Snap IPO igniting furor; institutions not pleased

The absence of shareholder voting rights in Snap Inc.'s recent IPO has large institutional investors and asset managers gearing up for a battle they hope will prevent a war from erupting among future corporate issuers.

“There is a line in the sand, and Snap crossed it. We don't want Snap to set a precedent,” said Aeisha Mastagni, portfolio manager with the $196.4 billion California State Teachers' Retirement System, West Sacramento. Anne Sheehan, CalSTRS' director of corporate governance, said that while CalSTRS and other large investors have been critical of dual-class shares elsewhere, the Snap IPO was the “spark that raised the discussion to a new level.”

The $3.4 billion March 2 initial public offering for the parent company of Snapchat — the disappearing photo, video and messaging app — made it the first U.S. company in recent history to go public with non-voting shares, with its two young co-founders retaining more than 90% of voting power.

Leading the charge against trimming or eliminating public shareholder voting rights is the Washington-based Council of Institutional Investors, representing $3 trillion in combined assets and 120 members, including CalSTRS, the $311 billion California Public Employees' Retirement System and other large public pension funds, plus 50 money manager associate members that manage more than $20 trillion in assets.

In a Feb. 3 letter to Snap Inc. co-founder and Chairman Michael Lynton, CII Executive Director Ken Bertsch and 18 CII members acknowledged that in recent years, “some young companies with dynamic leadership and promising products, like Snap, have attracted capital on public markets” despite having dual-class structures.

“However, the performance record of dual-class companies is decidedly mixed in the long run and even in the medium term,” the CII letter said. “Some companies lacking effective accountability to owners do soar for a time, but others crash and burn, and still others pursue mistaken strategies for far too long.”

Mr. Lynton responded, saying the structure, “which prolongs our ability to remain a founder-led company, will maximize our ability to create stockholder value.” Much of the company's success so far, he argued, “is due to the founders' leadership, creative vision and management abilities,” and the board structure calls for a majority of independent directors. While the offering is now in a quiet period, Mr. Lynton promised to meet later with CII to discuss corporate governance and stockholder engagement.

Bottom reached?

Mr. Bertsch told the Securities and Exchange Commission investor advisory committee March 9 that its 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.” With Snap's New York Stock Exchange listing that came with no shareholder voting rights, “perhaps the bottom has been reached,” Mr. Bertsch said.

Voting rights are crucial for institutional investors relying on indexes, Rakhi Kumar, Boston-based managing director and head of ESG investments and asset stewardship for State Street Global Advisors, told the SEC group, “because your voice is only as loud as your controlling interest in a company. We do not hesitate to use our vote when engagement fails,” she said in the letter.

Anne Simpson, investment director, sustainability, at Sacramento-based CalPERS, was even more blunt at the SEC meeting. “Ceding power without accountability is very troubling. I think you have to relabel this junk equity. Buyer beware.” While large investors are up for innovation, “this is a rather immature attempt to avoid accountability,” she said.

With U.S. exchanges under intense competitive pressure from Singapore and Hong Kong, where exchange officials are considering allowing listing companies to offer common stock with unequal voting rights, CII and other institutional investors are not pinning much hope on U.S. exchanges addressing their concerns. Still, said CalSTRS' Ms. Sheehan: “It is certainly an avenue of oversight, and they can play a powerful role. They could do something.”

A 2012 request from CII for the NYSE and Nasdaq to refuse to listcompanies with multiple share classes and unequal voting rights went nowhere. But CII will try again this year for new standards, such as five-year sunset provisions. A new company's founders might argue that multiclass structures buy them time to create long-term value, but five years should be enough time before at least revisiting the unequal voting structure, Mr. Bertsch said. “Eventually, every company runs into problems, and there needs to be an effective mechanism of accountability to owners.”

Realistic regulation

Investors are also realistic about what the SEC can do. After the NYSE followed Nasdaq in relaxing its standards on dual-class shares in the 1980s, the SEC did try to limit multiclass structures with differential voting rights by issuing rules, but they were thrown out after a court challenge in 1990.

Mr. Bertsch urged the investor committee to work with the SEC to review the adequacy of exchange rules on voting rights. And investors found a sympathetic ear in SEC Commissioner Kara M. Stein, who told the advisory committee that “unequal voting rights present complex and new issues that need to be understood and addressed. We also must be mindful of the precedent being created.”

A more likely avenue for change is through the index providers, where institutional asset owners and managers figure prominently. They have asked firms like MSCI Inc. and S&P Dow Jones Indices to exclude Snap and any future issuers that come without voting rights, and index officials say they are considering the request. S&P Dow Jones Indices will study the issue while seeing if Snap meets other requirements on market capitalization and profitability

Sebastien Lieblich, head of index management research for MSCI in Geneva, said unequal voting rights have been a topic of discussion for the past 10 years, and “Snap is just one of those cases which puts the spotlight on this issue.” MSCI recognized that March 2 when, while announcing Snap's qualification for early inclusion in both the MSCI USA index and the MSCI U.S. equity indexes by virtue of meeting market capitalization standards, it also asked investors worldwide to submit feedback on whether companies with non-voting shares should continue to be eligible for MSCI indexes.

“We have reopened the debate by asking market participants whether or not truly we should be changing our criteria. If the answer is yes, then the next step is for us to propose something,” said Mr. Lieblich, who expects further action in the coming weeks. “You need to strike while the iron is hot. We are committed to making a decision.”

CII also plans to reach out to officials at index providers FTSE Russell.

“This issue has never been laid on the door of the (indexers) before, especially (exchange-traded funds). Those big investors have a lot of leverage because they are their biggest client,” said Patrick McGurn, special counsel and the head of strategic research and analysis at Institutional Shareholder Services Inc., a Washington corporate governance and proxy advisory firm. He noted that as money managers join the battle, “for the first time a broad coalition of interest is emerging. It's an evolving process right now. Institutional investors clearly see it as a basic threat to their franchise.”

Unequal voting rights

Another idea being floated is creating a new index that excludes companies with unequal voting rights “so these companies have a way of measuring themselves against other companies,” said Jim Allen, head of Americas capital markets policy for the CFA Institute, Charlottesville, Va. Mr. Allen sees a role for Congress and states where new companies are incorporated. “Investors want to be able to participate in the hot new IPOs.

Investors will also be keeping a sharp eye on performance. An upcoming CII study of 1,763 U.S. firms in the Russell 3000 index from 2007 through 2015 found that multiclass structures have no impact on return of invested capital. And an ISS/Investor Responsibility Research Center Institute study of controlled companies in the S&P 1500 also showed no outperformance and many failures.

As Ms. Sheehan of CalSTRS put it: “By using all these avenues, we are sending a message that this is not acceptable behavior.”