After testing the waters with Senate Bill 826's gender diversity mandate in 2018, with Gov. Gavin Newsom's signature on Sept. 30, California has now further committed public companies headquartered within the state to a statutory mandate for equitable board representation with its new corporate board diversity measure, Assembly Bill 979.
The bill's precursor, which mandates gender diversity measures for boards of publicly held corporations headquartered in California, is currently under legal attack based upon a plaintiff-taxpayer's claim that SB 826's gender classifications violate the equal protection clause of the California Constitution. While one case (Crest v. Padilla) remains pending in Los Angeles County Superior Court, two other cases mounting similar challenges to SB 826 have thus far been dismissed. AB 979 will likely face similar legal challenges.
While many corporations (if not all) aspire to diversify their boards of directors, AB 979 makes that aspiration a legal mandate. Public companies should, therefore, at least prepare to make some important modifications to board governance relating to board recruiting to meet the new the statutory mandate.
What "Compelling Interests" Does AB 979 Address?
The rules applicable to governmental classifications based on racial, gender or other protected categories are well known: Such classifications will only pass constitutional muster if they are narrowly tailored to further a "compelling governmental interest." Toward this end, and presumably in anticipation of legal challenges, the introduction to AB 979 recites the legislative underpinnings for its purpose. Those legislative findings note, among other things, that there are 662 publicly traded companies headquartered in California, and of this number, 233 have an all-white board. In addition, of this same group, 13% have at least one Latino board member, 16% have one African-American board member, 42% have one Asian board member, and 6% have at least one non-white or "other" board member as of May 2020. But all public companies with California headquarters have at least one white board member.
Citing these statistics, among others, the California Legislature found that board directors "exert considerable influence" over corporations and therefore society. As directors gain seats on more boards, they influence the creation of policy and, according to the legislative findings, this rise in corporate status, which the Legislature referred to as "the corporate elite," in turn enhances influence on the creation of policy.
What Does AB 979 Require for California- Based Public Companies?
By the end of 2021, AB 979 will require that, in addition to female representation, public companies headquartered in California must have at least one board member from an "underrepresented community." The law defines an individual from an underrepresented community as someone 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 law will take a phased approach, and by the end of 2022, will require:
• If there are nine or more directors, a board must have at least three directors from underrepresented communities;
• If there are four but fewer than nine directors, a board must have a minimum of two directors from underrepresented communities; and
• If there are fewer than four directors, a board must a minimum of one director from an underrepresented community.
As with SB 826, the law dictates that the California secretary of state shall issue appropriate reports reflecting those companies in compliance and those who moved their United States headquarters to California from another state or out of California into another state during the preceding calendar year and those who ceased being publicly traded. And, like SB 826, the law permits the secretary of state to impose significant fines upon transgressors ($100,000 for the first violation and increasing from there). While the law appears to mirror SB 826's reporting requirements (which mandates the filing of an annual statement with the California secretary of state), the law does not require corporations to identify by name each director who the company reports as reflecting the underrepresented community the director represents.
How Does AB 979 Square with Laws Prohibiting Discrimination?
Here in California, in addition to the rights the California Constitution affords to citizens, the Unruh Civil Rights Act (Civil Code Section 51) guarantees the equal protection of laws for all California citizens without regard to their sex, race, color, religion, ancestry, national origin, disability, medical condition, genetic information, marital status, sexual orientation, citizenship, primary language, or immigration status. The law unambiguously guarantees that all individuals are entitled to the full and equal accommodations, advantages, facilities, privileges, or services of all business establishments of every kind. The Unruh Act applies to service by individuals on both profit and non-profit corporate boards. Board of Directors v. Rotary Club of Duarte, 487 U.S. 537 (1987).
Despite these legal protections, however, it is equally clear that the government may, to promote a compelling governmental interest, narrowly tailor certain legal classifications in order to achieve what it determines to be compelling interests. Whether AB 979 will withstand legal challenge on this basis remains to be seen, but the law may be subject to others challenges on the basis of vagueness given its reliance on self-identification with the applicable underrepresented community classification and the lack of legal guidance regarding how such self-identification complies with this legislative scheme.
AB 979 categorizes individuals who are members of underrepresented communities as those who "self-identify" with the specific categories the law protects. But the law does not provide guidance regarding the concept of "self-identification." For example, an individual born to a designated "underrepresented community" who is raised in that community, and who may have hallmarks of that community (color, physical characteristics, language, name, and other cultural attributes), may appear to the world at large as someone who is a part of that community. But it is also possible that an individual, for a variety of reasons relating to upbringing and personal experiences, in fact "rejects" their "designated" heritage and instead self-identifies with another cultural or racial heritage. There is no objective barometer to determine the legitimacy of any individual's self-identification nor does such a barometer seem something that is properly the subject of legislation. This lack of objective guidance could invalidate the law on the basis of vagueness because no legislative guideposts exists as to the concept of "self-identification" and how such identification functions in this legislative scheme.
What Steps Should Boards Take to Comply with AB 979's Mandate?
Unlike employment recruiting, which lends itself to a more transparent -- and given our digital world and the dominance of social media -- very public solicitation of applicants for available positions, board seats are rarely (if ever) publicly "advertised" and the recruiting, vetting and nomination process for board seats vastly differs depending on company size, the sophistication of its board and governance procedures, and the skill of the individuals who sit on the governance and nominating sub-committees. But these boards must plan for AB 979's implementation, design the implementation process, and prepare the recordkeeping and reporting that AB 979 requires.
