Paul Hodgson: Facebook, AP7 and the rise and fall of the no-vote share

Facebook’s recent decision to give in over its plan to issue non-voting shares to allow its founder, CEO and controlling shareholder Mark Zuckerberg to retain the same voting power while selling off stock to fund his philanthropy could be the death knell of the non-voting share.
Zuckerberg and his board decided against fighting for the plan the day before he was to appear in court, over obvious concerns that they may not have won the case brought against them by two shareholders, the massive AP7 Swedish public pension fund and the Amalgamated Bank of New York. In a Facebook post, Zuckerberg said: “At the time, I felt that this reclassification was the best way to do both of these things. In fact, I thought it was the only way. But I also knew it was going to be complicated and it wasn’t a perfect solution.” But the lawsuit and the subsequent collapse of the defence are likely to be a warning to companies like Uber and Airbnb, which are expected to go public in the next couple of years.
The CEO of AP7, Richard Gröttheim, explained why the fund had become involved: “KTMC [Kessler Topaz Meltzer & Check] brought up this case as an interesting one for us to participate in and we thought that, because we have an active ownership policy, we can use different tools to get companies to behave regarding corporate governance and sustainable investment in the right manner. And in this case, as minority owners, we would potentially lose value from the new class of shares, that it would harm the B shares that we already own. For this reason, we thought it would be a good time to go to court and say that it’s not the right way to treat minority owners.”
The no vote share practice is, of course, not limited to Facebook. There is still Snap, the owner of Snapchat, which gave all the voting power to its two cofounders after it went public and none to its public shareholders. At least Snap was upfront about it in its prospectus. Having done so, however, both the S&P Dow Jones Indices and the FTSE Russell announced that companies with non-voting shares would be excluded from their main indices. One other indexer – MSCI – has the decision under consideration.
And there’s Alphabet, Google’s parent company, which implemented its change of share structure, adding to its existing classes for public investors and its founders, with one vote and 10 votes per share respectively, a third class with no vote attached. That was also the subject of a shareholder lawsuit, which the company settled, again on the eve of the trial, by offering compensation to existing investors for the loss in value of their holdings.
But the Facebook surrender may have swung things back in favour of shares with actual votes. I spoke to Stuart Grant of Grant & Eisenhofer, the lead trial lawyer for the plaintiffs in the case, about the consequences of Facebook’s decision.
“This is speculation, but I think Facebook’s chance of winning was not good,” said Grant, “and Mark Zuckerberg likely did not want to spend a whole day in court facing cross-examination where he would be asked a lot of difficult questions and where there’s no opportunity for a lifeline as you’re out there by yourself. Also, just to give a bit of context – there’s a lot going on with Facebook at the moment, and it would not be irrational for them to ask: do we really need to take on our shareholders when we could use their support as we’re getting grief for some of the other things that we’ve done?”I asked Grant what he thought the chances of success were before the trial: “Every time you walk into a trial it presents a risk,” he replied, “and, presumably, both sides, if they walk in, are confident they can win. While we were confident of our legal position, we understood it was not without risk.”
Gröttheim agreed: “We read it that they realized that this was going too far, introducing a new class of shares and deflating the minority owners’ stock values; it was the wrong way to go.”
I also asked if there had been any attempt at mediation, but Grant replied that there had been none, but he could not comment on whether there was any attempt by Facebook to come to some settlement before the case went to trial.

But what about the similarities and parallels with the Alphabet situation? “We can’t equate the case against Alphabet with our Facebook case,” cautioned Grant, “because the Alphabet case was not dropped at the 11th hour. The difference is that Facebook raised the white flag and said ‘we are withdrawing the reclassification proposal’. Alphabet actually went through with its reclassification proposal and put together a settlement, in which after a year, the company paid out a dividend to make up for the difference for the C stock selling at or below the price of the A stock. They called it a true-up payment. But since the true-up was paid to all stockholders it didn’t really have the right effect. One [Alphabet] was a settlement, the other one [Facebook] was a surrender.”
The firm put together a complaint that, among other things, showed that public shareholders would be losing a lot of money. “We certainly had experts pull together reports,” said Grant, “indicating that the linkage between what a share would sell for before reclassification and what an A share and two Cs would sell for post-classification; which in an ideal world would be equal. Our projections were based on what other companies that have undertaken similar reclassifications indicated that they’re not of equal value, and that there’s a certain amount of leakage, estimated between 2% and 6%. That doesn’t sound a lot unless you realize that Facebook is worth $450 billion, which means that $27 billion of class A public stockholders money would potentially have been lost through reclassification; something that Mark says wouldn’t harm anyone.”

