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Governance

Investors intensify fight against dual-class shares

Institutions pushing ahead on several fronts to encourage one share, one vote structure

CFA Institute’s Jim Allen

Institutional shareholders are considering all possible options in an increasingly active campaign to discourage companies from adopting dual-class share structures, from one-on-one engagement to a longer-term push to give regulators more power to curb them.

"It all starts with one share, one vote. If shareholders don't have that, it's hard for them to push for improved governance and performance," said Jim Allen, head of Americas capital markets policy at CFA Institute in Washington. Newly launched companies "are leaving money on the table" if lower governance standards translate into lower multiples. "That's money you'll never have to invest, and you are starting out at a disadvantage. When you mess with the governance, investors are going to notice."

Particularly for founders of new companies, choosing a share structure can seem like a choice between offering a single class of common stock, with directors chosen by the most active investors, or dual-class share, which gives them more control over the company's goals and operations.

Dual-class shares have become an almost-daily topic for investors and asset managers, spurred by recent initial public offering announcements from technology companies such as Lyft Inc. and the expectation of others later this year including Uber Technologies Inc., Pinterest Inc., Airbnb Inc., Slack Technologies Inc., and The We Co. And it's not only technology companies. Levi Strauss & Co. announced that its re-entry to public markets, set to begin March 28, under a 10-to-1 voting structure will keep control in family hands, not public shareholders.

For some investors, that means engaging those companies one by one. A group of institutional investors with $3.2 trillion in assets told ride-hailing company Lyft in a March 14 letter that its plan to give two founders 20 votes per share for every publicly held share, amounting to more than 60% of voting power, "imposes a significant gap between those who exercise control over the company and those who have significant exposure to the consequences of that control." Trading for Lyft is scheduled to begin March 29.

Those investors include the $17 billion Los Angeles City Employees' Retirement System; the $93.9 billion Ohio Public Employees Retirement System, Columbus; New York state Comptroller Thomas DiNapoli and New York City Comptroller Scott Stringer; Chicago Treasurer Kurt A. Summers Jr.; International Brotherhood of Teamsters; Hermes Equity Ownership Services; Legal & General Investment Management America; BNP Paribas Asset Management; the U.K.'s Local Authority Pension Fund Forum; and CtW Investment Group, whose members are pension funds sponsored by unions affiliated with Change to Win. Messrs. DiNapoli and Stringer are the sole fiduciaries of the $197.3 billion New York State Common Retirement Fund, Albany, and $186.3 billion New York City Retirement Systems.

Activist investors like CtW vow to fight to end dual-class shares altogether, while others, led by the Council of Institutional Investors in Washington, are hoping to persuade new companies to at least have sunset provisions on the share structure, preferably no longer than seven years. That gives the founders some time to grow their company, said CII Executive Director Ken Bertsch.

Feeling the pressure

Exchanges are also feeling the pressure from investors.

In November, CII filed petitions with the New York Stock Exchange and Nasdaq Inc. calling on them to limit listings of companies with dual-class share structures. The move was supported by many asset managers including BlackRock (BLK) Inc. (BLK) and T. Rowe Price Group Inc., which are also speaking up individually.

So far, exchanges have said little. Responding to the CII petition, Nelson Griggs, Nasdaq Stock Exchange president and executive vice president of corporate services, said that flexibility of share structure was necessary to provide all investors access to growth companies, but pledged to review listing standards to make sure they protect investors.

Kurt Schacht, New York-based managing director of the CFA Institute's Standards and Financial Market Integrity division, is not expecting much from exchanges. "The CFA Institute has been advocating globally to stop this practice, but it prevails due to the commercial interests of the exchanges and entrepreneurial managers that want your money but not your input as a shareholder. Given subscription rates for these IPOs, there's apparently no shortage of flip-or-flop speculation that passes for investment. The goal of more long-term capital formation and shareholder rights is now an afterthought in the IPO debate," Mr. Schacht said.

Members of the Securities and Exchange Commission's Investor Advisory Committee urged the regulator a year ago to require more disclosure from companies with dual-class shares, but they are not holding their breath, particularly after comments by SEC Chairman Jay Clayton that he was "not persuaded by absolutists on either end" of the issue.

On the sidelines

The SEC has been on the sidelines of this debate since 1990, when the U.S. Court of Appeals for the District of Columbia Circuit ruled that the agency exceeded its authority when it tried to bar national securities exchanges and self-regulatory organizations from listing stock that restricted or reduced per share voting rights. Mr. Clayton has also expressed disdain for the strategy of pressuring indexes to exclude companies from indexes, a practice he called "governance by indexation" at a CII conference in March 2018.

The tactic has had mixed results. MSCI Inc. decided not to eliminate companies with unequal voting structures from global equity indexes after pressure from investors, while competitors FTSE Russell and S&P Dow Jones Indices limited certain listings, including in the S&P 500 index. S&P limited the access of multiclass companies to their benchmark equity indexes, and FTSE Russell requires companies to offer non-restricted shareholders at least 5% voting rights to be included in its main indexes.

That approach also doesn't sit well with SEC Commissioner Robert J. Jackson Jr., who thinks investors will be hurt if high-performing dual-class companies are removed from indexes, and he doesn't see stock index providers going along. "They have no incentive to do it. The question is whether someone else should do it," Mr. Jackson said at a University of Delaware corporate governance symposium on March 20.

One tactic that Mr. Jackson urges investors to consider is taking the fight to the states, particularly Delaware, where many U.S. companies are registered and therefore subject to state law, which tends to favor shareholder rights.

Other critics are starting to lay the groundwork for Congress to overturn the appeals court decision that clipped the SEC's authority, an effort that could take years.

Corporate board members may also feel the pressure from asset owners and asset managers. Dayna Harris, a Pasadena, Calif.-based partner with corporate governance consultancy Farient Advisors LLC, said that board members are becoming more responsive on governance issues like executive pay and board diversity, and the increasing sensitivity of dual-class shares could become another concern. Unequal voting rights "takes away what governance is all about, which is to be responsive to investors. It's just not the right answer for the long run, for a company that's relying on public money," she said.

CII's Mr. Bertsch agrees that more questions should be raised to the board because "they are legally responsible at the end of the day."

Another tactic is to make it a matter of policy for asset owners, said CII Chairman Ash Williams, executive director and chief investment officer of the Florida State Board of Administration in Tallahassee, which oversees a total of $204.3 billion. The board just modified its corporate governance principles and proxy-voting guidelines so it can now track voting results by share class, wherever dual-class structures exist.

"You do all of the above," Mr. Williams said.