From Dual-Class Shares-Lite to Full Fat: The FCA’s Potential About-Turn on Dual-Class Shares

Back in the news again are dual-class shares—a capital structure where certain privileged shareholders hold shares with greater voting rights than other shareholders. Dual-Class shares have had a storied history on the London Stock Exchange. The exchange shifted from a generally permissive environment to an informal discouragement of dual-class share structures in the 1960s and 1970s, and then to a formal prohibition on the premium tier, the Main Market’s most prestigious segment, in the early 2010s. However, in December 2021, in an attempt to attract high-growth, innovative companies to the exchange, the Financial Conduct Authority (FCA) revised the listing rules to permit companies with ‘specified weighted voting rights shares’ to list on the premium tier.

In a recent article, I noted that the FCA’s 2021 reforms amount to nothing more than dual-class shares-lite. Overly restrictive conditions are attached to specified weighted voting rights shares that negate many of the benefits that founders seek when adopting dual-class shares. For a start, specified weighted voting rights shares structure may only endure for up to five years after the company has listed on the premium tier. Even more pertinently, an insider possessing enhanced-voting rights can only exercise those rights on a resolution to remove that person from the board, unless there is a change of control of the company, in which case those rights can be exercised on all matters. Essentially a glorified five-year takeover blocker. In my book, Founders Without Limits, I predicted that the structure would not be attractive to founders of the high-growth, innovative companies the London Stock Exchange was seeking to attract, and, as of the time of writing, no firm has adopted specified weighted voting rights shares.

In May 2023, however, the FCA published an updated consultation on merging the standard and premium tiers of the Main Market; a radical potential reform which presents an opportunity for the FCA to revisit its approach to dual-class shares. A little more than a year since the introduction of specified weighted voting rights shares, it seems that the regulators have tacitly acknowledged the structure’s deficiencies by proposing that many of its restrictive conditions should be disapplied if a merged Main Market comes to pass. For example, it is proposed that the five-year ‘sunset’ be extended to ten years, and, critically, enhanced-voting rights would be exercisable on nearly all shareholder voting matters, not just upon a change of control.

Could the new-found acceptance of more expansive dual-class shares be the jolt in the arm that the UK’s founder ecosystem needs? The ten-year sunset will indeed be more attractive to founders. It gives founders of high-growth, innovative, early-stage firms a longer period of insulation from the public markets during which their businesses’ future prospects are not easily observable to public shareholders. Although ten years is still a rather arbitrary period of time, given that firms develop at different paces, at least it is less restrictive than the current five-year limit. It also better aligns with the takeover market, where I have shown that, at least in recent years, companies are more often subject to takeovers bids five to ten years post-initial public offering (IPO) rather than in the first five years after IPO. Additionally, the greater scope to exercise enhanced-voting rights outside of a change of control will allow founders to protect their executive roles leading their companies, which is likely, alongside blocking takeovers, the primary rationale for adopting dual-class shares.

The potential relaxation of the dual-class shares rules must, though, be assessed in the context of another reform that the FCA is proposing as part of its premium/standard tier merger – discarding the premium tier requirement that large related-party transactions between a company and its controlling shareholder be approved by the public shareholders. A controlling shareholder would not have complete free-reign, since independent directors will still need to approve related-party transactions under rules promulgated under the FCA’s Disclosure Guidance and Transparency Rules sourcebook. However, previous studies have noted that the genuine independence of directors can be questioned in the face of a controlling shareholder, and existing provisions, which are proposed to remain in place, that give public shareholders some say in the appointment of independent directors are largely ineffective.

A discussion of the merits of the related-party transaction regime generally is for another day. In the dual-class shares realm, though, surely disenfranchising public shareholders when a company enters into a large transaction with its controlling shareholder invites exploitation. Not long has passed since the controlling shareholder controversies of the 2010s, including at ENRC, Bumi, Sports Direct, Exillon and Ferrexpo. The opportunities for abuse are higher with dual-class shares, since the FCA is not additionally proposing that enhanced-voting shareholders be required to retain at least some ‘skin-in-the-game’ through the ownership of a minimum level of equity cash-flow rights—a dual-class shares controlling shareholder could enter into self-serving related-party transactions largely detached from any ensuing impact on share value.

It is true that the US exchanges also do not mandate independent shareholder approval of related-party transactions, and US instances of abuse by controlling shareholders of dual-class shares firms are few and far between. However, as the FCA acknowledged, controlling shareholders of Delaware corporations potentially owe fiduciary duties, and in some circumstances related-party transactions can be challenged under an entire fairness regime. Furthermore, the US’s litigation-friendly culture and opt-out class action procedures can act as ex ante deterrents to controlling shareholder abuse.

I advocated for a more relaxed approach to dual-class shares on the London Stock Exchange as far back as 2019. Notwithstanding possible risks, it is a vital part of the package of reforms, both regulatory and more market-oriented, required to resuscitate the London Stock Exchange’s ailing equity market. The initial attempt to introduce dual-class shares to the premium tier was far too restrictive; however, in a complete volte-face, the new proposals appear to abandon an important ancillary form of public shareholder protection that would have buttressed the risks of more expansive dual-class shares. It is understandable that the UK is attempting to mimic the US’s success with dual-class shares, but the legal environments in the UK and US are not identical, and there is greater justification for at least some measure of related-party transaction protection in the UK. The FCA’s consultation is not absolutely determinative of the final rules, and there is still time for the FCA to reconsider its position on related-party transactions in dual-class share firms. Dual-class shares-lite was clearly an unambitious misstep, but full fat dual-class shares accompanied by a regulatory bonfire of the related-party transaction regime may not be the change the London Stock Exchange needs.

Bobby Reddy is an Associate Professor at the University of Cambridge.