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Corporate Board Diversity: Next Steps for Employers After Court Strikes Down California Board Diversity Law

By Alyesha Asghar, Corinn Jackson, Dionysia Johnson-Massie, and Lysette Roman

April 18, 2022
12 minute read

On April 1, 2022, a Los Angeles County Superior Court ruled that California Assembly Bill 979—a bill designed to increase diversity and improve the persistently low number of underrepresented groups on corporate boards—violated the Equal Protection Clause of the California Constitution and was therefore unenforceable. In its ruling, the court acknowledged the pitfalls of homogeneity in business and communities, but it cautioned against quotas and specific number requirements.

With the global trend towards prioritizing inclusion, equity, and diversity (IE&D) in the workplace, how will this decision affect current and future IE&D legislation? And how can corporations lean into this trend, while remaining within the bounds of the law?

AB 979—Summary and Purpose

On September 30, 2020, California Governor Gavin Newsom signed AB 979 into law, stating that the purpose of the legislation was to tackle the persistent absence of underrepresented groups on corporate boards in the state.¹ The bill required publicly held corporations, whose principal executive office was in California, to include at least one director from an underrepresented community by December 31, 2021.² The law defined an individual from an underrepresented 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.”

AB 979 was designed to increase representation over time. While all boards were required to have at least one director from an underrepresented community by the end of 2021, that number was set to incrementally grow for larger boards in 2022. The California Secretary of State was required to track and report compliance with AB 979 and levy significant fines for non-compliance.

The passage of AB 979 came on the heels of California SB 826, which mandated similar requirements for gender diversity on corporate boards.³ SB 826 has been the subject of multiple lawsuits.⁴ As Littler anticipated in our initial discussion of the bill, pushback on AB 979 was similarly swift.⁵

The Parties’ Positions

On the same day that AB 979 was passed in September 2020, three California taxpayers filed a lawsuit against the Secretary of State in Los Angeles County Superior Court. This lawsuit—often referred to as Crest II—sought to prevent the State from using taxpayer dollars to enforce AB 979.⁶ Plaintiffs argued that AB 979 was unconstitutional because it required corporations to include a specific number of directors based upon race, ethnicity, sexual orientation, and transgender status. More specifically, the plaintiffs maintained that a quota based upon such classifications was suspect, presumptively invalid under the Equal Protection Clause of the California Constitution, and could not pass muster under “strict scrutiny” in California courts.

The Secretary of State took the opposing position that AB 979 was constitutional because its express purpose was to remedy the effects of past and present discrimination and to enhance the public benefits of diverse corporate boards. It further argued that AB 979 could operate in a way that did not conflict with Equal Protection, and that the listed groups are not similarly situated because they are underrepresented and have been subjected to discrimination.

The parties filed dueling motions for summary judgment beginning in December 2021 and argued their motions before Judge Terry A. Green on March 14, 2022.

The Court’s Ruling

On April 1, 2022, the court granted the plaintiffs’ motion for summary judgment and ruled that AB 979 was unconstitutional.⁷ More specifically, the court concluded that AB 979 violates the Equal Protection Clause of the California Constitution because it cannot pass muster under strict scrutiny:

First, AB 979 expressly applies to suspect classes—race, ethnicity, sexual orientation, and gender identity—and the State could not present a scenario in which this is not the case.

Second, AB 979 “treated similarly situated individuals—qualified potential corporate board members—differently based on their membership (or lack thereof) in certain listed racial, sexual orientation, and gender identity groups. It requires and reserves a specific number of board seats for this listed group, and necessarily excludes members of other groups.” Dismissing the State’s argument that the covered groups are not similarly situated, the court reasoned that equal protection involves “individual rights, not group rights”—the relevant set of individuals in this instance are those “who are qualified to sit on corporate boards.” These individuals are subject to the same process for selecting board members, and therefore similarly situated.

