CII ramps up pursuit of dual-class sunsets

The Council of Institutional Investors (CII) has asked the SEC to seek authority enabling the commission to, in effect, require companies to limit the length of time company founders can exert outsize control over companies after they go public.

CII general counsel Jeffrey Mahoney notes in a letter sent to the SEC earlier this month that the group last October submitted listing-standard petitions to the US stock exchanges asking them to propose new rules that would require newly listed companies that choose dual-class voting structures to adopt a sunset provision that clicks in within seven years of an IPO.

‘We understand that some believe the commission may not currently have the statutory authority to require the US stock exchanges to adopt CII’s petitions,’ Mahoney writes. ‘We, therefore, would respectfully recommend that the commission request that the US Congress amend the federal securities laws to explicitly permit the SEC to adopt rules requiring the US stock exchanges to revise their listing standards generally consistent with our petitions.’

A Nasdaq person says in a statement: ‘Nasdaq is a firm believer in the flexibility of share structure, in order to provide all investors access to growth companies. That said, we consider the input of all stakeholders when establishing and modifying listing standards and have an independent body that includes investor representation, which makes recommendations to our board about changes to those standards.

‘We will continue to review our listing standards to make sure they protect investors, while also allowing those investors access to innovative companies.’

An NYSE spokesperson says in a statement: 'Investors should have access to the broadest opportunity set possible and the freedom to make their own investment decisions. Denying companies the ability to access the public markets with flexibility in governance structures will lead to more companies choosing to stay private.' 

CII’s letter comes in response to the SEC’s request in June for feedback on ways the agency could ‘simplify, harmonize and improve’ its exempt-offering framework to expand investment opportunities and promote capital formation while maintaining suitable investor protections. The initiative is consistent with SEC chair Jay Clayton’s stated priority of ‘[m]aking our capital markets, particularly our public capital markets, more accessible to businesses and investors.’

The concept release sought comment on whether changes should be made to improve these exemptions for both companies and investors. It also looked at issues including:

• The limitations on who can invest in certain exempt offerings, or the amount they can invest
• Whether the SEC should make it easier for a company to switch from one offering to another or to a registered offering
• Whether the SEC should expand companies’ ability to raise capital through pooled investment funds
• Whether retail investors should be allowed greater exposure to growth-stage companies through pooled investment funds.

In the recent letter, Mahoney writes that the falling number of US public companies has not significantly diminished the ability of firms to obtain capital, given in part the corresponding growth in the private markets. He states that, between 2003 and 2017, private market fundraising increased from roughly $100 billion to almost $750 billion, adding: ‘Given the various choices US businesses have for funding, many have chosen to remain private longer.’

Mahoney argues that what he describes as an excess of capital available to private companies has led to some ‘troubling practices’ the SEC should look at, such as: a decline in underwriting standards in corporate debt; increasing leverage ratios in private equity-financed acquisitions; an increase in the number of IPOs for very large companies that have not yet become profitable; and a shift in bargaining power from investors to founders, as reflected by the growing prevalence of dual-class stock structures, among other things.

Dual-class stock structures often enable founders to keep control over the board for lengthy periods or even forever despite their having a relatively small financial stake in the company, Mahoney says.

‘When founders control the board, an important source of discipline over the companies’ operations are neutralized,’ he writes. ‘And of particular concern for CII members and other long-term shareowners, there is no practical ability to exercise meaningful oversight of the founder and public company board, even in the face of extended poor performance or changed company circumstances that suggest a different management or long-term strategy.’

Mahoney states that CII believes the developing market practice of sunset mechanisms ‘offers a logical and reasonable solution to the lack of accountability created by dual-class stock public companies.’ Such time-based limits allow companies to tackle any alleged problem of short-termism without requiring shareholders to entirely surrender the ability to hold the managers of their assets accountable, he adds.

CII has recorded 29 US companies going public with time-based sunsets since 2004, including 21 between 2015 and 2019. It believes a sunset of no more than seven years offers an appropriate balance.