Reed Smith Client Alerts

Public companies and their boards should be aware – and may well be the target – of shareholder derivative demands and lawsuits for lack of racial diversity. These claims allege that board members and other executives have breached their fiduciary duties by failing to implement their diversity and inclusion programs into the companies’ board and C-suite positions. On September 30, 2020, California enacted a law requiring public companies headquartered in California to elect at least one director from an underrepresented community by the end of 2021, and institutional investors are mounting pressure on public companies in their investment portfolios to increase racial diversity. More than a dozen U.S. companies have signed on to The Board Challenge, pledging their commitment to elect at least one Black person to their boards by the end of 2021.1 The Board Challenge is backed by Charter Pledge Partners - companies that already have at least one Black director on their boards - such as Nordstrom, Lyft, Verizon, Merck, and Redfin.2

In addition to compliance with and consideration of legislation and voluntary initiatives such as The Board Challenge, companies and their board members should look to their directors’ and officers’ liability (D&O) insurance, and potentially their cyberliability policies, in the event of litigation or potential privacy liability exposure. In fact, shareholder diversity derivative litigation already is among the trends impacting the rise in D&O insurance premiums.3

This year alone, at least seven diversity-related shareholder derivative suits have been filed in federal courts across the country, including against Oracle, Monster Beverage Corporation, and Facebook.4 Although it is too early to predict the outcome – no dispositive motions have thus far been filed – companies may incur substantial fees to defend against them.

Shareholder derivative suit allegations

Of the seven derivative actions filed to date, six have been filed by a single law firm out of La Jolla, California, against California-based companies, and the allegations in each of these cases are essentially identical. The complaints allege that the boards have violated federal and state laws, and breached their fiduciary duties, by refusing to appoint Black or minority5 individuals to the boards and other executive management positions. The complaints also allege that the boards have filed false and misleading proxy statements regarding the companies’ commitment to diversity and that the boards have breached their duties by continually rehiring the same auditors. As recently as September 1, 2020, a new lawsuit against Danaher Corporation was filed by a different law firm in the U.S. District Court for the District of Columbia, which suggests that this trend of derivative suits might not be limited to one geographical location or one plaintiffs’ class action firm.

Among other remedies, the plaintiffs demand the resignation of board members and executive officers to make room for diverse candidates; “disgorgement” of the current board’s compensation (including stock gains); a commitment to promoting hiring, advancement, and pay equity to minorities; required annual diversity, affirmative action, anti‐discrimination, and anti‐harassment training of board members and executive officers; termination of auditors; punitive damages; and attorney’s fees.

California’s AB-979

On September 30, 2020, California Governor Gavin Newsom signed into law California’s Assembly Bill 979, which requires any public company with its principal offices located in California, whether foreign or domestically incorporated, to comply with the following requirements:

  • No later than the close of the 2021 calendar year, the company must have a minimum of one director from an underrepresented community; and
  • No later than the close of the 2022 calendar year, a company with more than four but fewer than nine directors must have a minimum of two directors from underrepresented communities, and a company with nine or more directors must have a minimum of three directors from underrepresented communities.6

 AB-979 defines a “director from an underrepresented community” 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.” Companies may increase the size of their boards in order to comply with the law. AB-979 builds on California’s AB-826, signed into law in 2018, which requires at least one woman to sit on any corporate board with its principal offices located in California.

Under AB-979, no later than March 1, 2022, and each year following, California’s secretary of state must publish reports that detail the number of companies in compliance with AB-979’s requirements, the number of companies moving their principal executive offices to or from California, and the number of public companies that were subject to the law during the preceding year but are no longer publicly traded. As a penalty for noncompliance, AB-979 allows California’s secretary of state to impose fines in the amount of $100,000 for a first violation or failure to timely file board member information pursuant to AB-979, and $300,000 for any subsequent violation.

Public companies based primarily in California should be aware of AB-979’s requirements and begin planning ahead to comply with AB-979 by December 31, 2021. Failure to comply could not only result in fines but also generate additional litigation.