Snap Inc., which debuted on the New York Stock Exchange (NYSE) on March 2nd, was the largest tech IPO since Alibaba went public in 2014.  Initially priced at $17 per share, the share price jumped to more than $24 by the end of the first trading day, raising $3.4 billion and beating market expectations.

Beyond the magnitude of the offering and its implications for the broader deal pipeline, Snap’s IPO has raised interesting governance issues around its non-voting shares, which the SEC’s Investor Advisory Committee (IAC)[1] tackled on March 9th at its quarterly meeting.  The IAC’s discussion centered on Snap’s three-tiered capital structure: Class C shares with 10 votes per share for founders Evan Spiegel and Bobby Murphy, Class B shares with one vote per share for pre-IPO VC investors and other insiders, and Class A shares with no voting rights for public investors. Companies like Facebook and Google have employed similar structures in the past; in fact, a recent study by Institutional Shareholder Services (ISS) noted that dual- and multi-class capital configurations are common, especially in the technology sector.[2]  However, the notion of affording no voting rights whatsoever to public investors is unprecedented.

SNAP RAISES CONCERNS FROM INVESTOR GROUPS AROUND GOVERNANCE CONTROLS

Some have expressed concern that the issuance of no-vote shares weakens corporate governance controls. The same ISS study referenced above found that “controlled companies” – those with multi-class or unequal voting rights like Snap – tend to underperform relative to their non-controlled peers in several key areas of assessment including shareholder returns, revenue growth, and return on equity.  The most critical investors’ rights advocates argue that Snap’s no-vote share class will be disastrous for the company’s shareholders who will be left without a say while Snap is given the go-ahead to operate as a public company without being subject to traditional public company voting and disclosure requirements.[3]

Others who were not on the IAC’s meeting agenda are less fatalistic in their assessment of Snap’s potential impact on shareholder rights. Looking at industry trends, some of the most successful public technology companies have concentrated voting power among the company’s founders, and shareholders appear to have benefitted (or at least not to have been disadvantaged) as a result.[4]  Facebook and Alphabet are prime examples.  Others maintain that Snap is an anomaly – as a tech “unicorn” (one of a select group of private ventures valued at more than $1 billion), Snap is able by virtue of its rarefied status to issue no-vote shares whereas smaller-cap or less prestigious companies likely could not.  As long as Snap continues to prosper, so will its Class A holders, even without a direct say in the company’s decision making.

SNAP’S DISCLOSURE OBLIGATIONS TO CLASS A HOLDERS

Beyond the general governance concerns, Snap’s IPO has also generated discussion around the company’s disclosure obligations. Are Snap’s no-vote shares entitled to the same degree of disclosure as voting shares?  Technically no, though Snap has indicated in its SEC filings that it intends to afford Class A holders the same degree of transparency as those with voting rights.[5]  According to Snap’s prospectus, the company plans to invite the Class A holders to attend the annual meeting and to submit questions to the management team.  Snap simultaneously acknowledges that its Class A shares are its only class of stock registered under Section 12 of the Exchange Act, and therefore Snap is not required to file a proxy statement unless a vote of Class A holders is required by applicable law.  The company promises, “[W]e will provide holders of our Class A common stock … any information that we provide generally to the holders of our Class B common stock and Class C common stock, including proxy statements, information statements, annual reports, and other information and reports.”[6]

Snap caveats that promise in several important ways. First, if the company doesn’t deliver proxy statements or information statements to Class B holders, then it will not do so to Class A holders – that goes without saying.  Second, Snap will be still obligated to comply with the ongoing periodic and current disclosure requirements of the Exchange Act, including Form 8-K, which may be filed up to four business days after a material event and which, by its nature, is less detailed and more open ended in terms of content requirements than a proxy statement.  This means that Snap’s disclosures on executive compensation and related matters may include less information than would otherwise be required by a proxy statement.  Lastly, because Snap is not bound by the proxy filing requirements, any filing the company does make may not contain all the information that would otherwise be required of a public company with voting shares.  Class A holders will essentially be reliant on the company’s annual, quarterly and current reports, without the ability to refer to proxy statements for information on, for example, its compliance with proxy access rules.  As a side note, Snap will not be required to comply with the Dodd-Frank Act’s “say-on-pay” and “say-on-frequency” rules, by virtue of its status – for now – as an emerging growth company under the JOBS Act.[7]

