You might remember that the first legal challenge to SB 826, California’s board gender diversity statute, Crest v. Alex Padilla, was a complaint filed in 2019 in California state court by three California taxpayers seeking to prevent implementation and enforcement of the law. Framed as a “taxpayer suit,” the litigation sought a judgment declaring the expenditure of taxpayer funds to enforce or implement SB 826 to be illegal and an injunction preventing the California Secretary of State from expending taxpayer funds and taxpayer-financed resources for those purposes, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution. A bench trial began in December in Los Angeles County Superior Court that was supposed to last six or seven days, but closing arguments didn’t conclude until March. (See this PubCo post.) The verdict from that Court has just come down. The Court determined that SB 826 violates the Equal Protection Provisions of the California Constitution and enjoined implementation and enforcement of the statute. This verdict follows summary judgment in favor of the same plaintiffs in their case against AB 979, California’s board diversity statute regarding “underrepresented communities,” which was patterned after the board gender diversity statute. (See this PubCo post.) The Secretary of State has not yet indicated whether there will be an appeal. In light of pressures from institutional investors and others for board gender diversity, together with the Nasdaq “comply or explain” board diversity rule (see the SideBar below), what impact the decision will have on board composition remains to be seen.

Background. SB 826 required that, by December 31, 2021, all public companies listed on a major exchange and headquartered in California, no matter where they are incorporated, include at least two women on their boards if the corporation had five directors, and three women directors if the corporation had six or more directors. A minimum of one woman director was required if the board had four or fewer directors. The statute also required that the office of the California Secretary of State post on its website reports on the status of compliance with the law. Under the statute, the Secretary could impose fines for violations, ranging from $100,000 to $300,000 per violation. To date, the Secretary has neither proposed nor adopted regulations regarding fines or imposed fines for violations.

In the litigation, the plaintiffs claimed standing as “taxpayers,” under “California’s common law taxpayer standing doctrine and Code of Civil Procedure Section 526a, which grants California taxpayers the right to sue government officials to prevent unlawful expenditures of taxpayer funds and taxpayer-financed resources.” They contended that, in so-called “taxpayer suits,” it is “immaterial that the amount of the expenditure is small or that enjoining the illegal expenditure will permit a savings of tax funds.” Further, they alleged, the Assembly Appropriations Committee indicated that SB 826 would require “ongoing General Fund costs of approximately $500,000 each year for the Secretary of State to develop regulations, investigate claims, and enforce violations of the statute’s provisions and unknown additional costs to produce a required annual report.”

In the complaint, the plaintiffs contended that the law’s requirement for female representation on corporate boards “employs express gender classifications. As a result, SB 826 was immediately suspect and presumptively invalid” under the equal protection provisions of the California Constitution and subject to “strict scrutiny” in the California courts, requiring the state to have a compelling governmental interest and the classifications to be narrowly constructed to serve that interest, according to the plaintiffs. The complaint requested entry of a judgment declaring any expenditures of taxpayer funds to implement or enforce SB 826 to be illegal and issuance of an injunction permanently prohibiting the Secretary from expending taxpayer funds to enforce or implement the provisions of the legislation.

Even proponents of the California law recognized the possibility of “equal protection” claims and other legal challenges—when then-Governor Jerry Brown signed the bill into law, he acknowledged that “serious legal concerns” had been raised. (See this PubCo post.) And many expected a flood of legal challenges to frustrate efforts to implement the bill. Nevertheless, California’s businesses appear to have accepted the requirements of the legal mandate—perhaps also feeling the pressure from large asset managers such as BlackRock and State Street—and have not filed suit. However, several groups did file challenges, this case being one of them.

The Verdict. As a preliminary matter, the Court found that the plaintiffs were taxpayers and had standing for purposes of challenging the statute and that the cause of action was ripe. The Court also found that the plaintiffs had “carried their burden to prove an actual or threatened substantial expenditure of taxpayer funds or taxpayer-financed resources by Defendant by promulgating regulations and implementation of fines for enforcement of S.B. 826,” notwithstanding testimony from witness for the State that no regulations imposing fines had been adopted or were even planned. According to the Court, “[i]t was apparent…through defense testimony that the collection of information and analysis of S.B. 826, by the State of California, and its importance to the anticipated increase in tax revenues, once S.B. 826 was implemented, was purposeful and significant. Ongoing and or anticipated expenditures indicated implementation planning was occurring and in its beginning state. Fines to compel compliance was anticipated and expected by S.B. 826.”

The key issue in the case was the claim of violation of the Equal Protection Clause of the California Constitution. In that context, the Court explained that “[w]hen a statute makes express use of a suspect classification, a plaintiff challenging the statute meets their initial and ultimate burden simply by pointing out the classification….The statute is presumed to be unconstitutional, and the government bears the burden of demonstrating otherwise.” The Court noted that “classifications based on gender have long been considered ‘suspect.’” The plaintiff must also show that the State has “adopted a classification that affects two or more ‘similarly situated’ groups in an unequal manner.” Here, the Court found that the plaintiffs had “carried their burden to prove that men and women are similarly situated for purposes of S.B. 826’s gender-based quota.”

As a result, the Court found that the statute was presumptively unconstitutional, and the burden shifted to the defendant to prove that the statute survived “strict scrutiny.” To meet the test, the defendant “must show (1) a compelling state interest, (2) that S.B. 826 is necessary and (3) that S.B. 826 is narrowly tailored.” According to the Court, the State claimed a compelling state interest in remedying discrimination in the board selection process, increasing board gender diversity to benefit the public and the state economy, and increasing gender diversity at public companies to benefit California taxpayers and other Californians. But, after considering the evidence, the Court concluded that SB 826 wasn’t really about remedying discrimination; “S.B. 826’s goal was to achieve gender equity or parity; its goal was not to boost California’s economy, not to improve opportunities for women in the workplace nor… to protect California’s taxpayers, public employees, pensions and retirees.”

