California’s Proposed AB 979 Requires Public Company Boards to Include Racial and Ethnic Diversity
[Editor’s Note (9/30/20): Governor Newsom signed the bill into law on September 30, 2020.
The draft bill was revised on August 20, 2020, to add LGBT self-identification to the definition for directors to be included on boards. This follows a prior revision on July 28, 2020. Together, the two revisions update the critical definition for directors to be included on boards as "an individual who self-identifies as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identifies as gay, lesbian, bisexual, or transgender."]
California lawmakers have proposed legislation mandating that public companies headquartered in the state appoint board members from underrepresented communities. AB 979 defines underrepresented communities as African American, Hispanic or Native American. It would require companies to have at least one director who self-identifies with those groups by the end of 2021. The requirement would scale up in the next year depending on the size of the board. In light of the current focus on social justice, including the role that companies may play in these efforts, we believe that some form of the legislation has a meaningful chance of passing. This article offers recommendations for company boards to prepare to comply.
The legislation — introduced in the state Legislature on June 29, 2020 — is similar to SB 826 adopted in 2018, which requires gender diversity on corporate boards in California. Like SB 826, AB 979 would require the California Secretary of State to track and report compliance as well as levy fines for noncompliance.
AB 979 would require by the end of 2022 that the number of directors from underrepresented communities be at least:
The Legislature has until August 31, 2020, to amend and pass the bill, and the governor has until September 30, 2020, to sign or veto the bill, assuming it passes in the Legislature (otherwise, the sponsors will have to begin again in the new year). As with SB 826, we anticipate there will be pressure to include other groups in the definition of underrepresented communities as well as other forms of diversity (e.g., Asian Americans, non‑Native Americans of African descent, Latinx, non‑Native American Indigenous peoples, gender identity, religion, sexual orientation, culture, disability, nationality, veteran status, political affiliation, etc.). There may also be pressure to extend the deadlines, as the period to comply with the proposed step-up requirement is one year shorter than with SB 826.
In light of the relatively short deadlines for compliance and the long timelines for board recruiting and transitions, we recommend that public companies, nominating committees and their advisors attend to developments in this legislation. We also recommend that they work with reputable and/or diversity-focused recruiters and continue to include people from underrepresented groups in their candidate pools.
As with SB 826, there are a number of open questions and ambiguities in the proposed legislation. If passed into law, there may be similar challenges to the legislation on constitutional and other grounds. We recommend that companies use care not to cite the proposed legislation as a reason for selecting one board candidate over another (and to not let their recruiters do so).
Independent of the legislative effort, proxy advisory firm Institutional Shareholder Services (ISS) is encouraging all public U.S companies to provide greater transparency regarding the racial and ethnic makeup of their boards and top executives. ISS has sent survey requests (subscription required) asking companies to provide “the self-identified race/ethnicity of each of the company’s directors and named executive officers (NEOs).” ISS has made it clear that the information provided will not be kept confidential and stated that it intends “to use this information within our product sets to provide our clients [institutional investors] with a more holistic picture of board and leadership diversity.” (Read the ISS letter in full)
The inquiry is accompanied by an Excel spreadsheet listing the current directors and NEOs and asking companies to classify them in the following categories (permitting three classifications for each person, plus a free-form space for additional comment):
Notably, ISS is tracking more racial and ethnic categories than the California legislation. However, as with AB 979, it omits other categories of diversity such as gender identity, religion, sexual orientation, political affiliation, culture, disability, nationality and veteran status.
We recommend that public companies consider the ISS request in light of their broad diversity and inclusion communications plans (including alternative avenues for disclosure and broader aspects of diversity), the current social justice environment—including consumer and employee calls for corporate social justice—and investor interest. We also recommend that they consult with counsel and investor relations advisors as they consider whether and how to respond to the ISS request.
As we noted in our Proxy Season Trends to Watch for 2020, support has been building for public companies to increase gender and racial diversity. Women and ethnic minorities are joining boards of directors at rates never before seen.
A record-breaking 59% of the 432 independent directors added to S&P 500 boards over the past year were women or men belonging to minority groups, according to the 2019 U.S. Spencer Stuart Board Index. Women represented 46% of the incoming class.
Two of every three companies surveyed by Spencer Stuart reported that diversity would be a board recruiting priority for at least the next three years. It’s important to note that this survey occurred even before recent worldwide protests drew much-needed attention to racial justice in our society.
Regardless of whether AB 979 becomes law or whether shareholders use the ISS survey data to pressure boards to change, public companies will continue to come under increased scrutiny to ensure their boards of directors reflect the diversity of the communities they serve and in which they operate. Public companies should be prepared to discuss these diversity plans and efforts, either in a public forum or in discussions with individual investors.