In the wake of a national discussion about institutional racism after the highly publicized murder of George Floyd, investors quickly took action. Beginning in July 2020, over a dozen shareholder derivative actions were filed with an almost singular focus on reforming public companies incorporated in Delaware that lacked Black directors. Unfortunately, these actions to date have been halted at the courthouse doors, facing substantive and procedural hurdles. Nonetheless, they have been a vocal part of a broader conversation that is driving more disclosures for investors and will help shape the leadership of public corporations.
Each of these lawsuits had its own nuances, with attention-catching allegations, and included multiple claims under state law. Each complaint also included a claim under section 14(a) of the Securities Exchange Act of 1934 (the Exchange Act), a federal law that prohibits material misrepresentations and omissions in proxy solicitations. While the underlying alleged misstatements in the proxy materials varied, the plaintiffs alleged that the directors misled investors by making statements about their purported commitment to increasing racial diversity when, in reality, the directors failed to have sufficient—or in some cases, any—Black board members or nominees.
The plaintiffs in these cases sought a range of corporate governance reforms, typically only available in derivative lawsuits, including putting forth shareholder proposals to require the resignation of at least three current directors and setting forth a resolution to replace those directors with two persons who are Black and one from another minority group, funds for economic and social justice programs, and more transparency through disclosure.
The section 14(a) claims faced numerous procedural and substantive headwinds—materiality, causation, and forum-selection clauses, among them.
Courts have found some of the statements that the plaintiffs challenged—such as Facebook’s goal of “building a workforce that is as diverse as the communities [it] serves” or Qualcomm’s statement that “[t]he Governance Committee’s goal is to assemble a board of directors that brings to us a diversity of perspectives and skills”—were “non-actionable puffery” and aspirational statements not “capable of objective verification.” See Ocegueda v. Zuckerberg, 526 F. Supp. 3d 637, 651 (N.D. Cal. 2021); Kiger v. Mollenkopf, 2021 WL 5299581, at *2–3 (D. Del. Nov. 15, 2021); see also Falat v. Sacks, 2021 WL 1558940, at *6 (C.D. Cal. Apr. 8, 2021) (Monster’s statements that it “seek[s] to capture diversity in [its] candidates” were “puffery and do not constitute objectively verifiable statements of fact”). Thus, these courts decided that the statements were not material in this context to investors’ voting decisions in response to the proxy solicitations containing those statements.
Courts in these cases also found the “essential link” between the challenged statements and the loss-generating corporate action (no Black directors) too attenuated. “[T]he proxy solicitation itself, rather than the particular defect in the solicitation materials,” must be “an essential link in the accomplishment of the transaction.” Mills v. Elec. Auto-Lite Co., 396 U.S. 375, 385 (1970). For example, in a lawsuit against Danaher’s directors, in which the plaintiff’s pleaded “causation theory” was that “the misleading proxy statements caused the election of the Directors, who then failed to nominate an African American director, which harmed the company because companies with less diverse boards are less profitable,” the court held that the proxy statement was not “‘an essential link in the accomplishment of the transaction’ that caused the harm” because “the election itself did not harm the company—the Directors’ failure to nominate an African American director did.” In re Danaher Corp. S’holder Deriv. Litig., 549 F. Supp. 3d 59, 73 (D.D.C. 2021). Another court agreed in a case against Cisco’s directors, finding that the plaintiff’s “multi-step theory that false proxy statements mislead shareholders into re-electing directors who fail to nominate a black director and thus harm the company is too tenuous to rise to the level of ‘essential link.’” City of Pontiac Gen. Emps.’ Ret. Sys. v. Bush, 2022 WL 1467773, at *5 (N.D. Cal. Mar. 1, 2022); see also Lee v. Frost, 2021 WL 3912651, at *13 (S.D. Fla. Sept. 1, 2021) (finding reelection of OPKO’s directors only indirectly caused alleged losses and was not an essential link).
Under Delaware law, companies incorporated in the state can select state court as the exclusive forum for any derivative lawsuit. Accordingly, defendants in these derivative actions consistently moved to dismiss based on the doctrine of forum non conveniens. Federal courts have exclusive jurisdiction over claims under section 14(a), however, and thus a plaintiff cannot bring this claim in the Delaware Court of Chancery. See 15 U.S.C. § 78aa.
Several courts skirted this issue by exercising their “discretion to sever the federal claim” and then dismissing the section 14(a) claim separately from the state law claims. See, e.g., Ocegueda, 526 F. Supp. 3d at 649; Klein v. Ellison, 2021 WL 2075591, at *8–9 (N.D. Cal. May 24, 2021); Esa v. NortonLifeLock Inc., 2021 WL 3861434, at *3 (N.D. Cal. Aug. 30, 2021).
