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By Sheldon Gordon
Do dual class share (DCS) structures need to be more strictly regulated in the interests of shareholder democracy—or even banned outright—by Canada's securities commissions?
Professor Anita Anand, academic director of the Centre for the Legal Profession, voiced that provocative view at a recent panel discussion, only to encounter spirited resistance from former dean Rob Prichard, chair, Torys and chair, BMO Financial Group, who insisted capital markets are not about democracy.
The clash of perspectives occurred at a roundtable that also included panelists Stephen Erlichman, executive director of the Canadian Coalition for Good Governance and Naizam Kanji, director of the Office of Mergers and Acquisitions, Ontario Securities Commission.
The Oct. 20th event was organized by the Program on Ethics in Law and Business at the Faculty of Law. The panel was introduced by Dean Edward Iacobucci and the Hon. Hal Jackman delivered closing remarks.
Anand began by noting: “The dual class rationale has it that [the insiders] need to maintain decision making over the firm; that leaves the public shareholders with limited or no voting rights. What we see in DCS structures is the absence of a one-to-one ratio in voting rights.” Ratios may be as high as 500 to 1.
“Democracy is not the name of the game when it comes to capital markets. Capital markets are about accessing capital.” -- Rob Prichard
DCS structures undermine good corporate governance, she said. “Dual class share structures exacerbate the position of minority shareholders. They entrench management, and as a result lead to a lack of accountability. They force public shareholders to carry a disproportionate financial risk relative to their voting power.”
Anand cited the Magna International Inc. 2010 buyout of the voting shares of founder Frank Stronach as an example of the need for proportionality in the relationship between what's being sold and what's being paid for. “The sale of shares worth $45 million went for $1 billion,” she said. “This puts minority shareholders in a very unfair position in these buyout transactions.“
“We can't simply look at DCS structures as contract law issues,” she said. “We must be cognizant of the securities regulation overlay,” which requires regulators to act in the public interest.
“I would favour a prohibition on DCS companies in the public markets,” Anand said. Failing this, she urges a sunset clause for each issuer. “When a company goes public, its dual class structure should remain in place only for a limited period.” For any change of control, not just takeover bids, she advocates a one-to-one voting ratio. “Governance as well as the proportionality of buyout deals need to be on the table in a reform effort.”
Prichard rebuffed the criticism of dual class shares—that they are undemocratic and undermine the one share, one vote principle—as misplaced. “Democracy is not the name of the game when it comes to capital markets,” he said. “Capital markets are about accessing capital.” There is no consistent empirical evidence that DCS causes mispricing in a systematic way that disadvantages investors, argued Prichard.
”We do know, however, that use of DCS does increase access to capital markets and does provide investment opportunities that otherwise would not be available. In the U.S., some of the most important, innovative, growing companies in the world are being formed under this structure.”
He cited Onex Corp., where he's been a director since 1984, as a company with multiple voting shares that “helps make Toronto an important capital market and provides opportunity for public investors, no matter how small, to invest in private-equity in a way they couldn't otherwise do.” Four Seasons Hotels Inc. is another company whose DCS structure was crucial to its success, he said.
“Of course there can be abuse of this structure, but there can be abuse of any form of public corporation,” he said. “Fortunately, good disclosure, strong markets, strong regulators—all these are powerful forces in exposing abuse.” The Magna buyout, he said, should have been stopped by the courts or the OSC, but one case does not provide a basis for judgment.
Directors should be held by the courts and regulators to high standards in discharging their fiduciary duty. In the case of DCS structures, “the regulator and the courts, in articulating the directors' duty, should hold them to a higher standard the greater the divergence between the votes and the equity.”
Erlichman discussed the Canadian Coalition for Good Governance (CCGG) policy on DCS released in 2013. The coalition's working group considered three options: disclosure only; disclosure together with an independent committee to review conflicts; and prohibition.
In the end, CCGG issued a policy that explained the pros and cons of DCS companies and set out principles for future IPOs of such companies. In addition, it requested DCS corporations that didn't comply with the principles to explain annually to their shareholders why they're not doing so.
The principles adopted by CCGG include:
● Holders of the majority voting shares don't nominate 100 percent of the directors of the board. Subordinate voting shareholders should have some say in selecting directors.
● Holders of the majority voting shares must have a meaningful ownership stake in the DCS company. If the ratio of multiple to subordinate shares were equal to or less than four to one, that would be meaningful.
● There should not be any non-voting common shares.
● There should be standardized “coattails” for TSX-listed DCS companies and for all other public DCS companies. (A coattail allows the holders of non-voting or restricted voting shares to convert their holdings into superior voting shares in the event of a takeover offer.)
● The DCS structure should collapse at the appropriate time, as determined by the board. Whenever it does collapse, no premium would be paid to holders of multiple voting shares.
Since this policy was announced, said Erlichman, the principles generally have not been followed. Subordinate shareholders do not have a say in who has been nominated to the boards. No annual explanation has been given to shareholders of why CCGG's principles shouldn't apply.
Kanji, speaking for himself rather than the OSC, noted that there are approximately 83 public companies with dual class share structures listed on the TSX, and TSX Venture exchanges, about 10 percent of total listees. This is up from 6.6 percent in 2005.
“The key balancing act in dealing with dual class structures is whether prohibiting them or regulating them strictly would deter founders from taking companies public, or they would only do so in jurisdictions that permit dual class structures... In my personal view, there is no need to prohibit dual class companies in Canada.”
In general, he said, Canadian securities regulation has had a “defensive” posture toward DCS structures. That is, the accent has been on limiting the downside risks of a controlling shareholder rather than on increasing the governance rights and structural protections of minority shareholders.
“For example, OSC Corporate Finance staff and M&A staff review disclosure and coattail provisions in dual class IPOs. M&A staff also look closely at the disclosure and independent board process in connection with related party transactions in which shareholders are being asked to approve an extension of dual class structures.”
While the OSC has no policy review in mind on dual class specifically, Kanji said that reforms to the related party regime are being considered – and that these are inspired by dual class transactions such as Magna and others.
Prichard cautioned against “perfecting governance for the sake of governance. We need to keep our eye on the ball, which is well-functioning capital markets.”