Multiple class share structures have come under increasing scrutiny since Snap Inc. (“Snap”) offered exclusively non-voting shares in its March 1, 2017, initial public offering (“IPO”). Companies employing the multiple-class structure argue that the structure contributes to corporate stability and long-term returns for shareholders, and aides in the revival of the sluggish IPO market by helping issuers overcome a reluctance to go public in the face of activist investors. However, citing corporate governance concerns and following considerable pressure and lobbying from institutional investors, both the FTSE Russell and Standard & Poor (“S&P”) Dow Jones have recently taken measures that may be seen as discouraging the practice.
On July 27, FTSE Russell said that it was “draw[ing] a principled line in the sand” by barring the inclusion of companies in its indices unless over 5% of their voting rights are in the hands of public–“unrestricted”–shareholders. The application of this rule with respect to Snap, whose public shareholders exclusively hold non-voting shares, is clear. But many companies employ multiple class voting structures in which founders and other early-round investors hold higher vote shares and others, often public shareholders, hold lower vote shares, typically in a 10 to 1 ratio. Prior to announcing its new rule, FTSE Russell conducted a study and found that 37 companies already listed in its indices fail to meet the new 5% threshold given these high/low vote share structures or other structures similarly reducing public shareholder voting power. Those companies, which include Hyatt Hotels Corp. and Dell Technologies, will have until September 2022 to conform their capital structures or be removed from these indices. The final rule will be published on August 25, 2017, though some are already speculating that the 5% threshold may increase when the FTSE Russell conducts its intended annual reviews of the rule. Indeed, the Council of Institutional Investors (“CII”) initially recommended that the FTSE Russell set the threshold at 25% and CII and others are likely to continue pressing for an increase in the FTSE’s contemplated 5% threshold.
The S&P Dow Jones went a step further than FTSE Russell when, on July 31, it categorically barred companies with “multiple share class structures” from its S&P 500, S&P MidCap 400 and S&P SmallCap 600 indices, effective immediately. Unlike the FTSE Russell’s move, the S&P Dow Jones rule will not apply retroactively, and accordingly, companies that are currently listed with multiple classes of shares can remain on these indices.
One uncertainty with the S&P Dow Jones move involves companies with “up-C” structures in which an existing limited liability company or other partnership form (“LLC”) undertakes an IPO through a newly formed holding company that owns interests in the LLC. These structures may be covered by the new S&P Dow Jones rule because public shareholders in up-C structures have voting and economic rights in the holding company, whereas pre-IPO shareholders have voting rights in the holding company and economic rights in the LLC. Even if these different classes of stock have equal voting rights in the holding company, it remains to be seen whether the S&P Dow Jones will view up-C structures has having “multiple share class structures,” which would preclude up-C structured IPO companies from being included in the S&P indices.
Public companies and companies considering or preparing for an IPO should carefully consider these rule changes and monitor developments as the application of these rules is further clarified.
Thanks to Sean Sullivan and Alon Sachar in San Francisco for their contributions in this post.