California Governor Gavin Newsom on September 30 signed into law Assembly Bill No. 979, which requires publicly held companies headquartered in California to have a minimum number of directors from “underrepresented communities.”
In passing Assembly Bill No. 979 (AB 979), a first-of-its-kind legislation in the United States, the California legislature cited numerous studies showing the lack of minority members serving on public company boards. For example, out of 662 publicly traded companies headquartered in California, only 13% have at least one Latino board member, 16% have at least one African American board member, 42% have at least one Asian board member, and notably, only 6% have at least one other minority board member. In contrast, 100% of these boards have at least one white board member, and 35% of these companies have all white board members.
AB 979 represents California’s continuing effort to expand diversity requirements of public company boards and enhance equality and opportunities for minority groups through the legislative process. In 2018, California enacted SB 826, which requires California publicly held companies to have a minimum number of female directors, including at least one female director, no later than the end of 2019. The structure and statutory provisions of AB 979 are modeled closely after SB 826. Accordingly, California publicly held companies now are required to comply with both the female and the minority director rules. For a more detailed discussion of the female director rules, please see our LawFlash, California Requires Female Directors on Public Company Boards.
The following summarizes specific requirements of AB 979 and certain practical considerations for California public companies in response to these new requirements.
SB 979 adds Sections 301.4 and 2115.6 to the California Corporations Code to require a publicly held domestic or foreign corporation whose principal executive offices are located in California, as set forth on the corporation’s annual report on Form 10-K filed with the US Securities and Exchange Commission (SEC), to have a minimum of one director from an “underrepresented community” no later than the close of calendar year 2021.
Additionally, such California publicly held companies must comply with the following director composition requirements no later than the close of calendar year 2022:
An individual is from an “underrepresented community” if such individual “self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native,” or “self-identifies as gay, lesbian, bisexual, or transgender.” In addition, a “publicly held corporation” means a corporation with outstanding shares listed on a major “United States stock exchange.” While the statute does not define “major United States stock exchange,” the California secretary of state has previously stated that a “publicly held corporation” means a corporation with shares listed on the New York Stock Exchange, Nasdaq, or American Stock Exchange, and excludes corporations with shares quoted or traded on over-the-counter markets.
We note that AB-979 applies to publicly held companies with principal executive offices in California (as disclosed in the Form 10-K) regardless of the state of incorporation. Accordingly, any publicly held company incorporated in another state, such as Delaware, or any other country, will be subject to the new requirement if its principal executive office is in California.
Under AB 929, a company is permitted to amend its bylaws or charter to increase the total number of directors to accommodate the required directors from underrepresented communities, so that no incumbent director needs to be replaced. In addition, a director from an underrepresented community is not required to hold office for the entire calendar year to satisfy the rules—it is sufficient that they hold a seat for only a portion of the calendar year applicable under the requirement.
The new rules authorize the California secretary of state to impose fines for violations as follows: (1) $100,000 for a first violation, and (2) $300,000 for a second or subsequent violation. The secretary of state is required, no later than March 1, 2022, to include in its report required by the female director rules under SB 826 certain information regarding compliance with AB 979, including the number of corporations subject to the rule that were in compliance with the requirements, and the number of publicly held corporations that moved their US headquarters to California from another state or out of California into another state.
Similar to SB 826, we expect AB 979 will face legal challenges based on a number of theories, including a violation of the equal protection clause of the US and California Constitutions. In fact, on the very day that Governor Newsom signed AB 979, the same taxpayer plaintiffs challenging SB 826 (represented by Judicial Watch, Inc.) filed a second lawsuit challenging AB 979. In Crest v. Padilla (Sup. Ct. No. 20STCV37513), the plaintiffs assert that AB 979 also violates the equal protection and antidiscrimination provisions of the California Constitution. The case is pending in the Superior Court for the County of Los Angeles.
Currently two separate litigations involving SB 826 are winding through the court systems. In Meland v. Padilla (E.D. Cal No. 2:19-cv-02288), an individual shareholder of a company subject to SB 826 (represented by the Pacific Legal Foundation) asserted that the law impaired his right to vote for the board member nominee of his choice, in violation of the Equal Protection Clause of the Fourteenth Amendment of the US Constitution. The US District Court for the Eastern District of California dismissed the action because the shareholder plaintiff lacked standing. The case is currently on appeal before the US Court of Appeals for the Ninth Circuit.
In Crest v. Padilla (Sup. Ct. No. 19STCV27561), individual taxpayers (the same plaintiffs referenced above) asserted that SB 826 requires a gender-based quota in violation of equal protection and antidiscrimination provisions of the California Constitution. In June 2020, the Superior Court for the County of Los Angeles overruled a demurrer and subsequently set the case for trial in mid-2021.
Given the uncertainty of legal claims and the timing of compliance requirements for both SB 826 and AB 979 for calendar year 2021, publicly held companies headquartered in California should be prepared to comply fully with both rules notwithstanding the pending court cases.
We believe that the boards of directors of California publicly held companies, particularly those that do not currently have any directors from underrepresented communities, should consult with counsel familiar with SB 826 and AB 979 to understand fully the implications of these new legal developments in California, and formulate a plan to comply with applicable requirements or seek alternative action. As was the case with SB 826, AB 979 raises several interpretative questions and uncertainties, including the following:
We recommend that boards and management of California public companies consider the following practical steps in response to the new rules:
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact