Right-leaning groups have gone to court to challenge board diversity rules formulated by the Nasdaq stock exchange and the state of California, arguing that the measures amount to racial and gender discrimination.
But even if the plaintiffs ultimately succeed in overturning those rules, they are unlikely to stop banks’ ongoing efforts to diversify their boards of directors, according to corporate governance experts. Increasingly, companies are motivated by shareholders pushing for more boardroom diversity and by studies suggesting that diverse boards perform better, these experts say.
“There is a change in the atmosphere and the culture that is pushing for these changes,” said Gillian Emmett Moldowan, a partner at the law firm Shearman & Sterling. “Irrespective of the different laws hitting on this point, it does seem we’re starting to see some meaningful increase in women on boards of directors in the last few years.”
The composition of boards
The state of California passed a law in 2018 requiring public companies headquartered in the state to add more women to their boards — or face fines of $100,000 for the first violation and $300,000 for each subsequent violation.
Last year, California passed another measure that’s intended to boost the number of corporate directors from underrepresented groups. More recently, the Securities and Exchange Commission
The National Center for Public Policy Research, a conservative think tank and activist shareholder firm, has filed lawsuits against both the SEC and the state of California challenging those rules. In its lawsuit against the SEC, the organization argued that the agency did not have the authority to approve the Nasdaq rule, which it characterized as unconstitutional.
The Pacific Legal Foundation, a conservative nonprofit group, is representing the National Center in its lawsuit challenging California’s 2020 rule. The two groups argue that the state’s requirements violate the equal protection clause of the Constitution’s 14th Amendment.
“Racial discrimination, even when it’s meant to benefit minorities, is ugly, it’s racist,” said Daniel Ortner, an attorney with the Pacific Legal Foundation.
Board diversity rules effectively amount to “affirmative action quotas” for the boardroom, said Justin Danhof, executive vice president with the National Center for Public Policy Research.
Danhof added that the board diversity rules could also violate the First Amendment by forcing board candidates to declare their sexual orientation, though that objection is not a basis for his group’s lawsuits.
Under the First Amendment, the government cannot compel speech, just as it cannot restrict speech, Danhof said. “If you think about declaring your sexual orientation while you’re interviewing for a board seat, you’re quite literally going to out some people who may not want to be outed,” he said.
In 2019, the Pacific Legal Foundation filed another lawsuit against the state of California over its earlier rule requiring more women on corporate boards. In that lawsuit, a shareholder in a California-based firm argued that the 2018 rule would effectively require him to discriminate by voting for board candidates based on their gender, rather than who he believed was the candidate the best for the job.
A federal district court ruled that the plaintiff’s status as a shareholder didn’t give him the standing to challenge the rule, but the Ninth Circuit Court of Appeals overturned that decision and said that he did have the necessary standing.
The plaintiffs have asked for a preliminary injunction to block the California law from being enforced, but some observers doubt that will happen.
“The further away we get, the less likely it becomes that a preliminary injunction will be granted,” said Mallory Brennan, a litigation partner at Shearman & Sterling. And even if the courts ultimately side with the plaintiffs, she said, they could end up with a pyrrhic victory, having spent tremendous amounts of time and money to overturn a law that companies have already begun to comply with anyway.
More generally, experts in corporate governance say that the conservative groups’ efforts amount to trying to put toothpaste back into the tube. Disclosures about board composition have become more common since 2019, and companies have continued to add more women and minorities to their boards, according to a recent analysis of 100 publicly traded companies by Shearman & Sterling.
“As a practical matter, companies have already been complying with those requirements that are in force, and even if those requirements change, you are unlikely to see companies spend additional money and effort to undo what they’ve already done,” Brennan said.
Increasingly, companies are seeking to diversify their boards for reasons other than legal mandates, said Keith Meyer, a global practice leader of the CEO and board practice at the recruiting firm Allegis. Their rationales include pressure from shareholders and a desire to better represent the communities in which they operate. For banks in particular, such representation can be especially critical because banks provide access to capital and financial security, Meyer said.
“At the end of the day, our belief is the governance of the enterprise and the individuals charged with that responsibility should represent and be as diverse as the customer base, the supplier base and the constituents driving the success of the enterprise,” he said.
Some observers also point out that historically, company directors have often relied on their own networks to find suitable board candidates. Board openings typically aren’t filled in the same type of “open and transparent” way that job openings are, said Jennifer Rubin, a partner at the law firm Mintz.
She said that efforts like the California laws are intended to encourage corporate insiders to look more broadly for board talent.
“It can be a somewhat insular, highly networked, highly leveraged world where individuals use their board positions in order to seek and gain introductions,” Rubin said. “If you don’t allow that world to be opened up, all these individuals, many of whom are highly qualified, don’t have that opportunity to compete.”
