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Exchanges say ‘no’ to non-voting shares

Joe Mont | August 4, 2017

The current wave of online upstarts going public is disrupting beyond their market segments. They are also upending traditional approaches to shareholders and corporate governance and resorting to increasingly complex share structures to offer greater flexibility to corporate founders and their managerial picks.

In March, Snap Inc., the parent company of Snapchat, moved forward with a $3.9 billion initial public offering. It immediately faced the wrath of investor advocates over the fact that only non-voting shares in the company were offered to investors.

Public shareholders of Class A common stock will have no say in the running of Snap. Co-founders Evan Spiegel, chief executive, and Bobby Murphy, chief technology officer, owned 44 percent of total outstanding shares in the company prior to the IPO. They will, however, continue to control more than 90 percent of all votes even if their ownership interest dilutes over time. Control of the company will only change once both founders either die or voluntarily give up their shares.

Snap’s approach to corporate governance shouldn’t come as a shock. Tech companies have increasingly favored tiered voting structures in recent years, with dual-class and multi-class share structures built around limited public voting rights.

Google/Alphabet, Alibaba, Facebook, Groupon, Zillow, Under Armour, and LinkedIn are among the companies where most company control resides with owners of superior shares granted greater voting rights than the class of publicly owned stock.

Objectives in doing so include giving founders—often lauded as visionaries—greater say in how their companies are run, with the ability to be nimble and pursue long-term strategies otherwise endangered by the short-term performance demands of typical shareholders.

Blue Apron Holdings, a meal-kit delivery company, is among the latest companies to limit shareholder clout, its case with a triple-class public offering.

The Council of Institutional Investors was among critics urging the company to not issue shares that give investors no voting rights, and to adopt a single class of shares with equal voting rights.

CII also urged the main providers of stock market indexes—FTSE Russell, MCSI and S&P Dow Jones—to bar non-voting share classes from their indexes.

Those exchanges are starting to heed the call.

On July 31, S&P Dow Jones Indices announces its decision regarding multi-class shares and voting rules following a consultation published in April.

The S&P Global BMI Indices and S&P Total Market Index will continue to include companies with multiple share classes or with limited or no shareholder voting. The S&P Composite 1500 and its component indices, however, will no longer add companies with multiple share class structures.

Existing index constituents are grandfathered in and are not affected by this change. The methodologies of other S&P and Dow Jones branded indices remain unchanged.

The S&P Global BMI Indices and S&P Total Market Index are broad market indices intended to represent the investment universe. “S&P DJI has determined that the methodologies for these indices should not consider governance arrangements when selecting the universe of constituents. Therefore, the methodologies for these indices are not being modified,” it wrote.

The S&P Composite 1500 (comprised of the S&P 500, S&P MidCap 400 and S&P SmallCap 600) is designed to reflect the U.S. equity market and, through the market, the U.S. economy. Unlike the S&P Global BMI Indices and S&P Total Market Index, it follows more restrictive eligibility rules including a minimum float of 50 percent and positive earnings as measured by GAAP.

The Council of Institutional Investors praised S&P Dow Jones’ decision to ban new multi-class companies from its key U.S. stock indexes. 

“This is a huge win for investors and a blow to companies that deny shareholders any say in how the company is run,” said Ken Bertsch, CII’s executive director. “Multi-class structures, especially those with non-voting shares, rob shareholders of the power to press for change when something goes wrong, which happens sooner or later at most if not all companies. Shareholders at these companies have no say in electing the directors who are supposed to oversee management.”

S&P’s move is “more far-reaching” than FTSE Russell’s July 26 preliminary decision to bar companies with greatly diminished from inclusion in the Russell 3000 and other FTSE Russell indexes, CII said. Nevertheless, its actions are admirable and a step in what they see as the right direction.

FTSE Russell recently consulted index users and other stakeholders on whether FTSE Russell indexes should include a minimum hurdle rate for the percentage of a company’s voting rights in the hands of non-restricted shareholders.

The results of the consultation “showed broad support for the introduction of such a hurdle,” a summary of the consultation says.

In the light of the consultation results, FTSE Russell proposes to proceed as follows:

  • developed market constituents of all FTSE Russell indexes will in future be required to have greater than 5 percent of the company’s voting rights (aggregated across all of its equity securities, including, where identifiable, those that are not listed or trading) in the hands of unrestricted (free-float) shareholders as defined by FTSE Russell.
  • the hurdle will apply to all standard FTSE Russell indexes;
  • the hurdle will also apply to the FTSE UK Index Series, however its application there is likely to have minimal effect given that constituents of that index are already required to have a minimum free float of 25 percent for UK incorporated companies, or 50 percent for non-UK incorporated companies;
  • companies that have 5 percent or less of their voting rights in the hands of unrestricted shareholders will have their securities rendered ineligible for index inclusion;
  • for potential new constituents, including IPOs, the rule will apply with effect from the September semi-annual and quarterly reviews; and
  • for existing constituents, the rule will apply with effect from September 2022, thus affording a five-year grandfathering period to allow constituent companies to change their capital structure if they so wish.

The rate at which the hurdle is set, along with its definition, will be reviewed in the light of subsequent developments on an annual basis. If, following an annual review, FTSE Russell should determine that a more restrictive threshold would be appropriate, the grace period will be extended by a further year.