Monday, March 13, 2017

Snap IPO has Investor Advisory Committee debating no-vote offerings

By Anne Sherry, J.D.

In the shadow of Snap Inc.’s enormous and controversial IPO, the SEC Investor Advisory Committee heard representatives from the industry and academia about the relative merits and pitfalls of unequal voting rights. Snap’s dual-class structure, which lacks a sunset provision, effectively gives the company’s twentysomething founders control of the company until both die. Some panelists cautioned about the risks and disenfranchisement that such a structure entails, while one suggested it is a correction to a “corporate governance misalignment” that panders to short-term shareholder interests.

Snaps are ephemeral; founders’ control is near-permanent. Jill Fisch (University of Pennsylvania Law School) explained that Snap’s three-tier share structure means that the founders will retain control of the company as long as they live, unless they sell 70 percent of their class C shares. The founders could sell all of their A and B shares, and a majority of their class C shares, and still retain control. Some have defended dual-class structures for giving founders a defined period of time to review their objectives and take risks, Fisch observed, but that justification is absent because unlike a number of dual-class IPOs, Snap does not have a compelling transition plan.

Disclosure and state law implications. Fisch also said that the issue does not end at voting rights. A number of SEC disclosure requirements are keyed to voting stock. Snap, which does not have to prepare a proxy statement, has indicated that it intends to provide disclosures voluntarily, but it is unclear what that means. The issue also implicates state law, Fisch noted: Delaware, for example, has given shareholders the power to cleanse transactions or affect transaction form through the vote. Will nonvoting shares obtain the right to vote in a conflict-of-interest transaction, which is likely to come up for Snap? Fisch concluded by cautioning against outright prohibition of no-vote structures because companies may simply opt to stay private.

Do investors have a choice? Several of the panelists raised the quandary that investment advisers, particularly passive managers, are facing. Rakhi Kumar (State Street Global Advisors) pointed out that passive managers have a mandate to replicate indices. If S&P, MSCI, or Russell puts non-voting or unequal shares into the index, State Street’s index funds has to buy them. Kumar said that 31 of S&P 500 companies—representing 12 percent of the index—have unequal share structures. This goes beyond tech companies; Berkshire Hathaway, Ford, and Nike are other examples. Fisch also mentioned that this issue goes beyond passive management. If enough companies in the tech sector adopt unequal share classes, active managers will not be able to opt out and still represent that they are offering tech funds.

Corporate governance misalignment. David Berger (Wilson Sonsini Goodrich & Rosati) disagreed with the notion that there is no such thing as good corporate governance in Silicon Valley. Instead, he believes it’s time to rethink what is considered good governance. Why are some of the most innovative and successful companies so heavily criticized for their corporate governance structures? Berger chalks this up to corporate governance misalignment: an overwhelming focus on the needs of stockholders and short-term results. This misalignment has caused companies to adopt other structures so their boards can explore longer-term strategies.

Listing standards should be tightened. Ken Bertsch (Council of Institutional Investors) allowed that it is important to pay attention to other stakeholders, not just shareholders. Ultimately, though, he said that this is a power question. At Snap, the two founders have all the power and are making all the decisions with no accountability. Bertsch reminded the committee corporations are led by human beings who do not always see their own mistakes and limitations. “One share, one vote” has been a bedrock principle of CII since shortly after its founding in 1985.

Snap CEO Evan Spiegel said that it will take five years to educate the markets as to the value of the company. If that is true, Bertsch asked, why did Snap not sunset the share structure in five years? He cited recent problems at Viacom, controlled by ninetysomething Sumner Redstone by virtue of dual-class shares, as an example of the long-term pitfalls of multi-class stock companies.

Bertsch called on the SEC and exchanges to revisit the rules on new offerings of multi-class structures. CII members “have watched with rising alarm for the last 30 years as global stock exchanges have engaged in a listing standards race to the bottom,” which may have been reached with the Snap no-vote offering.

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