Governor Jerry Brown signed a bill into law on Sept. 30 that requires publicly held companies headquartered in California to include women directors on their board of directors. SB 826 requires California-based public companies to have at least one woman on their boards of directors by the end of calendar year 2019. Companies that do not comply would face fines in the six figures, in addition to ramifications to their brand and reputation. As drafted, SB 826 contains a number of open questions and ambiguities that may impact implementation.
Requirements of SB 826
In addition to the requirement of one woman in 2019, the law increases the required number of women directors by the end of calendar year 2021, depending on the size of the board, as follows:
SB 826 defines a “publicly held corporation” as a corporation with outstanding shares listed on a major U.S. stock exchange. While a major U.S. stock exchange is not defined by the law, it is expected that exchanges such as The New York Stock Exchange, NYSE American, Nasdaq Global Market and Nasdaq Capital Market would qualify. A corporation would be deemed to be headquartered in California based on whether its principal executive offices, according to the corporation’s Annual Report on Form 10-K, are located in California.A board can comply with the law by adding one or more board seats (rather than removing directors). However, small boards may find that challenging in 2021 (without removing a man), due to the step function of the requirement. For example, an all-male, four-person board that satisfies the 2019 requirement by adding a woman as a new director (without removing a man) will find it needs to add two additional women by 2021. Adding the new director in 2019 steps the company into the two women requirement for five-member boards, and adding another woman to satisfy that (without removing a man) would then result in a six-member board, which has a requirement for three women.
Companies that fail to comply will be fined $100,000 for the first violation, and $300,000 for each additional violation. Each required director seat not held by a requisite woman shall count as a separate violation, but a seat held by a woman director for at least a portion of the year shall not be a violation. While the fines are not particularly consequential, they may add up, and the cost of public criticism and embarrassment should not be underestimated (e.g., the impact on brand and reputation, recruitment and retention, and investor relations, should be considered).
In signing SB 826, Governor Brown acknowledged that there are “potential flaws that indeed may prove fatal to its ultimate implementation.” It is expected that the constitutionality of the SB 826 will be challenged, perhaps within the first few weeks following the signing of SB 826, on various constitutional and other grounds. In addition to Equal Protection Clause and Civil Rights Act-based arguments, it is expected that the bill will be challenged under the “internal affairs doctrine” (a longstanding doctrine under the Commerce and Full Faith and Credit Clauses) which provides that the internal affairs (e.g., corporate governance) of a corporation should be governed by the state law in which it is incorporated.
Irrespective of the potential legal challenges, publicly held corporations headquartered in California should make preparations for compliance.
The law, as drafted, contains a number of open questions, gaps and ambiguities. While the statute provides that the California Secretary of State may adopt implementing regulations, it may be some time before we receive answers to these questions. These questions, gaps and ambiguities include, among many others:
- How will the California Secretary of State determine violations?
- There is currently no requirement that public companies disclose the gender of their board members and the law is silent as to what new reporting requirements will be implemented as a result of this law.
- How does it apply to newly public companies that IPO late in a year (e.g. December 2020)?
- On the face of the statute, there is no transition provision.
- The law says there is no violation if a woman held a seat for at least a portion of the year, but how small is a portion?
- Literally read, the bill seems to invite “holiday directors,” where a company could temporarily add a woman to the board for a day in order to meet the requirements.
- What if there is a proxy contest, and the women nominated by the company lose?
- To penalize a company in such circumstances may be unfair and undercut shareholder democracy.
- Would a company satisfy the requirement, if the company with five directors had two different women on the board for a portion of 2021?
- The law does not state whether the women need to overlap, whether they need to hold different seats, how vacancies would be counted, how the requirement is treated if the board size was adjusted during the year, or when the number of seats would be counted.
Subject companies should also monitor any implementing regulations that the California Secretary of State may adopt and/or consult with legal advisers.
Despite the expected legal challenges to SB 826 and the open questions and ambiguities related to its implementation, the topic of board diversity remains an important issue for investors. Board diversity shareholder proposals are on the rise and several institutional investors, such as Blackrock and State Street Global Advisors, have announced plans to proactively campaign for increased diversity on public company boards. We advise that companies and their board of directors take the following steps to address board diversity and SB 826:
- Have a plan to consciously consider traditional diversity factors, such as gender, race and ethnicity, as a plus when recruiting new board members.
- Consider adopting an adapted version of the “Rooney Rule” for board recruiting (e.g., interview at least one woman or minority as potential final candidate for each open board seat).
- Use reputable and/or diversity-focused recruiters and state that the candidate pool must include women and minority candidates.
- Be prepared to discuss these diversity plans and efforts, either in a public forum or in discussions with individual investors.
- The company’s PR and investor relations teams should have a prepared response on this subject.
- Do not state a specific intent to comply with SB 826, and do not cite the statute as a reason for selecting one board candidate over another (and do not let your recruiter do so).
- Given the expected legal challenges to SB 826, stating specific compliance with the law could put the company at risk for getting involved in a public controversy and in potentially expensive litigation.
- Instead, consider a general statement to the effect that the company is complying with all legal requirements and that the company seeks the best qualified candidate to suit the needs of the company and the board, and takes into consideration many factors, including diversity.