London’s Premium Segment and High-Growth Companies: Return of the Dual-Class Structure

Sam Bagot and Sebastian R. Sperber are partners and Chris Gollop is an associate at Cleary Gottlieb Steen & Hamilton LLP. This post is based on his Cleary Gottlieb memorandum. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here); The Perils of Small-Minority Controllers (discussed on the Forum here); Keynote Presentation on The Lifecycle Theory of Dual-Class Structures; and The Perils of Dell’s Low-Voting Stock (discussed on the Forum here), all by Lucian Bebchuk and Kobi Kastiel.

The Premium Segment of the London Stock Exchange (LSE) is London’s highest standard listing regime: companies listed on the Premium Segment must comply with stringent eligibility criteria and continuing obligations.

However, in recent years there has been a material reduction in the number of companies seeking admission to the Premium Segment. In addition, a number of market participants believe that high-growth tech companies are materially under-represented on the Premium Segment.

In an article published in late 2019, [1] the Financial Times indicated that, against this backdrop, the UK Government had recently consulted with the investment industry over potential changes to the UK Listing Rules (Listing Rules) designed to encourage high-growth companies to list on the Premium Segment. Most notably, this article indicated that the UK Government was considering the introduction of a regime to cater for the listing on the Premium Segment of companies with dual-class structures.

Background

There has been significant debate in recent years over the merits of dual-class structures.

On the one hand, a number of institutional investors and stock indices are increasingly vocal in their criticisms of dual-class structures (and the potential associated founder and management entrenchment issues). These protagonists advocate the benefits of the one-share, one-vote principle in promoting good corporate governance, transparency and accountability and warn about the risks of conflicts arising between entrenched founders and management and other shareholders.

On the other hand, others, including high-growth companies with significant long-term capital projects, particularly companies in the technology sector, have advocated the benefits of insulating founders and entrepreneurs from increasingly short-term public market forces and from shareholder activists.

Current position in the UK

Although dual-class structures were prevalent in the UK until around the mid-1960s, they have since largely disappeared from the Premium Segment.

It is possible, in principle, for companies with dual- class structures to list on the AIM market and on the Standard Segment of the LSE. However, the Listing Rules contain a number of restrictions on companies with dual-class structures listing on the Premium Segment.

In 2014, the Financial Conduct Authority (FCA), which administers the Listing Rules, clarified this stance by introducing two new Premium Listing Principles, which apply to companies listed on the Premium Segment:

  • Premium Listing Principle 3: All equity shares in a class that has been admitted to premium listing must carry an equal number of votes on any shareholder vote.
  • Premium Listing Principle 4: Where a listed company has more than one class of securities admitted to premium listing, the aggregate voting rights of the securities in each class should be broadly proportionate to the relative interests of those classes in the equity of the listed

The FCA specified, in a policy statement [2], that the purpose of the latter principle was “to prevent artificial structures involving multiple classes with different voting powers, which are designed to allow control to rest with a small group of shareholders”.

Competitive pressures

In recent years, the FCA has indicated a willingness to consider further the introduction of dual-class structures. For example, in a 2017 discussion paper, the FCA consulted on the effectiveness of the UK’s primary equity markets in supporting the growth of science and technology companies. [3] Dual-class structures were among the proposals considered.

The creation in 2018 of a new category in the Listing Rules for premium listings of sovereign-controlled companies, reportedly to attract Saudi Aramco to a London listing, also suggests that the FCA is ready to respond to competitive pressures, regardless of criticism it might receive from certain institutional investor bodies.

Dual-class Structures in the U.S.

Many major U.S. corporates have undertaken IPOs with dual-class capital structures over the past decade or so. These companies have included LinkedIn, Alibaba, Facebook, Zillow, Zynga, Square, Yelp and First Data.

Despite the prevalence of dual-class structures in the U.S., they remain controversial.

For example, in its IPO in 2017 SNAP, Inc. offered a class of stock (class A) with no voting rights. Following SNAP, Inc.’s IPO, some stock indices took steps to ban certain companies with dual-class structures: in the same year, FTSE Russell changed its eligibility requirements so that any company with 5% or less of its voting rights in the hands of unrestricted (free-float) shareholders would no longer be included in certain of its indices (subject to grandfathering provisions for existing constituents) [4], and S&P Dow Jones Indices announced [5] that it would cease to add companies with dual-class structures to certain of its indices.

The implementation of dual-class structures in the U.S. has also been the subject of high-profile litigation proceedings. Some of these proceedings have involved derivative claims by shareholders alleging that directors have breached their duties in connection with the implementation of dual-class structures and related transactions. There have been allegations, for instance, that the board failed to implement appropriate safeguards for minority shareholders.