But Grant felt that the ramifications of the surrender were much broader. “There is a wider battle going on right now between Silicon Valley entrepreneurs and Wall Street institutional investors that this case represented. That is this belief in Silicon Valley that the founder is omnipotent and should have absolute control over a company for his or her own lifetime, and maybe beyond the grave, against the belief from institutional investors that, once you take public money, the way you operate and the way you think really needs to be different.”
Gröttheim also thought that the case had wider consequences for other companies considering introducing no vote shares. “Very much so, we thought it was important for us to be lead plaintiffs in this case to show others that they should be careful in doing this, because other stock owners will not accept it in the future.” But his comments held a warning for others looking to follow the Facebook lead: “We would definitely consider being lead plaintiffs in a case if the same issue comes up, it’s a useful tool to be able to use, suing a company. It’s also AP7’s proxy voting policy to support shareholder resolutions that call for the elimination of classes of shares with unequal voting rights.”

Grant brought in the example of Snap. “I give Snap some credit in that when they went public they were very open, saying we get all the votes, you get none, because we’re running this. But that idea was not well-received by shareholders; and, certainly, after the individual investors jumped in and pushed the price up on the first day, there wasn’t the institutional support and so it quickly dropped below its IPO price and continues to sit somewhere below that now.” But then contrasted it with the Facebook situation: “Facebook is a little different because, when it became public, there were two classes of stock – the class that Mark held, and the single voting A’s, which were publicly held. But it was structured so that people thought that Mark would likely give up control as he sold down his shares. And, in fact, there were triggers within the charter itself that said, when Mark sells down below 50% of his votes, the board becomes classified, you can’t act by written consent and other protections. So, people assumed that for the first several years, Mark would control it but then he would start to sell off his stake and diversify and then control would shift to the public shareholders.”
Changing the rules part way through the game was the issue, noted Grant: ‘What bothered a lot of people about this [proposal to create a new class of non-voting shares] was that, yes, the company has been successful but now you’re changing the rules and taking advantage of your good performance to say, in effect, now I should be president for life. The battle was about: how long can I hold on to control and still use the public’s money? Facebook’s surrender was an important step in that battle for institutional investors.And, let’s face it, if Zuckerberg couldn’t do it, it’s hard to believe that anyone could change the rules in the middle of the game like this.”

For Gröttheim too, changing the game was the issue: “Of course there are founders who wish to retain control, but they will in the future be very careful about using this tactic as a tool to do that. If we buy shares in an IPO and we know that there is already an arrangement when it comes to shares with unequal voting rights, we know about that and we invest in line with it, but if you try to change that after the company has been operating for a number of years, then it becomes a problem for minority owners.”
Grant stressed what he saw as a sea change in investor power versus Silicon Valley power: “It used to be that everyone wanted to jump into every one of these new IPOs by Silicon Valley entrepreneurs. Now I think the public is saying we have to look at this more carefully. It has been a significant shift towards power for the public shareholders and away from the entrepreneur.” But he also wanted to stress that the case was about governance, not about Zuckerberg’s aims: “We absolutely do not stand in the way of Mark Zuckerberg giving lots of money to philanthropic endeavours to, hopefully, cure disease and hunger. I don’t want to stop those pursuits, we are just saying you can’t do that by selling off your stake in the company and keep control of how it operates. Sometimes, when you grow up, you have to make choices. I’m glad we were able to keep some governance control at the same time.” Link