Snap’s nonvoting stock — everything sold in the IPO — is junk, investor says

Los Angeles technology company Snap Inc.’s historic decision to go public last week with an issuance of only nonvoting shares sets a damaging precedent for the stock market, leading investors warned Thursday.

The comments came as a government advisory group comprised of investor advocates began weighing whether to urge regulators to ban public companies from significantly curbing the power of certain shareholders.

Traditionally, most companies offer investors a vote for every share they own — aligning control with economic interest. But the technology industry in recent years has split apart one from the other. Snap, the developer of the messaging and entertainment app Snapchat, took it furthest in a $3.9-billion IPO, giving zero control to all but its pre-IPO investors and employees. And an outsized amount of power is held by co-founders Evan Spiegel and Bobby Murphy.

People in the world of finance are worried that issuing such dual-class shares “might be the next big thing,” Kurt Schacht, who chairs the Securities and Exchange Commission’s investor advisory committee, told his fellow members.

The group didn’t reach a conclusion Thursday, setting up deeper discussion in a later subcommittee hearing.

Investors say their input leads to better-run and more resilient companies. For instance, a clear seat at the table allows them to show executives personal shortcomings they might not see themselves. Votes offer a weapon to ensure follow-through.

The system has led “to the vitality of American capitalism … even when egos are bruised, strategies are upended and executives” get booted, said Ken Bertsch, executive director at the Council of Institutional Investors.

Boardrooms have become more diverse, executive pay has been ratcheted down and companies operate more efficiently than ever because of investor demands, said University of Pennsylvania law professor Jill Fisch. They’ve done it by suing, calling meetings and setting agendas.

“This is shareholders using their voting power, their voice to achieve a wide variety of social goals, and dual-class shares obviously insulates companies” from such actions, she said.

The investor experts put the blame on stock exchanges that, to drum up business, allow companies to sell nonvoting stock.

David Berger, a partner at the Silicon Valley law firm Wilson Sonsini Goodrich & Rosati, said the development stems instead from too many debates in boardrooms ending with what’s best for shareholders as opposed to what’s best for other stakeholders, including employees, customers and the communities in which the firms operate. That becomes a problem because most shareholders are driven by short-term monetary goals, which discourages companies from spending on longer-term strategies or keeping several interests in mind. It’s a sentiment echoed by Snap Chairman Michael Lynton.

Snap has refrained from commenting on the issue, citing a quiet period tied to the IPO.

Berger said the disconnect has contributed to a slowdown in initial public offerings and forced those that do go public to get creative.

“Some of the most innovative companies in the country will continue to develop novel solutions to solve this governance misalignment,” Berger said. He cautioned that nonvoting stock would remain rare compared with structures in which top executives consolidate power by holding several votes per share.

To Anne Simpson, an investment director at the California Public Employees’ Retirement System, there’s no innovation in the nonvoting structure.

“You’re constraining the capital markets in a way you’ll come back to regret. Innovation, we’re interested in that, but this is an immature attempt to avoid accountability,” she said.

Simpson said shares without votes in a company controlled by just two men should be labeled as “junk equity.”

Should the Securities and Exchange Commission not act on the issue, investors have other options. They’re urging stock market indices such as the S&P 500 to not include companies such as Snap, which would mean millions of investors whose holdings track the indices wouldn’t be forced to buy no-vote shares.

Companies with disproportionate voting power represent about 12% of the S&P 500, said Rakhi Kumar, a managing director at State Street Global Advisors, the world’s third largest fund manager.

Bertsch of the investor council said he also would ask companies to make nonvoting shares temporary. He noted that Snap’s Spiegel told the Los Angeles Times last week that it would take five years to educate investors about Snap’s business objectives. If so, then-educated investors should get a vote after those five years, Bertsch said.

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