PLF Lawsuit: Can the Government Force Private Citizens to Operate a Racial Classification Scheme?

In a federal lawsuit filed last week, the Pacific Legal Foundation is representing a Colorado venture capital fund challenging a 2023 California law that requires venture capital funds to report to the state the race and gender and even sexual orientation of the founders of companies they fund.

The law, known as the Fair Investment Practices by Venture Capital Companies Act, applies to any companies anywhere in the country that invest in California entrepreneurs.  It was designed to pressure venture capitalists to fund members of certain preferred identity groups. In his signing statement, Gavin Newsom said the legislation was intended to  “improve the diversity of venture capital investments.”

The lawsuit, filed in the United States District Court for the Eastern District of California,  says, “This law is unconstitutional three times over. First, because it compels venture capital funds to survey their founders on race, ethnicity, sex, gender identity, and sexuality when they otherwise would remain silent. Second, because it seeks to compel indirectly what the state cannot compel directly: force venture capital funds to consider race and sex in their funding decisions. And third, because it reaches far outside the borders of the state to regulate conduct with no nexus to California.”

Pacific Legal Foundation lawyer Wilson Freeman told the California Globe that, “This case is about whether the government can force private citizens to operate a racial classification scheme. The First Amendment protects the right against compelled speech; forcing venture capital companies to interrogate their founders [about] their race and sexuality, on the government’s script, violates that principle.”

“The law forces firms to ask questions they’d never otherwise ask, then directs [the California Department of  Financial Protection and Innovation] to publish a scorecard ranking them by the race of the founders they fund. This is compelled speech about race, in an attempt to coerce decisions based on race.”

The Colorado firm that filed the lawsuit is known as the 1517 Fund, and it “specializes in providing funds to extremely early stage founders; they seek out young people, the uncredentialed, and renegade scientists and help them get their ideas off the ground to advance science and civilization.”

The lawsuit says that the 1517 Fund always makes investment decisions based on “merit, without regard to race, ethnicity, gender, gender identity, sexual orientation, disability, or veteran status.”

But forcing the firm to determine the demographics of the people they fund is a form of conscripted speech in violation of the First Amendment.

“The firm’s public identity as a meritocratic, identity-blind investor is undermined by the statutory requirement that the firm participate in racial classification of its founders. 1517 Fund cannot accurately represent its investment philosophy [of meritocracy] to founders, limited partners, or the public while it is simultaneously required to administer a state-mandated demographic-classification regime.”

The complaint says that the First Amendment “protects Plaintiffs from having to survey the founders they invest in about race, ethnicity, gender, and sexuality.”

The mandatory questionnaire “is a content-based restriction on Plaintiffs’ freedom of speech because it prevents them from communicating on the issue in their preferred fashion and requires them to use a specific form with specific content.”

The complaint also says the law violates the Equal Protection Clause of the 14th Amendment because it is a conduit for discrimination, forcing investment funds to make decisions based on race to satisfy California’s diversity scheme.

The law requires the “1517 Fund to administer a racial classification scheme as a condition of operating their venture capital business” and to “alter their investment decisions to favor founders of particular races.”

On top of that, by covering companies like the 1517 Fund that are not even located in California, the law runs afoul of the Fourteenth Amendment’s Due Process Clause that  “forbids a State from extending its regulatory authority to persons, conduct, or transactions lacking significant contacts with the State.”

“The Constitution recognizes the States as co-equal sovereigns. The structural design of the Constitution forbids any State from projecting its sovereign authority into the territory of another State to regulate persons, conduct, or transactions occurring wholly outside the regulating State’s borders.”

But under the law, the 1517 Fund is required to report to California demographic information about the founders it funds anywhere in the country.

“On its face, the [law] compels  1517 Management, a Colorado company, to demand demographic information from individuals who have no connection to California, concerning their ownership of and participation in businesses that have no connection to California, for transmission to a California state agency and for publication on a California state website.  By extending its regulatory authority to persons, conduct, and transactions lacking significant contacts with California, Defendant maintains and actively enforces a set of laws, practices, policies, and procedures under color of state law that deprive Plaintiffs of their right to due process.”

The media office for the California Department of Financial Protection and Innovation, which administers the law and is the defendant in the lawsuit, did not reply to a request for comment.