Friday, March 09, 2018

SEC advisory committee approves recommendations on dual-class share structures

By Amanda Maine, J.D.

The SEC’s Investor Advisory Committee (IAC) unanimously voted to approve recommendations on the use of dual-class and other entrenching governance structures. The Investor as Owner Subcommittee proposed a series of reforms aimed at improving the disclosure of such structures to investors. The IAC also agreed to hold a discussion before the next scheduled IAC meeting in June to explore concerns recently raised by Commissioner Robert Jackson on the use of “perpetual” dual-class share structures.

Dual-class share structures. The subcommittee’s report found that dual-class and similar share structures, which allow for a concentration of voting power in the hands of company insiders through a disproportionate allocation of voting rights among shareholders, have increased dramatically since 1980. Among prominent companies to employ such dual-class structures are Google, Facebook, Snap, LinkedIn, and Nike.

These dual-class share structures result in insiders’ voting power to outstrip their ownership interest, according to the subcommittee. While the use of dual-class structures can benefit the founders of companies that have recently gone public by allowing them to retain control in the face of investor pressure for short-term gains, they can also create risks, such as difficulty influencing management, an increased risk of divergent views over strategy and conflict or litigation over these views, risks that those with small ownership interests will use their voting to control to approve changes in governance to the detriment of non-controlling investors, and risks that non-voting investors will not be entitled to the same information of voting investors, according to the subcommittee’s report.

Recommendation. The subcommittee’s report recommends that the Division of Corporate Finance continue to scrutinize disclosure documents filed by companies with dual-class share and similar structures. In particular, the subcommittee recommends that public companies with these share structures prominently and clearly disclose the numerical relationship between ownership interests and voting rights. These companies should also disclose risks of increasing further disparity between ownership interests and voting rights with regards to corporate governance changes.

In addition, these companies should clearly disclose risks that their share structures may result in the exclusion of company shares from major indices, as well as risks that stock exchanges could delist their shares if the control persons use their voting rights to increase their relative voting power or decrease the relative voting power of other shareholders.

The subcommittee also recommends that the staff implement a pilot program to monitor shareholder disputes arising out of these share structures and to determine if enhanced disclosures requirements related to these disputes are necessary. The report recommends that the term “common stock” be defined more specifically for securities law disclosure purposes to distinguish between stock with voting rights under the one-share, one vote system from diminished-rights stock.

“Perpetual” dual-class stock structures. Speaking at the beginning of the meeting, Commissioner Robert Jackson directed the committee’s attention to a speech he gave last month where he expressed concern that most companies with dual-class share structures do not provide for the sunset of their dual-class structures, according to a study performed by his staff. Jackson said that the study revealed that the companies with sunset provisions for their dual-class share structures outperformed those that did not.

While Jackson’s concerns about perpetual dual-class share structures were not addressed in the subcommittee’s report, several members of the committee echoed his concerns. Committee member Anne Simpson, investment director at CalPERS, said she thought that Jackson had raised an extremely important point and that she would be in favor of looking further into the issue. However, she stressed that such an important step shouldn’t be done “on the fly.”

Allison A. Bennington, partner and general counsel at ValueAct Capital, noted that the recommendations provided by the subcommittee are about disclosure, which is the SEC’s focus. Mandating sunset provisions would be a policy action to be taken by the exchanges, she said. It should definitely be examined, but this on policy issue, as opposed to the disclosure considerations identified by the subcommittee, the committee should take more time to analyze what implementation of this policy might entail, she said.

Heidi Stam, former managing director and general counsel of Vanguard, praised the work of the subcommittee, calling it meaningful and important, advising that it should not be held up by a discussion of imposing sunset provisions. Committee secretary Craig Goettsch, director at the Iowa Insurance Division, suggested that the committee approve the recommendations and schedule a conference call on the perpetual dual-class share structure issue prior to the committee’s next scheduled meeting in June.

Following this discussion, Anne Sheehan, CalSTERS director of corporate governance and chair of the full committee, moved for approval of the recommendations put forth by the subcommittee with the added recommendation that the subcommittee look into the issues identified by Commissioner Jackson and report back to the full committee. The recommendations were approved unanimously

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