Does the dual share structure have merit?

Several complications resulting from TELUS Corporation’s recent attempt to consolidate its voting and non-voting shares into a single class of common shares is raising questions about the merits of using the dual share structure.

In May, the Vancouver-based company lost the first stage of its very public battle with US-based hedge fund Mason Capital, which prevented TELUS from carrying out its original share consolidation plan, raised the question of how voting shares can be fairly priced in comparison with non-voting shares within the dual share set-up, and exposed how the hedge fund exploited the proxy voting system to create leverage to pay a higher-than-average premium for voting shares when the conversion actually goes through.

‘In Canada, there are several companies with dual structures, which is essentially a control block,’ explains Richard Leblanc, an associate professor of law, governance and ethics at York University in Toronto. Dual share structures cause problems for corporate governance, he says, because ‘they introduce the possibility of related-party transactions, self-dealing, preferential treatment of shareholders and potential entrenchment of management as an anti-takeover device in the market for corporate control.’

On the other hand, David Masse, senior legal counsel and assistant corporate secretary at CGI, says, ‘There is a feeling the dual share structure is important to preserve the autonomy of Canadian companies.’ Over the years there have been many Canadian public companies lost to foreign interests as a result of takeovers ‒ Rio Tinto’s $38 billion takeover of aluminum producer Alcan being just the latest example ‒ so the dual share system became more popular because of its anti-takeover defenses.

‘The company I work for would not exist if we did not have a dual share structure,’ Masse concedes. ‘We would have been taken over in an acquisition a while back.’

Putting it to the vote

In the case of TELUS and Mason Capital, the issue of preferential treatment of shareholders is key. Much of what Mason Capital did to extract financial gain from the situation could be tied to its contention that voting shareholders, who essentially have control of the company under the dual share structure, would have been forced to take a loss if the consolidation plan was approved.

‘For management to consolidate without acknowledging the enrichment [of non-voting shareholders] is sort of unjust enrichment for the people who didn’t have the vote to begin with, trading on those who had the vote,’ Leblanc notes. As a hedge fund, Mason Capital was obliged to protect the investors in its fund, even if it had to resort to legal means others might not approve of.

TELUS originally announced its plans to eliminate its dual class share structure in February, which it said would result in a much larger common share class that would theoretically improve liquidity by enabling shareholders to buy and sell shares more easily, as well as enhance the company’s reputation for good governance by allowing the 46 percent of shareholders with non-voting shares to actually vote.

Under the proposal, however, consolidation of the dual share structure would have required owners of voting shares to forego any compensation for their shares, which trade at a higher price than non-voting shares. Mason Capital argued that voting-class shareholders should be compensated for the premium they paid for their shares, otherwise the non-voting shareholders would be unfairly receiving voting rights for free.

Soon after the plan was announced, Mason Capital reportedly began accumulating shares of TELUS while implementing hedging strategies to ensure financial gain from the situation. It also began campaigning to defeat the plan to consolidate the two classes of shares, much to the displeasure of TELUS’ management.

In an April letter to investors, TELUS expressed its frustration: ‘After TELUS proposed the share conversion on February 21, Mason rapidly acquired TELUS common shares – coming to hold 33 million shares in that class – while shorting an almost equivalent number of non-voting shares and common shares,’ the letter read. ‘While Mason has less than a 0.25 percent net economic interest in the company due to its short trades, it controls the votes of almost 19 percent of the common shares and has announced it will vote against the proposal, a tactic called empty voting. Empty voting, or voting without an economic interest, makes a mockery of the well-established governance principle of voting in proportion to one’s economic interest in a corporation.’
 
Self-interest

The plan was defeated and Mason Capital said its economic interests were fully aligned with the interest of its fellow holders of voting shares. But TELUS’ CFO Robert McFarlane questioned Mason’s real motives in an interview in the Canadian in April.

‘So why would someone go long and short in the same company?’ he asked. ‘The answer is it has got a trading strategy that maximizes the gap between the two share classes, so it will benefit economically to the extent that gap widens.’ The spread was about 4 percent, or $2.50, before the announcement, but had narrowed to between 40 cents and 50 cents by the time the paper reported.

While company management may not like empty voting and hedging strategies, these are legal choices large investors have at their disposal. Mason Capital did what it thought would best protect its shareholder value. There is no way of knowing whether it would have resorted to empty voting if TELUS had offered to pay a 4 percent premium to voting shareholders.

‘The empty voting issue is something that will be revisited by legal counsel to companies as a potential issue they may need to understand and be aware of,’ notes Laurel Hill Advisory Group senior vice president Brad Allen. He says companies need to begin studying how these derivative-type actions can have an impact on company decision making. Ultimately, if a practice affects management’s decision making, it will also affect shareholder value. Legal counsel may also begin considering the effects the dual share structure may have on shareholder value.  

‘There is an argument in Canada that companies with dual share structures produce better shareholder value,’ says Masse. ‘A well-crafted dual share structure can avoid some of the harm shareholders suffer, but there are egregious cases where owners of multiple voting shares have been pigs at the trough when the time came to eliminate the share structure. There may be potential for more of this to come about due to the seeming success of Mason.’