Index Providers and Dual-Class Stock
CII and some institutional investors turned to three major index providers in the wake of Snap Inc.’s egregious no-vote IPO, which led to three public consultations:
- S&P Dow Jones' 2017 consultation resulted in barring the addition of multi-class companies to the S&P Composite 1500 index and its components, which covers the S&P 500, MidCap 400 and SmallCap 600 indexes. Existing constituents were permanently grandfathered. In 2023 the index provider reversed itself, resuming traditional accomodations for the imperial governance model with no sunset requirement.
- FTSE Russell's consultation resulted in excluding past and future developed market constituents whose free float constitutes less than 5 percent of total voting power. Although only a handful of companies did not meet this requirement, the change sent a signal to the market: trampling on shareholders' right to vote has consequences.
- MSCI conducted the most prolonged consultation of the three, but ultimately chose to continue to ignore voting rights for the purpose of major index construction. MSCI originally contemplated modest reform: excluding no-vote shares from major indexs in cases where the company's listed shares constitute under 17% of total voting power (25% for new constituents). MSCI subsequently released an expanded consultation with a discussion paper contemplating more significant reform: a weight adjustment for each index security based on the proportion of total voting power in free float hands, with no exemption for existing constituents. CII's supportive comment letter offered three ways to realize the benefits of this proposal while softening portfolio disruption: a three-year grace period for existing constituents; immediate and permanent exemptive relief for adopters of reasonable sunset provisions; and a gradual phase-in of the new methodology. Concluding its consultation, MSCI announced in 2018 it would continue to ignore voting rights for major index construction.
Some believe that the exclusion of dual-class shares is misguided because indexes capture the "investable universe." This is a myth. Providers of public equity indexes have an extensive and ongoing history of exercising discretion to under-represent parts of the investable universe that don't meet fundamental norms of public equity. The S&P 500, for example, excluded REITs for many years, and continues to exclude master limited partnerships (MLPs), business development corporations (BDCs) and limited liability companies (LLCs). Additionally, public equity indexes that bill themselves as higher quality than broad market indices routinely exclude companies on arbitrary liquidity and financial criteria. The S&P 500, for example, excludes high-growth large cap companies on the grounds of not having yet achieved positive GAAP earnings for one year. S&P's decision in 2017 to begin excluding prospective entrants with no plan to achieve proportionate voting rights according to economic stake was one chapter in a long history of excluding parts of the investable universe.
Additionally, it is important to recognize the role of indexes within the context of deep impediments to addressing this issue elsewhere in a substantive way. The Securities and Exchange Commission currently lacks statutory authority to require exchanges to curb unequal voting rights due to a federal suit brought decades ago by the Business Roundtable, establishing judicial precedent against the SEC taking action. Stock exchanges could address the matter by requiring listed companies to have equal voting rights or reasonable sunset provisions, but the for-profit model and intense competition for new listings present insurmountable conflict for these "self-regulatory organizations." Major U.S. exchanges have rebuffed formal proposals to act since 2014. Further reducing the likelihood of exchange-based reform, multiple non-U.S. exchanges with long-standing "one share, one vote" requirements recently have yielded to "race to the bottom" pressure to attract new listings, permitting dual-class structures in certain circumstances. Global regulatory coordinators like the International Organization of Securities Commissions (IOSCO) are empowered to provide guidance, but not to compel action.