California Board Diversity Rules:
Struck-Down Statutes and Paths Forward

A Tale of Two Bills
Enacted on September 30, 2018, Senate Bill (“SB”) 826 required public companies that hold their principal executive office in California, including publicly held domestic or foreign corporations, to have at least one female on its board of directors by the end of 2019. By the close of 2021, the bill increased this requirement to two female directors if the board was made up of five directors, and three female directors if the board was made up of six or more directors. The Secretary of State was authorized to impose violations of $100,000 for first time violators and $300,000 for repeat violators. (We discuss SB 826 in detail here.)

Exactly two years after SB 826 was legislated, a second groundbreaking piece of legislation was enacted on September 30, 2020. Assembly Bill (“AB”) 979 required any publicly held domestic or foreign corporation with its principal executive office in California to have a minimum of one director from an underrepresented community on its board of directors by the end of 2021, and by 2022 to have additional directors from underrepresented communities based on the size of the board. As set forth in the law, an “underrepresented community” includes individuals who self-identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identify as gay, lesbian, bisexual, or transgender. The Secretary of State has the authority to impose fines on companies who violate this law, similar to SB 826 discussed above. (We discuss AB 979 here.)

California Courts Strike Down Both Diversity Rules
On May 13, 2022, a California Superior Court struck down SB 826 in Crest v. Padilla, No. 19-STCV-27561, which was challenged on the basis that it violates the Equal Protection Clause of the California Constitution for its “suspect classification” that “affects two or more similarly situated groups in an unequal manner.” The court applied the strict scrutiny test and was not able to find (1) a compelling state interest, (2) that SB 826 was necessary to boost California’s economy, improve opportunities for women in the workplace or even improve corporate performance or governance and (3) that SB 826 was narrowly tailored. The court commented that SB 826 “does not identify any purposeful or intentional, unlawful discrimination it sought to remedy” and that the law was promoting “gender-balancing, not remedying discrimination.”

AB 979 was similarly struck down in Crest v. Padilla, 20-STCV-37513, for violating the Equal Protection Clause of the California Constitution. The court determined that certain board seats should not be reserved for individuals from the list of underrepresented communities because, in doing so, companies blocked members from other groups from taking those positions, “only in very particular cases should discrimination be remedied by more discrimination.” The court was not swayed by a compelling interest to justify this classification and the court found that the statute was not narrowly tailored to serve the interest of this law.

Next Steps
Though these two statutes were unique in that—no other state in the country required corporate boards to include either women or individuals from underrepresented community on public company boards at that time, let alone require both—legislation is not the only agent in the public sector pushing for board diversity. Other actors include CEOs, proxy advisors, institutional investors and, most notably, Nasdaq’s Board Diversity Rule (adopted August 6, 2021), which requires Nasdaq-listed public companies to have at least two diverse directors, including one who self-identifies as female and one who self-identifies as either underrepresented minority or LGBTQ+. A company that does not meet the diversity objective can alternatively provide an explanation for not doing so, and its explanation may include a description of a different approach (there are certain exceptions to these rules available for Smaller Reporting Companies and Foreign Issuers). Additionally, all Nasdaq-listed companies are required to annually disclose board-level diversity statistics.

The Securities and Exchange Commission commented that the Nasdaq rule was a “starting point for initiatives related to diversity, not the finish line,” and companies seeking to form and execute board diversity strategies going forward would do well to take this perspective to heart.