Restricting shareholder rights is not a new phenomenon. Companies frequently issue stocks with differential voting rights so that pre-IPO investors can maintain voting control. Many multi-class share companies give at least token voting rights to public shareholders. The most common structure is to give ten votes per share to insiders, and one vote per share to non-insiders. ((James Moloney et al., Non-Voting Shares Make Their Public Debut and Generate Some Governance Concerns, but How Will Courts View the Structure When First Presented?, Gibson, Dunn & Crutcher (Mar. 12, 2017), http://www.securitiesregulationmonitor.com/Lists/Posts/Post.aspx?ID=288.)). In the technology sector, dual-class share issuance has become the mainstream; co-founders prefer this method so that they can continue to exercise freedom in managerial and decision-making control that they believe allowed them to achieve a high level of success in the first place. For example, the founders of Google and Facebook preserved significant control when they went public by creating two classes of stock with different voting rights. ((Jen Wieczner, Why Some Investors May Boycott Snapchat’s IPO, Fortune (Feb. 7, 2017), http://fortune.com/2017/02/07/snapchat-ipo-snap-stock-buy/.)). When they became public, each company did so after requesting shareholder approval for the issuance of a third class of non-voting shares. ((Rob Kalb & Rob Yates, Snap, Inc Reportedly to IPO with Unprecedented Non-Voting Shares for Public, Institutional Shareholder Services, Inc. (Feb. 7, 2017), reprinted in Harvard Law School Forum on Corporate Governance and Financial Regulation, https://corpgov.law.harvard.edu/2017/02/07/snap-inc-reportedly-to-ipo-with-unprecedented-non-voting-shares-for-public/.)). However, Snap, Inc., the parent company of social messaging app Snapchat, just took it a step further: it recently became the first company to sell non-voting stock in an IPO on a U.S. stock exchange. This bold move may troublingly deprive shareholders of any say in corporate matters whatsoever. ((Wieczner, supra note 2.)). It’s not surprising, then, that many on Wall Street may fear that this sets a dangerous precedent for corporate governance.
Details of the filing
Snap’s S-1 filing fully disclosed the implications of offering only non-voting Class A common stock. Cofounders Evan Spiegel and Bobby Murphy will each have 44.3% voting control of Snap due to their 100% ownership of Class C shares that are entitled to ten votes per share. ((Snap, Inc., Registration Statement (Form S-1) pp. 4, 151 (Feb. 2, 2017).)). Their concentrated control gives either or both of them together the ability “to control the outcome of all matters submitted to our stockholders for approval, including the election, removal, and replacement of directors and any merger, consolidation, or sale of all or substantially all” of Snap’s assets. ((Id. at 9-10)). Notably, if their employment is terminated, they will continue to be able to exercise “the same or significant voting power” and control the outcome of all matters submitted to stockholders for approval. ((Id.)).
The result is that Snap’s Class A shareholders won’t be able to vote on fundamental governance issues and changes to the company. They cannot participate in board member elections or nominate members, submit shareholder proposals, pressure the board of directors to replace the CEO or anyone upper level management, or exercise voting rights to approve or block a merger or takeover of the company – all rights that stockholders have traditionally held in public companies. ((Wieczner, supra note 2.))
Of note is the fact that the non-voting stock structure nullifies the requirement that Schedule 13D filings be submitted to the US Securities and Exchange Commission within ten days by anyone who acquires beneficial ownership of more than 5% of the now publicly-traded company. ((U.S. Sec. and Exch. Comm’n, Fast Answers, Schedule 13D (Dec. 5, 2012), https://www.sec.gov/fast-answers/answerssched13htm.html)).
The main concerns cited
Institutional investors and their representatives, including The Council of Institutional Investors, the California Public Employees’ Retirement System, and Institutional Shareholder Services have voiced and continue to voice strong opposition to these dual-class structures in the past. ((Moloney et al., supra note 1.)). They argue that the dual-class capitalization creates the equivalent of a “corporate safe room”, for the reasons outlined above. ((Id.)). CII has gone as far as urging the New York Stock Exchange (NYSE) and NASDAQ to adopt rules prohibiting companies with dual class structures from listing on their exchange. ((Id.)).
