As noted in previous client alerts (including here), boardroom diversity continues to be an
increasing focus of stakeholders ranging from legislators to
institutional investors to retail stockholders. In recent years,
their efforts have yielded significant legal developments that
impose pressure — and, in some cases, mandatory requirements
— on corporations to include more directors from historically
underrepresented groups on their boards. Against this backdrop,
multiple stockholder lawsuits have challenged companies’
alleged failures to fulfill their corporate diversity aspirations,
by bringing fiduciary duty and securities claims against directors
and officers of these companies.
This client alert provides an update on the landscape in which
U.S. corporations ramp up their boardroom diversity efforts. Topics
include (1) the legal challenges directed against state and
regulatory corporate diversity requirements; (2) the status of
certain stockholder litigations; and (3) the updated board
diversity policies of proxy advisory firms and large institutional
investors.
Legal Challenges Directed Against State and Regulatory
Corporate Diversity Requirements
California Statutes
California spurred the growing legislative movement focusing on
corporate diversity. In 2018, the state signed into law SB 826, a
statute requiring a minimum number of women to serve on the boards
of public corporations with principal offices located there (even
if those entities are not incorporated in California). AB 979
followed two years later and extended similar requirements to the
number of directors from historically underrepresented communities.
Both of these statutes — predictably — have been
subject to legal challenge in state and federal courts.
A post-trial decision is pending in the first of the actions,
Crest v. Padilla, filed in California state court to
prevent the implementation and enforcement of SB 826. Asserting
standing as taxpayers, three plaintiffs alleged that the
statute’s mandate is unconstitutional in setting a gender-based
quota and, therefore, sought to prevent the unlawful expenditure of
taxpayer funds to enforce it. California argued that the statute
did not set any quota because it simply required adding seats for
women without eliminating seats for men, reflecting the state’s
“compelling interest” in gender diversity.1 A companion
suit filed by these plaintiffs challenges AB 979 on essentially the
same grounds, with a trial scheduled to begin before another judge
in California state court at the end of March. Together, these
rulings could help clarify the constitutional parameters of state
corporate diversity provisions.
Meanwhile, two ongoing federal lawsuits claim that these
California statutes violate the Equal Protection Clause of the U.S.
Constitution. In Meland v. Weber, a shareholder of a
public company headquartered in California filed an action
challenging SB 826. The district court dismissed for lack of
standing, only to be reversed by a three-judge panel of the Ninth
Circuit. The panel reasoned that “[a] person required by the
government to discriminate by ethnicity or sex against others has
standing to challenge the validity of the requirement, even though
the government does not discriminate against him.”2 Back in the
district court, the parties now await a ruling on a preliminary
injunction motion, which the state opposed by reasserting a
standing challenge on the grounds that the plaintiff purportedly
did not own enough stock to affect the outcome of any director
election and could not have been coerced to vote for a woman when
he in fact had just voted against her. The same district court
judge presides over Alliance for Fair Board Recruitment v.
Weber, a lawsuit filed by a nonprofit organization whose
members claim to be aspiring directors or shareholders of companies
subject to both SB 826 and AB 979.
The extent to which corporate diversity provisions can withstand
these equal protection claims remains an open question. Once the
courts issue their rulings, these cases may provide guidance on how
legislators in other states can draft their own versions of these
provisions, as well as how corporations can meet the applicable
legal standards.3
SEC Order Approving Nasdaq’s Proposed Rule
Changes
Signifying an increasing regulatory interest in board diversity,
in August 2021, the U.S. Securities and Exchange Commission (SEC)
issued an order approving the “comply or disclose” board
diversity framework introduced by Nasdaq Inc. As discussed in a
previous client alert (here), Nasdaq’s proposed rule changes
require companies listed on its stock exchange to either (1)
include on their boards at least one woman, as well as at least one
individual who identifies as a racial minority or as LGBTQ+, or (2)
file a written explanation for why they are not meeting
Nasdaq’s diversity targets. In Alliance for Fair Board
Recruitment v. SEC, the same nonprofit that challenged
California’s corporate diversity statutes filed an action in
the Fifth Circuit, arguing that the SEC’s order violated the
Equal Protection Clause. The nonprofit also asserted that the SEC
lacks statutory authority to regulate the demographic composition
of corporate boards. While Section 25(a) of the Securities Exchange
Act of 1934 permits any “person aggrieved by a final
order” to seek review of the order, the filing of the petition
does not operate as a stay of the rule.