OBLIGATIONS OF NYSE AND OTHER NATIONAL EXCHANGES

Testifying before the IAC, Ken Bertsch of the Council of Institutional Investors (CII) questioned what Snap’s IPO means for institutional asset owners, which hold the majority of publicly traded securities in the U.S.[8]  He criticized the NYSE for being “asleep at the wheel” by allowing Snap to list a non-voting class of securities on the exchange, which he argued were more akin to preferred stock or derivatives.  Aside from Snap’s ability to trade on the NYSE, Bertsch asserted that the company should not be permitted to participate in public company stock indices.  Under his theory, an investment in an index fund pegged to the S&P or any other index carries with it certain expectations regarding the underlying disclosures of listed companies, and Snap’s no-vote shares run afoul of those expectations by adding a layer of complexity that will not be adequately reflected in the price.

Given the SEC’s regulatory power over national securities exchanges like the NYSE, a number of related questions emerge: How does allowing Snap to list on NYSE impact exchanges outside the U.S. where listing requirements are generally less onerous? Should the SEC be concerned about a potential race-to-the-bottom amongst non-U.S. exchanges?[9]  How should the SEC balance investor protection directives against the desire to entice private companies to go public?

None of these questions were answered on March 9th.  At most, the testimony amounted to a call by investor groups to revisit the rules surroundings multi-class common structures listed on U.S.-domestic exchanges in light of Snap and the potential for other companies to replicate its offering structure.  Those who are skeptical of CII’s argument with respect to index funds will note that Snap is still subject to ‘34 Act reporting requirements, which generally puts it on par with other companies listed in the index (proxy rules excepted).  Certainly, fewer or limited disclosures are of concern to any investor who wants to ensure the share price accurately reflects the totality of information available.  Those concerns may be better directed at deregulatory efforts generally, rather than at Snap, which continues – at least as of this writing – to trade above its initial IPO price.

CONCLUSION

It’s unclear whether the Commission will address the topic of no-vote shares again in the near term, especially given its change in leadership and priorities. All parties would benefit to wait and see how Snap performs over time and whether the company endeavors in good faith to provide its Class A holders with a degree of transparency that resembles that of more traditional shareholders.

[1] The IAC is a mandate under Dodd-Frank, set up to advise the SEC on various regulations affecting investors. Here’s a link to the agenda, as posted on the IAC’s website: https://www.sec.gov/spotlight/investor-advisory-committee-2012/iac030917-agenda.htm.

[2] See Rob Kalb and Rob Yates, Snap Inc. Reportedly to IPO with Unprecedented Non-Voting Shares for Public, Harvard L. Sch. Forum on Corp. Governance and Financial Regulation (Feb. 7, 2017), https://corpgov.law.harvard.edu/2017/02/07/snap-inc-reportedly-to-ipo-with-unprecedented-non-voting-shares-for-public/ (looking at post-IPO companies holding their first annual meetings, finding several instances of 10-to-1 voting structures between insiders and outsiders).

[3] See generally Testimony of Ken Bertsch before the IAC (Mar. 9, 2017), available at https://www.sec.gov/spotlight/investor-advisory-committee-2012/bertsch-remarks-iac-030917.pdf.

[4] See, e.g., Kurt Wagner, One way Shapchat’s IPO will be unique: The shares won’t come with voting rights, Recode (Feb. 21, 2017), http://www.recode.net/2017/2/21/14670314/snap-ipo-stock-voting-structure.

[5] See, e.g., Preliminary Prospectus, filed with the SEC: https://www.sec.gov/Archives/edgar/data/1564408/000119312517056992/d270216ds1a.htm.

[6] Id. at 5.

[7] See Eleanor Bloxham, Snap Shouldn’t Have Been Allowed to Go Public Without Voting Rights, Fortune (Mar. 3, 2017), http://fortune.com/2017/03/03/snap-ipo-non-voting-stock/.

