In an effort to increase female representation on corporate boards, California’s Senate recently passed a bill mandating that public companies based in the Golden State have at least one woman on their board by the end of 2019.
The legislation, SB-826, was signed into law Sunday by California Gov. Jerry Brown. The one-woman boardroom mandate will take effect by the end of next year. Furthermore, public companies based in California with at least five directors must make two of them women, and companies with six directors will need to have three women on their board by 2021 or face penalties.
SB-826 will impose a $100,000 fine for the first violation, with subsequent infractions of up to $300,000. Companies that fail to file information about their boards with the Golden State’s secretary of state in a timely manner could also be fined $100,000.
While few would argue against including more women on corporate boards, critics of the bill claimed the law could tokenize some companies. Wachtell, Lipton, Rosen & Katz, known for its famous client memos, released a missive on Sept. 21 pointing out that the proposed law has flaws since it would apply “only” to companies incorporated in California. (Wachtell partner David Katz and consulting attorney Laura McIntosh, the wife of current U.S. Department of the Treasury general counsel Brent McIntosh, wrote more about SB-826 in a July column for the New York Law Journal.)
“Despite attempts by the bill’s sponsor to argue that the statute’s scope will survive constitutional scrutiny, there should be little doubt that the law cannot be applied to Delaware corporations with headquarters in California or to any other corporations chartered outside of California,” wrote Wachtell litigation partners Theodore Mirvis and Kevin Schwartz in last week’s memo. ”In our view, it is unwise to risk certain constitutional challenge and the resultant confusion about the salutary goal of increased diversity.”
Among public company watchers tracking the progress of SB-826 is Shelly Heyduk, a corporate partner at O’Melveny & Myers in Newport Beach, California, who has advised a wide range of publicly listed companies on governance issues, including board member composition. The Recorder caught up with Heyduk in the run-up to the governor’s decision to sign the bill into law to discuss the possible implications of the new bill and the challenges companies may face on compliance.
TR: So how did this conversation first get started? Do we need the bill?
Heyduk: There has been a growing recognition in recent years that corporate boards lack diversity. According to statistics cited in the bill, just over 25 percent of public companies headquartered in California did not have any female directors as of June 30, 2017. The California Legislature attempted to address concerns about gender diversity on corporate boards in 2013 by adopting a resolution urging public companies to add women to their boards and setting targets for the number of female directors on corporate boards to be met by the end of December 2016. The current legislation before Gov. Brown, which mandates a minimum number of women on the boards of all public companies headquartered in California, is in response to a concern that the rate of change has been too slow.
My view is that a gender quota mandate is premature at this point. Board diversity is a real problem, but what the legislation ignores is that there has been increasing momentum over the past two years to improve board diversity. A growing interest in the issue by institutional shareholders has led to increased engagement with companies about their efforts to improve board diversity. These efforts—through shareholder outreach, votes against directors on boards with no female directors and shareholder proposals—have resulted in change. For example, according to data from Equilar, the percentage of public companies in the Russell 3000 index with no female directors decreased from almost 25 percent in 2016 to approximately 17 percent as of June 30, 2018. While the changes may seem slow, there is momentum toward improved board diversity that is expected to continue.
What is the attitude of companies toward the bill?
In terms of the companies I have talked to, they understand the goal of the legislation and the value of a diverse board, but they do not believe a gender quota mandate is an appropriate way to effectuate change. There are a number of companies that, for a variety of reasons, do not have an immediate need to refresh their boards and add additional directors, but that are committed to including qualified female and other minority candidates in the slate of [individuals] they consider when they next seek a new director. These companies want to be able to address the issue when they are next ready to refresh their boards and on a time frame that allows them to select a qualified director candidate with skills and experience that are complementary to other existing board members.
The other concern some opponents of the bill have raised is that the legislation is focused solely on gender diversity and does not seek to address other areas of underrepresentation on corporate boards, such as race or ethnicity. By focusing solely on gender diversity, the legislation appears to prioritize that over these other areas.
What will happen if the bill gets passed?
If the bill is signed by Gov. Brown, each public company having its principal place of business in California as stated in the company’s most recent Form 10-K filed with the SEC will be required to have at least one female director on its board by Dec. 31, 2019, and, by Dec. 31, 2021, [three female directors if the board has six or more directors and two female directors if it has fewer than five individuals]. The bill applies to all public companies headquartered in California regardless of where the company is incorporated. For purposes of the bill, a company is considered a “public company” if its securities are listed on a major U.S. stock exchange.
Even if the bill is signed by Gov. Brown, there is a strong possibility that it will be challenged as unconstitutional under the equal protection clause of the U.S. or California constitutions or, for public companies incorporated outside of California, under the internal affairs doctrine. If challenged, a court may stay the effectiveness of the law pending resolution of its constitutionality. Regardless of whether the bill is signed or challenged, the current momentum toward board diversity will continue. Institutional shareholders, proxy advisers and other governance activists are continuing to focus on board diversity as an issue and will be looking for progress at companies that lack sufficient board diversity.
How will the bill affect law firms and lawyers representing the companies?
I don’t expect any significant impact. We will continue to advise companies as we currently do with respect to director independence, board committee qualifications and related requirements under stock exchange and SEC requirements and proxy adviser voting policies. These are regular conversations we have with our clients any time they seek to add new directors to their boards. The bill’s mandated timeline for adding female directors may temporarily increase those requests, but overall I do not expect the change to have a long-lasting impact.
We may also see more questions about how to implement the requirements of the bill’s gender quota mandate in compliance with a company’s organizational documents. The legislation expressly includes a provision that permits a company to expand the size of its board to accommodate the addition of a female director. Supporters of the bill hope that this provision will help defend challenges to the bill on equal protection grounds because it would enable companies to add a female to a board without requiring them to displace a male director. What the provision ignores, however, is that the charter and bylaws of many companies set a maximum number of board directors and increasing this limit often requires shareholder approval.
Are female directors going to be in high demand? Can the companies meet the deadline?
Estimates are that there are more than 100 public companies headquartered in California that do not have female directors, and would need to add one by the end of 2019 if the bill is signed by Gov. Brown. That is a significant number of companies, all at the same time seeking out female director candidates. And those numbers increase significantly if you’re also considering the public companies headquartered in California that would have to add two or three directors by the end of 2021. At the same time, many other public companies outside of California will also be actively seeking to add women to their boards. This significant demand and competition for qualified female directors may make it more difficult for some companies to find the right director by the mandated deadline as it can take time for a board to identify a qualified director that fits in and complements the skills and expertise of the company’s other directors. No board diversity effort will be effective if boards are adding “token” female directors simply to satisfy a gender quota mandate.
All interviews are condensed and edited for style, grammar and clarity.