U.S. – SEC Dual-Class Shares & Governance

U.S. – SEC Dual-Class Shares & Governance

On 15 October 2019, SEC spoke on problem of dual-class shares, and solutions.

  • Speech by SEC's Rick Fleming, titled dual-class shares: a recipe for disaster.

Dual Class Shares Justification

  • Particular technology companies have founders so visionary and charismatic that the companies could not be as successful without them, and they need to steer the ship.
  • Lack of voting rights for public shareholders is good, as it allows these founders to guard against activists demanding short-term profits at expense of long-term growth.
  • Dual-class shares give public an opportunity to participate in the company’s growth.

Entrenched Management

  • A few very well-known companies have thrived with long-term founders at helm.
  • But entrenched management produces lower returns for investors over the long-term.
  • Dual-class structures tend to under-perform companies with dispersed voting power.

Negative Effects

  • Without an appropriate level of accountability to shareholders created by dual-class, investors will be hurt, and badly, beyond lower profitability; other negative effects.
  • Including management self-dealing and treating company like a personal piggy bank.
  • Outsized optimism and over-estimation of the skills needed for long-term success.
  • Insular group-think, in which the founder surrounds himself with unqualified yes-men.
  • Poor accounting controls; taking eye off ball, burning cash by investing in ancillary.
  • Abusive working conditions, including discriminatory practices and harassment.

Weak Corporate Governance

  • Investors, particularly late-stage venture capital investors with deep pockets, been willing to pay astronomical sums while ceding massive amounts of control to founders.
  • Effect is other investors must agree to terms that were once unthinkable, including low-vote or no-vote shares; the result companies with weak corporate governance.
  • Hopeful recent events with founder-controlled companies will serve as wake-up call.
  • And investors will do more to push back against the trend toward weak governance.

Role of Regulators, Exchanges

  • Policymakers should not be content to let the market fix itself, as stakes are too high.
  • Cannot expect this problem to be solved by investors acting for the common good.
  • SEC tried to ban creation of super-voting share classes, but defeated in court.
  • Still SEC can enhance disclosure of heightened risks associated with dual-class shares.
  • Stock exchanges not prevented from addressing issue, except their IPO listing profits.
  • But exchanges are self-regulatory organizations, and such act as guardians of market.

Compromise Solution

  • Several organizations have offered compromise solution for the exchanges to consider.
  • Sun-setting of super-voting rights, which would protect a visionary founder from activist investors for a reasonable length of time while preventing long-term harms.
  • Urged exchanges to quickly adopt these types of reforms to promote fair markets.