A California court has invalidated a state law intended to increase diversity on boards of directors of California-headquartered publicly traded companies.

The law, which took effect in 2020, required that corporations "have a minimum of one director from an underrepresented community on its board" as of the end of 2021, and allowed corporations to increase the number of directors on their boards to comply. By the end of 2022, the law required that those companies must have at least three directors from underrepresented communities if they had nine or more board members, a minimum of two if the board has five to eight directors, and a minimum of one if the board is four or fewer, among other requirements.

Underrepresented communities were defined in the statute as people who self-identified as "Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, or who self-identified as gay, lesbian, bisexual or transgender."

The lawsuit challenging the statute was filed in October 2020 by Judicial Watch, which describes itself on its website as a "conservative, non-partisan educational foundation," and argued that the statute mandated quotas and was unconstitutional under California's Equal Protection Clause. (Crest v. Padilla, No. 20ST-CV-37513)

Los Angeles County, Calif., Superior Court Judge Terry Green in an April 1 decision allowed that California lawmakers had identified a social problem related to lack of diversity on boards of directors.

"It is not difficult to accept the proposition that diverse boards may be 'good for business,'" Green wrote. "Nor is it hard to believe that the knock-on effects of strong businesses include more tax revenue, better performance for pension funds and better workplaces with happier employees. But if these downstream, indirect effects were to be compelling interests, there is no limit to what might be allowed, providing the economic data were properly massaged."

But, Green said, the 2020 law, known as AB 979 but referred to by the judge as the Corporations Code, violated the equal protection clause of the California Constitution "on its face" by treating similarly situated individuals — qualified potential corporate board members — differently based on their membership, or not, in certain listed racial, sexual orientation or gender identity groups. Because the statute requires a certain number of board seats be reserved for members of the groups on the list, the judge said it also "necessarily excludes members of other groups from those seats."

That made the statute as written unconstitutional, the judge concluded.

"Only in very particular cases should discrimination be remedied by more discrimination," Green wrote. "And that should only happen after obvious alternative measures have been tried. Sometimes the direct approach should be the last resort, not the first."

Judicial Watch has also challenged a 2018 California statute which required women to be included on corporate boards of directors.

The U.S. Securities and Exchange Commission in 2021 approved a Nasdaq board diversity rule requiring Nasdaq-listed companies to disclose the makeup of their boards and include at least two "diverse" directors, or explain why they do not meet that level of diversity with some flexibility for smaller companies. Judicial Watch filed a public comment challenging that rule.

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.