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Questions About Diversity On Public Company Boards

In a well-intentioned push for more diversity on public company boards, California has passed two different laws in recent years that effectively establish quotas based on gender, race and/or sexual orientation for publicly held corporations with principal executive offices in the state.  
There are at least 28 public companies with principal executive offices in Orange County with a market cap in excess of $1 billion, and several dozen more smaller public companies.
Senate Bill 826, passed in 2018, added Section 301.3 to the California Corporations Code, and requires such publicly held corporations to have at least one female director on its board by Dec. 31, 2019. The term “female” was expressly defined to mean “an individual who self-identifies her gender as a woman, without regarding to the individual’s sex at birth.”  
The problem that SB 826 aimed to address—a lack of gender diversity on public company boards— is a real one.  A 2018 Report by Board Governance Research LLC analyzed 632 public companies with headquarters in California and found that only 15.5% of the California director seats are held by women, and that 29% of public boards had no women. The problem was particularly acute with micro-cap companies, of which 53% had no women on their boards.    
However, SB 826 does not simply mandate one female director, as is often reported, it also contains an “escalation clause” which requires each company meet minimum numbers by Dec. 31, 2021.
On the heels of SB 826, California passed Assembly Bill 979 in 2020, which added Section 301.4 to the Corporations Code. That section requires that by Dec. 31, 2021, boards of public companies also have at least one member from an “underrepresented community,” defined 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 lack of racial diversity on corporate boards is also a real problem. In passing AB 979, the legislature noted that currently over 35% of publicly traded corporations with principal executive offices in California have all white boards of directors.  
However, like SB 826, Section 301.4 has an “escalation clause” which also has minimum requirements to meet by Dec. 31, 2022.
Both laws now provide for stiff penalties for non-compliance, including $100,000 fine for an initial violation and a $300,000 fine for a subsequent violation.
While both laws were well intentioned, the “escalation clauses” in these laws effectively mean that by the end of 2022 a public company board with nine members would need to have three female directors and three underrepresented directors (representing 66% of its board). A public company board with five members would need to have two female directors and two underrepresented directors (representing 80% of its board). A public company board with six members would need to have three female directors and two underrepresented directors (representing 83% of its board). Accordingly, these laws would effect a sea change in the composition of boards of public companies with principal executive offices in California. One important caveat is that directors whom are both female and underrepresented will satisfy the requirements of both laws.  

Immediate Impacts and Suggestions
In order to comply with these laws, companies may prioritize board candidates that are both female and from an underrepresented group— as such candidates will satisfy the requirements of both laws at the same time and thereby minimize board disruption. However, this may also have the unintended consequence of limiting opportunities for heterosexual white women, or underrepresented men, who check only one box, not two. Another potential avenue to compliance is to simply make boards larger in order to accommodate new board members who fulfill these requirements without reducing existing board members.  
Notably, these laws also have been and will be challenged as violating the 14th Amendment Equal Protection Clause of the United States Constitution. Initial challenges to the gender diversity law on this basis were rejected by a Federal District Court because the shareholder of a public corporation challenging the law was found not to have suffered a direct injury and so lacked standing to bring the case. However, once public companies start being fined $100,000 or $300,000 for non-compliance with these new laws, company challenges based on 14th Amendment grounds will be ripe.  
Another interesting question is how “self-identification” as a female or an underrepresented person will be enforced, if at all.
There is no definition of “majority” or “minority” in the law. There is no guidance as to what percentage someone needs to be, as long as they “self-identify” as an “underrepresented person.”
For instance, if an individual who for all other purposes would fall into the “majority” category has a grandparent who was born in Argentina, does that person qualify as “underrepresented” and “Latino” if they so state? Issues of interpretation and equal protection will no doubt be litigated in the Courts.

Editor’s Note: Shane P. Criqui, a partner at Newport Beach-based Stuart Kane LLP, has defended publicly traded companies, has been named a “Best Lawyer” in America for 2021, and has been named a “Rising Star” by Super Lawyers magazine four times. Prior to becoming a lawyer, he worked as an investment banking analyst for CIBC World Markets (aka CIBC Oppenheimer) in New York City.

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