Status of Certain Stockholder Litigations
We have previously noted the uptick in stockholder litigation
claiming that large corporations and their directors committed
fiduciary duty breaches and securities laws violations in
connection with alleged diversity shortcomings (including here). This month, a California district court
granted a motion to dismiss a shareholder derivative action against
Cisco Systems Inc. where the plaintiff did not properly allege that
the board wrongly refused its pre-suit demand, or that such demand
would have been futile.4 To the contrary, the court pointed to the
“extensive investigation and review” conducted by the
company’s demand review committee over the course of several
months, which involved 22 witnesses. On that basis, the committee
found that the company had “accurately described its diversity
initiatives . . . and that none of its public statements in the
Proxy Statements, [in the Corporate Social Responsibility] Reports,
or elsewhere were false or misleading,” thus recommending that
the board not pursue the claims. This decision is consistent with
Ocegueda v. Zuckerberg, in which the magistrate judge
dismissed the complaint on similar grounds.5
Proxy Advisory Firms and Institutional Investors
As we previously discussed here, the two largest proxy advisory firms in
the United States, Institutional Shareholder Services (ISS) and
Glass Lewis, have released their U.S. voting policies for the 2022
proxy season, which include specific guidelines relating to board
diversity.
Regarding gender diversity, ISS will recommend voting against
the chair of the nominating committee for companies in the Russell
3000 or S&P 1500 indices if there is not at least one woman on
the board. For companies not in the Russell 3000 or S&P 1500
indices, this policy will be effective for meetings on or after
Feb. 1, 2023. Glass Lewis goes a step further, and will recommend
voting against chairs of nominating committees of companies in the
Russell 3000 Index if the board has fewer than two gender-diverse
directors (identifying as female or outside of the gender binary),
and against the entire nominating committee if the board has no
gender-diverse directors. Starting Jan. 1, 2023, Glass Lewis will
recommend voting against the nominating committee chair if the
board is not at least 30{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} gender diverse. However, Glass Lewis’
current policy requiring a minimum of one gender-diverse director
will continue to apply to companies not in the Russell 3000 Index
or with boards of six or fewer directors.
With respect to racial and ethnic diversity, ISS will recommend
voting against the chair of the nominating committee of any company
in the Russell 3000 or S&P 1500 indices if the board does not
have at least one apparent racially or ethnically diverse member.
Starting in 2023, Glass Lewis will adopt a similar policy,
recommending shareholders vote against the chair of the nominating
and/or governance committee of companies in the S&P 500 index
that do not disclose individual or aggregate racial or ethnic
demographic information for the board.
Finally, ISS will approach shareholder proposals asking a
company to conduct an independent racial equity and/or civil rights
audit on a case-by-case basis, considering a number of factors,
including the company’s established internal processes for
addressing racial inequity/discrimination, the company’s
engagement with impacted communities, whether the company has been
the subject of recent controversy and whether the company’s
actions are aligned with market norms.
Large institutional shareholders including BlackRock, Vanguard
and State Street have also released updates to their 2022 proxy
voting guidelines that address diversity concerns. For example,
BlackRock has adopted a policy regarding board diversity that is
similar to Glass Lewis’, and has stated that companies should
aspire to reach 30{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} member diversity on their boards, with at least
two directors who identify as female and at least one director who
is a member of an underrepresented group. Unlike the policies
proposed by the advisory firms, Vanguard has not adopted minimum
diversity requirements, but stated it will vote against the chair
of the nominating or governance committee of the company if it is
making “insufficient progress” with regard to board
diversity. And State Street, starting in 2022, expects each of its
portfolio companies to have at least one woman on the board of
directors, and in 2023 will increase this requirement to 30{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} women
for companies in major indices. Additionally, State Street will
vote against responsible directors if (1) companies in the S&P
500 and FTSE 100 do not have a person of color on their boards, (2)
companies in the S&P 500 and FTSE 100 do not disclose the
racial and ethnic diversity of their boards, and (3) companies in
the S&P 500 do not disclose their EEO-1 reports.
Conclusion
As these recent developments demonstrate, boardroom diversity
continues to be a hot-button issue. Directors and executive
management, and their advisors, should be proactive in monitoring
the constantly evolving legal, regulatory and private frameworks
governing diversity objectives.
Footnotes
1.
See https://www.law360.com/articles/1444974/calif-ag-defends-corp-board-diversity-law-as-trial-opens.
2.
See https://cdn.ca9.uscourts.gov/datastore/opinions/2021/06/21/20-15762.pdf.
3. A
number of states have followed California’s lead in enacting
(or considering enacting) some type of board diversity measure. For
example, New York requires every public and private for-profit
corporation authorized to do business in the state to report the
number of directors on its board and how many of them are women,
thus encouraging gender diversity through this disclosure-based
legislative regime. Meanwhile, Washington mandates that the boards
of public companies incorporated in the state either include at
least 25 percent women or comply with disclosure
requirements.
4.
See https://www.law360.com/dockets/download/621e91c5f53a6a032e2b86ae?doc_url=https{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}3A{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}2F{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}2Fecf.cand.uscourts.gov{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}2Fdoc1{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}2F035121661814&label=Case+Filing.
5.
See https://storage.courtlistener.com/recap/gov.uscourts.cand.361956/gov.uscourts.cand.361956.61.0.pdf.
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