Dual class share structures have been thrust back into the spotlight by a recent flurry of initial public offerings of subordinate voting shares, a proposed going private transaction of a dual class share company and shareholder approval of amendments to an issuer’s multiple voting share terms.
However, multiple voting shares have been a fixture of the Canadian financial markets for over 60 years. From holding companies of insurers, real estate investments or communications assets to retailers and restaurants, and from manufacturers of electronics, semi-trailers, snowmobiles or bicycles to resource and children’s entertainment companies, Canadian issuers from a variety of industries have dual class share structures. Further, from founders to venture capitalists, and from families to financial investors, dual class share structures have been utilized by a range of shareholders to access Canadian capital markets.
Dual class share structures include companies with multiple voting shares (e.g. 10 votes per share) and subordinate voting shares (e.g. one vote per share) and companies with voting and non-voting common shares. While much of the discussion below is relevant to voting and non-voting share structures, the focus of this update is on multiple voting and subordinate voting share structures.
REGULATORY REQUIREMENTS OVERVIEW
Between 1979 and 1983, the number of dual class share companies listed on the Toronto Stock Exchange (TSX) increased from 64 to 130. However, possibly reflecting the heightened regulation subsequently implemented (e.g. the Ontario Securities Commission’s (OSC) Rule 56-501 – Restricted Shares (OSC Rule 56-501) and part VI.H of the TSX Company Manual), over the past few years this number has sustained at approximately 80 companies (exclusive of investment funds and special purpose acquisition companies).
Business Corporation Acts
Canadian corporate statutes such as the Canada Business Corporations Act and the Business Corporations Act(Ontario) generally stipulate that a company’s articles may provide for more than one class of shares and, if they do so, the rights to vote at all meetings of shareholders and receive the remaining property of the company upon dissolution must each be attached to at least one class of shares, but all such rights are not required to be attached to one class. Accordingly, companies can create and issue different classes of shares, with each class being entitled to different shareholder rights, including, for example, multiple voting shares, participating preferred shares or non-voting shares.
Toronto Stock Exchange
Since 1987, the TSX has required “coattail” provisions for all newly-listed dual class share issuers. While the specific terms and conditions of the coattail are left to the issuer, subject to TSX pre clearance, the provisions generally require that any take over bid made to the holders of multiple voting shares be extended, on identical terms, to the holders of subordinate voting shares. Such coattails are often described as being designed to prevent take-over bid transactions that could otherwise deprive the holders of subordinate voting shares of rights under Canadian securities laws to which they would be entitled if the multiple voting shares were subordinate voting shares.
Since the TSX coattail requirements only apply to new listings, any dual class share companies listed on the TSX upon the effective date of the 1987 requirements have been “grandfathered”. Over time, the number of such “grandfathered” issuers without coattails has declined and, currently, fewer than 10 TSX-listed dual class share companies do not have coattails.
The TSX Company Manual also contains various disclosure requirements regarding dual class share structures, similar to those noted below under “Canadian Securities Administrators”, which are designed to “alert investors of the fact that there are differences in the voting powers attached to the different securities of an issuer”.
Canadian Securities Administrators
The current regulatory regime of the Canadian Securities Administrators has primarily resulted from the OSC’s review of dual class share structures during the period of 1981–84. The OSC determined that it was not contrary to the public interest to permit the distribution of securities of a dual class share company, provided that certain conditions as to initial and continuous disclosure were met.
Presently, all dual class share companies, including those issuers grandfathered under the TSX requirements are subject to, among other provisions:
- Requirements concerning the creation of, or conversion to, a dual class share structure, pursuant to OSC Rule 56-501 and part 12 of National Instrument 41-101 – General Prospectus Requirements
- Expanded continuous disclosure requirements imposed by part 10 of National Instrument 51 102 –Continuous Disclosure Obligations
- Detailed prospectus disclosure requirements imposed by item 10.6 of Form 41-101F1 – Information Required in a Prospectus and item 7.7 of Form 44-101F1 – Short Form Prospectus
Generally, the foregoing disclosure requirements focus on avoiding the use of confusing share nomenclature (i.e. cannot refer to dual class shares as “common shares”) and on providing clear disclosure of the relative voting power of each class of shares, any restrictions on the voting rights of each class of shares, and a description of the ability, or lack thereof, of shareholders to participate in a take-over bid made for shares of another class within the structure.
DUAL CLASS SHARE STRUCTURES
Proponents of dual class share structures note that such structures provide the following benefits, among others:
- Increased participation of family-and entrepreneur-controlled firms in the public capital markets:Many company founders seeking sources of capital to finance growth place a premium on retaining control of the companies they have created and will access public equity markets only if structures are available that permit them to maintain such control. Accordingly, it is reasoned that dual class share structures provide investors the opportunity to purchase shares in companies that otherwise might not be available.
- Management and the board of directors are permitted to focus on long term success and profitability: It is contended that a dual class share structure permits long-term investment decisions to be made without the need to satisfy short-term financial expectations that can be detrimental and result in the incurrence of disproportionate risks (relative to expected rewards) for stakeholders. It has also been asserted that control through a dual class share structure is an effective measure for protecting a company’s stakeholders from opportunistic acquirers who seek to take advantage of negative short-term fluctuations resulting from a target company’s focus on long-term value creation.
