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Following in the steps of precedent setting legislation mandating women on boards two years ago, on September 30, 2020, California Governor Gavin Newsom signed AB 979 into law mandating diversity on certain public company boards of directors. The new law requires publicly held corporations headquartered in California to include at least one person from an underrepresented community by the end of next year, with additional appointments required in future years.

New Obligations

The new legislation is the first of its kind in the U.S. and is the second time California seeks to mandate diversification of public company boards through legislation. (Read more about the 2018 legislation requiring companies to put female directors on their boards here.) The first piece of legislation aimed at increasing gender diversity; AB 979 seeks to increase diversity from “underrepresented communities.”

AB 979 defines a member of an underrepresented community as anyone “who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender.”

Covered corporations include any publicly held domestic or foreign corporation whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California.

By December 31, 2021, covered corporations must have:

    • A minimum of one director from an underrepresented community on its board.

By December 31, 2022: covered corporations must have:

    • At least three directors from an underrepresented community, if the board has nine or more members;
    • At least two directors from an underrepresented community, if the board has five to eight directors; and
    • At least one director from an underrepresented community, if the board has four or fewer directors.

Note that corporations are allowed to increase the number of directors on its board to comply with the law.

Stiff Fines for Noncompliance + Fines for Failure to Meet New Board Diversity Reporting Requirements

Noncompliance may result in a fine of $100,000 in the first violation and $300,000 for each subsequent violation, with a separate $100,000 fine for failing to provide required information to the State. These track the penalties enforced for noncompliance with the gender diversity mandate.

Expected Challenges

The gender diversity mandate has been met with constitutional challenges. To date, none have been successful. We expect that AB 979 may face similar challenges on grounds that it allegedly violates the U.S. Constitution, the California Constitution and California civil rights laws based on equal protection grounds. We will continue to track developments.

A Few Key Findings Included in the New Legislation 

  • According to 2018 data from Deloitte and the Alliance for Board Diversity, the percentages of Fortune 500 company board seats held by people identified as African American/Black, Hispanic/Latino(a), and Asian/Pacific Islander were 8.6 percent, 3.8 percent, and 3.7 percent, respectively.
  • The United States Bureau of Labor Statistics also reported that in the year 2019, 90 percent of chief executives were White.
  • According to the Latino Corporate Directors Association, there are 662 publicly traded companies headquartered in California. Two hundred thirty-three of these companies have all White boards of directors as of this year.
  • According to a report by McKinsey and Company, for every 10 percent increase in racial and ethnic diversity on the senior-executive team, earnings before interest and taxes rise 0.8 percent.

Broader Implications

Board diversity has been in the spotlight for the past few years. Many companies, institutional investors, and industry groups have recognized the benefits of a diverse board of directors, and have advocated for public companies to increase the representation of women and minorities on their boards. For instance, at Davos this year, the CEO of Goldman Sachs said it would only take firms public with at least one diverse board member. Other institutional investors including State Street Global Advisors and BlackRock have made statements about the need for diversity in the companies they invest in.

At the same time, there have been a growing number of shareholder derivative suits filed against large companies for failings related to board diversity. Allegations against companies include: (1) failing their fiduciary duty in not hiring minority board members; and (2) misleading investors about their commitments to diversity while having no (or too few) minority board members or senior executives.

In total, whether or not other states choose to adopt measures similar to California’s now, companies will be well-served not to wait for a legislative mandate to examine their board composition.

For assistance complying with the new legislation, contact your Baker McKenzie employment lawyer.