Corporations with a principal executive office in California that have shares listed on a major U.S. stock exchange will be required to have a minimum number of women on their boards of directors, under a bill signed into law on September 30, 2018, by the Governor of California. Although the new law may be subject to challenge in court, affected public companies and those contemplating an initial public offering within the next year should begin to consider board composition and director recruiting, or risk future fines by the State, pressure from institutional investors, or exploitation by activists.
The new law, which had been California Senate Bill 826, requires any corporation (whether or not incorporated in California) with a principal executive office in California that has shares listed on a major U.S. stock exchange, to have at least one female director on its board by December 31, 2019.1 By December 31, 2021, at least two female directors must sit on any board with five directors, and at least three female directors must sit on any board with six or more directors. Except for this initial phase-in, the new law does not provide any transition period for newly listed companies.2 Therefore, for example, a corporation headquartered in California with a six person board of directors that undertakes an IPO in 2022 would need at least 50% of its board to be women at the outset.
Failure to comply with the law could result in the imposition of fines by the California Secretary of State. Each director seat required but not held by a female during at least a portion of a calendar year constitutes a separate violation of the new law. The fine for the first violation is $100,000; for a second or subsequent violation, the amount is $300,000. In addition, the law contemplates regulations that will require a corporation to file board member information with the Secretary of State, and the failure to file such information timely may result in a fine of $100,000.
What is the impact of the new law on public companies currently headquartered in California? According to a study by Equilar, the vast majority of publicly companies headquartered in California today would comply with the new law’s requirements based on the initial December 31, 2019 criterion, but would fail the December 31, 2021 criteria.3 Specifically, 18% (37 companies) have no female directors and therefore would fail the initial December 31, 2019 criterion. Moreover, under the more stringent December 31, 2021 criteria, 79% of the companies would fail.4 Consequently, these companies should be evaluating the new law and their director recruiting activities.
Although this is the first time a state has mandated women on public company boards, institutional investors have been ratcheting up the pressure on public companies to increase gender diversity for several years. In 2017, State Street voted against the re-election nominating/governance committee directors at 400 companies that “failed to make any significant effort to address the issue.”5 Earlier this year, BlackRock updated its proxy voting guidelines (available here) to state that it “would normally expect to see at least two women directors on every board”. According to a recent survey of over 60 institutional investors (available here) 82% believe that board composition, with a focus on gender diversity, should be a board priority. See also our prior publications, available here and here.
Proxy advisory firms Institutional Shareholder Services and Glass Lewis have also taken note of investors’ interest in board diversity. Beginning in 2019, Glass Lewis will generally recommend voting against the nominating committee chair of a board with no female directors.6 Although ISS does not currently have a formal proxy voting policy with respect to board gender diversity, as we have previously written here, ISS’ latest Governance Principles Survey suggests that board gender diversity remains top of mind for ISS.
As acknowledged by Governor Brown in his signing letter, the law could still be subject to legal challenge.7 The law’s constitutionality could be challenged on equal protection grounds due to the creation of an express gender classification and quota system. In addition, the law could be challenged under the internal affairs doctrine given its application to companies incorporated outside California.8 It is not clear whether any other jurisdiction, such as Delaware, would enforce the California law.
- SB 826 applies to “publicly held domestic or foreign corporations who principal executive offices, according to the corporation’s SEC 10-K form, are located in California.” It defines “publicly held corporation” as one with outstanding shares listed on a major United States stock exchange. There is no definition of “major” stock exchange. The law also does not provide for circumstances where the principal executive office has not yet been disclosed in a Form 10-K (e.g., for IPO companies the principal executive office typically would have been first disclosed on a Form S-1 registration statement). The law defines “female” as “an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.”≈
- In contrast, NYSE and Nasdaq corporate governance listing rules permit a transition period for IPO companies to come into full compliance with certain of the exchanges’ director independence requirements.≈
- See Equilar, Inc., “Gender Quotas in California Boardrooms May Pave Way for Diversity” (Aug. 14, 2018). The study examined public companies headquartered in California with annual revenues of $5 million or more (a total of 211 companies with an aggregate of 349 female and 1,466 male board members). The study also indicates that California companies currently are slightly below other states and the national average in terms of the average number of women on a board (California – 1.65; other states – 1.76; U.S. as a whole – 1.75).≈
- A different study, based on California headquartered companies in the Russell 3000 Index and board composition as of September 2018, found that 377 companies will have to add female director(s) to their boards in order to be in compliance with SB 826 under the December 31, 2021 criteria. 66 companies would have to add three women to their boards; 175 companies would have to add two women to their boards; and 136 companies would have to add one woman to their boards. Furthermore, the author of this study notes that these numbers do not reflect all of the listed companies headquartered in California since there are many that are too small to be in the Russell 3000 Index. Based on her research, the author believes that “the majority of microcap companies (i.e., smaller than $300M in market capitalization) do not have women on their boards, so many more companies will have to make changes to be in compliance with SB 826.” Annalisa Barrett, “How Many California Companies Have To Add Women To Their Boards?” (October 1, 2018).≈
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- Although the new law would appear to apply to hundreds of companies, a different author’s analysis concludes that it currently could apply only to a universe of 72 corporations (based on September 2018 data from Compustat) because the internal affairs doctrine would further narrow its scope to corporations incorporated California. See Grundfest, Joseph, “Mandating Gender Diversity in the Corporate Boardroom: The Inevitable Failure of California’s SB 826” (September 12, 2018), available here.≈