Can a Company Be Required to Have a Diverse Board of Directors?

Many state lawmakers have focused on improving workplace gender and racial equity in recent years, which has prompted legislation that encourages or requires diversity on corporate boards. But can a state's efforts to promote diversity infringe on constitutional rights? Several lawsuits against California's gender board diversity law make this claim.

"Despite the legal challenges, it appears that these diversity initiatives are here to stay," noted Allison Scott, an attorney with Dykema in Los Angeles. She said employers should be mindful of federal and state anti-discrimination laws when implementing diversity and inclusion programs, including at the leadership level.

How can employers strike a balance between diversity, equity and inclusion (DE&I) goals and compliance with anti-discrimination laws? "Employers may consider using diversity-focused recruiters to increase the likelihood that the applicant pool includes a diverse group of applicants for consideration," Scott suggested. She also noted that many employers are hiring diversity, equity and inclusion officers to help their organizations achieve their goals. 

Challenges to Board Diversity Laws

In 2018, California lawmakers enacted SB 826, which required boards of California-based publicly held companies to have at least one female director by the end of 2019 and to increase the number of female directors by the end of 2021 according to board size. Boards must have two female directors if the corporation has five directors and three female directors if the corporation has six or more directors.

In 2020, lawmakers approved a similar bill, AB 979, requiring covered California corporations to have one director from an underrepresented community by the close of the 2021 calendar year. Additional requirements apply by the end of 2022, depending on the size of the board. The bill defines a director 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."

Corporations that don't follow the two laws may face steep fines, ranging from $100,000 to $300,000 for each violation.

Lawmakers who supported SB 826 said "California has a responsibility to ensure that women are included in the discussions and decisions that affect corporate actions and profitability." Additionally, the author of AB 979, Assemblyman Chris Holden, D-Pasadena, said, "If we are going to address racial injustice and inequity in our society, it's imperative that corporate boards reflect the diversity of our state."

Opponents of these laws, however, argue that they are unconstitutional. "California's quota doesn't remedy discrimination, it perpetuates it," said Anastasia Boden, an attorney with Pacific Legal Foundation in Sacramento, Calif. "This law forces shareholders to cast votes based on immutable characteristics that people were born into. The government should treat people as individuals, not based on immutable characteristics."

In one pending case, Meland v. Weber, the 9th U.S. Circuit Court of Appeal found that a corporate shareholder has legal standing to challenge SB 826. "Because [the plaintiff] has plausibly alleged that SB 826 requires or encourages him to discriminate based on sex, [he] has adequately alleged an injury in fact," the appeals court said.

The plaintiff is seeking a preliminary injunction to halt the rule. "But it is worth noting that the district court expressed doubt as to whether the plaintiff could prevail on the merits and a preliminary injunction would serve the public interest," Scott explained. The district court noted that SB 826 has had the desired effect of increasing female membership on corporate boards of directors and has addressed past discrimination.  

Although this case is still being litigated, the outcome will likely not be the final word on the constitutionality of diversity initiatives, because it's not the only case challenging California's board diversity laws, Scott explained. For instance, claims have been brought in state court by taxpayers who allege that California is using funds to enforce laws that discriminate based on gender and race.  

Emerging Trend

Despite the backlash from some business groups, many entities are adopting similar initiatives that require companies to disclose diversity information and encourage them to set a minimum board-diversity objective, Scott noted. "Given this desire to increase diversity and inclusion at the top-levels of corporations, corporations may need to address their diversity and inclusion initiatives regardless of SB 826 or similar state laws."

California is not the only state to pass a board diversity law. Washington's Women on Corporate Boards Act required public companies to have gender-diverse boards by Jan. 1. On a "gender-diverse" board, at least 25 percent of the directors self-identify as women, according to the act. Companies that don't comply must provide shareholders with an analysis that discusses the company's approach to achieving board diversity. 

Other states require corporations to disclose diversity data or have taken steps to encourage board diversity but don't require it. For example, a corporation with its principal executive office in Illinois must include board diversity data in its annual reports, and that information will be made available to the public. New York and Maryland also have board-diversity reporting requirements.

"Some states may want to see how things shake out in California and Washington before passing their own mandates," said Ann Marie Painter, an attorney with Perkins Coie in Dallas. "But the trend is toward transparency."

She noted that leaders can look to other companies to see what they are doing to improve board diversity.

Scott said employers may want to adopt a version of the so-called Rooney Rule for recruiting leadership positions, which means the employer interviews a certain number of diverse candidates for the position. "This is preferable to a hiring quota, which could run afoul of federal and state equal employment laws."

Inclusion Is Essential

When establishing board DE&I goals, the key is not only the number of diverse individuals around the table but also whether they have a voice, said Kathy Jaffari, an attorney with Cozen O'Connor in Philadelphia. "Boards have to decide whether they are committed to inclusion."

Boards may consider providing members with unconscious bias training, anti-harassment training and relationship training. "At the end of the day, it's about how people relate to each other," Jaffari observed. "Inclusion is about being willing to embrace differences."

She added that change is usually uncomfortable. "We have to be willing to dig deep, be authentic and be real. It takes courage to do that."