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Oct 23, 2019

SEC investor advocate seeks action on dual-class shares

CII has also called for rule changes curbing the structures

SEC investor advocate Rick Fleming has urged the commission and US exchanges to take action against dual-class share structures.

Speaking at an International Corporate Governance Network event in Miami recently, Fleming noted that SEC efforts to essentially ban the creation of super-voting share classes had been thwarted in court some years ago. ‘[B]ut there is still a lot the SEC can do,’ he said. ‘For example, the SEC’s investor advisory committee, on which I serve, has recommended that the commission enhance the disclosure of the many heightened risks associated with dual-class shares.’

He also urged the exchanges to ‘step up and reassert their role as self-regulatory organizations. They have an important role to play as guardians of market integrity.’ Specifically, he encouraged the exchanges to adopt changes such as sunsets of dual-class share structures.

Fleming outlined his concerns about such structures, under which company founders can exert outsize control over companies after they go public. He pointed to what he called a growing body of research suggesting that the entrenchment of company founders produces lower returns for investors in the long term. ‘Specifically, companies with dual-class structures tend to underperform companies with dispersed voting power,’ he told attendees.

He then outlined what he described as potential problems arising from ‘unchecked corporate control,’ such as self-dealing, insular group think, poor accounting controls and poor working conditions.

‘Granted, things can go well for a few years before these symptoms begin to appear,’ he conceded. ‘Indeed, it is quite possible that underlying issues may not be apparent until or even after a company launches its IPO. But founders are subject to human nature, just like the rest of us, and there is little doubt in my mind that we will see some really bad outcomes in the future.’

Fleming also urged his audience to acknowledge that ‘[i]nvestors, and particularly late-stage venture capital investors with deep pockets, have been willing to pay astronomical sums while ceding astonishing amounts of control to founders. This means other investors, in order to deploy their own capital, must agree to terms that were once unthinkable, including low-vote or no-vote shares. The end result is a wave of companies with weak corporate governance.’

He added that investors accepting weak corporate governance in the belief they can exit before disaster strikes are just handing down the damage to other investors and eventually harming the marketplace. Rather, he hoped investors will do more to resist what he termed the trend toward weak corporate governance.

‘However, I believe this is an area where policymakers should not be content to let the market fix itself,’ Fleming argued. ‘The stakes are far too high, and the issue presents a classic collective action problem… We cannot really expect this problem to be solved by investors acting for the common good when it goes against their individual interests, so regulators need to help us achieve the common good.’

The Council of Institutional Investors (CII) is also concerned about dual-class voting structures. It wrote to the SEC earlier this month asking the commission to seek the authority that would enable it to, in effect, require companies to limit the length of time company founders can retain super-voting rights after they go public.

CII last October submitted listing-standard petitions to the US stock exchanges asking them to propose rules that would require newly listed companies that choose dual-class voting structures to adopt a sunset provision that goes into effect within seven years of an IPO.

‘We understand that some believe the commission may not currently have the statutory authority to require the US stock exchanges to adopt CII’s petitions,’ wrote CII general counsel Jeffrey Mahoney. ‘We, therefore, would respectfully recommend that the commission request that the US Congress amend the federal securities laws to explicitly permit the SEC to adopt rules requiring the US stock exchanges to revise their listing standards generally consistent with our petitions.’

A Nasdaq spokesperson said in a statement last week on CII’s letter: ‘Nasdaq is a firm believer in the flexibility of share structure, in order to provide all investors access to growth companies. That said, we consider the input of all stakeholders when establishing and modifying listing standards and have an independent body that includes investor representation, which makes recommendations to our board about changes to those standards.

‘We will continue to review our listing standards to make sure they protect investors, while also allowing those investors access to innovative companies.’

Also commenting on the CII letter, an NYSE spokesperson said in a statement last week: ‘Investors should have access to the broadest opportunity set possible and the freedom to make their own investment decisions. Denying companies the ability to access the public markets with flexibility in governance structures will lead to more companies choosing to stay private.’

Ben Maiden

Ben Maiden is the editor-at-large of Governance Intelligence, an IR Media publication, having joined the company in December 2016. He is based in New York. Ben was previously managing editor of Compliance Reporter, covering regulatory and compliance...