Third, the State failed to adequately show a compelling interest to justify AB 979. The court acknowledged the State’s interests—the public benefits that abound from diverse and inclusive boards, and remediation of past and present discrimination in corporate board selection. However, it maintained that “generic interest in healthy business” does not amount to a compelling interest. And while remediation of discrimination can be a compelling interest, the State did not define the “specific arena” in which the discrimination has occurred—“corporate board selection is neither confined nor specific.” Corporate boards canvas all industries and parts of the United States. Also, the court maintained that the State did not present enough statistical evidence of discrimination to support its anecdotal evidence.

Finally, AB 979 was not narrowly tailored to serve the interest of improving representation on corporate boards, and the quota requirement was not the least restrictive means of accomplishing this goal. The court maintained that the California Legislature had “skipped over several possible intermediate and neutral steps,” such as a demographic disclosure or reporting requirements.

As a result of the court’s ruling, the State is precluded from enforcing AB 979 at this time. In other words, California cannot require boards to include any specific number of individuals from underrepresented groups and cannot fine corporations that fail to do so. And corporations that do institute a quota or specific number requirement under AB 979 may be subject to liability.

Despite its ultimate decision, the Crest II court recognized that the “natural result” of homogeneity is “the loss of the acumen that those [excluded] people would bring to a conversation, business, or any other group.” It recognized that “demographic diversity is a reasonable proxy for differing perspectives and life experiences.” And it recognized that the California Legislature was simply attempting to address the pitfalls of homogeneity on its corporate boards with the most “immediate and obvious solution.” But the court cautioned that the California Constitution protects the right of individuals to equal treatment, so the most direct solution is not always the most lawful.

The Broader Implications of the Crest II Court’s Ruling

As SB 826 and AB 979 have weaved their way through the judicial system, the legislative and regulatory trend towards mandating inclusion of women and other individuals from underrepresented groups on corporate boards has continued.⁸

At least a dozen states⁹ have drafted or passed board diversity legislation—though the focus primarily remains on improving the representation of women on corporate boards. For instance, New York State recently enacted a law requiring foreign and domestic corporations to report the number of directors sitting on their board and how many of those directors are women.¹⁰ Similarly, a recent Illinois law requires domestic and foreign companies to include in their state annual filings data on board composition, the corporation’s process for identifying and evaluating nominees for the board and executive officer positions, including whether and how demographic diversity is considered, and a description of the company’s policies for promoting diversity.¹¹ And a new Maryland law encourages companies doing business in the state to have at least 30% women directors by December 31, 2022, but the requirement to report board composition applies only to domestic companies.¹² These laws differ in an important way from California’s AB 979—they do not mandate a specific number of individuals on any corporate board, which the Crest II court deemed unconstitutional.¹³ Instead, they merely require reporting, which the Crest II court’s ruling has seemingly deemed permissible.

But Crest II has called into question the future of recent legislation – in California and beyond – that requires or would require corporations to include a minimum number of individuals from underrepresented groups on their boards. One such law is California SB 826, enacted two years before AB 979, which requires corporations to include a specific number of women on its boards, or face a fine.¹⁴ Similarly, Oregon’s proposed HB 3110 requires publicly traded corporations to include a specified number of women and individuals from underrepresented communities on their boards or face a hefty fine.¹⁵ HB 3110 largely reflects California’s bills, and it is on the Oregon Senate floor for review. Also, Massachusetts SB 2080, if enacted, would require one female director on the board of domestic and foreign publicly held corporations in its first year as law, with that number set to increase over time.¹⁶ Violators would be fined up to $100,000.