Legal issues in UK context

In general, where an English company’s constitutional documents already provide for weighted voting rights, shareholders are unlikely to have grounds for challenging the exercise of those weighted voting rights. [6]

However, where a company introduces a dual-class structure (with weighted voting rights benefitting only some of the existing shareholders), a minority shareholder could, in principle, have potential grounds for challenge. These could include claims that the establishment of the dual-class structure involves:

  1. an amendment to the company’s articles of association that was not made bona fide for the benefit of the members as a whole;
  2. a breach of duty by the company’s directors; or
  3. a variation of a shareholder’s class rights that has not been

The first two areas of potential challenge overlap to an extent. Amendments to articles will generally be found to be made bona fide for the benefit of the members as a whole unless the majority has been motivated by a desire to harm the minority in making the amendments or the amendments discriminate against the minority without, in any way, benefitting the company as a whole. Similarly, in the context of a company introducing a dual-class structure pre-IPO, the directors will have to consider, in good faith, whether the introduction of the dual-class structure will promote the success of the company for the benefit of the members as a whole (i.e., including whether or not it will detract from the company’s listing prospects or its attractiveness to investors post- listing). The third area of challenge seems less likely unless the company’s articles of association specify the introduction of weighted voting rights as a class rights issue.

Paradigms for London—Hong Kong and Singapore?

Both the Hong Kong Stock Exchange (HKEx) and Singapore Exchange (SGX) recently changed their listing rules to permit dual-class structures in certain circumstances. Both new regimes contain a number of safeguards and protections (some of which are summarised in more detail in the Appendix) against
some of the typical criticisms of dual-class structures. In principle, these safeguards, at a high level, include [7]:

  • applicants needing to demonstrate the necessary characteristics of innovation and growth and needing to have a minimum market capitalisation (HKEx);
  • restrictions on implementing dual-class voting arrangements after listing (HKEx and SGX);
  • restrictions on holders of weighted voting rights (in the case of HKEx, at listing holders must be directors; and, in the case of SGX, holders and potential future holders must be identified at listing);
  • sunset provisions including weighted voting rights ceasing on transfer (HKEx and SGX);
  • voting power of weighted voting shares not exceeding 10 times the voting power of ordinary shares (HKEx and SGX);
  • ordinary shares being entitled to at least 10% of votes at shareholder meetings (HKEx and SGX); and
  • certain matters being reserved for one vote per share including changes to constitutional documents, variation of class rights, appointment/removal of INEDs/auditors and winding-up (HKEx and SGX).

The way forward in London?

Since the Financial Times reported in late 2019 that consultations on dual-class structures had surfaced, some institutional investors in London have already made very clear their opposition to these structures. [8]

However, the argument to introduce dual-class structures may be more compelling now given the introduction of similar regimes in Hong Kong and Singapore and the desire for London’s Premium Segment to remain a competitive financial market post-Brexit, and to attract a higher proportion of high- growth tech companies.

Should the FCA (which administers the Listing Rules) launch a consultation on dual-class share structures, it seems possible that the parameters that HKEx and SGX have introduced could be considered to mollify dissenting institutional investors.

Endnotes

1UK seeks change in listing rules to lure tech start-ups” published by the Financial Times on 5 November 2019 (https://www.ft.com/content/d4d2da5a-fee8-11e9-be59-e49b2a136b8d).(go back)

2See FCA Policy Statement PS14/8, published May 2014, p. 31 (https://www.fca.org.uk/publication/policy/ps14-08.pdf).(go back)

3See FCA Discussion Paper DP17/2, published February 2017, p. 8 (https://www.fca.org.uk/publication/discussion/dp17-02.pdf).(go back)

4See paper entitled “FTSE Russell Voting Rights Consultation—Next Steps” published by FTSE Russell in July 2017 (https://research.ftserussell.com/products/downloads/FTSE_Russell_Voting_Rights_Consultation_Next_Steps.pdf).(go back)

5See announcement entitled “S&P Dow Jones Indices Announces Decision on Multi-Class Shares and Voting Rules” released by S&P Dow Jones Indices on 31 July 2017 (https://www.prnewswire.com/news-releases/sp-dow-jones-indices-announces-decision-on-multi-class-shares-and- voting-rules-300496954.html).(go back)

6Bushell v Faith [1970] AC 1099.(go back)

7Subject to exceptions and qualifications in certain cases.(go back)

8See article entitled “Big investors fight back over dual-class shares” published by the Financial Times on 24 November 2019 (https://www.ft.com/content/bc220535-5055-47ce-811d-fc4a56d32937).(go back)

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