By contrast, one district court enforced Gap’s forum-selection clause and dismissed the action entirely in favor of Delaware as the proper forum. Lee v. Fisher, 2021 WL 1659842, at *6 (N.D. Cal. Apr. 27, 2021). A three-judge panel of the Ninth Circuit affirmed the district court’s dismissal in Fisher and acknowledged that finding Gap’s bylaw enforceable left the plaintiff without a forum for the section 14(a) claim because that claim cannot be brought in state court. Lee v. Fisher, 34 F.4th 777, 782 (9th Cir. 2022).
The Ninth Circuit’s decision in Fisher admittedly conflicted with the Seventh Circuit’s recent decision by a split panel in Seafarers Pension Plan ex rel. Boeing Co. v. Bradway, 23 F.4th 714 (7th Cir. 2022), which held that a nearly identical forum-selection clause in Boeing’s bylaws was unenforceable because it was “contrary to Delaware corporation law and federal securities law.” Id. at 718. The Seventh Circuit reasoned that upholding the forum-selection clause would be “checkmate for defendants,” depriving the plaintiff of any forum for the section 14(a) claim. Id. at 720. The Seventh Circuit found this result “would be difficult to reconcile” with the anti-waiver provision of the Exchange Act, 15 U.S.C. § 78cc(a), “which deems void contractual waivers of compliance with the requirements of the” Exchange Act. Id.
The Ninth Circuit in Fisher cited the holding in Boeing but held that it was bound by prior Ninth Circuit precedent finding that “the strong federal policy in favor of enforcing forum-selection clauses . . . supersede[s] antiwaiver provisions in state statutes as well as federal statutes, regardless whether the clause points to a state court, a foreign court, or another federal court.” Fisher, 34 F.4th at 781 (quoting Sun v. Advanced China Healthcare, Inc., 901 F.3d 1081, 1090 (9th Cir. 2018)). The question remains whether a circuit split will occur and whether Fisher will proceed after the full Ninth Circuit vacated the three-judge panel’s decision and reheard the appeal en banc on December 12, 2022. 54 F.4th 608 (9th Cir. 2022). As of the date of this article, the full Ninth Circuit had not issued a decision.
For now, these derivative actions aimed at increasing corporate director diversity have not yet proceeded beyond the motion to dismiss stage. Nonetheless, they do appear to have driven change outside the courtroom. Particularly, they increased litigation risk and publicity around the lack of diversity in the companies that were sued. This incentivized other shareholders and the companies themselves to make changes. For example, many of the companies that were the subject of the derivative actions have since had Black directors appointed to their boards, including Danaher, Qualcomm, Cisco, NortonLifeLock, Monster Beverage, Oracle, and Gap.
The story does not end here, however, as these lawsuits have also joined a meaningful conversation around changing social sentiment that is driving the diversification of public boards and shining a positive light on board diversity. Perhaps most notably, the actions have spurred other non-litigation mechanisms that are shaping and redefining expectations for corporate leadership aimed at giving power to voices that reflect diversity across gender, race, ethnicity, and sexual orientation. At least two forms of relief that were sought through the derivative actions are moving forward in other forums: mandated diversity and mandated disclosure about board diversity.
States have enacted legislation mandating diversity in boardrooms. California was the first, passing AB 979 in September 2020, which mandated that public corporations with a principal executive office in California have, by the close of 2022, at least two directors from an “underrepresented community.” Cal. Corp. Code § 301.4. Unfortunately, the law was struck down by the Los Angeles Superior Court along with a similar California law, SB 826, which had required California companies to add women directors, on the grounds that the laws violated the equal protection clause of the California Constitution. Crest v. Padilla, 2022 WL 1565613 (Cal. Super. Ct. May 13, 2022) (holding SB 826 unconstitutional); Crest v. Padilla, 2022 WL 1073294, at *1 (Cal. Super. Ct. Apr. 1, 2022) (holding AB 979 unconstitutional).
To avoid the same fate, Hawaii lawmakers proposed a measure in January 2023 aimed at gender balance, which would require Hawaii-based public companies to have at least three female or non-binary directors and three male or non-binary directors. This measure will test whether a “quota”-based rule can survive equal protection scrutiny when it includes the purported non-diverse population, too.
