LawFlash

California Requires Female Directors on Public Company Boards

October 17, 2018

California Governor Jerry Brown on September 30, 2018, signed into law Senate Bill No. 826 (SB 826), which requires publicly traded companies with principal executive offices in California to have a minimum number of female directors. The California legislature found that having more women serve as directors of public corporations will boost the California economy, improve opportunities for women in the workplace, and protect California shareholder value. SB 826 notes that gender disparity on public company boards is an intractable problem, and if substantive measures are not taken proactively to increase the number of female directors, it will take 40 or 50 years to achieve gender parity among directors. Studies cited in the statue indicate that approximately 26% of Russell 3000 companies based in California, or 117 of them, have no women directors serving on their boards, and for the remaining 74% of such companies, women directors represented only 15.5% of the boards.

Director Composition Requirements

SB 826 adds Sections 301.3 and 2115.5 to the California Corporations Code and requires a “publicly held domestic or foreign corporation” whose principal executive offices are located in California, as set forth on the corporation’s SEC 10-K form, to have a minimum of number of female directors as follows:

  • No later than the end of the 2019 calendar year, at least one female director;
  • No later than the end of the 2021 calendar year,
  • a minimum of three female directors if the number of directors is six or more;
  • a minimum of two female directors if the number of director is five;
  • a minimum of one female director if the number of directors is four or fewer.

We note that because SB 826 applies to “foreign” corporations, any public company incorporated in another state, such as Delaware, or any other country, may be subject to the new requirement if it has its principal executive offices in California. For purposes of this new law, a “publicly held corporation” means a corporation with outstanding shares listed on a major United States stock exchange. The statute does not define “major United States stock exchange.”

SB 826 expressly permits a company to amend its bylaws and charter to increase the total number of directors to accommodate the female director or directors, so that no male director needs to be replaced. In addition, a female director is not required to hold office for the entire calendar year to satisfy the rules—it is sufficient that a female director holds a seat for only a portion of the calendar year.

Enforcement, Penalties, and Reports

The new rules authorize the Secretary of State of California to impose fines for violations by California-based public companies as follows: (i) $100,000 for a first violation, and (ii) $300,000 for a second or subsequent violation. The Secretary of State is required to publish a report on its website to provide the public with compliance information, including the number of California public companies that have at least one female director, the number of companies that were in compliance during the calendar year, and the number of California public companies that have moved their headquarters outside of California.

Potential Legal Challenges

While there is little controversy that achieving gender parity at the highest level of corporate governance is an important and valuable goal, SB 826 is likely to be challenged as the wrong method to accomplish this goal. During the signing of SB 826, Governor Brown admitted that SB 826 may contain “potential flaws that indeed may prove fatal to its ultimate implementation.” Nevertheless, in an apparent response to the prevailing political environment after the #MeToo movement, he stated that enacting the law is still critical given that “recent events in Washington, D.C.—and beyond—make it crystal clear that many are not getting the message”.

We expect SB 826 to be litigated based on at least two theories. Given the explicit gender classification, a constitutional challenge based on the Equal Protection Clause seems inevitable. In addition, because SB 826 applies to public companies incorporated outside of California (most commonly in Delaware), it may run afoul of the longstanding “internal affairs doctrines,” which provide that matters relating to the internal corporate governance should be determined in accordance with the laws of the state in which the company is incorporated. The US Supreme Court developed this doctrine in its interpretation of the Commerce Clause of the US Constitution, finding that a state has no interest in regulating the internal affairs of a foreign corporation. Given the fast approaching deadline for compliance by the end of 2019, we expect to see court cases filed soon challenging the validity of SB 826.

Practical Consideration for California Public Companies

We believe that the boards of directors of California public companies, particularly those that do not currently have any female directors, should consult with legal counsel to understand fully the implications of this new law. SB 826 is not a model of clarity and includes several interpretative ambiguities and uncertainties. For example, what is a “major” United States stock exchange? How do you determine principal executive offices of foreign private issuers who are not required to file on Form 10-K? Is there any exception for a new public company that just completed an IPO and is publicly held only for a few days of the year? What happens if shareholders fail to elect a female director at a shareholder meeting, even if one was nominated? If more than two female directors are required for a calendar year, do they need to serve at the same time or can they serve at different times during the calendar year? California public companies are well advised to consult with counsel to examine these questions, many of which may not have definitive answers for some time.

Perhaps more importantly, and notwithstanding the fact that SB 826 may fail to withstand judicial scrutiny, boards of directors should take proactive steps to implement a responsive and thoughtful diversity strategy. This approach is recommended in part due to the increasing interest of public and private institutional investors, which are putting increasing pressure on public companies to more proactively address diversity issues. This strategy should include not only a more robust search and recruitment process for qualified individuals to serve on the board, but also a more sensitive policy for communications and investor relations that focuses on the value and benefits of gender diversity in the boardroom.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the author, Albert Lung, or  any of the following Morgan Lewis lawyers:

Boston
Laurie Cerveny
Michael Conza
Bryan Keighery
Julio Vega

Frankfurt
Torsten Schwarze

Hong Kong
June Chan
Eli Gao
Louise Liu
Edwin Luk
Billy Wong

London
Timothy J. Corbett
Iain Wright

Moscow/London
Carter Brod

New York
Thomas P. Giblin, Jr.
Howard A. Kenny
Christina Melendi
Kimberly M. Reisler

Palo Alto
Albert Lung
Thomas W. Kellerman

Philadelphia
Justin W. Chairman
James W. McKenzie
Joanne R. Soslow

Pittsburgh
Celia Soehner

San Francisco
Scott D. Karchmer

Singapore
Bernard Lui*
Joo Khin Ng*

Washington, DC
David A. Sirignano

*A solicitor of Morgan Lewis Stamford LLC, a Singapore law corporation affiliated ‎with Morgan, Lewis & Bockius LLP