On September 30, 2018, California Governor Jerry Brown signed Senate Bill No. 826 (SB 826) into law, making California the first state to require corporate boards to include female directors. Pursuant to SB 826, California-based publicly held domestic or foreign corporations must have at least one female director by December 31, 2019 and, depending on board size, up to three female directors by December 31, 2021.
Specifically, publicly held corporations, defined as corporations with “outstanding shares listed on a major United States stock exchange” with principal executive offices in California as stated in its Form 10-K, must appoint at least one female director by the end of the 2019 calendar year. By the end of the 2021 calendar year, a board composed of:
- six or more directors must include at least three female directors,
- five directors must include at least two female directors and
- four or fewer members must include at least one female director.
The new law allows corporations to increase their board size to comply, making outright replacement of a male director unnecessary. If a female holds a director seat for any portion of a calendar year, that seat will be deemed to have been held by a female for that year and will count toward the number of female directors required. SB 826 does not allow a grace period for newly public companies or companies that move their headquarters to California.
SB 826 is intended to be a significant, proactive step toward gender parity. According to SB 826, as of June 2017, only 15.5% of board seats at Russell 3000 companies headquartered in California were held by women and 26% of such companies had no female directors. The new law cites studies indicating that gender parity will not be achieved for another 40 to 50 years if proactive steps are not taken.
SB 826 also references various studies showing that a higher proportion of female directors is associated with improved financial performance. “More women directors serving on boards of directors of publicly held corporations will boost the California economy, improve opportunities for women in the workplace, and protect California taxpayers, shareholders, and retirees,” according to SB 826.
SB 826 grants discretionary enforcement powers to the California Secretary of State. The Secretary of State may impose a fine of $100,000 for the first violation of the new law and $300,000 for any subsequent offense. The Secretary of State will publish reports and statistics on its web site related to compliance with SB 826.
Public companies headquartered in California should monitor the implementation process of SB 826 and evaluate their board composition in light of the new law. Such companies with fewer than three female directors should begin preparing for compliance with the new law by seeking out qualified female director candidates and considering whether to expand the size of their boards. They should take into account what approvals may be required (e.g., charter or bylaw amendments to increase the maximum size of the board, election of a new director by stockholders at an upcoming annual meeting) and the related timing implications.
Under the internal affairs doctrine, matters relating to corporate governance (e.g., shareholder voting rights) are determined in accordance with the law of the state in which the company is incorporated. The vast majority of corporations headquartered in California are incorporated in other states (most commonly Delaware). SB 826 explicitly says that it “shall apply to a foreign corporation that is a publicly held corporation to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated.” This express attempt to supplant the internal affairs doctrine may be susceptible to challenge as a violation of the commerce clause of the U.S. Constitution. The U.S. Supreme Court has ruled that, under the commerce clause, a state “has no interest in regulating the internal affairs of foreign corporations.”1 By requiring a minimum number of female directors, the new California law arguably conflicts with the corporate law of every other U.S. state.
The new law may also face additional constitutional challenges under the California and U.S. Constitutions. The California Chamber of Commerce, for instance, claims that the policy violates federal constitutional prohibitions against discrimination on equal protection grounds, on the theory that even benevolent discrimination on the basis of sex still constitutes a suspect classification that is not narrowly tailored to advance a compelling governmental interest. On this point, the California Constitution is tougher than its federal counterpart, and will subject the bill to strict, rather than intermediate, scrutiny. The legislative history in the California Assembly echoes this concern, noting that the new law creates an express gender classification that renders the bill vulnerable to a challenge on equal protection grounds. The Assembly’s report states that “[t]he use of a quota-like system, as proposed by this bill, to remedy past discrimination and differences in opportunity may be difficult to defend.” Governor Brown acknowledged these objections, saying the flaws may prove “fatal” to the successful implementation of the law. Nevertheless, the malleability of corporate board membership in general, along with the provisions in the bill that allow companies to increase board sizes to facilitate compliance, make it less likely that the bill will be susceptible to a facial constitutional challenge; instead, any meritorious challenge to the bill will more likely be “as-applied,” and will necessarily depend upon the unique circumstances facing the particular company that seeks to challenge the bill (such as board size, membership history, and burden of including additional women directors).
Other Efforts to Increase Board Gender Diversity
All public companies–regardless of where they are headquartered–face greater pressure to diversify their boards. The new California law follows an increased focus on board gender diversity by key institutional investors which are continuing to scrutinize board composition and refreshment. In 2017, the New York City Comptroller and the New York City Pension Funds launched the “Boardroom Accountability Project 2.0” by sending letters to more than 150 companies seeking enhanced disclosure about the board’s composition and the company’s process for refreshing the board. The New York City Comptroller announced in March 2018 that he received “encouraging” responses from 130 of the companies targeted in the campaign, and several companies enhanced the board composition and diversity disclosure in their proxy statements.
Key institutional investors and others have increased engagement and voted against certain directors at companies they believe have failed to take sufficient action to add female directors. In 2017 and 2018, State Street voted against nominating committee chairs at hundreds of its portfolio companies with no female directors. Beginning in 2020, State Street will vote against all nominating committee members at a company with no female directors that has failed to adequately engage on the issue. BlackRock issued updated proxy voting guidelines in February 2018 stating its expectation for the U.S. public companies in which it invests to have at least two female directors. In March 2018, CalPERS identified board diversity as a “high priority initiative” and announced plans to withhold votes from directors at targeted companies that failed to take steps to add female directors. Vanguard reported that in 2018 it discussed board composition in more than 50% of its engagements and voted in favor of four out of nine shareholder proposals relating to board gender diversity. The New York State Common Retirement Fund announced in March 2018 that it will vote against all directors at companies with no female directors and against governance committee members at companies with just one female director. Finally, beginning in 2019, Glass Lewis will generally recommend voting against nominating committee chairs at companies with no female board members, with limited exceptions.
These efforts to increase board gender diversity are slowly making an impact. According to data from Equilar, nearly 35% of Russell 3000 company directors newly elected during the second quarter of 2018 were female, compared to 29% of newly appointed directors in all of 2017. All public companies should familiarize themselves with the guidelines and policies of their institutional investors and other stakeholders, as well as proxy advisory firms, relating to board gender diversity.
1 Edgar v. MITE Corp., 457 U.S. 624 (1982).
Sidley Austin LLP provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Readers should not act upon this information without seeking advice from professional advisers.
Attorney Advertising—Sidley Austin LLP, One South Dearborn, Chicago, IL 60603. +1 312 853 7000. Sidley and Sidley Austin refer to Sidley Austin LLP and affiliated partnerships, as explained at www.sidley.com/disclaimer.
© Sidley Austin LLP