SEC Challenges Dual-Class StructuresMarch 2018
On March 8, 2017, the Investor Advisory Committee (the “Committee”) of the Securities and Exchange Commission (“SEC”) approved a recommendation of the Investor as Owner Subcommittee (the “Subcommittee”), which called on the SEC’s Division of Corporation Finance (“CorpFin”) to scrutinize registration statements and other SEC filings of companies with “dual-class and other entrenching governance structures” and provide comments on those SEC filings that focus on enhancing the disclosure related to dual-class structures.
Dual-class share structures involve companies that have two or more classes of authorized common stock: one class having one vote per share (or no vote), and another class having multiple votes per share. These dual-class structures allow a company to concentrate voting power in the hands of insiders, giving them greater control over the management of the company while maintaining limited ownership exposure and accountability—often, under the radar of non-affiliate shareholders.
The controversy over dual-class shares is not a new one. From the 1920s through the 1980s, the New York Stock Exchange did not list companies with dual-class structures. When the New York Stock Exchange relaxed its own prohibitions, the SEC sought to implement Rule 19c-4 under the Securities Exchange Act of 1934, which prohibited self-regulatory organizations from listing and trading the stocks of any company that had a dual-class structure, a move which was ruled by United States Court of Appeals for the District of Columbia Circuit as exceeding the SEC’s authority. As of late, three stock index compilers have moved to exclude or limit dual-class companies from significant stock indices. While dual-class structures were traditionally employed by family-run companies, recently, the dual-class structure has become popular among technology companies—Google, Facebook, Snap, LinkedIn, Groupon and Yelp all adopted the dual-class structure for their initial public offerings.
Currently, companies that file with the SEC are not required to provide quantitative disclosure that illustrates the distinction between ownership and control, making it difficult for investors to identify the size of the gap between ownership of shares and voting rights. Further, companies with dual-class structures often do not provide robust risk factor disclosure to clearly outline the potential risks to which non-affiliate shareholders are exposed.
In addition to recommending that CorpFin scrutinize filings of companies with dual-class structures, the Subcommittee recommended that CorpFin adopt disclosure requirements for companies with these structures to provide better transparency to shareholders. These disclosure recommendations include that CorpFin:
- define “common stock” for securities law disclosure purposes to restrict its usage to shares that have traditional one share, one vote governance rights;
- require companies with dual-class structures to disclose the quantitative relationship between the amount of common equity economic ownership interest held by any person entitled to control or direct the voting of 5% or more of shares entitled to vote in director elections and the amount of voting rights held or controlled by such shareholder;
- enhance risk factor disclosure requirements to include disclosure relating to: (a) the ability of shareholders with greater voting rights to approve governance changes that further increase the disparity between the ownership interests and voting rights, (b) the exclusion or limitations of dual-class shares in indices, and (c) delisting by stock exchanges of dual-class shares if control persons exercise voting rights they have under state or other organizational law to increase or decrease their relative voting power; and
- for issuers of non-voting stock, add disclosure requirements to Form 10-K to provide all information equivalent to the information ordinarily included in a Schedule 14A.
The Subcommittee also proposed that CorpFin develop guidance to address issues that dual-class structures raise and monitor shareholder disputes to determine whether additional disclosure requirements related to the disputed issues should be required.
Companies with dual-class shares should expect that the SEC will be focused on these structures in its next review of their filings. Companies should review risk factor disclosure to determine if the unique risks arising out of dual-class structures are adequately addressed. In addition, companies would be well advised to consider ways to enhance transparency around disclosure on these nontraditional structures so as to reduce SEC scrutiny and comment.
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