California Law Awaiting Governor’s Signature Exceeds State’s Jurisdiction

Theodore N. Mirvis and Kevin S. Schwartz are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Mirvis and Mr. Schwartz.

We previously reported that California made headlines this summer with legislative action that would institute gender quotas for boards of directors of public companies headquartered in the state. This first-of-its-kind measure has now been approved by both legislative chambers and may be signed by the Governor in the coming week. California’s commitment to increasing diversity in the boardroom is laudable, but this proposed law would unconstitutionally sweep within its scope all publicly traded corporations with headquarters in California, even if those corporations are chartered outside of California. This constitutional infirmity warrants immediate reconsideration.

The California bill (SB 826) would require any public company with shares listed on a major U.S. stock exchange that has its principal executive offices in California to have at least one woman on its board by December 31, 2019. By year-end 2021, such companies with five directors would be required to have at least two women on the board, and companies with six or more directors would be required to have at least three women on the board. The law would be enforced with fines of $100,000 for a first-time violation and $300,000 for subsequent violations.

The statute’s unconstitutional reach deserves immediate scrutiny. Given the long-recognized constraints on state control of companies incorporated in other jurisdictions, the bill could properly apply only to corporations incorporated in California, regardless of the situs of their operations or headquarters. 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. In our view, it is unwise to risk certain constitutional challenge and the resultant confusion about the salutary goal of increased diversity. It would certainly be ill-advised to disregard the long- standing internal affairs doctrine, which guards against the chaos of multi-jurisdictional regulation of corporate affairs by confining regulatory power to the state of incorporation. If it is not reconsidered, the enforceable reach of the statute will be severely limited, as Professor Joseph Grundfest demonstrated in a significant article on the measure.

From the perspective of those concerned with effective corporate governance, increased diversity in the boardroom is a valuable and important goal. One can readily appreciate the concerns of those who believe that achieving that diversity has taken too long. A robust debate about various methodologies and strategies for advancing the cause of diversity will doubtless yield results in the near term. Boards and investors share a common interest in this subject. The key is to find the right path forward, while recognizing that the time for removing all barriers to increased diversity is overdue.

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