In June, the Ninth Circuit handed down its opinion in Meland v. Weber, holding that an individual shareholder of OSI Systems had standing to challenge California’s board diversity law, which mandates that publicly-traded companies with headquarters in the state appoint a certain number of women directors.

The shareholder is claiming that the mandate violates the 14^th Amendment, and the Meland opinion naturally doesn’t engage that; the question before the Ninth Circuit was simply whether the shareholder can sue.

To find standing, the court had to make two necessary findings: first, that the law actually operated on the shareholder, i.e., it demanded some kind of action or behavior from the shareholder despite being targeted to corporate boards (what the Ninth Circuit called being the “object” of the law); and second, that there was a cognizable injury to the shareholder, i.e., some kind of threat to the shareholder personally if OSI Systems did not comply.

With respect to both findings, the connections that the court found between the law and the shareholder’s injury were, shall we say, attenuated.

As for the first finding, that the law operates on the shareholder, the essence of the plaintiff’s claim is that California is forcing him to discriminate in favor of women and against men by mandating that he cast his ballot in favor of women directors.  The Ninth Circuit agreed with this summary of the law’s operation, writing:

As a general rule, shareholders are responsible for electing directors at their annual meetings. E.g., Cal. Corp. Code §§ 301(a), 600(b). OSI is no exception. Thus, the only way a person can be elected to OSI’s board is if a plurality of shareholders vote in favor of the nominee at an annual shareholder meeting. OSI itself has no authority to elect its own board members. For SB 826 to hasten the achievement of gender parity—or indeed, for SB 826 to have any effect at all—it must therefore compel shareholders to act. Accordingly, the California Legislature necessarily intended for SB 826 to require (or at least encourage) shareholders to vote in a manner that would achieve this goal….

SB 826 necessarily requires or encourages individual shareholders to vote for female board members. A reasonable shareholder deciding how to vote could not assume that other shareholders would vote to elect the requisite number of female board members. Therefore, each shareholder would understand that a failure to vote for a female would contribute to the risk of putting the corporation in violation of state law and exposing it to sanctions. At a minimum, therefore, SB 826 would encourage a reasonable shareholder to vote in a way that would support corporate compliance with legal requirements. Indeed, the California Legislature must have concluded that SB 826 would have such an effect on individual shareholders; otherwise, if each individual shareholder felt free to vote for a male board member, SB 826 could not achieve its goal of reaching gender parity.

A couple of things about this reasoning.  Theoretically, yes, in a plurality voting system, in an uncontested election, if every single shareholder voted against whoever the female nominee was, she’d lose.  But the possibility of that outcome – well, let’s just say “hypothetical” does not begin to cover it.  The reasoning also makes the standing determination dependent on treating shareholders as a group rather than focusing on them as individuals, even though the harm alleged operates on the shareholder individually.  Which matters because I assume that some shareholders will enthusiastically – even joyfully – vote for whoever the female nominee is (if she’s a shareholder, she’ll vote for herself), and they are not experiencing any harm or compulsion at all.

Most importantly, though, it’s an entirely unrealistic look at how shareholder voting actually operates.  In an uncontested, plurality election, the corporate nominating committee decides who goes on the ballot and ultimately who ends up as a director.  And it’s far more likely that SB826 was intended to operate on the nominating committee – to make the committee its “object” – than the shareholder.  The Ninth Circuit dealt with this objection in a footnote:

California also suggests that SB 826 does not require Meland to make a discriminatory decision because board candidates are typically nominated by OSI’s nominating committee, and the committee will ensure that the slate of candidates complies with SB 826. At this juncture, however, we “must accept as true all material allegations of the complaint, and must construe the complaint in favor of the complaining party.” The complaint does not allege that OSI’s nominating committee has exclusive control over the slate of board candidates or that the number of candidates included in the slate always matches the number of available board seats. To the contrary, Meland alleges that shareholders, or groups of shareholders, may submit names of candidates for election to the board, an allegation that undermines California’s suggestion. Accordingly, we do not consider California’s argument, which is unsupported by the pleadings, at this stage of the proceedings.

That’s the first finding.

The second finding concerned how the shareholder would actually suffer if he defied the law, and on this, the Ninth Circuit recognized two injuries.  First, the corporation will be fined, and second, the corporation will be “sham[ed]” by the state of California via the publication of lists of noncompliant companies.  These outcomes will damage the value of the shareholder’s investment, which is sufficient for Article III purposes. 

Now, we’d call these derivative harms for corporate law purposes but that’s not really the issue for constitutional ones; the Article III question is whether there is an injury-in-fact.  Still, OSI reported $19 million of income last quarter, and California’s fines are at most $300,000 per violation (there aren’t rules yet but I assume that means annually).  I don’t know how many shares Meland owes but it does seem like the monetary harm to him individually is microscopic, and the “shaming” harm can only be described as speculative.

Where am I going with all of this?