(a) Guidance for the Board Committee Responsible for Recruiting
AB 979 imposes unique requirements not only on the corporation, but more importantly, on the specific sub-committee of the board tasked with recruiting candidates to fill board seats. These sub-committees, typically denoted "Gov/Nom" in board-speak, may be fortunate enough to be composed of one or more individuals with actual recruiting or employment compliance experience. But the vast majority of Gov/Nom committee members may only have general recruiting experience in their particular industries; while that experience is necessary and invaluable, it is insufficient to meet the challenges that AB 979 poses.
AB 979 mandates that corporations fill vacant board seats (or newly created board seats upon a bylaw amendment expanding the board) with individuals who identify with the statutorily defined underrepresented communities. The first challenge board members face is facilitating the process for delineating the self-identification of the individual recruit, i.e., into what "underrepresented community" the individual places themselves, if any. This is similar to the Equal Employment Opportunity Commission mandate that requires employers of 100 or more employees or those with federal government contracts in excess of $50,000 to file annual EEO reports designating the demographic categories into which applicants and employees fall. Those categories align closely (though not exactly) with the AB 979 classifications. Those familiar with EEO reports know that this information is collected on a purely voluntary basis. In other words, an applicant or employee may be asked to voluntarily self-identify the category into which the individual falls (e.g., identifying themselves as Black, Hispanic, etc.) but an applicant or employee cannot be forced to self-identify. If the individual elects to not identify this information, then the employer must rely upon the employer's observation (and subjective determinations) of where the employer believes the individual is properly categorized.
AB 979 imposes similar requires on corporate boards which must now designate a board governance representative (general counsel or chief legal officer, chief human resource officer, chair of a Gov/Nom committee) to collect this data, track it, and retain it. That informational process begins with a request to individual board members and candidates to self-identify. The process necessarily also requires a determination into whether someone is a legitimate candidate or someone who is a potential candidate: AB 979 does not give guidance in this regard but instead focuses on the final result -- the actual board members who are seated. Training for Gov/Nom committee members as well as engaging expert assistance (particularly professional board recruiters who may not only provide guidance, but who may be a fertile source of non-traditional but qualified candidates) will be critical in meeting these needs. And while making the appropriate identification and seating the successful candidate may be the result, it is the means to that end that merits board focus. In other words, these issues are critical not just for compliance purposes but more importantly for strategic planning to construct a board sufficiently diverse that outperforms legislative mandates.
(b) Audits and Education
Corporations will not suddenly (and magically) find themselves governed by boards that meet AB 979's mandate. Rather, recruiting strategies and practices start with the corporation's mission. Long-term strategy doesn't begin with a quota-driven mandate but with a critical review of what has transpired to date -- and whether those practices have been effective. A self-audit, like any good compliance practice, with feedback from key stakeholders (including shareholders) is a starting point. Here, providing educational resources for board members to understand the purpose of board recruiting, its function, and the genesis of candidate selection, is necessary to directing that strategy moving forward. This is where good board governance meets AB 979.
Accordingly, before implementing an AB 979 compliance policy, boards should undertake a self-audit to determine not only the current gender and racial makeup of their boards, but also to review term limits and upcoming vacancies, as well as industry or other particular expertise necessary to fulfill the corporation's mission. Repeating the same recruiting errors -- such as identifying candidates solely through long-standing industry business groups or networks -- should cease or be diminished. Mentoring and other long-term programs intended to reach underrepresented communities should also be explored as these programs may produce non-traditional but qualified candidates for board roles.
(c) Resources and Recordkeeping
AB 979 poses a similar challenge to SB 826 that appears to remain unresolved: a new reporting mechanism that may (or may not) correspond with proxy season, Federal regulatory reporting, and the election (or re-election) of board members. Procedures should be established to track this information for purposes of reporting, perhaps aligned with existing board governance and management practices. In addition, with respect to personnel, the right individuals should be selected who will compile, track and maintain this information. The data privacy laws (particularly in California) will apply to much of the sensitive information collected from board candidates. Other sensitivities should be observed, such for example, respecting the wishes of an individual who self-identifies with the LGBT community but who does not wish that information to be publicized.
Some critics of the legislative solution to board diversity note the legal challenges that quotas pose and the sensitivities around requiring board candidates to self-identify, whether that identification be as to gender or as to belonging to one or more underrepresented communities. Moreover, board members may not possess the skill to make determinations regarding the validity of membership in certain categories as part of the board vetting process. Some detractors of statutory mandates believe that the significant but potentially more impactful efforts that shareholder activism could have on effectuating diversity and inclusion in the boardroom is a more appropriate process to ensure board diversity. That activism -- together with the growing significance of the ESG movement -- may speed the process more organically and possibly more effectively as corporations recalibrate their mission and purpose in light of current events, such as calls for racial equity and the impacts of the pandemic on our economy and social welfare generally.
But it is undeniable that the precursor to AB 979 requiring gender representation has had a positive impact on gender representation for public company boards -- and in fact, that impact might even be understated due to potential flaws in the timing and methodology of reporting to the secretary of state. That beneficial impact has certainly motivated the California Legislature to pursue tackling diversity and inclusion in the boardroom on a much broader scale. It remains to be seen whether AB 979 is equally as effective -- or whether is succumbs to legal challenge.