Talking The Talk Versus Walking The Walk: Shareholder Suits Aim To Push Board Diversity And Punish Companies Supposedly Failing To Make Meaningful Change

A lot of attention has been paid to board diversity – or lack thereof – in recent months. California enacted AB-979, which expanded upon California’s earlier gender diversity law and requires boards to make strides in other types of diversity, including racial and ethnic minorities. The law requires every public company with securities listed on a major U.S. stock exchange and that has its principal executive office in California, as listed on its form 10-K annual report, to have at least one director from an underrepresented community on its board by the end of the 2021 calendar year and upwards of three directors from an underrepresented community on its board by the end of the 2022 calendar year.^[1] See New California Law Will Require Increased Diversity on Public Board.

Last month, the NYSE and corporate governance company Diligent Corp. published data suggesting that nearly half of public company boards do not have actionable plans to diversify their ranks in the near term. Kira Ciccarelli, Impossible Until It’s Done: Corporate Board Diversity and Refreshment Practices, Diligent. And now, the plaintiffs’ securities bar has jumped in, using lawsuits to push board diversity and penalize companies that they contend have misled shareholders into believing they are taking bold action but have done little to meet their stated diversity and inclusion objectives.

To date, eight lawsuits have been filed, all but one in federal court in California.^[2] Most, but not all, of the targets are technology companies headquartered in California. The complaints are lengthy, averaging more than 89 pages. They are intended as public relations pieces as much as legal challenges. For example, they characterize companies as “Old Boy’s Club[s]” engaging in “tokenism” who merely pay “lip service” to create a “veneer” of commitment to diversity.

The suits accuse directors of misrepresenting company commitment to diversity in proxy statements to avoid market scrutiny and mislead shareholders. These claims are brought under Section 14(a) of the Securities Exchange Act of 1934. Under that statute, if a Plaintiff can show that a false or misleading statement was made and that the statement caused harm, in most jurisdictions they need not show the company acted with scienter.

The suits also allege that the directors have breached their fiduciary duties of candor, good faith, and loyalty by repeatedly making false assertions about the company’s commitment to diversity and by failing to act in the company’s best interest, which includes maximizing corporate value by attaining diverse leadership. Typically, the suits allege that they are excused from making the required demand on the board – so-called demand futility – based on the risk of liability to the entire board. Particular focus is given to the activities of the Nomination and Governance Committees and their alleged failures to recruit diverse candidates.

While each complaint is specific to each target company, they all share substantially similar structure, arguments, and claims:

• They analyze references to “diversity,” “inclusion,” or similar terms used in proxy statements filed since 2017 and compare those statements with recent board composition;
• They argue that diverse companies are more profitable and thus enhance shareholder value to underscore that diversity is in the company’s best interest;
• They challenge corporate governance practices that allegedly entrench incumbent directors and prevent fair consideration of diverse candidates; and
• They allege that the companies are failing to live by their own diversity initiative policies, quoting from board-adopted governance policies and cherry-picking statements made by CEOs and Human Resources and Diversity & Inclusion leaders.

The remedies sought combine both damages – money damages under the ’34 Act and state law – and corporate governance therapeutics – the replacement of existing directors with new, diverse directors, including specifically Black directors and other ethnic minorities, and the creation of programs to ensure fair and equitable hiring. In a more unusual move for a shareholder suit, these plaintiffs demand multi-million dollar investments to promote minority hiring or social justice programs in the Black community. The amounts demanded are eye-popping, ranging from $150 million to $1 billion.

It is likely that more suits of this type will be brought. The law firms behind these suits are well known and well-funded. While it appears that technology companies are their primary target, there is no reason to infer that these plaintiffs’ firms (or others) will not turn their focus on other industries, and in jurisdictions other than California. There are factual and legal defenses available to such attacks and we expect to see these targets filing motions to dismiss these cases in the weeks and months to come. While these cases pose some legal risk, they also pose considerable reputational risk. We expect these filings are the first stage of a long battle that will play out in courtrooms and in the court of public opinion.

In light of this trend, public companies should take care in drafting their annual proxy statements with regard to board composition and diversity efforts – relying on prior years’ statements may be insufficient. Public statements that companies make about their diversity initiatives are likely to come under greater scrutiny going forward, and public companies should work with their outside counsel in reviewing these important disclosures. And board diversity should be a high priority topic for boards (and subcommittees) as they discuss board succession, composition and recruitment.

Please contact any member of the Goodwin team if you have questions about how this trend may impact your company.

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^[1] AB-979 followed California Senate Bill No. 826 requiring these covered corporations to have a similar minimum number of female directors beginning in calendar year 2019.
^[2] Of the eight companies targeted, only one has Black directors. The boards of the remaining seven companies are composed primarily of White males, with women making up, at most, 46% of the board. See City of Pontiac General Employees' Retirement System v. Bush et al., Case No. 5:20-cv-06651, available at https://www.law360.com/articles/1313264/attachments/0; City of Pontiac General Employees' Retirement System v. Joyce Jr. et al., Case No. 1:20-cv-02445, available at https://www.law360.com/dockets/download/5f4ea04d04886000cf324e08?doc_url=https%3A%2F%2Fecf.dcd.uscourts.gov%2Fdoc1%2F04518026072&label=Case+Filing; Ocegueda v. Zuckerberg et al., Case No. 3:20-cv-04444, available at https://www.law360.com/dockets/download/5eff0b472067a001b130dfd1?doc_url=https%3A%2F%2Fecf.cand.uscourts.gov%2Fdoc1%2F035119442423&label=Case+Filing; Lee v. Fisher et al., Case No. 3:20-cv-06163, available at https://www.law360.com/articles/1306557/attachments/0; Falat v. Sacks et al., Case No. 8:20-cv-01782, available at https://www.law360.com/articles/1311854/attachments/0; Esa v. Pilette et al., Case No. 5:20-cv-05410, available at https://www.law360.com/articles/1298820/attachments/0; Dinsmore v. Ellison et al., Case No. 3:20-cv-04602, available at https://www.law360.com/articles/1291193/attachments/0; Kiger v. Mollenkopf et al., Case No. 3:20-cv-01355, available at https://www.law360.com/articles/1293358/attachments/0.