On September 30, 2018, Governor Jerry Brown signed SB 826 into law (effective January 1, 2019), requiring a minimum number of female directors on the boards of publicly traded corporations with principal executive offices in California. Under this new Section 301.3 to the California Corporation Code, the location of a corporation's principal executive office will be determined by the corporations' Annual Report on Form 10-K, and publicly traded corporation means any “corporation with outstanding shares listed on a major United States stock exchange."
A corporation covered by the law must have at least one female member on its board of directors by December 31, 2019, and additional female members by 2021 depending on the size of the board. If the corporation has a board of directors with:
- four members or less, no additional female directors are required
- five members, the board must have at least two female directors by December 31, 2021, and
- six or more members, at least three female directors are required to be in place by December 31, 2021.
The California Secretary of State can impose fines of $100,000 for a first violation and $300,000 for subsequent violations. Each board seat not filled by a female director for at least a portion of each year will count as a violation. The Secretary of State can also impose fines of $100,000 for failure to comply with annual reporting requirements regarding board composition. Specific provisions regarding the form and timing of these reporting requirements will be established by regulation.
As California Governor Brown acknowledged in his signing statement, this new law has “potential flaws that indeed may provide fatal to its ultimate implementation" and will likely be subject to challenge. Potential challengers argue that the law violates the commerce clause and the equal protection clause of the US Constitution. Internal affairs of a corporation, including the governance of a corporation, are generally governed by the law of the state in which it is incorporated, not where it is physically located. California would bear the burden in showing a compelling interest in regulating the internal affairs of foreign corporations as it relates to its local interests if forced to defend the law against a commerce clause challenge. More broadly, commentators have noted that a mandate based on gender classification at private organizations such as corporations could run afoul of the equal protection clause of both the US and California constitutions.
The adoption of this bill comes amidst increasing pressure from institutional investors, including major asset managers like BlackRock and major public pension funds like CalPERS, on public companies to increase gender diversity on their boards. For example, in February 2018, BlackRock updated its proxy voting guidelines, adding a stipulation that it expects companies to have at least two women directors on their boards. As a result of the increasing focus on gender diversity and board diversity more generally, many public companies have already begun to take diversity into account as they evaluate board composition. Despite the scrutiny that Section 301.3 is likely to face in courts, unless and until the law is successfully challenged, we believe it would be prudent for public companies headquartered in California to begin to evaluate and plan for compliance with the provisions of Section 301.3.