Board quotas challenged as unneeded, unconstitutional

The battle to diversify corporate boards is coming down to the wire, with a state court challenge expected to go to trial in Los Angeles Dec. 1 and two federal court challenges consolidated in Sacramento.

Under a new California law, boards of directors of more than six seats must appoint at least two women by the end of the year or face penalties. Nasdaq is requiring companies to diversify their boards or publish a report explaining why -- a rule that was blessed by the U.S. Securities and Exchange Commission.

But even if legal challenges to California's law and Nasdaq's rule are ultimately successful, corporate lawyers say companies are rushing to diversify their boards anyway.

"There is such a strong push from so many sides for greater diversity on boards, which is a good thing for society, corporate performance and more," said Teresa L. Johnson, partner at Arnold Porter Kaye & Scholer LLP, who advises clients on corporate and financial matters. "It's hard to say whether diversity laws will survive constitutional challenges, but the big picture is, they seem to be accomplishing societal change in the meantime."

California's Senate Bill 826, known as the "women on boards" law, was first challenged in Los Angeles County Superior Court two years ago by taxpayers represented by Judicial Watch, a conservative nonprofit. The plaintiffs seek an order barring the state from spending tax dollars to enforce the law, which they say violates the equal protection provisions of the California Constitution. That case is headed to trial before Judge Maureen Duffy-Lewis on Dec. 1. Crest et al v. Padilla, 19STCV27561 (L.A. Super. Ct., filed Aug. 6, 2019).

Federal court challenges to Senate Bill 826 and Assembly Bill 979, a law that requires members of underrepresented communities to be included on the boards, are pending in the Eastern District of California.

Texas-based Alliance for Fair Board Recruitment, led by Edward Blum, sued the state this year, arguing that both laws clash with the internal affairs doctrine, which provides that the laws of the state of incorporation govern the internal actions of a corporation. Alliance for Fair Board Recruitment v. Dr. Shirley N. Weber, 2:21-cv-1951 (C.D. Cal., filed July 12, 2021).

Blum has brought several challenges to affirmative action programs. A challenge that argues Harvard University's race-based admissions programs disadvantages Asian Americans will be heard by the U.S. Supreme Court this year. Students for Fair Admissions, Inc. v. President and Fellows of Harvard College, 980 F. 3d 157 (1st Cir. 2020).

The alliance argues that California's laws harm its members by forcing them to compete on an uneven playing field for board seats. The same group has challenged the SEC's approval of the Nasdaq rule that requires disclosure of board diversity. That case is pending in the 5th U.S. Circuit Court of Appeals in New Orleans.

Conservative think tank National Center for Public Policy Research filed a similar challenge this month in the 3rd U.S. Circuit Court of Appeals in Philadelphia.

The SEC defended its decision in a statement on Aug. 6.

"Public company boards of directors should not be private clubs with membership limited to narrow social circles. Regardless of intentions, it appears that existing board members' social and business networks can be a predominant source for companies seeking new director candidates," Commissioner Elad L. Roisman stated in a news release.

The Pacific Legal Foundation, a libertarian and property rights legal nonprofit, represents stockholder Creighton Meland in his challenge to SB 826. The case, which is pending before U.S. Judge John A. Mendez of the Eastern District of California, was thrown out but then revived by the 9th U.S. Circuit Court of Appeals in June. Meland v. Weber, 2021DJDAR 6120 (9th Cir. June 21, 2021).

Anastasia P. Boden, senior attorney with the Pacific Legal Foundation, said the law threatens to create stereotypes about women.

"Here, California says it needs more women on boards because women have a certain management style and behave a certain way. But the Constitution demands that the government treat women as individuals, not simply members of the group they were born into," Boden said. "And to the extent the state says SB 826 is necessary to remedy discrimination, not only does it lack evidence sufficient to justify a quota across every board in every industry in the state, it imposes a quota, which is a sloppy tool for remedying real instances of discrimination."

Recent studies published by data analytics firm ESGauge and consulting firm Spencer Stuart show that public companies across the nation have added the most diverse lineup of board members in the last year. The recent social unrest over racial injustice became a catalyst for organizations and companies to diversify boards, or its investors and other stakeholders to insist on it, the study's authors said.

"In the last year alone, we have witnessed a social reckoning on a scale that was not seen before. The racial justice movement has galvanized consumers and employees," ESGauge's study states.

Peggy Little, senior litigation counsel with the New Civil Liberties Alliance, which represents the National Center for Public Policy Research, said the SEC is not authorized by Congress to get involved in the areas of diversity on boards.

"The commission is there to prevent fraud and manipulative practices, and to ensure markets are free and open, and that investors are protected," Little said. "The commission has disclosure rules regarding companies and their values, but it has never been asked by Congress to decide who's on boards of directors. They are acting outside of their authority."

Little said companies are approaching diversity goals on their own without interference from regulators, and calls the Nasdaq rules and California laws "a solution in search of a problem." Little also said she believes the SEC is acting vicariously through Nasdaq to establish rules that it cannot establish.

Pamela S. Palmer, a partner at Troutman Pepper Hamilton Sanders LLP, who defends corporations, agreed that companies are already diversifying boards, even if it may be costly to do so and in the absence of any threat of penalty. It is notable, she said, that it is nonprofits and industry organizations -- not companies themselves -- that are filing the challenges, she said.

"Its customers are interested and more importantly its stockholders are interested in diversity," Palmer said.