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Cai Jin

Stick with 'one man, one vote' in the market

Debate on dual-class shares highlights issues of entrenched control elsewhere

Coddling the owners of a company when it goes public with multiple classes of shares is seldom a good idea.

Just watch the furore unleashed by the Singapore Exchange (SGX) among stock activists and corporate governance experts after its recent suggestion to allow dual-class shares in a bid to attract more big-time listings.

So far, the debate appears to be focusing on the safeguards that would be needed if such a move came about.

One obvious question is whether the local investment community is ready for share structures of such complexity; yet, this factor has not been raised at all.

What makes dual-class shares so unpalatable to many investors is that, while they offer the same economic benefits, returns and rights to dividends as ordinary shares, they carry substantially different voting rights.

This entrenches the control that owners of these shares have over a company, making potentially lucrative takeovers next to impossible to conduct and poorly performing managers difficult to dislodge.

Some Rickmers bondholders were at One Raffles Quay last Wednesday to file an acceleration notice with the trustee to seek immediate redemption of their notes.
Some Rickmers bondholders were at One Raffles Quay last Wednesday to file an acceleration notice with the trustee to seek immediate redemption of their notes. ST PHOTO: JAMIE KOH

Yet, there are already instances here where control in a listed firm is entrenched at an initial public offering (IPO), with the original owner reducing his stake by a substantial margin but scarcely any concerns are raised about these cases. It makes me wonder if investors know what they are getting into. Let me elaborate with an example.

Manulife US Reit went public in May with a clause that none of its unit holders could hold more than 9.8 per cent of the Reit.

To enforce this rule, there was a rare "forfeiture mechanism". This stipulated that units held directly or indirectly by any person in excess of 9.8 per cent would be automatically confiscated and held by the trustee.

The "forfeited" units would then be sold and the proceeds, which could not be more than what the investor initially paid, returned.

This acts as an effective poison pill to discourage hostile takeovers and entrenches the control of the sponsor, Manulife, which owned 9.5 per cent of the Reit after the IPO. Not that there is anything wrong with this arrangement, given the valuable experience that the firm accumulated managing real estate in North America.

What makes dual-class shares so unpalatable to many investors is that, while they offer the same economic benefits, returns and rights to dividends as ordinary shares, they carry substantially different voting rights.

This entrenches the control that owners of these shares have over a company, making potentially lucrative takeovers next to impossible to conduct and poorly performing managers difficult to dislodge.

But this works out even better than having a dual-class share structure, even though the sponsor's intention might not have been to preserve control over the Reit through such means in the first place.

Indeed, the 9.8 per cent ownership restriction was put in place ostensibly for tax reasons - to ensure that the dividends declared by the Reit would flow through to Singapore without incurring the United States withholding tax of 30 per cent. It is a feature common among US Reits in order to ensure that the tax transparency benefits a dispersed group of unit holders.

To its credit, it is not as though the Listings Advisory Committee (LAC) - established last year to advise SGX on complex or unusual IPOs - wasn't aware of the problem when the listing application was referred to it in March.

Without referring to Manulife US Reit by name, the LAC observed in a report on July 29 - two months after the Reit went public - that such a forfeiture mechanism "should generally not be permitted" unless there is a compelling reason to comply with statutory requirements.

The LAC also advised that use of such a mechanism should be proportionate to the "risk which the issuer intended to mitigate against".

But the LAC's remedy was to recommend "clear prospectus disclosure on the rationale and functioning of the forfeiture mechanism". Is offering disclosure a sufficient safeguard? I don't think so.

Indeed, as the LAC advised, disclosures of the forfeiture mechanism were made on the first few pages of the Manulife US Reit IPO prospectus and highlighted again at the top of the section on risk factors that might affect the Reit.

Yet, there was scarcely a debate over the issue and few, if any, of the analyst reports written about the IPO even dwelled on it.

This speaks volumes about the "caveat emptor" approach we want investors to adopt by giving them all the necessary information so they can make an informed decision about their investments.

The LAC also recommended prospectus disclosure of how the forfeiture mechanism would apply when there was a takeover offer.

To this end, there is an acknowledgement in the 556-page document that this might "delay, discourage or, as the case may be, prevent a transfer of units or the ability to acquire control of Manulife US Reit and, as a result, may adversely affect the ability to realise any potential change of control premium".

This inconvenience might not pose a big problem for investors who bought into the Reit in the first place because of its mouth-watering yield and not because they were taking a wager that sometime in the future it might become a takeover target.

But I believe that such a forfeiture mechanism establishes a bad precedent in the Reit sector, which is one of the rare successes in the Singapore stock market, despite the emphasis that it was an exception.

In hindsight, it would have been better if the LAC had published the report ahead of the IPO and not two months later, as that would have made investors better aware of the issues involved.

It also begs the question: Did the LAC press for more robust safeguards, other than recommending prospectus disclosure? This is considering that there is a Code on Takeovers in place here to protect shareholder rights, unlike in the US.

What about the other concern over dual-class shares - that entrenched control makes it difficult for poorly performing managers to be dislodged?

To my mind, this is best answered by the way in which firms in the beleaguered marine and offshore sector have been negotiating with bondholders regarding the mountain of debt that is due to mature in coming months.

Take AusGroup, which wants its bondholders to extend the tenure of its $110 million bonds due for repayment by another two years. It is sweetening the deal by throwing a higher interest rate and monthly interest payment into the bargain.

Then, look at container ship operator Rickmers Maritime, which is playing hardball with its note holders. It wants them to take a substantial haircut on the bonds in order to get access to a $260.2 million bank facility that it says it would need to stay afloat.

Are the very different approaches that the two companies are adopting towards their debt problems due to the way their companies are structured?

AusGroup is the usual type of SGX-listed firm, subject to all the usual checks and balances, including the threat of a hostile takeover given depressed prices or anxious shareholders convening a meeting to oust management if the company's survival is jeopardised.

But Rickmers is a business trust where control is ensured once the sponsor owns more than 25 per cent of the trust.

That means that, other than voting with their feet, it is impossible for the remaining unit holders to take any action, even if they are uncomfortable with the steps taken thus far to resolve the debt issue.

It proves my point: For the stock market, like everywhere else, it is better to stick with the "one man, one vote" rule, come rain or shine.

A version of this article appeared in the print edition of The Straits Times on October 03, 2016, with the headline 'Stick with 'one man, one vote' in the market'. Print Edition | Subscribe