California law set to boost board diversity

Sep 30, 2020
Governor to decide this week whether to sign bill into law

California’s Assembly Bill (AB) 979 is set to make waves both within the state and across the country as a groundbreaking new law that would require companies to diversify their boards and reserve seats for directors from ‘under-represented communities.’

If Governor Gavin Newsom signs the bill this week, it will be the first of its kind in the US as no other law mandates representation from deemed under-represented communities on company boards. Newsom has until this Wednesday to sign or veto the bill.

The bill defines a director from an under-represented 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.’

The bill, which the state legislature passed on August 30, 2020, would require all publicly held companies with headquarters in California to have a minimum ratio of members from under-represented communities.

What the new law requires

If signed into law, AB 979 will apply to any publicly held company, both foreign and domestically incorporated, whose principal executive offices are in California. It will impose that boards of such companies:

  • Have a minimum of one director from an under-represented community on its board no later than December 31, 2021 and
  • By no later than December 31, 2022, have at least:
    • Three directors from under-represented communities if the board has nine or more directors
    • Two directors from under-represented communities if the board has more than four but fewer than nine directors, or
    • One director from an under-represented community if the board has four or fewer directors.

Companies may increase the size of their boards in order to comply with the law.

In addition, no later than March 1, 2022, and each following year the California secretary of state will publish reports on its website related to the law. The reports will include information on the number of companies in compliance during at least one point in the preceding calendar year, the number of companies moving their principal executive offices to or from California during the preceding year and the number of public companies that were subject to the law during the preceding year, but are no longer publicly traded.

The secretary of state may also impose fines of $100,000 for a first violation and $300,000 for any subsequent violation, and may fine companies $100,000 for failure to file board member information in a timely fashion pursuant to this bill.

Preparing for compliance

General counsel of public companies in California will have an important role in helping their board navigate compliance with AB 979, if passed. At a minimum, general counsel will need to educate their board, and in particular nominating and corporate governance committees, about the new law’s requirements and timetable for compliance, and should consider updates to companies’ corporate governance guidelines, nominating and corporate governance committee charters and other documentation setting forth standards for director qualifications.

Companies should not take an isolated approach to implementing the law. Rather, its passage should provide a new impetus for boards of directors to consider companies’ diversity and inclusion policies and director qualifications overall.

Companies may wish to consider higher standards for diversity than those required by the law or widen the scope of metrics for under-represented communities beyond those set by the law while still meeting its minimum requirements.

For example, a board could consider whether board composition should mirror the workforce of the company and what messaging the company wants to convey regarding diversity and inclusion as it searches for new directors. Indeed, whatever updates are made to a company’s director qualification policies will also need to be communicated in its next proxy statement.

Boards should also work with counsel to ensure any new standards adopted regarding board composition are relayed to director search firms, and that search firms are identifying potential candidates based not just on the new law but also on expertise needed at the board level, potentially with reference to a matrix of qualifications already represented by the current directors.

Furthermore, companies should start to prepare their messaging on efforts to comply with AB 979, as well as their diversity and inclusion principles generally, for future stakeholder engagements as such questions will likely arise.

Unless boards of directors want to expand their size, or already happen to be compliant with AB 979’s requirements, some existing board members will need to be replaced by new directors to comply with the law. Therefore, it is imperative that companies’ upcoming annual board evaluation process is thoughtful and takes into consideration such board dynamics.

General counsel should assist nominating and corporate governance committees’ evaluations of current director qualifications by ensuring evaluation questionnaires submitted to directors contain questions that enable boards to determine the right board composition, including questions about which directors’ expertise and qualifications are critical and therefore cannot be replaced.

Although a sensitive topic, general counsel may need to determine a method to solicit and gather information regarding the self-identification of their board members, as these affirmations will enable companies to evidence compliance with AB 979.

Potential challenges

This new law will likely be met with heavy scrutiny. California’s previous legislation regulating board composition, Senate Bill No 826, requires publicly held companies whose principal executive offices are located in the state of California to meet minimum requirements for female board representation. Senate Bill No 826 was heavily opposed by the California Chamber of Commerce as well as other state organizations and has been the subject of at least two lawsuits challenging its constitutionality.

The first suit, which is pending, was filed in state court by Judicial Watch on behalf of three California taxpayers on the grounds that the mandate is an unconstitutional gender-based quota under the California Constitution. The second suit, which is currently on appeal, was filed by the Pacific Legal Foundation in federal district court and alleged that the state’s mandate is in violation of the equal protection clause of the US Constitution because it discriminates on the basis of sex.

AB 979 will likely face similar legal pressure as critics see it as unconstitutional for creating a mandatory quota related to race and sexual orientation.

The bill defends itself from legal challenge within the text, asserting that affirmative action plans to increase the representation of minorities further the legislative goals of the Civil Rights Act of 1964. AB 979 states that it is permissible under the act because the act:

  • Permits affirmative action plans to address past discrimination and patterns of discrimination
  • Permits state actors to create affirmative action plans that are moderate, temporary and designed to attain a balanced workforce
  • Does not forbid private actors from voluntarily creating plans to increase representation of minorities, as long as they are temporary and do not place an absolute bar against white employees.

Despite potential challenges to the law, companies with their principal executive offices in California should closely monitor this law, as well as their own board compositions.

Alexa Belonick, Jackie Liu and Alfredo Silva are partners and Will Carter is an associate with Morrison & Foerster

This article originally appeared in IR Magazine sister publication Corporate Secretary

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