Hearing on Board Gender Diversity Statute

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here); and Will Nasdaq’s Diversity Rules Harm Investors? by Jesse M. Fried (discussed on the Forum here).

On October 19, a federal district court judge held a hearing on a motion for a preliminary injunction in Meland v. Weber, a case challenging SB 826, California’s board gender diversity statute, on the basis that it is unconstitutional under the equal protection provisions of the 14th Amendment. The judge had previously dismissed the case on the basis of lack of standing, but was reversed by the 9th Circuit. What did the hearing reveal?

SideBar

As you may recall, SB 826 requires that public companies (defined as corporations listed on major U.S. stock exchanges) that have principal executive offices located in California, no matter where they are incorporated, include specified minimum numbers of women on their boards of directors. Under the law, each public company was required to have a minimum of one woman on its board of directors by the close of 2019. That minimum increases to two by December 31, 2021, if the corporation has five directors, and to three women directors if the corporation has six or more directors. The statute also requires 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 may impose fines for violations, ranging from $100,000 to $300,000 per violation. So far, the Secretary has neither adopted regulations regarding fines or imposed fines for violations.

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.

Case history. In Meland v. Padilla, a shareholder of a publicly traded company that is incorporated in Delaware and headquartered in California filed a complaint seeking a declaratory judgment that SB 826 was unconstitutional under the equal protection provisions of the 14th Amendment and a permanent injunction preventing implementation and enforcement of the statute. The plaintiff claims that the statute is a sex-based classification that violates the equal protection provisions of the 14th Amendment by imposing a sex-based quota directly on shareholders and by seeking to force shareholders to perpetuate sex-based discrimination. More specifically, the complaint contends that the statute “facially discriminates on the basis of sex” and “serves no important government interest” because “[s]ex-based balancing is not an important government interest that can sustain a sex-based classification under the Equal Protection Clause.”

In April 2020, a federal district court dismissed that legal challenge on the basis of lack of standing, finding that none of the provisions of SB 826 affected the plaintiff’s 14th amendment rights to an extent sufficient to establish standing under Article III. While the plaintiff had argued that he had standing because the statute was compelling him, as a shareholder, to vote in a way that perpetuated sex-based discrimination, the district court concluded that SB 826 “places a requirement and a possible penalty on publicly held corporations, but Plaintiff is not a publicly held corporation. He is a shareholder. And that is a distinction with a difference.” In addition, the district court reasoned, the plaintiff is not being forced to vote for any particular director: “notwithstanding SB 826, Plaintiff, as a shareholder, can vote in shareholder elections as he pleases. If, at future shareholder meetings, Plaintiff prefers a male board member nominee, there is nothing in SB 826 preventing him from casting a vote in favor of that nominee.” The plaintiff, the district court also concluded, was not affected in any “personal or individual way.”

In June 2021, a three-judge panel of the 9th circuit reversed that decision, allowing the case, now called Meland v. Weber, to go forward. The court held that, because the plaintiff “plausibly alleged that SB 826 requires or encourages him to discriminate on the basis of sex, he has adequately alleged that he has standing to challenge SB 826’s constitutionality.” The panel observed, “we have long held that ‘[a] person required by the government to discriminate by ethnicity or sex against others has standing to challenge the validity of the requirement, even though the government does not discriminate against him.’” Accordingly, the court concluded, if the plaintiff has plausibly alleged that SB 826 “requires or encourages” him to discriminate on the basis of sex, “then he has suffered a concrete personal injury sufficient to confer Article III standing.” (For a more detailed rundown of the history of this case, see this PubCo post and this PubCo post.)

Shortly after the 9th Circuit decision, Meland moved for a preliminary injunction to prevent the California Secretary of State from enforcing the statute while the case is pending. On October 19, there was a hearing in the district court on the plaintiff’s motion.

At the hearing. During the hearing, the federal district court judge indicated that he was unlikely to grant the preliminary injunction.

According to the transcript, the court made clear that “to secure a preliminary injunction, the plaintiff has to show that he is, one, likely to succeed on the merits, that he’s likely to suffer irreparable harm in the absence of a preliminary injunction, that the balance of equities tips in his favor, and that an injunction is in the public interest.” From a procedural standpoint, the State attempted to take another stab at the argument that the plaintiff had no standing, but the judge questioned whether, in light of the 9th circuit opinion, the State would “really want to double-down on this standing argument.”

