Diversity, Equity, and Inclusion Audits - - No Longer a Vision of the Future but are They Here to Stay?

05.26.2022

The recent cases of Crest v. Padilla II (March 14, 2022, 20 STCV 37513) and Crest v. Padilla I (May 13, 2022, 19STCV27561) struck down California’s corporate board diversity statute, California Corporations Code § 301.4 and California’s corporate board gender diversity statute, California Corporations Code § 301.3, which required a certain amount of minority and female directors being on a Board of Directors for publicly-traded for-profit corporations. Two different Superior Court judges both found the respective statutes in question violated the Equal Protection Clause of the California Constitution. As noted by Lt. Governor Eleni Kounalakis, since the passage of Section 301.3 in 2018, women directors on California boards went from 766 to 1844 in a mere three years. These types of benefits fulfill the goals created by this type of litigation. One blip in the progressive march of representation on boards will not quash this movement that has been gaining steam, and employers either can wait to see what will be required of them once the dust settles (since the decisions will most likely be appealed), or they can be proactive and get ahead of the curve and voluntarily institute Diversity, Equity, and Inclusion (“DEI”) audits.

Another avenue where DEI audits are being demanded is through pension funds. In New York, the New York State Comptroller, Thomas DiNapoli, has been in the forefront in the fight for racial equality on Board of Directors for publicly held corporations. The Comptroller runs the New York State Common Retirement Fund (the “Fund”), one of the largest pension funds in America. The Fund uses shareholder proposals to raise issues directly to fellow shareholders and boards of directors. The Fund’s shareholder proposals seek new reporting and policies that would enhance transparency, mitigate investment risks, and improve shareholder value. Shareholder proposals by DiNapoli have taken many forms. In some proposals the Fund has sought disclosures from companies on their progress on improving workplace DEI. The disclosures sought in these proposals include the recruitment, retention, and promotion rates, as well as pay data of employees by gender, race, ethnicity, sexual orientation, age, disability and veteran status. In other proposals, the Fund has requested EEO-1 Reporting data to increase transparency on DEI and provide comparable, reliable data versus peers and the market. In January 2022, the Fund filed a shareholder proposal against Amazon requesting an independent and public audit of its impacts on civil rights, equity, diversity and inclusion, and the impacts of those issues on the company’s business. A month ago, Amazon announced that it would conduct a racial equity audit of its workforce. Since 2010, the Fund has filed 39 shareholder proposals asking companies to take concrete steps to increase board diversity. As a result, the Fund has secured 21 agreements to promote diversity, which helped add 29 diverse members to boards of directors. Those companies that ignore the shareholder proposal do so at their own risk. The Fund uses it powers to vote against incumbent board directors standing for re-election at companies that ignore its shareholder proposals.

Besides pension funds exercising their economic power to force audits, another method of forcing DEI audits is through the use of derivative lawsuits. The allegations in these types of lawsuit are essentially the same. Boards that make statements of commitment to diversity, equity, and inclusion are sued for breach of fiduciary duty by failing to have boards comprised of diverse directors and for proxy solicitation violations under § 14(a) of the Federal Securities Exchange Act. To date, these types of lawsuits have been dismissed. See City of Pontiac General Employees’ Retirement System v. Bush, 2022 WL 1467773 at *4 (N.D. Cal. 2022)(Cisco’s proxy statements promoting diversity and inclusion at all levels of the company are merely aspirational statements, which emphasize a desire to commit to and embrace diversity, and is a vague statement of optimism not capable of objective verification; derivative shareholder suit was dismissed); Ocegueda on Behalf of Facebook v. Zuckerberg, 526 F. Supp. 3d 637 (N.D. Cal. 2021)(Shareholder failed to state a derivative claim against social media company's directors for false and misleading statements under the Securities Exchange Act based on company's public proxy statements about its commitment to diversity and inclusion; statements themselves were non-actionable puffery or aspirational). Conversely, in September 2020, Alphabet, Google’s parent company, settled a derivative lawsuit in which it agreed to establish a $310 million diversity, equity, and inclusion fund to support workplace initiatives focusing on several key areas, including but not limited to hiring, progression, and retention of historically underrepresented talent, fostering respectful, equitable, and inclusive workforce cultures, and assisting historically underrepresented groups outside Google to succeed with their businesses.

Legal action is not the only methodology being used to create social change. NASDAQ announced a Board Diversity rule in August 2021, which will go into effect on August 8, 2022. The rule requires a NASDAQ listed company to disclose annual statistics about their board’s diversity using a matrix prescribed by NASDAQ. Board members must self-disclose gender identity, relevant underrepresented racial/ethnic/religious identities, and LGBTQ+ status. By August 7, 2023, all NASDAQ listed companies are to have one director from a diverse background and by August 6, 2025, for NASDAQ Global Select or Global Markets companies, they must have two diverse directors. For NASDAQ Capital Market companies, the two diverse director requirement will go into effect on August 6, 2026. If a company does not meet these objectives, it must instead include a disclosure of the reasons why it did not meet these objectives.

The federal government has also gotten into the act. In November 2019, the House of Representatives passed H.R. 5084, the “Improving Corporate Governance through Diversity Act of 2019.” This bill would have required issuers of securities to disclose the racial, ethnic, and gender composition of their boards of directors and executive officers, and further disclose any plan to promote racial, ethnic, and gender diversity among these groups. The bill went on to die in the Senate. The bill was reintroduced in the House on February 24, 2021, and most recently was reported favorably by the House Committee on Financial Services on January 20, 2022, and awaits action by the entire House of Representatives. If passed, this law would impact all public companies and not just be limited to corporations listed on NASDAQ.

These various laws and regulations will require some effort and attention both from companies and their investors. While clearly efforts have been focused on for-profit publicly traded corporations, how long will it take before closely-held and nonprofit corporations become a focus for this movement? To decide how best to respond to these ever growing concerns, it might behoove companies to invest in diversity, equity, inclusion audits to help not only with board members but leadership as a whole. DEI audits evaluate how well organizations support minority and female employees. A diversity, equity, and inclusion audit will involve compiling existing company DEI data, surveying employees, and creating a report for further analysis. There are a variety of metrics a company can choose to focus on in its determination of meeting its DEI goals including:

total percentage of underrepresented people in employment
eliminating bias from job descriptions, applications, and marketing materials
hiring rates for different demographics
promotion rates for different demographics
retention rates for different demographics
underrepresented group pay gap analysis
job satisfaction of different demographics
objectivity of policies and practices to mitigate against unconscious bias
percentage of the underrepresented community in organizational leadership

Although employers so far have fended off mandatory DEI audits, studies have correlated better profitability to employers that embrace DEI. Thus, even if not mandated, employers who incorporate DEI audits and practices into their business model may reap the rewards of being proactive.

If you have questions about DEI audits, contact the author or your usual trusted counsel at AALRR.