Diversity, Discrimination, and Derivative Suits

by | Mar 1, 2021 | Blog | 0 comments

Shareholder derivative suits are brought by an investor on behalf of the corporation itself. In a derivative case, the plaintiff alleges that the actions of the defendants, typically the company’s officers and directors, have harmed the company and reduced the price of shares. Traditionally, such cases were most often used to challenge mergers, with investors alleging that the defendants breached their fiduciary duties by agreeing to a deal that undervalues the company.

But in the latter half of 2020, a number of shareholder derivative complaints were filed based on a novel theory. Instead of challenging a mishandled merger, these cases alleged that the defendants’ failure to meet their public commitment to diversity, particularly with respect to the composition of the companies’ boards and leadership teams, had financially harmed the companies. The first two cases against Facebook and Oracle were filed on July 2, 2020, and since then, similar complaints have been filed against Qualcomm, NortonLifeLock, The Gap, Monster Beverage, and Cisco.

As evidence of financial harm, most of the complaints reference a 2015 McKinsey report that found a statistically significant relationship between a diverse leadership team and superior financial performance. McKinsey reaffirmed that finding in subsequent reports in 2018 and 2020, with the most recent report reiterating that “[t]he most diverse companies are now more likely than ever to outperform non-diverse companies on profitability.”[1] The complaints also cite the damage to each company’s goodwill and reputation, and list a variety of unnecessary expenditures caused by the defendants’ conduct, including the costs associated with investigations and lawsuits, compensation of executives that engaged in misconduct, the costs of hiring employees to replace those who quit in protest, and the payment of fines and settlements.

In addition to the cases focused on board diversity, another case has been filed against Pinterest, alleging that the defendants had created or ignored a culture of racial and gender discrimination at the company. In September, Alphabet settled a similar case in September that alleged the directors and officers directly participated in a scheme to cover up sexual harassment and discrimination at Google, which is a subsidiary of Alphabet.

The Alphabet settlement of the Alphabet case indicates that allegations of harassment and discrimination in a derivative suit can be successful, although courts have yet to rule on the validity of the claims in any of the board diversity cases. Rulings are expected in the coming months, and if these suits are successful, they will dramatically expand the scope of derivative liability.

[1] Sundiatu Dixon-Fyle, Kevin Dolan, Vivian Hunt, & Sara Prince, Diversity wins: How inclusion matters, McKinsey & Co. (May 2020), https://www.mckinsey.com/~/media/McKinsey/Featured%20Insights/Diversity%20and%20Inclusion/Diversity%20wins%20How%20inclusion%20matters/Diversity-wins-How-inclusion-matters-vF.pdf.