Getting to the merits, the judge cited two 9th circuit cases on gender preferences that survived a facial challenge. In one of the cases, the court found that the defendant had a “legitimate and important interest,” and that the means chosen to remedy the “many disadvantages that confront women business owners” were “substantially related to the objective.” In addition, the “utilization goals under both the set-aside and preference methods are legitimate means of furthering the objective and are not unduly onerous.” In that case, the judge said, the court “properly granted summary judgment” to the defendant. The court highlighted that strict scrutiny was not applied: “It’s only intermediate scrutiny,” that is, the state needed to show only “that some degree of discrimination has occurred in a particular field before a gender-specific remedy may be instituted.”

The hearing then turned to the issue of the pattern of gender discrimination. Counsel for the plaintiff pointed to data showing that about 40% of new directors were women, and argued that the state “has to show discrimination in the relevant industry” and tailor its remedy more narrowly to particular industries affected. But the court pointed out that plaintiff’s data was post-adoption of SB 826 and only about new directors. The State pointed to an MIT study of over 5,000 corporate board members between October 2015 and June 2016, which found that 44% of publicly held companies “considered no women as candidates for nonexecutive board seats.” The same study also found a “diversity feedback loop,” where boards with more women tended “to consider both the larger pool of candidates and a higher proportion of women candidates when filling vacancies. Where 61 percent of boards without women fail to consider a single woman candidate in most recent board vacancies.” Plaintiff’s counsel contended that there are other non-discriminatory reasons for that data. However, the State pointed to evidence showing that women experience bias at work and maintained that “gender-neutral policies would not have solved the problem given these biases that had been documented.”

There was also a discussion about whether SB 826 imposes a “quota,” with the judge reasoning that it’s not a quota because you can always add board seats—i.e., that the law doesn’t require that men be replaced on boards with women nor does it prohibit more men from joining the board. Plaintiff’s counsel argued that it was a quota under Bakke because those seats are set aside for women in perpetuity. But, the State argued, there’s no fixed percentage involved and the potential women directors aren’t walled off in a separate competition. Rather, the fact that the law specifies numbers depending on board size is intended to ensure a “critical mass” of women are elected to boards and to avoid “token” board appointments.

The parties also discussed whether SB 826 was “premised on a stereotype” and whether there’s evidence to support the business case for SB 826. The State argued that nothing in SB 826 requires that women directors have a particular leadership style or advocate for particular policies. In addition, the State referred to a body of research over 20 years that supports the positive impact on corporate performance of gender diversity. Counsel for the plaintiff responded that their research showed mixed results for business case. The parties also discussed whether the absence of a sunset date was problematic.

The judge then asked for a discussion of whether a preliminary injunction would be in the public interest, noting that there is a strong argument that, based on evidence, the law has been working. “So why is it in the public interest,” the court asked, “to allow an out-of-state shareholder who holds 65 shares in an 18-million share company, [to] stop a law that no corporation objects to, that no corporation is challenging and is working?” Plaintiff’s counsel responded that “it’s always in the public interest to enjoin an unconstitutional law,” and that “increasing representation for its own sake is not a legitimate interest.” According to counsel for the plaintiff, “increased representation is not necessarily remed[ying] discrimination, and is therefore perpetuating the very stereotypes that equal protection laws are meant to protect against.”

Finally, the judge asked whether, as this is a question of state law, he should delay a decision in this case until the case on SB 826 that is being tried in L. A. Superior Court is completed. (Presumably he’s referring to Crest v. Alex Padilla, which is now scheduled to begin trial on December 1. See this PubCo post.) While that seemed to be fine with the State, plaintiff’s counsel objected.

Recognizing that “no matter what happens, this is going to go up on appeal,” the judge took the case under submission with the intention of reviewing more documents and cases and ultimately issuing a written decision.

“However,” he said, that “always drove me crazy as a lawyer, because you want to leave court with at least having some indication of which way the judge is leaning. I think it’s only fair that I give you that indication with respect to the issues in this case. And, again, this is not my final decision. It’s tentative, but these are some of the thoughts that I have based on everything I’ve read and the arguments today.

