Less than a week after the FTSE Russell index announced plans to exclude Snap Inc. and other companies that offer virtually non-existent voting rights to public shareholders, the S&P Dow Jones went a step (or several) further with a ban on multi-class share structures for new entrants to several of its flagship indices, including the S&P 500.
The changes at both indices follow consultations held in response to Snap’s controversial plan to issue fully non-voting shares under its initial public offering – and to the wider trend of voting structures that insulate founders and disenfranchise independent shareholders. MSCI is similarly undertaking a consultation on the subject, to be completed later this summer.
As many institutional investors shift towards more passive investment strategies and don’t necessarily have the same level of flexibility to dispose of shares in the open market, there is a greater emphasis than ever before on proxy voting and proactive engagements with investee companies. By diluting or removing the vote itself, and in turn the leverage to push for change through engagement, multi-class structures and non-voting stock represent a serious threat to the rights of investors who can’t simply sell due to indexing.
In requiring that a minimum 5% of voting rights be held in free-float, Russell’s proposal cuts off the thin end of the wedge, but still allows for highly disproportionate voting structures. By contrast, the S&P ban represents a monumental shift in policy that will go much further than just excluding worst-case offenders like Snap. While existing S&P constituents will be exempted from the new requirements, newcomers will either have to phase-out their multi-class structures or risk exclusion from indices. By extension, these newcomers may also be excluded from trillions of dollars of capital passively tracking these indices. The level of uncertainty associated with these changes may well send pre-IPO companies that had hoped to implement similar voting structures back to the drawing board.
It’s worth noting that two-thirds of the participants in Russell’s consultation supported a minimum free-float threshold – and a majority of those favored setting that threshold higher, at 25%, potentially excluding household names like Alphabet and Facebook. By contrast, less than a quarter considered 5% appropriate. The threshold is subject to annual review and, in light of investor sentiment and the S&P’s bold move, it will be interesting to see if Russell bumps it up in future.
Snap is only one of the latest examples of a broader trend. Many of both the S&P 500 and Russell indices’ most prominent constituents, including Alphabet, Facebook, Berkshire Hathaway, Ford, Visa, Viacom and CBS, already have multi-class voting structures in place that effectively allow founders to retain control of their companies, without having to retain majority ownership of the company’s equity capital. Moreover, recent years have seen a cascade of aggressive attempts by founders to consolidate their positions, arguably starting back in 2012 when Google (now Alphabet) redrew its existing multi-class structure back to ensure its founders retained majority control. Since then, Facebook embarked on a similar plan to create non-voting shares which, if implemented, will preserve Mark Zuckerberg’s control over the company for many years to come. Non-voting shares are also used by Visa and CBS, to name a few, and were included in the recent IPO of Blue Apron Holdings Inc.
The allure for founders is unmistakable: keep control of the company even as public offerings, share disposals and corporate transactions dilute your economic stake. On the investor side, the threat is just as clear – and has prompted action. Alphabet’s founders got to redraw their voting structure and maintain their control, but the plan cost the company more than half a billion dollars in legal settlements. Now, Facebook’s move is similarly stuck in legal limbo, and in June legal pressure from CalPERS led IAC/InterActiveCorp to abandon plans to implement a new class of non-voting shares.
Perhaps Snap’s IPO was the next logical step for founders seeking to retain control of their companies indefinitely. Preferential voting rights can be susceptible to dilution over time and efforts to re-consolidate control after a company has already been taken public are clearly problematic, so why not just eliminate voting rights altogether from the beginning? Whatever the rationale, it’s clear that Snap’s voting structure was a bridge too far.