Stakes raised on multiple voting-class structures

Measures taken by the FTSE Russell and S&P Dow Jones indexes to restrict access to new listings are expected to spark further investor-founder-market tensions
By Cooper Langford

It’s usually company news that moves the markets. But this summer, several international markets made news designed to move companies—specifically, when it comes to their embrace of multiple voting-class share structures. Now more news, and moves, are likely to follow.

In late July, FTSE Russell got the ball rolling when it announced it would exclude from its indices any new listings that didn’t offer at least 5% of voting rights to subordinate shareholders. Existing listings will be grandfathered into the indices, but only for five years. After that, any company that does not meet the minimum will be shown the door.

A week later, S&P Dow Jones went even further, announcing that new companies with multiple share classes won’t be included in the S&P 1500 Composite Index and its component indices, including the S&P 500.

These announcements came in response to intense lobbying from institutional investors upset by the increasing number of companies coming to the capital markets with multi-class share structures. The list includes many familiar names, mostly in tech—Alphabet, Facebook, LinkedIn, Blue Apron and Ottawa-based Shopify Inc. (TSX:SHOP), among them. But the proverbial straw that broke the camel’s back was the IPO by Snap Inc. in March. Not only did the maker of the popular SnapChat app follow the trend of issuing shares with different voting rights, it also claimed the dubious distinction of being the first to make only non-voting shares available to the public.

Besides being a blatant assault on shareholder rights, Snap’s move came at a time when the institutional investment community and their investing clients are tilting heavily toward passive investment strategies. Those institutions argued that forcing index funds and other passive investing vehicles to buy non-voting shares was an affront to public company governance, reducing their ability to influence corporate decision-making to near-zero.

After the S&P and FTSE announced their new policies, Ken Bertsch, executive director of the Council of Institutional Investors in Washington, D.C., called it “a huge win for investors.”

The next question is how will potential listees respond to the index bans? Observers expect a period of adjustment as companies evaluate their options for raising capital and their overall share-structure strategy. The volume of money sloshing around in passive funds tied to these indexes is growing rapidly. And the ability to tap into that funding is a strong incentive for public companies to conform to new index rules. “Access to key indices is important,” says Sharon Geraghty, a partner at Torys LLP. “Being eligible for those indices is a positive factor in generating investor demand. Now, prospective issuers and underwriters who sell their shares will know they don’t have access to an index and that will impact pricing for their shares at some level.”

Mark Wilson, a partner and corporate governance specialist at Wildeboer Dellelce, doesn’t think that disincentive on its own will be enough to persuade new companies to abandon multi-class structures. “Entrepreneurs are going to want this structure all the time because they are entrepreneurs. That’s like water being wet,” he says.

Geraghty agrees. While the prohibitions will alter the cost-benefit analysis for companies seeking capital, in the end, “I don’t think [companies] will stop using these structures and I don’t think underwriters will stop underwriting these types of offerings,” she says. “I don’t think they will disappear from the landscape.”

Of course, further action by the exchanges might shift the balance. It’s worth noting, for example, that FTSE Russell’s 5% listing threshold isn’t a major ask for insiders who want to retain control of public companies. That prompted Shane Keenaghan, a governance analyst at Glass Lewis, to ask in an August post on the advisory firm’s blog if FTSE Russell might hike that threshold down the road. “Two-thirds of the [institutional] participants in Russell’s consultation [prior to its announcement] supported a minimum free-float threshold—and a majority favored setting that threshold higher, at 25%, potentially excluding household names like Alphabet and Facebook,” he wrote. “By contrast, less than a quarter considered [the chosen] 5% appropriate.”

At press time, the markets were also waiting to see what a third index provider, MSCI, will do. It took feedback until the end of August on proposed new rules that would exclude non-voting shares from its GIMI and U.S. Equity Indexes in cases when company-level “voting power” of listed shares (voting rights of listed shares vs. total voting rights of the company) is less than 25%.

The worst-case scenario from a public markets perspective, according to some observers, is that these measures will encourage companies to turn to private equity for funding. Given that the overall number of IPOs and publicly listed companies is already in decline, anything that exacerbates these trends would be a concern. “While the index providers are taking different approaches… the impact in each case will likely deny eligibility to fairly common high-vote/low-vote structures that have met widespread market acceptance,” Joseph Hall and Michael Kaplan, partners at Davis Ward & Polk LLP in New York, wrote in an August post on the Harvard Law School corporate governance forum. These moves, they added, “also seem likely to reduce opportunities for retail investors to access mutual funds that reflect the broader U.S. market—in particular depriving them of investment exposure to some of the most innovative companies in the U.S. economy.”

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