“In terms of the standing issue, I think that’s going to be very difficult for the defendants to succeed on, and I don’t really see a way around the Ninth Circuit decision that remanded the case back to me. I know the defendants think otherwise, but I just think that’s a really difficult issue for the defendant.

“In terms of whether the plaintiff has demonstrated a likelihood of success on the merits so that he is entitled to a preliminary injunction, I think part of the problem with this motion at this time is it’s a preliminary injunction. This case, at some point, if it continues, will—will result in a full hearing and a request that the law be permanently enjoined.

“But I think that the plaintiff hasn’t demonstrated enough of a likelihood of success on the merits on his claim that this law is unconstitutional to warrant a preliminary injunction, to stop the law now. It goes to my question obviously loaded and somewhat biased about the balance of equities in the public interest of stopping this law now, particularly when it appears to be working so well and is accomplishing the primary goal of remedying discrimination.

“So in terms of a likelihood of success on the merits, I am leaning towards finding that the defendants are more likely to succeed on the merits, and that the law should be upheld.

“In terms of irreparable harm, again, I think that at this stage, by not issuing a preliminary injunction, that the harm would be irreparable to the plaintiff. If there is any harm to him, it really can and could be remedied through a permanent injunction, rather than a preliminary injunction.”

The judge then said that he “would address the quota argument and the lack of what appears to be a sunset provision, but again I don’t think those issues preclude the law continuing in its current state. Those are my preliminary thoughts. Again, I will review all of those, rethink those, and then issue an opinion.”

Initially the judge said that he was not certain that he could get an order out before December 31st, but then said that he would get an opinion out before the trial in the L.A. County Superior Court, which is now scheduled for December 1. So stay tuned.

SideBar

There are, of course several other ongoing legal challenges to SB 826, as well as to its companion legislation, AB 979, which requires boards of public companies, including foreign corporations with principal executive offices located in California, to include specified numbers of directors from “underrepresented communities.” The first legal challenge to 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 to enjoin Alex Padilla, the then-California Secretary of State (now U.S. Senator), from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, SB 826, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution. The court in that case has just denied each side’s motion for summary judgment after concluding that there were triable issues of material fact. The case was originally set for trial on October 25. However, on the court’s own motion, the jury trial estimated to last between six and seven days previously scheduled for October 25 was “trailed” to December 1. (See this PubCo post.)

The same three plaintiffs in that case also filed a similar lawsuit challenging AB 979 on essentially the same basis. Like Crest v. Padilla I, the case is framed as a “taxpayer suit” and seeks to enjoin the California Secretary of State from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, alleging that the law’s mandate is an unconstitutional quota and violates the California constitution. (See this PubCo post.)

In another case, Alliance for Fair Board Recruitment v. Weber, the plaintiff sought declaratory relief that both of California’s board diversity statutes violate the Equal Protection Clause of the 14th Amendment and the internal affairs doctrine. The case was filed in a California federal district court against the California Secretary of State, Dr. Shirley Weber, and seeks to enjoin Weber from enforcing those statutes. The plaintiff is described as “a Texas non-profit membership association,” with members that include “persons who are seeking employment as corporate directors as well as shareholders of publicly traded companies headquartered in California and therefore subject to SB 826 and AB 979.” According to the complaint, these statutes require all publicly traded corporations headquartered in California to discriminate based on sex and race in selecting their board members. The complaint alleges that “[t]hese laws are unconstitutional and patronizing social engineering. The legal regime they institute relies on and perpetuates invidious racial categories and sex stereotypes that the American legal system has rightly discarded.” In addition, the plaintiff contends that both statutes “trample on the sovereign rights of other states to regulate corporate governance for entities incorporated under their laws. SB 826 and AB 979 apply to all corporations headquartered in California, even if the corporation in question is incorporated under the laws of a different state. This policy is illegal because California lacks jurisdiction to regulate the internal affairs of entities incorporated under the laws of other states.” (See this PubCo post.) Notably, this same group has filed a slim petition under the Exchange Act in the Fifth Circuit Court of Appeals for review of the SEC’s final order approving the Nasdaq board diversity rule. (See this PubCo post.)

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