Investor activists showed little early interest in investing in Snap, given that the non-voting shares strip them of the tools that they would use to effect change. ((Wieczner, supra note 2.)). Just before the IPO, the Investor Stewardship Group, which includes BlackRock, the California State Teachers Retirement System, and Vanguard, took a stand against dual-class systems at publicly-traded companies, issuing a statement of principles urging companies to adopt a “one share, one vote” standard. ((Joe Cahill, “The Beginning of the End of Dual-class Stocks”, Crain’s Chicago Business (Feb. 3, 2017), http://www.chicagobusiness.com/article/20170203/ISSUE10/170209945/the-beginning-of-the-end-of-dual-class-stocks.)). They cited the familiar concern that unequal voting power severs the linkage between financial interest, management, and control, by insulating managers from accountability to the public shareholders. ((Id.)).
Studies show that the lack of external accountability in controlled companies (those with managers who have supervoting power) leads to underperformance with respect to shareholder returns, revenue growth, return on equity, and dividend payout ratios. Governance standards at these companies have been weaker. ((Kalb, supra note 3.)). There is less gender and ethnic diversity in the boardroom. Board directors have longer average tenures and there are more related-party transactions. The weaker governance and lack of accountability makes investors nervous, especially those who lived through the stock price crashes of 2000 and 2008. ((Id.)). In its 2016 policy survey, ISS found that 56% of investors consider controlled status before making an investment decision. ((Id.)).
On the other hand, dual-class structures can offer key advantages to companies and their shareholders in terms of company health and ensuing financial benefit. The dual class structure undoubtedly protects the implementation of long-term focused business plans and the founders’ vision. Management needs to retain control in order to continue to innovate without being beholden to short-term market forces and risk-averse shareholders. ((Moloney, supra note 1.)). Relatedly, founders of these companies reason that dual0-class structures provide a strong takeover defense, keeping the company on track to achieve their long-term objectives. ((Id.)). Some companies, such as Alphabet (the parent company of Google), whose founders hold near-absolute control, have thrived and outperformed peers, sector, and index while improving in other areas of governance. ((Kalb, supra note 3.)).
Where we are now
For now, doubters have been silenced; there was some worry that the governance structure coupled with lack of proven profitability would drive stock down, but it has been strong.
After a much-hyped stock market flotation earlier this month that valued Snap, Inc. at $29 billion, the company’s share price steadily sunk ((Mark Sweney, Snapchat ‘will be bigger than Twitter, Yahoo and AOL with advertisers’, The Guardian (Mar. 26, 2017), https://www.theguardian.com/business/2017/mar/26/snapchat-will-be-bigger-than-twitter-yahoo-and-aol-with-advertisers.)). The shares soared from their $17 IPO price to $26 in two days, then hovered around $19, but as of March 31, 2017, were back up to $22.55, only $1.45 short of its IPO opening price.
This comes on the heels of Snap’s underwriters and their analysts releasing reports examining the prospects of the company’s recently sold IPO shares. ((N.Y.S.E. Guide (CCH).)). At least eight of the underwriting institutional investors (which include banks and hedge funds) immediately gave the company the equivalent of a “buy” rating, and another four gave the stock a “hold” recommendation. ((Berkeley Lovelace, Snapchat Snags its First ‘Buy’ Rating; Shares Rise, CNBC (Mar. 20, 2017), http://www.cnbc.com/2017/03/20/wall-street-grants-snapchat-its-first-buy-rating-shares-rise.html.)). The rally was attributed to optimism around the youth-focused advertising and market potential for Snapchat, whose target audience is uniquely positioned to be the next largest market competing with Facebook, Google, and Twitter. ((Akin Oyedele, Snapchat Just Got a Deluge of Bullish Ratings from Wall Street, and its Shares are Rallying (SNAP), Business Insider (Mar. 27, 2017), http://markets.businessinsider.com/news/stocks/snapchat-stock-price-rises-bullish-analyst-ratings-2017-3-1001869777-1001869777.)). As one analyst from RBC Capital Markets put it: “Snap has become an innovation leader – for both consumers and advertisers – in arguably the single fastest advertising medium today – mobile. It has also emerged as one of the leading media platforms for millennials. We believe that if it sustains its current level of innovation, it can sustain premium growth for a long time and scale to profitability.” ((Id.)).
This is mild poetic justice for the company, after investors initially deemed its stock largely a “sell” or “hold” after its initial public offering in March, with smaller Wall Street firms criticizing Snapchat’s unprofitability and the stock’s lack of voting rights.
It remains to be seen whether Snap will weather the long-term storm.
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