Retail investors' rights must be protected as such shares concentrate power in select few
The recent moves by the Singapore Exchange (SGX) towards the listing of dual-class shares (DCS) have provoked much debate in business and legal circles.
It had been suggested several times last year that the authorities reconsider allowing dual-class listings here to reinvigorate a listless stock market and address the dearth of big initial public offerings. And also to keep from losing the likes of Manchester United after the football club in 2012 reportedly bypassed SGX in favour of the New York Stock Exchange because its share structure allowed the controlling Glazer family superior voting rights to entrench themselves.
It seemed just a question of time before SGX opened its doors to listed companies with DCS, after an amendment to the Singapore Companies Act to allow public companies to have DCS took effect in March this year.
SGX did move closer to allowing this after "an overwhelming majority" of the members of the Listings Advisory Committee (LAC) endorsed it with certain "safeguards" to mitigate the risks inherent in such structures. SGX has given assurance that there will be a public consultation before it makes its decision.
But these moves have drawn flak from some quarters. Critics argue that allowing such a structure will not guarantee that globally renowned companies will make a beeline for SGX. Some believe Singapore may end up attracting questionable firms, as the better ones will typically look to dual-list in the United States.
But not having it may preclude SGX from attracting quality firms that have compelling reasons to have such structures in place before listing.
WHAT ARE DUAL-CLASS SHARES?
A company with DCS has two classes of voting shares - one class with one vote per share; the other class with more than one vote per share. This structure gives an outsized degree of voting influence to founding members, and the right to control matters such as board composition.
DCS tend to appeal to early growth technology or research-based firms in the life sciences that have large initial capital requirements and need to tap external sources of funding, but do not want to risk diluting the management's shareholdings and voting rights.
Banks are unlikely to finance such high-risk start-ups. Typically, only venture funds and private equity firms would be keen, and the funding will usually come in the form of convertible bonds or debt instruments. Once the company shows results, these investors may convert their debt financing to equity, diluting the management or founders' shareholdings, lawyer Robson Lee of Gibson, Dunn & Crutcher said.
"The dual-class structure allows founding members the autonomy to make key decisions which, instead of focusing on short-term return of investments for shareholders, focus on long-term growth," said Mr Sin Boon Ann, Drew & Napier's deputy managing director of corporate and finance, and associate Ng Pei Tong in a joint statement.
AN EDGE OVER HONG KONG?
Industry observers are divided over whether DCS will put Singapore one up over Hong Kong when it comes to attracting quality listings.
Allowing DCS structures may make SGX a more attractive listing venue, but it is only one of many factors considered.
"Other factors include valuation, investor and analyst familiarity with the sector, the presence of a comparable peer group, corporate governance standards, specific listing requirements, aftermarket liquidity, and cost. Traditionally, the large tech companies have chosen to list in the US after having closely considered all of these many factors, and not simply because the US allows a DCS structure," said Credit Suisse.
Still, Singapore may appeal to companies considering a listing in the region and needing a dual-class structure, as SGX may be the only major exchange here allowing DCS.
But corporate governance expert Mak Yuen Teen argued that such a structure will not necessarily attract the likes of Google, Facebook and Alibaba here. "We may attract listings from less traditional markets like Russia. I understand there are Russian companies looking to list overseas and many have founders/ controlling shareholders with an interest in DCS. But are we ready for Russian-style governance?
"My point is that we need to be aware that the largest and better ones are very unlikely to head our way. The S-chips are a good case in point," said Professor Mak, referring to the type of foreign listings from China that Singapore attracted when it opened its doors to them.
WHAT ARE THE RISKS TO RETAIL SHAREHOLDERS?
In essence, DCS concentrate power in the hands of a select few, and this can be used for ordinary shareholders' greater good, or against them. That is because this could result in shareholders who hold shares with super-voting rights unilaterally controlling how the company is run, Mr Sin and Mr Ng said in the statement. Retail investors are generally considered to be less sophisticated than institutional investors, and have less direct access to senior management. They may also not have the resources to research into why a company needs to have DCS, or to pursue actions against the firm for matters such as breach of fiduciary duties or inappropriate management, they added.
While the loss of shareholder parity means that ordinary shareholders could pay a lower price for stock in a company with DCS, there is also a need to ensure they are not short-changed of their rights.
Therefore, retail investors should consider if the proposed safeguards will be complied with by the company and if it has put in place any safeguards voluntarily, and whether they can trust the ability and integrity of the shareholders holding the super-voting rights.
CORPORATE GOVERNANCE RISKS
There are also concerns that if more stock exchanges allow DCS structures to attract listings, this may potentially result in declining standards of corporate governance. That is because founders holding shares with super-voting rights may take actions that may be detrimental to the interests of the larger number of individuals, who hold common shares and can be outvoted.
As such, the specific details on the implementation of DCS will be important - particularly in terms of the safeguards and checks and balances that can be put in place, according to Credit Suisse.
Prof Mak said: "Institutional investors need to exercise proper stewardship by holding management and boards accountable, and with dual-class shares, they won't be able to do that effectively.
"On the one hand, we want to allow dual-class shares that basically trample over investor rights. On the other hand, we are going to soon issue a stewardship code that tells institutional investors to use their rights to hold boards and management accountable. I worry that we will become a laughing stock if we do both! If we allow dual-class shares, we should scrap the idea of issuing a stewardship code."
Industry experts are divided on the strength of the proposed safeguards.
According to Drew & Napier, the strongest safeguard is the maximum differential in voting power, where one class of shares can have at most 10 times more voting rights than the other class of shares.
Mr Sin and Mr Ng suggest that the differential could be a "fluid" number that is influenced by factors such as other safeguards in place, the industry type, reputational risks, the profile of the management, and the controlling shareholders.
But Prof Mak called it "a problem". "With a 10:1 differential, it allows one person holding relatively few shares to control. They will be able to easily outvote single vote shares. When someone has little skin in the game and controls the company, that could be a recipe for disaster."
Another safeguard suggested by the LAC is restricting DCS holders to one vote per share on voting on the election of independent directors, which would allow minority shareholders to have an adequate say in board composition.
But Prof Mak said the safeguard suffers from lack of accountability of independent directors.
While independent directors owe fiduciary duties to the company under the Companies Act, the prohibitive costs of litigation and dearth of derivative actions brought against directors here often make shareholders think twice about seeking recourse.
Retail investors cannot always count on independent directors to provide an effective check and balance on management, Prof Mak added. "We very rarely hold independent directors to account when they do not discharge their duties effectively, so why would they be effective safeguards?
"The retail investors really should just go to AGMs (annual general meetings) for the food because their votes won't really matter."
Prof Mak suggested imposing fiduciary duties on those who control companies through DCS and allowing contingency fee class action like in the US.
"Even so, if we start having foreign listings with dual-class shares, these safeguards may not work. Can you imagine trying to enforce your rights, say, for a Russian company with dual-class shares listed here, if things go pear-shaped? Have you seen our regulators or shareholders have much luck enforcing against S-chips that break rules? How do you enforce when the key management is overseas?" he asked.
Ultimately, investor rights and protection are fundamental to a strong capital market. Otherwise, Singapore may be able to bring in the listings using DCS structures, but many investors may avoid the shares. And we will have the same problem that the S-chip scandals have helped create - shares with low liquidity and valuations. That is a problem that we do not need in an already anaemic market.
A version of this article appeared in the print edition of The Straits Times on September 14, 2016, with the headline 'Dual-class shares - a must or a bust?'. Print Edition | Subscribe
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