Other rules fall somewhere in the middle, taking a “comply or explain” approach. For instance, the State of Washington recently enacted a law requiring certain corporate boards to have, by January 1, 2022, at least 25% of their makeup be members self-identifying as women.¹⁷ Different from AB 979, the law does not impose fines for non-compliance; the corporation must instead disclose to its shareholders how it considers diversity of its board and any measures taken to address a lack of diversity. Additionally, the Securities and Exchange Commission (SEC) recently approved a rule proposed by Nasdaq that requires companies listed on its exchange to have at least two self-identified “diverse” board members (a woman and underrepresented and/or LGBTQ+ individual) or explain in writing why they are not doing so.¹⁸ Nasdaq maintains that its disclosure-based framework is not a mandate or quota—it merely sets forth “aspirational diversity objectives.”¹⁹

All that said, it is unlikely that Crest II will put a halt to the trend towards diversifying boards. Instead, Crest II will likely direct states, agencies, and organizations away from minimum number requirements or workplace quotas, and towards reporting requirements and transparent efforts towards improving IE&D efforts at the board and management levels. The intent perhaps is that public disclosure—and the related review of Board selection processes leading to such dismal numbers historically—may ultimately generate market-based pressure sufficient to fuel Board diversity efforts.

Looking Ahead

Both internal organizational goals and external factors, like consumer and public expectations, are increasingly encouraging corporations to prioritize workforce IE&D. In developing their IE&D strategies, employers should remember that it is generally unlawful to implement workforce quotas (e.g., setting aside a specific number of opportunities to be occupied only by persons with a particular protected characteristic).

What can organizations do to proactively embrace steps to encourage diversity on their boards, while remaining within the bounds of the law? One option is to work with recruiters specializing in identifying diverse talent and incorporating diverse professional networks in board searches. Organizations also may consider evaluating the prerequisite qualifications necessary for board membership. IE&D specialists can work with a corporation to develop policies and committees aimed at improving diversity at all levels of the organization. Likewise, counsel can help organizations audit their boards, executive teams, and workforces, and advise on how to best voluntarily report on their demographics.

¹ Cal. Corp. Code § 301.4 (West).

² 2019 California Assembly Bill No. 979, California 2019-2020 Regular Session.

³ Cal. Corp. Code § 301.3 (West); see 2019 California Senate Bill No. 826, California 2017-2018 Regular Session; see also Dionysia L. Johnson-Massie, Alyesha A. Dotson, Detrachia M.N. André, Corinn Jackson, New California Law Mandates Corporate Board Diversity, Littler Insight (Oct. 1, 2020).

⁴ See, e.g., Crest v. Padilla, No. 19STCV27561 (Cal. Super. Aug. 6, 2019) (“Crest I”) (in which plaintiffs seek to enjoin enforcement of SB 826 on the basis that it violates the Equal Protection Clause of the California Constitution); Meland v. Weber, No. 20-15762, 2021 U.S. App. LEXIS 18378, at **8-10 (9th Cir. June 21, 2021) (determining that the plaintiffs had standing to enjoin SB 826 on the basis that they were pressured to either vote to elect a woman to the board, or face the threat of penalties against the company in which they owned shares); Meland v. Weber, No. 2:19-cv-02288-JAM-AC, 2021 U.S. Dist. LEXIS 246227 (E.D. Cal. Dec. 27, 2021) (denying the plaintiff’s request to enjoin enforcement of SB 826 on federal Equal Protection grounds because the plaintiff could not demonstrate the likelihood of success on the merits).

⁵ In addition to Crest v. Padilla, No. 20STCV37513, 2022 LEXIS 5531 (Cal. Super. Ct. Apr. 1, 2022)—discussed herein as Crest II—a lawsuit challenging both SB 826 and AB 979 on the basis that they violate the Equal Protection Clause of the 14th Amendment to the U.S. Constitution and the internal affairs doctrine has recently been filed in the Central District of California. The plaintiff in this lawsuit—Alliance for Fair Board Recruitment v. Weber, No. 2:21-cv-01951-JAM-AC (E.D. Cal. Oct. 21, 2021)—is a Texas-based nonprofit that claims its members are aspiring directors or shareholders of companies subject to SB 826 and AB 979 in California. The plaintiff and the State have filed dueling motions and the ruling is pending. It will likely be affected by the outcome of Crest II. See also Alliance for Fair Board Recruitment v. Weber, Case No. 2:21-cv-05644-RGK-RAO (C.D. Cal. July 12, 2021); National Center for Public Policy Research v. Weber, No. 2:21-cv-02168-JAM-AC (E.D. Cal. Nov. 22, 2021).

