Dual class shares – myopia or opportunism?

Published October 03, 2016

I have written extensively on the subject of dual class shares (DCS) and would have preferred to wait until the public consultation before saying any more. However, in recent days, I have seen the lobbying continue for DCS, with one describing those opposed to it as myopic. To be fair, the word “opportunistic” has also been used to describe the Listings Advisory Committee (LAC) decision to greenlight  it (although not by me). It is not difficult to understand that with more listings, there will be more business for various intermediaries such as bankers, lawyers and accountants.

Recently, I had a chat with a senior audit partner of a major accounting firm. He said he is against it. When I said other parts of his firm may be for it, he agrees that I may be right. A lawyer who supported my stance against DCS when I first wrote about it a couple of years ago has changed tune. I do not know whether it is business considerations that have caused this or a better understanding of the issues.

I recall a forum I attended a few years ago about REITs and business trusts. When someone proposed that the rules should be strengthened, a legal firm representative was very vocal arguing against it. He mentioned that his client, which he named, would be reluctant to list here if we strengthened the rules. That client’s share price has now been decimated, along with accusations of lack of transparency. Of course, most intermediaries owe their duties to the client, which tends to be management and founders. They generally do not owe fiduciary duties to the company and its investors. It’s very easy for them to support something that brings fees to their firm, without thinking of investors’ or the wider public interest. The investing world will be a much safer place if intermediaries have fiduciary duties to the company and its shareholders.

It is interesting to read a recent newsletter from a law firm which argued the case for DCS. The fact that US has a contingency-fee class action system which enhances shareholder protection was briefly mentioned. The article then proceeded to argue that dual class shares may be useful and show various “safeguards”  adopted by some US companies with DCS, such as auto-conversion into ordinary voting shares upon sale to outside investors or sunset clauses.

In the US, where the article draws examples from, those safeguards exist in the context of other safeguards such as a contingency-fee class action system, fiduciary duties of controlling shareholders, a very prescriptive approach to regulating corporate governance, and a very legalistic approach to resolving corporate governance issues (e.g., takeovers are governed by courts rather than an industry-based takeover panel). It is disappointing that we somehow think that we can just transplant something from the US into our environment, by adding the odd safeguard, but then ignoring many other aspects of the corporate governance eco-system which provides the real safeguards.

Although not a lawyer by training, I have tried to understand some of the unique features of the US legal system that helps ensure that DCS  work – or at least generally do not lead to rampant abuse. Last year, I spoke at an overseas corporate governance conference where fellow speakers include a Justice of the Delaware Supreme Court (many US companies are incorporated in Delaware), and a former chairman of a securities commission in a major market. I asked the chairman of the securities commission and he was straightforward: “Don’t introduce dual class shares”. I asked the Justice about the duty of controlling shareholders in the US. He confirmed to me that controlling shareholders owe fiduciary duties to the company in the US. His view is consistent what I had read in an article discussing duties of controlling shareholders in a DCS company. It helps explain why in companies with DCS in the US, the risk of rampant abuse is minimised. This is not the case here. I wonder how much the LAC has dived into understanding the different environments where DCS exist before arriving at its recommendation. Differences in environment can be legal or even cultural. For example, in many European countries where DCS exist, society is egalitarian. In such a society, human greed may be less of a concern.

In terms of myopia, I wonder who is being myopic – those who oppose it or those who are for it. We have been told that we will still have 99.8% of companies with single class shares. So, the LAC is supposed to choose the 0.2%? On what basis? And how will that 0.2%  improve the number of listings and volume of trading in our market? In the US, despite all its sophistication, they do not try to pick and choose which companies can list with DCS. Here, we are trying to marry a merit-based approach (with the LAC determining merit) to a disclosure-based caveat emptor approach when it comes to DCS.

Those safeguards that are being proposed by the LAC are generally voluntary safeguards adopted by US companies, not mandated by the regulators as we are proposing (except for the one that companies cannot convert to DCS after listing). The true safeguards are those in the broader institutional environment  I have alluded to earlier – contingency-fee class action, fiduciary duties of controlling shareholders,  and a prescriptive  and highly legalistic approach to corporate governance. I have not seen the LAC proposing these safeguards – because they will totally change our environment. Plucking DCS and just plonking it here is like buying the frame without the picture.

Are we looking for a quick fix rather than a longer-term more sustainable solution to building a stronger exchange with better valuations and liquidity? While it is good to be ambitious, are we setting our sights too far and high by trying to court listings with unusual structures from all around the world, when ASEAN and our own SMEs should be the centre of our attention?

Finally, I see an attempt to link DCS with innovation and long-term thinking. There are plenty of innovative companies without DCS. Companies like Microsoft do not have DCS and did not pay dividends for many many years as it focused on growth and investing in R&D. Jeff Bezos did not get thrown out even though Amazon does not have DCS and Amazon was burning through cash and losing money as it built its business in its early years. A recent analysis has shown that investors in Amazon have done better than those in many of the regularly-cited DCS companies. Truly innovative and entrepreneurial companies do not need financial engineering such as DCS to entrench their founders and to thrive and attract long-term investors.

My suggestion to investors here is this. If you are prepared to invest in companies with DCS, invest in those in the US where the legal protection is much stronger. If there is abuse, you can be sure that there will be class action lawsuits, and you may be able to join such lawsuits. If you lose, there is nothing to pay. In fact, from what I know, you may even be paid to join such lawsuits. At the very least, you know that there are US shareholders who will keep management and founders in check. If DCS companies list here from overseas, do you think that you or the regulators will be able to do much if there is abuse? Has anyone who has suffered from the S-chip scandals being able to enforce their rights? If you have, I would be most interested to hear your story.

Mak Yuen Teen

Updated on October 4, 2016 at 7.00 am





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