- Interests of minority shareholders and controlling shareholder(s) with meaningful equity ownership are aligned: Widely-held companies with one-share-one-vote structures are vulnerable to agency costs resulting from potential conflicts that exist between managers and shareholders, given the separation of ownership from control. Further, with dispersed ownership, given the challenges to collective action by shareholders, it may be difficult for shareholders of widely-held companies to effectively monitor and discipline managers in the absence of committed, knowledgeable and active long-term shareholders. It has been argued that, in a dual class share company, the interests of a controlling multiple voting shareholder with meaningful equity ownership are closely aligned with the interests of minority shareholders with regard to the supervision and discipline of management, thereby minimizing agency costs, and that such a controlling multiple voting shareholder is well positioned, incentivized and able to supervise management’s conduct.
Dual class share structures with non-voting shares can also be an effective means to ensure that the Canadian ownership restrictions imposed on certain industries (e.g. broadcasting, telecommunications, media and airlines) are met.
Opponents of dual class share structures assert that such structures are subject to a number of risks, including the following, among others:
- Disproportionate economic exposure: It has been contended that, while holders of multiple voting shares can wield significant power as shareholders, the majority of the financial risk is borne by the public owners of the subordinate voting shares and this risk increases as the number of votes attached to each multiple voting share increases.
- Self-enrichment: It has also been reasoned that holders of multiple voting shares can exert significant influence on a company, causing themselves or family members to be awarded excessive compensation as executive officers of the company or syphoning off corporate value through the approval of self-dealing transactions on off-market terms.
- Management entrenchment: It has been argued that dual class share structures can entrench poorly performing management by insulating them from accountability for their actions.
- Passive boards: It has been suggested that the directors may be beholden to the views of the controlling multiple voting shareholders, or risk being replaced on the company’s board, despite the duty of each director to act with a view to the best interests of the company.
A number of governance commentators, governmental bodies and institutional investor associations have commented on the use of dual class share structures, some of which have provided (cautiously) supportive, non-binding commentary regarding the use of dual class share structures, including the following:
- A 2005 study produced by the Economics Division of Canada’s Library of Parliament discussing the prevalence of dual class share structures in Canada and the reason for their emergence, noting that “[u]ndeniably, some of the best-performing companies in their sectors in Canada have multiple-voting share structures”.
- A 2007 study issued by the Organisation for Economic Co-operation and Development Steering Group on Corporate Governance regarding the lack of proportionality between ownership and control in dual class share structures determined, among other conclusions, that “there is nothing a priori onerous about separating ownership and control” and that “[s]imply ruling out voting right differentiation on companies’ shares would neither be effective nor efficient.”
- In 2013, the Canadian Coalition for Good Governance (CCGG), an organization representing institutional shareholders and asset managers, released its “Dual Class Share Policy”, which sets out CCGG’s governance guidelines for companies with dual class share structures (see our October 2013 Blakes Bulletin: CCGG Releases Governance Guidelines for Dual Class Share Companies).
- Prior to 2014, the Shareholder Association for Research & Education (SHARE), an organization concerned with “responsible investment services, research and education for institutional investors”, advocated in its model proxy voting guidelines that Canadian stock exchanges should ban shares with unequal voting rights under most circumstances. However, since 2014, SHARE has softened its stance, recommending that while Canadian pension funds should oppose unequal voting rights in most cases, in exceptional circumstance “[d]ual class share structures may be appropriate for new companies that need protection from hostile takeovers or from pressure to produce short-term profits.”
- In May 2015, the Institute for Governance of Public and Private Organizations (IGOPP) reiterated the benefits of appropriately structured dual class share companies, echoing the “framework of safeguards that could enhance the benefits of dual share structures and minimize their potential downside” outlined in a policy paper published by IGOPP in 2006.
- Also in May 2015, it was reported that David Beatty, the Conway chair of the Clarkson Centre for Business Ethics and Board Effectiveness at the University of Toronto’s Rotman School of Management, once a vocal critic of dual class share structures, now believes they might be an effective response to the “menace” of “the short-term thinking that leads public companies to react an[d] plan quarter-to-quarter, rather than for the long term.”
Good governance and bad governance can be found in all types of companies; whether they have a dual class share structure or follow the traditional one-share-one-vote model. For widely-held companies with one-share-one-vote structures, sound governance practices can protect shareholders and the value of their investment in the company by aligning the incentives of managers and holding them accountable, while ensuring that directors and management act in the corporation’s best interests. Just as conflicts may exist between controlling shareholders and minority shareholders within one share one vote structures with concentrated ownership, dual class share structures may create, absent a proper corporate governance framework, potential conflicts between controlling holders of multiple voting shares and minority holders of subordinate voting shares. Accordingly, proponents of dual class share structures contend that concerns surrounding dual class share structures should be addressed by a focus on implementing appropriate governance standards and protections to ensure that officers, directors and controlling multiple voting shareholders act in the corporation’s best interests, such as the use of related party transaction review committees, robust internal controls and independent auditors.