Over 10 states have introduced or considered laws mandating disclosure of diversity in board composition. For example, Illinois requires corporations to disclose directors’ self-identified gender, race or ethnicity, and sexual orientation; how demographic diversity is considered in their processes for identifying and appointing director nominees and executive officers; and their policies and practices for promoting diversity, equity, and inclusion among the board of directors and executive officers. 2021 Ill. Legis. Serv. P.A. 102-223 (S.B. 1730).
In addition, in October 2023, the Division of Corporation Finance of the U.S. Securities and Exchange Commission (SEC) will also consider recommending that the SEC propose rule amendments to enhance disclosures about the diversity of board members and nominees. See RIN: 3235-AL91.
Nasdaq’s board diversity rule, approved by the SEC, also requires Nasdaq-listed companies to (1) publicly disclose the diversity statistics of their directors and (2) have, or explain why they did not have, one “diverse” director by 2023 and more in later years. See Self-Regulatory Organizations; The Nasdaq Stock Market LLC; Order Approving Proposed Rule Changes, as Modified by Amendment No. 1, 86 Fed. Reg. 44,424 (Aug. 6, 2021). The same organization that successfully challenged California’s board diversity laws also challenged the constitutionality of Nasdaq’s board diversity rule in the Fifth Circuit. Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. Aug. 10, 2021), ECF No. 1-2. The Fifth Circuit had not yet issued a decision as of the date of this article.
Notably, the measures taken outside of the courthouse are addressing a much broader scope of diversity than what was sought in the derivate actions, which might also enable them to eventually succeed where the derivative actions have not. For example, California’s AB 979 defined “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,” Cal. Corp. Code § 301.4, while Nasdaq’s board diversity rule defines “diverse” as someone who self-identifies as female, from an underrepresented minority, or LGBTQ+.
By contrast, the derivative lawsuits largely focused on the addition of Black directors in line with the original racial justice movement that led to the filings. The corporations, while generally agreeing with the research-backed view that diverse leadership drives performance, rejected the premise that diversity required Black directors. The corporations pointed to their existing leadership as evidence that they were in fact diverse. At least one court explicitly credited this argument: “That there are no African Americans on Danaher’s Board does not inherently mean that the Board is not diverse. The Board could be racially diverse in other ways. And there are other types of diversity besides racial diversity.” Danaher, 549 F. Supp. 3d at 69.
Until the law develops further, the path forward to greater board diversity appears to rest on both a broader view of diversity and mandatory disclosures. While short of the full relief sought by the derivative actions, accurate disclosures sharpen investors’ non-litigation tools to directly pursue and ensure the diversity they wish to see at the board level. For example, investors can nominate and vote in candidates who reflect the diversity they wish to see, vote out directors who do not, and vote against members of nominating or governance committees who fail to effectuate board-level diversity. Indeed, two of the leading proxy advisory firms have stated they will vote or recommend against the chair of the nominating committee of companies in certain indices if the company lacks diverse directors. According to a comparison of Spencer Stuart’s Board Index for 2019 and 2022, for S&P 500 companies, the number of new independent directors from underrepresented groups shot up from 23 percent to 46 percent.
Shareholders can also submit shareholder proposals for specific qualitative or quantitative disclosures, racial equity audits, or measures to increase board refreshment and decrease entrenchment, such as director term limits or a mandatory retirement age. Large institutional shareholders, including BlackRock, State Street, and Vanguard, have released updates to their voting guidelines, detailed their expectations for board diversity, or described the metrics they will use to assess shareholder proposals aimed at increasing board diversity. In the 2022 proxy season, diversity-focused shareholder proposals constituted the largest subcategory of social proposals submitted, according to an analysis by Institutional Shareholder Services.
Moreover, specific disclosure requirements will demand that companies make concrete statements of fact about, for example, current board composition and practices for ensuring diverse candidates are available in director nominee pools. These statements, when proven false, will be less susceptible to dismissal for being unverifiable or puffery.
While unsuccessful thus far in the courts of today, the derivative actions have become part of a broader conversation concerning board diversity in other political forums that has given rise to a successful movement toward more transparency. Yet, disclosure concerning board composition is only the first step. It leaves the responsibility with shareholders to continue to exercise their powerful rights to nominate diverse directors and propose effective shareholder proposals to ensure that corporate leadership reaches and then continues to evolve with modern sentiments toward diversity. Moreover, concrete disclosure requirements and the ongoing conversation about the importance of board diversity will also provide investors with a broader set of evidence to show that proclamations about commitments to diversity are both false and material to their investment decisions if and when investors need to return to the courts.
