But the state’s generic interest in healthy businesses is not sufficiently specific or immediate to permit the use of suspect classifications,” Green said. 

“It is not difficult to accept the proposition that diverse boards may be 'good for business.' Nor is it hard to believe that the knock-on effects of strong businesses include more tax revenue, better performance for pension funds, and better workplaces with happier employees,” he continued. “But if these downstream, indirect effects were to be compelling interests, there is no limit to what might be allowed, providing the economic data were properly massaged.”

Judicial Watch is also challenging Senate Bill 826, another board quota law California enacted in 2018 that requires public companies to incrementally increase the number of women on their boards.

Historic decision

“This historic California court decision declared unconstitutional one of the most blatant and significant attacks in the modern era on constitutional prohibitions against discrimination,” Tom Fitton, president of Judicial Watch, said in a statement. “The court upheld the core American value of equal protection under the law.”

According to a report released last month by California Secretary of State Shirley Weber’s office, half of the 716 companies affected by both laws filed a disclosure on their boards. Of those, about 84 percent met the requirements for AB 979 and nearly 52 percent met the requirements for SB 826.

"Our office continues to support efforts to increase diversity," Joe Kocurek, a spokesman for Weber's office, said in an email. "We are currently exploring options moving forward."

States including Washington and New York have followed in California’s footsteps to create similar requirements for increasing board diversity, as Democrats agree with proponents of environmental, social and governance issues that a boardroom that is more representative of society leads to better company management and financial performance. 

At the federal level, the House Financial Services Committee marked up a bill (HR 1277) by Rep. Gregory W. Meeks, D-N.Y.,  in April 2021 that would require public companies to disclose to the Securities and Exchange Commission the racial and gender diversity of their boards of directors and executives. The full House hasn't acted on the bill. 

“Although the ruling invalidating the California law could be viewed as a setback in the effort toward board diversity, its practical impact might be mitigated by other developments,” said Jonathan Richman, a partner at Proskauer Rose LLP and co-head of the firm’s asset management group. 

“Institutional investors and shareholder groups have been expressing concern in recent years about the lack of diversity on corporate boards,” he said in written commentary. “Pressures toward greater diversity on corporate boards thus exist even apart from state-law requirements such as California’s.”

BlackRock

BlackRock Inc., The Vanguard Group Inc. and State Street Global Advisors all updated their proxy voting policies for this year to ratchet up pressure on companies to improve board diversity. BlackRock, the world’s largest asset manager, said boards should aim to reach 30 percent of members representing diverse groups and have at least two directors who identify as female and at least one who identifies as a member of an underrepresented group.

All three firms, which collectively manage more than $21 trillion in assets, expect companies to improve their disclosure on the diversity characteristics of their boards. Otherwise, companies could face “against” or “withhold” votes from BlackRock, Vanguard and State Street on their board nominees.

“This position is based on our view that diversity of perspective and thought — in the boardroom, in the management team, and throughout the company — leads to better long-term economic outcomes for companies,” BlackRock said in its guidelines. 

Institutional Shareholder Services Inc. and Glass, Lewis & Co., the country’s two biggest proxy advisory firms, disclosed earlier this year that they would recommend that their clients vote against corporate board directors that do little to increase board diversity. 

ISS this year began issuing vote recommendations to its clients on the basis of a lack of racial and ethic diversity for boards of corporations on the Russell 3000 and S&P 1500 indexes. Meanwhile, Glass Lewis said for Russell 3000 companies, it will “generally recommend” voting against the chair of a board’s nominating committee if the board has fewer than two gender diverse directors, or the entire nominating committee of a board with no gender diverse directors. 

ESG investors are also gaining another tool next proxy season to push corporations to have more diverse boards. The SEC last year adopted a final rule that will require companies to provide universal proxy cards in contested director elections, rather than making investors either vote for the company’s entire slate of directors or the dissidents’ slate. Companies have until Sept. 1 to comply.