The Council of Institutional Investors has announced that it has filed petitions with the NYSE and Nasdaq requesting that each exchange amend its listing standards to address the issue of multi-class capital structures (i.e., share structures that have unequal voting rights for different classes of common stock). As requested by the petition, the amendment would require that, going forward, companies seeking to list with multi-class share structures include provisions in their governing documents that would sunset the unequal voting at seven years following an IPO and return the structure to “one-share, one-vote” structures, “subject to extension by additional terms of no more than seven years each, by vote of a majority of outstanding shares of each share class, voting separately, on a one-share, one-vote basis.” According to CII, unequal voting rights impair the ability of shareholders “to hold executives and directors accountable.” But companies contend that these measures are being adopted for a valid reason: to protect the company from unwanted interventions by hedge-fund activists with short-term goals and perspectives. Accordingly, the debate has centered around whether these measures are a legitimate effort to protect companies from the pressures of short-termism exerted by hedge-fund activists and others or are a mechanism that causes shareholders to cede power without providing accountability. Of course, the answer depends on where you sit.
It has certainly been the trend over the last decade (plus) for a relatively small number of IPO companies, particularly tech companies, to offer low-vote or, more recently, no-vote common shares to the public. As reported in Law360, Dealogic said 21% of the 189 IPOs completed last year provided for multi-class structures, an increase from 12% in 2010. Of course, the concept of multi-class common with unequal voting rights is not novel at all. Many companies, particularly some that are family run, have in decades past had a class of common shares with 10:1 voting rights, not to mention the highly respected Berkshire Hathaway with a class holding voting rights of 10,000:1.
In response to the increased incidence of multi-class structures, in 2017, CII successfully requested that a number of index providers limit companies with unequal voting structures in their key indices. (See this PubCo post.) Nevertheless, CII contends, action from the exchanges is still necessary, not only because of their quasi-regulatory role, but also because they’re partly to blame for the proliferation: it is “critical that U.S. stock exchanges lead the way, because of (1) their size and leadership profile among global exchanges; (2) the significant regulatory role they play through listing rules, especially with regard to shareholder voting rights; and (3) the part played by U.S. exchanges over the last 30 years in eroding the concept of one-share, one-vote at public companies.”
CII makes clear that it intends the petition to apply broadly to “any capital structure through which any shareholder’s voting rights, calculated as a percentage of the company’s total voting power, do not equal his/her economic rights, calculated as a percentage of the company’s total equity. This definition includes companies that have a single class of common stock but confer additional voting rights attached to share ownership, for example through time-phased voting structures.” Time-phased voting, sometimes referred to as “tenure voting,” is a concept that would give investors additional votes if they hold their shares for at least a specified period of time, thus rewarding long-term holders by giving them more say in the future of the company than, say, short-term hedge fund activists that may favor short-term profits over long-term business strategies. In contrast to some other structures, however, nothing in tenure voting prevents any shareholder from obtaining super-voting rights. (See this PubCo post.)
The concept of tenure voting was reportedly invented during the 1980s as a shareholder protection measure in response to a wave of hostile takeover attempts. In 1996, in Williams v. Geier, the Delaware Supreme Court upheld adoption by a board of a similar plan as a proper exercise of the business judgment rule to promote long-term planning (even though the effect of the plan was to concentrate voting rights in hands of a controlling block); the plan was then approved by a fully informed stockholder vote, which was considered dispositive.
CII contends that when companies with unequal voting rights “stumble,” shareholders “have little recourse.” Time-based sunsets, CII argues, represent “a sensible solution to the growing problem of unequal voting rights, which poses danger to long-term resilience of an increasing number of companies.” Citing SEC Commissioner Robert Jackson, CII argues that “academic evidence suggests that the real problems with unequal voting rights develop in the medium to longer term.” In addition, according to CII, the market has validated the approach of time-based sunset provisions as an increasing number of multi-class companies have gone public in recent years with these types of sunset provisions ranging from three to 20 years, with the mean at seven years.
CII’s press release also cites endorsements of the subject of the petition from large asset managers, such as BlackRock, and institutional pension funds, such as CalPERS and CalSTRS. In the press release, a BlackRock co-founder said that “BlackRock believes that equal voting rights are a fundamental tenet of good corporate governance.” Similarly, the CEO of CalSTRS said: “One of the strengths of the U.S. economy is the dynamism of U.S. companies. Successful American companies are constantly changing—and reinventing the way they do business. So it only makes sense that they should embrace change in their own governance that ultimately will strengthen shareholder value.”