[8] See supra note 3.

[9] See generally SEC Should Bar No-Vote Share Structures, Committee Told, Law360 (Mar. 10, 2017), https://www.law360.com/capitalmarkets/articles/900042?utm_source=rss&utm_medium=rss&utm_campaign=section.

On August 5, by a vote of 3-to-2 with the SEC Commissioners voting along party lines, the SEC approved the final rule to implement the requirements of Section 953(b) of the Dodd-Frank Act, which instructed the SEC to amend existing rules under Item 402 of Regulation S-K to require public companies to disclose the ratio of their CEO’s annual total compensation to that of the median annual total compensation of all company employees. All public companies will be subject to this new disclosure requirement, with the exception of emerging growth companies, smaller reporting companies and foreign private issuers.

The rule requires companies to disclose:

(a) The median of the annual total compensation of all company employees, excluding the CEO;

(b) The annual total compensation of the company’s CEO; and

(c) The ratio of (a) to (b).

Companies will be required to provide disclosure of this ratio commencing with their first fiscal year beginning on or after January 1, 2017, which information will be disclosed in the Executive Compensation section of a company’s Form 10-K (or proxy statement). Thus, disclosure will begin in the 2018 proxy season. In addition to the ratio itself, disclosure describing the methodology used to identify the median employee, determine total compensation and any material assumptions, adjustments (including allowable cost-of-living adjustments) or estimates used to identify the median employee or to determine annual total compensation will also be required. As described in the proposed rule, when identifying the median employee, the final rule requires companies to include all employees, including full-time, part-time, temporary, seasonal, and foreign employees employed by the company or any of its subsidiaries and to annualize the compensation of permanent employees who were not employed for the entire year, such as new hires. Companies may not, however, annualize the compensation of part-time, temporary, or seasonal employees. Consultants and other advisors who are not employees and individuals who are employed by unaffiliated third parties are not to be included in the calculation.

Continue Reading SEC Finalizes the CEO Pay Ratio Rule – Additional Executive Compensation Disclosure for Public Companies Beginning in 2017

On Monday, the Securities and Exchange Commission (the “SEC”) proposed rules requiring disclosure of companies’ policies with respect to hedging transactions, in order to implement Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The rules do not prohibit hedging transactions or require companies to adopt policies with respect to hedging, but would instead require companies to disclose whether any corporate hedging policies exist and whether they permit directors, officers or other employees who receive equity securities as part of their compensation, or otherwise hold equity securities of the issuer, whether directly or indirectly, to hedge or offset any declines in the market value of those equity securities.

Many companies already prohibit hedging transactions as part of their corporate governance policies, or at the least require pre-approval by a policy administrator before such transactions can be entered into. Hedging by company personnel is generally frowned upon as a means of reducing the economic risks of share ownership.

Currently, Item 402(b) of Regulation S-K requires certain disclosures related to hedging policies, but only with respect to named executive officers of an issuer.  Furthermore, Item 402(b) does not apply to smaller reporting companies, emerging growth companies or registered investment companies.

The rules proposed on Monday would add new paragraph (i) to Item 407 of Regulation S-K, and would require companies to disclose, in annual meeting proxy and information statements, whether they permit employees and directors to hedge their companies’ securities.  Unlike existing requirements, the rules would not exempt smaller reporting companies, emerging growth companies, or closed-end investment companies that have shares listed on a national securities exchange, and would instead apply to all companies subject to the federal proxy rules.

Congress, as part of the Dodd-Frank Act, mandated the proposed rules to provide shareholders with information regarding whether employees or directors are permitted to engage in transactions that “avoid the incentive alignment associated with equity ownership.”  The proposed rules are the second of four sets of rules required to be adopted by the SEC under the Dodd-Frank Act relating to executive compensation, each of which is intended to provide investors with additional information about the governance practices of the companies in which they invest. The first set of these rules, pertaining to the ratio of the CEO’s compensation to that of a company’s median employee, have remained in proposal form since September 2013.

The SEC will collect public comments on the rule for 60 days following publication in the Federal Register. We’ll provide additional information as to the rules when they are finalized.