Snap Inc., the developer of the popular disappearing message app, is getting a barrage of criticism from institutional investors over its unprecedented plan to issue nonvoting shares as part of its expected initial public offering next month.
"This is egregious," said Aeisha Mastagni, a portfolio manager of mega-public-pension fund California Public Employees' Retirement System. "When you are a public company and you are tapping the public markets, there needs to be a mechanism to hold companies accountable to shareholders. A lack of voting rights means we have no say in the board of directors."
If it goes through with the IPO described in its S-1 filing, Snap would essentially be impervious to an activist investor at its gate as the board's makeup would be controlled primarily by insiders, led by co-founders Evan Spiegel and Bobby Murphy.
According to the Council of Institutional Investors, insiders would continue to control more than 90% of the votes even as their ownership interest declines over time. The group, which represents assets of over $20 trillion under management, sent a letter to Snap's founders and chairman-designee, Michael Lynton, urging them to reconsider plans to take the company forward with shares that have no voting power.
"We are concerned that Snap Inc. plans to go public with a structure denying outside shareholders any voice in the company, and request to meet with you to discuss our concerns," CII Executive Director Ken Bertsch said in the letter. "We strongly urge Snap to reconsider the proposed structure, and instead go to market with a single class voting structure."
Institutional Shareholder Services, one of the two main proxy voting advisory firms, also raised concern with the shares, arguing that it is issuing "phantom" voting rights to its post-IPO investors.
According to CII, the only scenario where Snap will have the "one share one vote" ownership structure favored by the institutional community is nine months after "both co-founders die or decide to transfer their superior holdings to a non-co-founder."
Snap appears to be the first company to ever issue any shares without voting rights in an IPO. However, Google's parent company Alphabet (GOOGL) recently issued a third class of shares, Class C (GOOG) that didn't come with any voting rights.
The nonvoting class shares are especially problematic for funds that seek better governance but can't control their investments.
CalSTRS, which has stakes in every company in the Russell 3000, owns an interest in Alphabet's nonvoting Class C shares. Mastagni said that if CalSTRS cashed out its investment in a particular company due to governance concerns over nonvoting shares, the move would shift the fund away from its passive investment strategy.
"Once it is in the index, we will own it, and it is tough for us not to own shares in the index," Mastagni said. "We're trying to send a message that it's not just CalSTRS, there is a cross-section of the market that does not like dual-class shares and fundamentally believes in one share one vote."
Instead, CalSTRS and other funds are hoping a new organization they publicly launched last week, the Investor Stewardship Group, will send a message to the corporate community that, among other governance initiatives, shareholders should have voting rights in proportion to their economic interest. The group, which is made up of a wide variety of different funds, including activist fund ValueAct Capital's Jeff Ubben, is hoping to demonstrate to corporations that many types of investors all have common goals.
"It gives us more leverage," said Mastagni. "The purpose of this was to show the commonality between all those investors."
The nonvoting share structure in the Snap IPO is an escalation of a trend away from the "one share one vote" ownership structure favored by both retail and institutional investors. Already some companies, particular California tech businesses, have IPO'd with dual-class unequal voting rights structures placing control of the businesses in the hands of founders or insiders.
Activist hedge funds can still target dual-class companies with unequal voting structures by nominating director candidates in the hopes that a large vote of the noninsider shareholders will back their nominees, sending an embarrassing message to the company that change is needed. However, companies with nonvoting shares will be impervious to activists.
"Owners may want to empower managers, but entirely divorcing capital from ownership and ending any accountability of management, is more commonly a feature of socialism. It doesn't work out too well in the end," said Jon Lukomnik, executive director at the Investor Responsibility Research Center Institute in New York.
ISS acknowledges that Google and Facebook have garnered significant positive returns for shareholders since their IPOs as controlled companies with dual-class unequal voting rights. However, Zynga (ZNGA) , GoPro GPRO and Groupon GRPN, each with dual-class unequal voting right stock systems, have had share prices that have tumbled since their IPOs.
"People remember Google and Facebook (FB) and they forget all the dual-class unequal voting rights IPOs that haven't been as successful, such as Zynga, GoPro," Mastagni said.
A Snap spokesman declined to comment.