However, the Court said, under applicable caselaw, there is “no compelling governmental interest in remedying generalized, non-specific allegations of discrimination,” and generalized assertions of discrimination are not sufficient. Rather, caselaw establishes that the state “must show purposeful or intentional, unlawful discrimination” and that “the lack of any effort to limit the remedial scheme to those who suffered such discrimination is fatal to the scheme.”

During the trial, the Court later wrote, the State “was unable to present specific evidence of actual, unlawful discrimination against any specific woman by any specific corporation subject to S.B. 826.” Instead, the legislature “cited only statistics about the number of women on corporate boards as compared to men, not any specific discrimination.” Indeed, the State’s witnesses, the Court concluded, “attributed the differences in the numbers of men and women on corporate boards to reasons other than actual discrimination, including the lack of open board seats, women’s networking issues, board propensity to select persons that they already know, and boards preference for choosing CEOs to fill open board positions.” The Court also pointed to the absence of evidence to show that “publicly held corporations headquartered in California engage in purposeful and intentional, unlawful discrimination against women in their board selection processes, but only offered more generally that the “board selection process” in the United States, including in California, is “significantly affected by anti-female gender discrimination.” In sum, the Court determined that there was “no Compelling Governmental Interest in remedying discrimination in the board selection process because neither the Legislature nor Defendant could identify any specific, purposeful, intentional and unlawful discrimination to be remedied.”

The Court was likewise not persuaded that SB 826 was necessary. According to the Court, the State did not establish that the “the use of a gender-based classification was necessary to boost California’s economy, improve opportunities for women in the workplace, and protect California taxpayers.” To the contrary, the Court found, it showed that there were a number of ways to accomplish those ends. In addition, neither party “identified any case in which boosting the economy, improving work opportunities for women, protecting taxpayers, public employees and retirees, or even improving corporate performance or corporate governance, was found to be a Compelling Governmental Interest that justified the use of a suspect-classification.”

Nor was the Court persuaded by any of the studies cited in the bill, which, in the Court’s view, “failed to sufficiently show a causal connection between women on corporate boards and corporate governance and did not otherwise provide reliable conclusions.” The Court considered the legislative analysis in the bill finding connections between women on corporate boards and improved corporate performance and corporate governance to be “inconclusive,” highlighting in particular a Norwegian study that did not show positive outcomes. In the view of the Court, the studies relied on by the State did “not sufficiently address discrimination …or causality nor utilize the most sophisticated, econometric methodologies and current statistical analysis available and thus were in this Court’s view, unreliable.” Instead, the Court concluded from the testimony that “high quality academic studies that use sophisticated econometric methodologies and the most current statistical analyses were unavailable to the Legislature when it enacted S.B. 826. It was noted that when the above methodologies and statistical information were utilized, they do not support the existence of a causal relationship between women on boards and improved corporate performance and corporate governance.” In essence, while the studies relied on by the legislature may have shown some correlation, correlation is not causation.

The Court also “found the evidence offered by defense tended to support gender parity and proactively putting more women on boards demonstrated that the Legislature’s actual purpose was gender-balancing, not remedying discrimination,” specifically pointing to the absence in the bill of any reference to discrimination or remedying discrimination. In the Court’s view, the arguments in support of more women in the boardroom just relied on “gender stereotypes”; the Court was “unpersuaded by this offer of stereotypes for a justification of SB 826.”

Finally, the Court determined that the State “did not carry the burden to show that the legislation was narrowly tailored. Defendant failed to show the Legislature considered gender-neutral alternatives to remedy specific purposeful or intentional, unlawful discrimination against women by private-sector corporations in the selection of board members or that gender-neutral alternatives were not available. The Legislature did not consider amending existing anti-discrimination laws or enacting a new anti-discrimination law focusing on the board selection process before enacting S.B. 826.” Likewise, the State “did not sufficiently prove that S.B. 826’s use of a gender-based classification was limited in scope and duration to that which is necessary to remedy specific, unlawful discrimination against women in the selection of board members. Further, Defendant did not sufficiently prove that S.B. 826’s use of a gender based classification was actually remedial. There is insufficient showing that S.B. 826 was designed as nearly as possible to restore the victims of a specific, purposeful or intentional, unlawful discrimination to the positions the victims would have occupied in the absence of discrimination.” As a result, the Court determined that the State had “not met its burden to show that this is necessary nor narrowly tailored” and determined “that S.B. 826 violates the Equal Protection Clause of the California Constitution and is thus enjoined.”

SideBar

Nasdaq has adopted a “comply or explain” board diversity rule, which establishes a “disclosure-based framework” that will require each Nasdaq-listed company (with specified exceptions) to have, or explain why it does not have, at least two diverse board members, including at least one who self-identifies as female and at least one who self-identifies as an underrepresented minority or LGBTQ+. Each company with a board of directors of five or fewer members will need to have, or explain why it does not have, at least one board member who is diverse. If a company elects disclosure in lieu of compliance with the diversity objectives, the company will be required to identify the applicable requirements and explain the reasons why it did not satisfy them. Nasdaq-listed companies will also have to disclose, to the extent permitted by applicable law, its board-level diversity data annually in a “Board Diversity Matrix.” (See this PubCo post.) Compliance with the diversity rule is required beginning in 2023, but it is also being challenged in court. (See this PubCo post and this PubCo post.