Nevertheless, CII has petitioned the exchanges on this issue in the past to no effect. And this time, the exchanges, which compete with each other for popular listings, have so far been noncommittal. As reported by Bloomberg, “Nasdaq President Nelson Griggs said his company is a ‘firm believer in the flexibility of share structure,’ but he left the door open for future changes. ‘We consider the input of all stakeholders when establishing and modifying listing standards,’ Griggs said in a statement. ‘We will continue to review our listing standards to make sure they protect investors, while also allowing those investors access to innovative companies.’ NYSE declined to comment.”
Nor does it appear that the SEC intends to act on this issue any time soon, if at all. CII observed that the SEC “believes it lacks the statutory authority to compel U.S. exchanges to amend their listing rules.” However, at a 2018 meeting of the SEC’s Investor Advisory Committee, SEC Chair Jay Clayton’s opening statement addressed why the topic of dual-class share structures, other than as a disclosure issue, was not on his list of near-term priorities. With regard to disclosure of the effect of multi-class shares, Clayton agreed that “we should be striving to address any material gaps in governance disclosure and address investor confusion. Disclosure regarding the operation of dual class voting structures is a question that should be discussed.” Beyond that, however, he preferred to see the issue first examined in a broader context, which included the reasons why many companies adopt multi-class structures in the first place: he “would like to see more analysis of this topic that considers other related issues of significance, including concerns about short-termism and concerns about the attractiveness of U.S. public capital markets compared to foreign public markets and global private markets.” (See this PubCo post.)
The issue of short-termism and its connection to the precipitous decline in the number of public companies has long been a concern raised by SEC representatives and others. (See, e.g., this PubCo post and this PubCo post.) At a 2017 meeting of the SEC’s Investor Advisory Committee, one panelist reported that, when a number of CFOs were asked why they would decide not to go public, at the top of the list was the need to maintain decision-making control. In the private market, another panelist suggested, companies and investors have a kind of unspoken “pact” about long-term strategy. But, said one panelist, the rise of hedge-fund activism in tech and other product-cycle-driven public companies—a relatively recent phenomenon—has fueled concerns among founders and other management that they will be hampered in pursuing long-term strategic goals by activists with short-term perspectives. Commentators have suggested that hedge-fund activists tend to target companies with significant cash and relatively high R&D and SG&A expenses, and that these companies are especially vulnerable when a new product or technology has not met expectations and stock prices fluctuate. As a result, these companies fear that activity that may have significant long-term payout, but a near-term adverse price impact (e.g., M&A activity, change in product strategy, substantial investment in R&D), will draw scrutiny and intervention from hedge-fund opportunists. In addition, the power of these short-term holders has caused companies to remove many types of protective measures, such as board classification.
These risks (and others) have led many companies to stay private longer, leading to a historic decline in the number of public companies. To withstand these pressures, a number of companies undertaking IPOs—and concerned about potential impediments to execution of their long-term strategies as public companies—have implemented dual- or multi-class common structures. (See this PubCo post.) Interestingly, one panelist characterized the dual-class capital structure as merging some private company benefits into a public company structure. (See this PubCo post.)
In this report, Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public, eight organizations—the American Securities Association, Biotechnology Innovation Organization, Equity Dealers of America, Nasdaq, National Venture Capital Association, Securities Industry and Financial Markets Association, TechNet and the U.S. Chamber of Commerce—joined forces to make recommendations about how to revitalize the IPO market and make public company status more appealing. The report recognizes that the need to maintain decision-making control is a factor for companies considering an IPO, and its recommendations advocate a regulatory hands-off approach:
“Another trend that has developed recently is companies adopting corporate structures that help founders maintain control. For example, dual class or multi-class share structures retain voting rights only for certain shareholders. While such structures have received criticism from some observers, policymakers should recognize that this trend has coincided with a steady rise in shareholder activism, and that companies should be free to choose a corporate structure that they believe will best enhance long-term performance. Instead of contemplating whether to prohibit or limit the use of such structures, policymakers should instead focus on the underlying causes of the trend and whether it is merely a symptom of a broken public company model. A broad focus on encouraging investor choice while assuring that issuer disclosure keeps investors sufficiently informed is necessary to prevent prescriptive regulations that harm market dynamism.” (See this PubCo post.