Securities Regulation and Corporate Governance

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Securities Regulation and Corporate Governance > Posts > Non-Voting Shares Make Their Public Debut and Generate Some Governance Concerns, but How Will Courts View the Structure When First Presented?
Non-Voting Shares Make Their Public Debut and Generate Some Governance Concerns, but How Will Courts View the Structure When First Presented?

On March 1, 2017, Snap Inc. (“Snap” or the “Company”) – owner of the popular social media platform Snapchat – priced its highly anticipated initial public offering (“IPO”). With 200 million shares sold at $17 per share, the IPO raised approximately $3.4 billion for the Company. On their first trading day, Snap shares opened at $22.41 per share and peaked as high as $28.84 the following day. As of March 10, shares closed at $22.07, above its initial offering price, but below its opening trading price. As the largest IPO of any U.S.-based company since Facebook’s public offering in 2012, many investors’ primary focus here has been on the complete lack of voting privileges associated with the shares sold in the IPO. 

As described in Snap’s IPO prospectus, the Company has three classes of shares: Class A common stock, the publicly traded shares; Class B common stock, reserved for early investors and executives; and Class C common stock, owned solely by the company’s co-founders Evan Spiegel and Bobby Murphy. Class A shares are not entitled to vote, while Class B and Class C shares are each entitled to one and ten votes, respectively, and vote together as a single class. Given this structure, even before shares were sold in the IPO, 88.5 percent of the voting power of the Company remained concentrated in its two founders. Furthermore, Class B shares lose voting privileges when sold or transferred, and Spiegel’s and Murphy’s control of the Company through their Class C shares will not diminish even if either or both leave Snap.

Attempting to preserve control through non-traditional voting structures is not a new concept for companies, especially technology companies. Many technology companies have dual class structures, in which founders and other early-round investors hold higher vote shares (typically ten votes per share) and others hold low vote shares (typically one vote per share).  In the last several years, a number of companies including Alphabet, Google’s parent company, Facebook, Zillow and Under Armour have introduced non-voting shares into their capital structures in order to delay the loss of voting control of their founder(s). Snap, however, is the first to issue only non-voting shares to the public in an IPO.

There has been a fair amount of criticism of Snap’s move to publicly offer shares that do not include voting rights. Kurt Schacht, the Chair of the Securities and Exchange Commission’s Investor Advisory Committee, described the structure as “a significant concern” and a “troubling development from the perspective of investor protection and corporate governance” if it were to spur a new trend for tech companies going public. Just prior to Snap’s IPO, top fund managers including BlackRock, Vanguard, and T. Rowe Price urged companies to allocate voting rights to shareholders “in proportion to their economic interest.” The Council of Institutional Investors (“CII”) sent a letter to Snap urging its board to adopt a single-class voting structure and is now leading an initiative to exclude Snap (and any other company that sells non-voting shares to investors) from market indices managed by S&P, Dow Jones and MSCI Inc.  In a March 9, 2017 CII Governance Alert, CII noted that it “also plans to renew its 2012 request to the NYSE and Nasdaq to bar listings of companies with multiple share classes with unequal voting rights. At a minimum . . . the exchanges should set standards for regulating dual-class companies, such as reasonable sunset provisions for multiple share classes.”

SEC Commissioner Kara Stein, a Democrat, said that regulators need to “critically assess” the IPO regime following the Snap IPO, noting that “[t]he current structure is premised on taking investor capital while giving that investor the rights that help hold a company’s management accountable [for] the use of the capital.”  How the SEC will proceed going forward will depend largely on the views of Jay Clayton, President Trump’s appointee to head the Commission. His views on this issue may become public during his confirmation hearings before the Senate Banking Committee, currently scheduled for March 23.

Absent, however, from the current discussion regarding the corporate governance issues raised by Snap’s capital structure is the potential impact of non-voting shares on future transactions and the judicial scrutiny that may follow.  Snap’s non-voting shares draw into question situations where a shareholder vote may be necessary.  The NYSE, NASDAQ, and other self-regulating organizations have rules requiring the submission of certain transactions to a shareholder vote, such as a change of control transactions or certain issuances of more than 19.9 percent of the Company’s outstanding shares. With most shareholders lacking any voting rights altogether, how Snap and other companies that may follow in their wake can cleanse such transactions via disinterested shareholder approval remains an open question.

Additionally, when reviewing disputed business transactions in the context of damages, courts will generally apply one of two basic standards of review:  business judgment or entire fairness. The well-known business judgment rule typically applies to arms’-length transactions, creates a rebuttable presumption in favor of the corporation and protects directors from after-the-fact second-guessing in litigation proceedings. Entire fairness, on the other hand, may apply to those transactions involving interested directors, officers, or controlling shareholders. The standard is more exacting in that it places the burden on the corporation to show that a challenged transaction is entirely fair to its shareholders both in terms of process and price.  Enhanced scrutiny may also apply in the context of an injunction, if shareholders seek to prevent consummation of a transaction. 

In its IPO prospectus, Snap explained that its co-founders Spiegel and Murphy “have the ability to control the outcome of all matters submitted to our shareholders for approval, including the election, removal, and replacement of directors and any merger, consolidation, or sale of all or substantially all of our assets” – the very transactions that will often trigger litigation where the courts must determine the appropriate standard of review.  While the presence of non-voting shares does not itself preclude a review under the business judgment standard, it seems one practical effect of Snap’s voting structure is that it may serve to hamper the company’s ability to seek shareholder ratification from disinterested shareholders or other procedural safeguards (e.g., obtaining a “sterilized vote” – from a majority-of-the-minority) that could otherwise help shield the directors’ actions from heightened judicial scrutiny.

This rather novel structure incorporating non-voting stock in an IPO will certainly raise some interesting issues for the courts to consider (when first presented), and it's only a matter of time before that happens!

Thanks to Sean Sullivan and Alon Sachar, corporate associates in Gibson Dunn's San Francisco office, for all their hard work and effort in drafting this blog. 


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