⁶ Crest v. Padilla, No. 20STCV37513 (Cal. Super. filed Sept. 30, 2020).

⁷ Id. at **51-54 (Cal. Super. Ct. Apr. 1, 2022).

⁸ The Secretary of State’s 2022 Report on California board diversity accounts for compliance with SB 826 and AB 979. Based on this Report, 716 publicly held corporations listed on major exchanges identified principal executive offices in California and just 358 of these corporations filed a 2021 California Publicly Traded Corporate Disclosure Statement reflecting compliance or non-compliance with SB 825 and AB 979. Of the 358 corporations that filed, only 186 reported that they were in compliance with SB 826—a decline from the 311 reported the prior year. The report also shows that 301 companies reported compliance with the 2020 requirements of AB 979. Shirley N. Weber, Diversity on Boards: March 2022 Report, Cal. Sec. of State (Mar. 1, 2022).

⁹ Rich Eisen, Will More States Set Board Diversity Mandates? LexisNexis (Jan. 13, 2022).

¹⁰ N.Y. Bus. Corp. Law § 408; see Eli Freedberg, New Year, New Trend? New York to Require Corporate Reporting on Number of Women on the Board, Littler ASAP (Jan. 6, 2020).

¹¹ 805 Ill. Comp. Stat. Ann. 5/8.12 (2019); see Johnson-Massie, Dotson, André, & Jackson, supra note 3.

¹² Md. Tax-Prop. Code Ann. § 11-101 (2020); see Johnson-Massie, Dotson, André, & Jackson, supra note 3.

¹³ It is important to reiterate that in Meland v. Weber, No. 2:19-cv-02288-JAM-AC, 2021 U.S. Dist. LEXIS 246227, at *26 (E.D. Cal. Dec. 27, 2021), the district court denied the plaintiff’s request to enjoin SB 826 because the plaintiff could not demonstrate a likelihood of success on the merits in the Equal Protection claim. In reaching this conclusion, the court explained, among other things, that race-based classifications are subject to strict-scrutiny, while sex-based classifications are subject to intermediate scrutiny. Id. at *11. SB 826 was deemed a sex-based classification. Id. at **18-19. As its name suggests, intermediate scrutiny is not as “exacting” as strict scrutiny. Id. at *22. In its decision – currently on appeal to the Ninth Circuit – the court determined that SB 826 likely passes muster. Id. at *11-25. This decision demonstrates the complexity of diversity board legislation.

¹⁴ See supra notes 4-5. There is yet to be a ruling in Crest I, which was set for bench trial in December 2021. The district court’s ruling on the State’s motion to dismiss in Alliance is also still pending. The outcome of National Center for Public Policy Research is also pending. And the district court’s decision in Meland is currently on appeal in the Ninth Circuit. See Meland v. Weber, Nos. 22-15149, 22-15207, 2022 U.S. App. LEXIS 4570 (9th Cir. Feb. 18, 2022).

¹⁵ H.B. 3110, 81st Leg. Sess., Reg. Sess. (Or. 2021); Press Release, Oregon House of Democrats, House Democrats Pass Legislation to Increase Workforce Diversity on Boards of Directors (May 4, 2021).

¹⁶ S.B. 2080, 192nd Gen. Court, (Mass. 2021).

¹⁷ Wash. Rev. Code Ann. § 23B.08.120 (West).

¹⁸ Philip Berkowitz, Corinn Jackson and Britney Torres, Inclusion, Equity, & Diversity Update–SEC Approves Nasdaq Rule on Board Diversity, Littler Insight (Aug. 20, 2021).

¹⁹ The constitutionality of the Nasdaq rule has nonetheless been challenged by the same group challenging SB 826 and AB 979. See, e.g., Alliance for Fair Board Recruitment et al. v. SEC, No. 21-60616 (5th Cir. Aug. 10, 2021); see supra note 5.