On September 30, 2020, California Governor Gavin Newsom signed into law a landmark bill (AB 979) requiring boards of directors of California-based public reporting corporations to have a minimum number of directors from underrepresented communities on their boards.
Definition of Underrepresented Communities
The law defines underrepresented communities broadly to include those who self-identify as “Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or . . . as gay, lesbian, bisexual, or transgender.” Modeled on California’s 2018 boardroom gender diversity law (SB 826), the new diversity statute is the first state or federal law to mandate such representation.
Applies to Publicly Traded Corporations Based in California
The law applies to the same universe of corporations that are subject to the gender diversity law—meaning corporations (1) whose shares are listed on “a major United States stock exchange,” and (2) whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California. Notably, the law applies to foreign corporations (e.g., those that are incorporated in a state other than California) as long as they meet the requirements listed above.
Phased-In Mandatory Minimums—One Director from an Underrepresented Community by End of 2021; Up to Three by End of 2022
All covered corporations must have a minimum of one director from an underrepresented community on their boards of directors by no later than December 31, 2021. By December 31, 2022, covered corporations must have a minimum of:
- three directors from underrepresented communities, if its number of directors is nine or more;
- two directors from underrepresented communities, if its number of directors is five to eight; or
- one director from an underrepresented community, if its number of directors is four or fewer.
Penalties for Failure to Comply
Corporations that do not comply may be subject to fines. The law authorizes the secretary of state to impose fines of $100,000 for a first violation and $300,000 for a second or subsequent violation, in addition to a $100,000 fine for failure to timely file board member information. Covered corporations will likely be subject to reporting obligations to allow the secretary of state to issue annual, publicly available reports regarding compliance with the law’s provisions and levy fines as necessary. However, as long as a director from an underrepresented community has held a seat for “at least a portion of the year,” a covered corporation will not be subject to fines.
Direct and Indirect Impact
The passage of the law may have wide-ranging direct and indirect effects. According to a study by the Latino Corporate Directors Association, referenced by the Assembly’s bill analysis, “233 of the 662 public-company boards in California have no ethnic or racial representation.” While the law provides for fines and penalties, it may be most effective by serving as a catalyst for voluntary compliance. For example, following passage of SB 826, mandating gender diversity, corporations subject to the law overwhelmingly chose to appoint female directors rather than raise legal challenges to the legislation. The law may also accelerate efforts by other states, institutional investors and other companies to increase the diversity of their directors and bring a broader range of perspectives to the boardroom.
Possible Constitutional Challenges
It is likely that the law will be challenged in court, as the Senate and the Assembly have noted that the law may be subject to claims that it violates the equal protection clauses of both Article I of the California Constitution and the Fourteenth Amendment of the US Constitution, which subject laws involving racial classifications to heightened scrutiny. SB 826, the gender diversity statute, is currently facing two different lawsuits. In addition, because it applies to corporations headquartered in California regardless of where they are incorporated, the law may also be challenged for violating the “internal affairs doctrine,” a conflict-of-laws principle that recognizes that the state of incorporation should have the authority to regulate a corporation’s internal affairs, such as the composition and election of its board of directors.
This post comes to us from Arnold & Porter Kaye Scholer LLP. It is based on the firm’s memorandum, “California Becomes First State to Require Members of Underrepresented Communities on Boards of Directors,” dated October 1, 2020, and available here.