Well, my general assumption with respect to California’s law has always been that since it applies exclusively to publicly-traded companies, there were few avenues to challenge it legally because most public company boards won’t want to declare themselves opposed to diversity.  But the Meland ruling allows boards to use shareholders as a cat’s paw for positions they don’t want to take openly.

And if the Meland ruling stands and/or is followed by other circuits, I wonder just how far it could go.  For example, could it be applied to less onerous diversity mandates, like the disclosure requirements some states have adopted, and possibly even the Nasdaq comply-or-explain proposal?  (Though Nasdaq’s a condition rather than a mandate, which might get different treatment on the merits, and Nasdaq likes to pretend it’s a private actor when it would legally benefit Nasdaq to do so.)  The Ninth Circuit found injury in shaming, not just fines, which I think might open the door for shareholders of, say, Illinois-headquartered public companies to sue claiming that Illinois’s diversity scoring system shames nondiverse companies.

(I highlight: Meland would not extend shareholder standing to matters that do not involve shareholder votes, like diversity in hiring; the voting aspect was necessary to the court’s ruling.)

Which brings me to my next point, which is, the plaintiff’s claim in Meland is rooted in equal protection, but there’s also the lurking issue of whether California’s law violates the internal affairs doctrine to the extent it operates on companies that are organized in other jurisdictions.  Not sure if this gets tested in court, but on this, I think California really shot itself in the foot when it passed SB826.  In the preamble, it said:

The Legislature finds and declares as follows:

(a) More women directors serving on boards of directors of publicly held corporations will boost the California economy, improve opportunities for women in the workplace, and protect California taxpayers, shareholders, and retirees, including retired California state employees and teachers whose pensions are managed by CalPERS and CalSTRS. Yet studies predict that it will take 40 or 50 years to achieve gender parity, if something is not done proactively…

(c) Numerous independent studies have concluded that publicly held companies perform better when women serve on their boards of directors, including:

(1) A 2017 study by MSCI found that United States’ companies that began the five-year period from 2011 to 2016 with three or more female directors reported earnings per share that were 45 percent higher than those companies with no female directors at the beginning of the period.

(2) In 2014, Credit Suisse found that companies with at least one woman on the board had an average return on equity (ROE) of 12.2 percent, compared to 10.1 percent for companies with no female directors. Additionally, the price-to-book value of these firms was greater for those with women on their boards: 2.4 times the value in comparison to 1.8 times the value for zero-women boards.

(3) A 2012 University of California, Berkeley study called “Women Create a Sustainable Future” found that companies with more women on their boards are more likely to “create a sustainable future” by, among other things, instituting strong governance structures with a high level of transparency.

(4) Credit Suisse conducted a six-year global research study from 2006 to 2012, with more than 2,000 companies worldwide, showing that women on boards improve business performance for key metrics, including stock performance. For companies with a market capitalization of more than $10 billion, those with women directors on boards outperformed shares of comparable businesses with all-male boards by 26 percent.

(5) The Credit Suisse report included the following findings:

(A) There has been a greater correlation between stock performance and the presence of women on a board since the financial crisis in 2008.

(B) Companies with women on their boards of directors significantly outperformed others when the recession occurred.

(C) Companies with women on their boards tend to be somewhat risk averse and carry less debt, on average.

(D) Net income growth for companies with women on their boards averaged 14 percent over a six-year period, compared with 10 percent for companies with no women directors….

(g) Further, several studies have concluded that having three women on the board, rather than just one or none, increases the effectiveness of boards….

Note that almost all of these justifications are rooted in the benefit to companies, rather than the benefits to women.  Now, the evidence of actual corporate benefit from gender diverse boards is mixed, but, as relevant here, internal arrangements that are intended to protect shareholders kind of fall into the core of what the internal affairs doctrine covers.  Employment law, however, which is about protecting employees as employees, does not.  If California had justified its law as a type of employment protection for women, it would be on much stronger ground here.  True, directors are not usually considered corporate “employees” in the traditional Restatement-of-Agency sense but there’s no reason that would matter for the purposes of assessing the contours of the internal affairs doctrine – California is free to define “employee” however it likes.

So why didn’t California just do that?

I think because there’s this persistent legal myth that somehow it’s only appropriate to regulate corporate internal governance arrangements for the benefit of investors; any regulation intended to benefit other groups should not operate via corporate governance.  That’s wrong, both descriptively and normatively, as I argue in my Beyond Internal and External essay, but it’s a default mindset.  California would have no trouble – and has had no trouble – enacting various antidiscrimination laws in the context of employment, public accommodations, and other areas, all to protect oppressed groups – but when it comes to corporate governance, suddenly the law is only legitimate, in lawmakers’ minds, if there’s an investor-oriented hook.

I’ll also note that Jens Dammann and Horst Eidenmueller make the same point in a pair of papers: they argue that co-determination (whereby employees, as well as shareholders, get to vote for corporate directors) may not be better for companies, but it is better for democracy, and that’s a legitimate reason to do it.  (And yes, I name-checked those papers before, for the same reason, in my earlier post: Doyle, Watson, and the Purpose of the Corporation).

