ESG in action: diversifying corporate governance
Before environmental, social and governance (ESG) issues became cultural and business movements, the lack of diversity and inclusion in corporate governance structures was identified but not assessed. There are currently at least ten shareholder derivatives lawsuits pending alleging a lack of diversity in the board of directors and management as a breach of fiduciary duty. Companies that lack diversity in their governance are also subject to increased regulation and guidance regarding state laws, investment bank requirements, and potential industry ordinances. Despite extensive research into the social and economic benefits of various bodies, it remains difficult to change the face of corporate governance. This article will:
- examine the issues raised in the lawsuits, regulations and mandates; and
- Providing simple (but not simpler) steps companies can take to begin diversifying their business leadership.
Board diversity lawsuits
The pending shareholder lawsuits, for the most part by the same group of companies and targeting many companies identified in a recent Newsweek article listing companies with no black director, generally allege that the defendants:
- have violated their fiduciary duties; and
- has violated Section 14 (a) of the Securities Exchange Act;
through false or misleading public statements about the company’s commitment to diversity, although no racially different – especially black – directors were represented on its board of directors and management. To emphasize this point, most complaints contain photos of racially homogeneous current board members.
Although the “Caremark” obligations set out in In re Caremark International Inc., Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), are not specifically mentioned in the complaints, they certainly influence plaintiffs’ arguments that The Directors have breached their fiduciary duties when they:
- has failed to prevent violations of the law by allowing discriminatory practices relating to governance;
- did not make different board appointments; and
- Authorized false statements about diversity priorities that should be made in proxy documents despite a lack of governance diversity.
To remedy these violations, the aggrieved shareholders’ actions demand:
- quantifiable plans to achieve board diversity and inclusion;
- annual diversity reports on recruitment, promotion, promotion, and pay;
- annual diversity and inclusion training;
- Resources (measured in the hundreds of millions) to recruit and promote diversity across the company;
- Creating open seats for new and appropriately compensated various directors; and
- Legal fees.
While the purpose of these lawsuits is laudable, there are significant legal threshold issues. First, the lawsuits typically use the “futility of asking” to explain why the underlying diversity concerns were not included on the board instead of filing the lawsuit directly. Given the focus on diversity issues in the new ESG environment and the lack of detail regarding board processes and deliberations, it is of vital importance whether such requests have been unsuccessful to be resolved by the courts. Next, statements about compliance with laws or ESG are usually not feasible. Ultimately, causes of damage and damage will represent high hurdles, since a direct connection must be established between board diversity / ESG errors and actual shareholder damage. Plaintiffs currently claim that having more board diversity leads to higher profits, relying, among other things, on a 2018 report by McKinsey & Company that found that companies with more diverse boards of directors were more likely to generate higher profits . Correlation is not a legal cause, however, and it will be difficult to convince courts that studies like this justify ignoring the protection of the Business Judgment Rule.
The U.S. District Court for the Northern District of California recognized many of these defensive measures and in a ruling dated March 19, 2021, dismissed a lawsuit against Facebook for diversity against Facebook. The court found that plausors in Ocegueda v Zuckerberg, ND Cal., No. 3: 20-cv-04444, were making an implausible claim that the claim was futile or a “materially false statement” under Section 14 (a) .
However, legal victory may not be the goal. In light of similar allegations made by some of the same attorneys in the board of directors’ diversity lawsuits, Google’s parent company recently settled its #MeToo derivative litigation by, among other things, creating a $ 310 million diversity, equity and inclusion fund (who operated for the next 10 years). Supporting global diversity and inclusion initiatives within Google and supporting various ESG programs outside of Google with a focus on the digital and technology industries. Ergo, the ultimate goal of board diversity suits may be similar settlements and surrenders.
Regulatory, industry and shareholder retention efforts
While the lawsuits are the most recent efforts to promote diversity among board members, they were preceded by federal and state regulatory efforts. The Securities and Exchange Commission (SEC) has issued compliance interpretations to advise companies on disclosing the characteristics of diversity to use when appointing directors. In November 2019, the House of Representatives examined a bill which, among other things, obliges issuers of securities to disclose:
- the racial, ethnic and gender makeup of their boards of directors and officers; and
- Plans to promote this diversity.
California was the first state to require that public corporations headquartered in 2019 have a minimum number of female directors or face sanctions. The minimum number should be increased in 2021. In June 2020, New York urged companies to report the number of their directors are women. More recently, California has ordered public corporations headquartered in the state to elect at least one director from an underrepresented community or face fines of up to $ 300,000 by December 2021. Directors with four to nine directors must have two such directors by December 2022, and companies with more than nine directors must have three. With these regulations in mind, it is no accident that the vast majority of board diversity lawsuits were filed in California.
At the industry level, the NASDAQ exchange (which lists many of the board diversity defendants) filed a proposal with the SEC to pass regulations requiring most publicly traded companies to have at least one female director and one director from an underrepresented minority underrepresented minority would have to choose who identifies as LGBTQ +. If accepted, the tiered requirements would force non-compliant companies to state the reasons for non-compliance with this diversity mandate in the company’s annual proxy statement or on its website. The SEC has requested public comment on this proposal.
In the private sector, institutional investors like BlackRock and Vanguard have encouraged companies to pursue ESG goals and expose the racial diversity of their boards of directors by using proxies to drive such efforts. Regardless, Institutional Shareholder Services, many private and public corporations, and some nonprofits have either encouraged corporations to disclose their diversity efforts or have joined private diversity challenges and commitments on their boards of directors.
Specific plans can reduce director risk
The business and social benefits of diversity are well established. and successful companies know that an organization’s commitment to diversity cannot be rhetorical and can be measured by the number of different board and management directors it has.
Since pending litigation and laws use diversity statements as a basis for liability and / or governmental fault, companies should ensure that their diversity proclamations are fully supported by their actions. Boards should include:
- Take the lead from public and private efforts and review – and reform (if necessary) – the composition of the board of directors to open or create seats for various directors.
- When recruiting new board members, identify and prioritize outstanding characteristics of diversity. If necessary, use a diversity-focused search advisor to ensure a diverse pool of candidates.
- Develop a quantifiable plan on diversity issues by reviewing and expanding governance guidelines, board committee efforts, and executive compensation criteria.
- Creation and promotion of diversity and inclusion goals as well as inclusion of training at board level and management level.
- Request quarterly reports from the Board of Directors on diversity and inclusion programs to show trends and progress towards set goals.
As companies express their commitment to board and C-level diversity and other ESG efforts through public statements, investor engagement and shareholder proposals, recent litigation and regulatory trends should encourage companies to go beyond the platitudes and instead:
- create and follow concrete plans with defined goals; and
- Meticulously measure your progress.
Want more? Attend a live CLE webinar on this topic at the upcoming Virtual Spring Meeting for Business Law! The program “Diversification of Corporate Governance Institutions: Who Should Be at the Table?” Will be unveiled on April 23, 2021 at 12:15 pm (CT). Registration is completely free for members of the business law department – register now!