Client Alerts
Oct. 07, 2022

Diversity in the Boardroom: A Periodic Litigation and Governance Update

Efforts to increase diversity at the top of public companies remain at the forefront of corporate consciousness and governance. As we have previously reported (including here and here), stakeholder interest in diversified leadership has led to a series of initiatives over the past several years to encourage firms to have more directors and officers from historically underrepresented communities, as well as greater gender diversity. But such efforts have also met with legal challenges from other interest groups who view these initiatives as misguided or unlawful “reverse” discrimination. We update and review some of these challenges below. While the litigation picture is so far somewhat mixed, we believe public company directors, under pressure from their major stakeholders and believing that diversity is, in fact, in the best interests of their firms, will continue to exercise their business judgment to expand diversity in governance and the workforce.

Nasdaq’s Board Diversity Rule

On Aug. 29, the U.S. Court of Appeals for the Fifth Circuit heard argument on a challenge by two nonprofit interest groups — the Alliance for Fair Board Recruitment and the National Center for Public Policy Research — seeking to overturn Nasdaq’s “board diversity” framework. As discussed here, the framework requires a company listed on the Nasdaq to have, or to explain why it does not have, two members of its board of directors from female, LGBTQ+ or non-white groups. New listing rules also require companies to disclose board-level diversity data using a standardized matrix. The plaintiffs sued the Securities and Exchange Commission (SEC) after the agency approved the framework, alleging the SEC’s approval order violated the free speech and equal protection clauses of the U.S. Constitution.

At argument, the three‑judge panel asked whether the SEC’s mere approval of the Nasdaq rules rose to the level of state action, rather than a ministerial approval of decisions made by Nasdaq Stock Market LLC, a private self-regulatory organization. There were also questions relating to whether the SEC had the regulatory authority and sufficient evidence before it to approve the rules. The SEC defended that the rules established a disclosure system consistent with the requirements of the Securities and Exchange Act and with the government’s interest “in making capital markets more open and efficient” by giving all investors access to board diversity data. It is conceivable that if the court rejects the challenge, the petitioners will seek en banc review before the full Fifth Circuit, which has historically been sympathetic to regulatory challenges.

California’s Board Diversity Statutes

The California secretary of state recently appealed two state court decisions that found California SB 826 and AB 979 to violate the state constitution. As we reported here and here, both lower court decisions held the statutes unconstitutional under the state’s equal protection clause. Senate Bill 826, codified at Corporations Code § 301.3, required publicly traded companies with “principal executive offices” in California to appoint a minimum number of female directors or face fines for noncompliance. Assembly Bill 979, codified at Corporations Code § 301.4, similarly required a minimum number of directors from historically underrepresented communities. Taxpayers challenged the requirements in two separate actions filed in Los Angeles Superior Court in cases that are both captioned Crest v. Padilla. Whether the taxpayer-plaintiffs have standing to bring these lawsuits remains an open question before the California Supreme Court.

Both judges enjoined the state from spending taxpayer money to implement or enforce the laws. However, on Sept. 16, the appellate court in both cases temporarily stayed the injunctions to the extent the injunctions prevented the secretary of state from collecting and reporting board diversity data. The temporary stays thus allow the state to collect diversity data on corporate disclosure forms pending resolution of its petitions for writs of supersedeas. Federal litigation challenging the laws under the U.S. Constitution is on hold in the Ninth Circuit until the appeal of either state decision is finalized.

Challenges to Starbucks Diversity Initiatives

On Aug. 30, the National Center for Public Policy, the nonprofit interest group also challenging Nasdaq’s diversity framework, sued Starbucks Corp. in a shareholder lawsuit in Washington state court, alleging that Starbucks’ directors and officers adopted several diversity policies that they knew constitute illegal racial discrimination. The plaintiff alleges that the directors and officers exposed Starbucks shareholders to material legal risk in order to “pose as virtuous advocates of ‘Inclusion, Diversity, and Equity’” and “buy[] themselves social-credit,” actions that the plaintiff says fall outside the defendants’ corporate authority.

As we have reported (here and here), prior shareholder derivative actions conversely accused companies of failing to meet their published diversity goals. This latest Starbucks lawsuit comes as part of a broader backlash to corporate diversity initiatives and environmental, social and governance (ESG) investing. We discuss new developments in pro-ESG and anti-ESG law and policy in our alert “The Increasing Legal Complexity Surrounding ESG” here.

Authors and Editors

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