Anyhoo, that said, I wonder if the easiest way for California and other states, or the Nasdaq, to deal with this is to require not that companies have diverse boards, but that their nominating committee present a diverse slate.  If I’m right that nominating committees won’t want to be the face of a legal challenge to the law, that leaves fewer people with any kind of standing – not shareholders under Meland’s logic, maybe not even disappointed board candidates, and it won’t create problems in situations where there may be majority-voting or a proxy contest, which are scenarios that would give the Meland shareholder a heftier claim to standing.

This just in from newly minted Northwestern Law Dean Hari Osofsky:

I am hiring a Climate and Energy Fellow to work under my supervision at Northwestern Pritzker School of Law on a variety of climate change and energy projects. The fellowship is ideal for someone planning on entering legal academia as it will provide opportunities for publishing and for mentoring on the academic market. It also would be good preparation for work in climate change or energy law and policy.

I’d be grateful if you would share the opportunity with your networks. Full position description and link to apply: https://careers.northwestern.edu/psp/hr857prd_er/EMPLOYEE/HRMS/c/HRS_HRAM_FL.HRS_CG_SEARCH_FL.GBL?Page=HRS_APP_JBPST_FL&Action=U&FOCUS=Applicant&SiteId=1&JobOpeningId=41064&PostingSeq=1

FINRA recently posted a regulatory notice seeking information on whether it should consider changes to “rules, operations and administrative processes that may create unintended barriers to greater diversity and inclusion in the broker-dealer industry or that might have unintended disparate impacts on those within the industry.”  Drexel’s Nicole Iannarone, who is currently chair of FINRA’s National Arbitration and Mediation Committee submitted a thoughtful letter.  As her letter explains, she’s particularly well-situated consider these issues:

My interest in this issue and its application to the FINRA arbitration forum is both professional and personal. I am a law professor who teaches business and securities law courses. My recent scholarship focuses specifically on consumer investors’ experiences in FINRA arbitration.3 I previously directed a law school securities arbitration clinic and supervised law students representing investors with smaller claims against their brokers in the FINRA arbitration forum. I am the chair of FINRA’s National Arbitration and Mediation Committee (NAMC). I am also a Mexican-American woman with her own non-retirement investment accounts. These experiences provide me a unique lens through which to view FINRA’s diversity and inclusion efforts as they relate to the FINRA Dispute Resolution forum. 

She rightly highlights that arbitrator diversity has been a challenge for FINRA for some time.  I also wrote about this issue in a 2014 op-ed and highlighted the need for FINRA to do more to recruit diverse arbitrators.  Since that time, FINRA has been quite active and has conducted outreach all across the country.  The numbers have been improving as a result of these efforts.  

Professor Iannarone also explains that new arbitrators are struggling to actually get selected for hearings and highlights some research from one of her forthcoming law review articles:

Last summer, I took steps to determine if arbitrators added to FINRA’s neutral roster in the past five years, who on the whole are more diverse than the prior pool, had been able to obtain the necessary qualification to preside as chairs over smaller claims.  My study, forthcoming in the Washington Law Review, was based on the hypothesis that two structural barriers made it likely that investors with smaller claims were unlikely to obtain the benefit of FINRA’s diversity recruitment efforts: (1) FINRA’s public chair qualification rule; and (2) the list selection procedures for three arbitrator cases whereby arbitrators already qualified as chairs have two opportunities to appear on lists compared to non-chair public arbitrators only having one opportunity to appear on a list. From the publicly available awards, I was able to determine that in smaller claims that concluded via hearing from 2014-2019, only 0.98% were decided by public chair qualified arbitrators who first appeared in FINRA’s awards database as an arbitrator in a case filed after December 31, 2014.22 The data indicate that virtually no customers in small cases whose proceeding concluded with an award after a hearing benefitted from the increased diversity FINRA achieved in the overall pool from 2015-2019, suggesting that the hypothesis was correct and two FINRA rules serve as barriers to inclusion. The study also showed that longer serving arbitrators far outnumbered new entrants. Over half of the arbitrators who presided over small claims in the study period first appeared in the FINRA awards database more than 20 years ago.  Over 80% first appeared in the awards database before chair qualification was a prerequisite to presiding over smaller claims. In addition, more than one-third of the arbitrators studied first appeared in cases filed before 1998, the date before which parties had no ability to select arbitrators in FINRA proceedings.

I agree with this analysis.  Legacy arbitrators have had many more opportunities to accumulate qualifications.  Once they obtain a chair qualification, they get twice as many chances to be selected as arbitrators.  Functionally, this makes it much harder for new arbitrators to gain the experience needed to qualify as chairs.  As smaller claims are only decided by chair-qualified arbitrators, the rules will need to change to increase the odds that investors with smaller claims will have access to a reasonably diverse pool.