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Zuckerberg’s Charity May Strike a Negative Blow to Shareholders’ Rights

Zuckerberg’s Charity May Strike a Negative Blow to Shareholders’ Rights

by: Richard Cogan

I. Introduction

On December 1, 2015 Mark Zuckerberg, Facebook’s founder and CEO, announced a plan to donate over 99% of his Facebook shares to charity during his lifetime.[1] Facebook, Inc. (Facebook), a Delaware corporation, has used a dual class common stock structure since its IPO.[2] Under Facebook’s existing share structure, common stock is divided into Class A and Class B shares. Each Class B share entitles the holder to ten votes, while the publicly traded Class A shares entitle the holder to one vote.[3]  Zuckerberg controls approximately 57% of all shareholder votes for Facebook, primarily through his massive voting rights in the non-publicly traded Class B shares (through both personal ownership of shares and contractual irrevocable voting proxies).[4] Most of Zuckerberg’s wealth is currently held in Facebook stock and, under the current share structure, Zuckerberg cannot donate his Facebook shares to charity without also reducing his voting interest in the company.[5]

Zuckerberg recently introduced a stock dividend plan that would allow him to maintain his majority voting interest as he slowly decreases his equity interest in the company.[6] Zuckerberg’s proposal requires Facebook to introduce a new non-voting stock class that is to be called “Class C” capital stock.[7] The proposal requires that two shares of new Class C non-voting stock be distributed to current Class A and Class B shareholders as a stock dividend.[8] After the dividend, Facebook will have outstanding 2,311,052,873 shares of Class A stock, 548,638,840 shares of Class B stock, and 5,719,383,426 shares of Class C stock.[9] With these stock proportions, Class B shares will hold 70% of the voting power but will only constitute 6.4% of the outstanding equity.[10] Class A shares will make up 26.9% of Facebook’s equity, and Class C shares will make up 66.7% of Facebook’s equity.[11] This dividend allows Zuckerberg to reduce the dollar value of his Class B holdings to approximately one third of their pre-dividend value without any diminution in his voting interest.

On April 29, 2016 and May 2, 2016 respectively, minority shareholders Eric McGinty and Eric Levy filed separate class action lawsuits in the Delaware Chancery Court challenging the Class C stock dividend proposal.[12] On May 10, 2016, institutional investor Sjunde AP-Fonden also filed suit against Facebook in the Delaware Chancery Court.[13] The complaints each cite breach of fiduciary duty as the primary cause of action.  While Facebook is not the first tech company to create a non-voting class of common stock, it seems to be the first to establish such a class for the express purpose of allowing a Founder/CEO to liquidate his shares while retaining voting control of the corporation.[14]

II. The Google Precedent

Google (now a component of Alphabet) set a major precedent in this arena when it created its non-voting share class in 2013. [15]  Google’s Class C stock was the first non-voting stock to be included in the S&P 500.[16] Prior to that time, S&P only included the most liquid stock class for each company in its stock indexes.[17] Google shareholders filed suit in the Delaware Chancery Court over the proposed Class C stock dividend, but the case was eventually settled out of court.[18]

Google was also among the first tech companies to create dual class stock for the primary purpose of ensuring that the founders could maintain a voting majority post IPO with a minority equity interest in the company.[19] Google’s dual class stock structure heavily influenced subsequent Silicon Valley IPO behavior.[20] Prior to Google’s IPO, few tech companies created dual class stock.[21] Dual class stock structures have been cited as a means of preventing hostile takeovers or, in the case of media companies, preserving journalistic integrity.[22] Zuckerberg has strongly emulated the founder control strategy of Sergey Brin and Larry Paige, both in the current Class C dividend proposal and in pre-IPO common stock structure.[23]

III. Legal Implications

Prior to 1988, the New York Stock Exchange (NYSE) rules expressly disallowed corporations with dual class stock to list shares on the exchange.[24] Since NASDAQ did not share NYSE’s concerns, NYSE began losing customers to NASDAQ.  To remain competitive, the NYSE amended its rules and allowed shares of corporations with dual class share structures to trade on the exchange.[25]  At that time, the same rule expressly precluded corporations from listing shares that did not include voting rights.[26]

The creation of Facebook’s Class C capital stock will allow Mark Zuckerberg to control a majority of the total shareholder votes even as he sells a large percentage of his equity interest in the company.  Shareholders contend that the proposed changes will decrease the aggregate value of publicly traded shares due to the diminished voting power of Class A shares.

NYSE Rule 303A requires listed companies to: (1) maintain a majority of independent directors on the board; (2) have nominating and corporate governance committees composed entirely of independent directors; and (3) have a compensation committee composed entirely of independent directors.[27] However, a “listed company of which more than 50% of the voting power for the election of directors is held by an individual, a group or another company” is considered a controlled company under the Sarbanes-Oxley Act and are not required to implement the aforementioned safeguards.[28] If Zuckerberg is unable to maintain his majority voting interest as he liquidates shares, then Facebook will no longer be a “controlled company” and Zuckerberg will be forced to comply with the shareholder protection rules contained in NYSE Manual § 303A.01, 04, & 05.

Facebook created a special committee of its board of directors to consider minority shareholder interests and to vote on the proposed stock dividend.  The complaints allege, among other things, that the special committee of the board of directors did not consider any alternatives when they adopted the stock dividend proposal.[29] This special committee vote allows Facebook to avoid the minority shareholder friendly “entire fairness” standard of review, which requires Facebook to equally consider the interests of minority shareholders.[30] However, Facebook did not allow minority shareholders to personally vote on this proposal.  In In re EZ Corp. Inc.,[31] the Delaware Chancery Court indicates that if a majority of the minority shareholders approve such a proposal then the standard of review switches to the “business judgment” standard, which would be highly deferential to Facebook.[32]

IV. Conclusion

This matter is scheduled for trial in the Delaware Chancery Court in January 2017.[33] If this case does proceed to trial, then Mark Zuckerberg and other Facebook executives will likely have to explain under oath how the creation of this new vote-less stock class is in the best interest of shareholders, or at the very least not detrimental to shareholders.  It is unclear what standard of review the court should apply, but this case should allow the Delaware Chancery Court an opportunity to clarify what duties majority shareholders owe to minority shareholders in founder controlled corporations.

[1]            Sarah Frier, Mark Zuckerberg Philanthropy Pledge Sets New Giving Standard, Bloomberg (Dec. 1, 2016), https://www.bloomberg.com/news/articles/2015-12-01/zuckerberg-to-give-99-of-facebook-stock-away-during-lifetime

[2]              Anna S. Han, The Facebook IPOs Face Off With Dual Class Stock Structure, U. Mich J.L. Reform A50, 50-53 (April 11, 2012), https://mjlr.org/2012/04/11/the-facebook-ipos-face-off-with-dual-class-stock-structure-2/#fn-1166-4.

[3]           Id.

[4]           J. O’Dell, Power Play: How Zuckerberg Wrested Control of Facebook from His Shareholders, Venture Beast (Feb. 1, 2012), http://venturebeat.com/2012/02/01/zuck-power-play/.

[5]           Jessica Guynn, Facebook Proposes New Shares to Keep Zuckerberg Control, USA Today (June 3, 2016), http://www.usatoday.com/story/tech/news/2016/04/27/facebook-mark-zuckerberg-class-c-nonvoting-stock-proposal/83612842/.

[6]           Id.

[7]           Id.

[8]           Id.

[9]           Facebook Inc., Information Proxy Statement (Schedule 14A) 35 (April 27, 2016), https://www.sec.gov/Archives/edgar/data/1326801/000132680116000053/facebook2016prelimproxysta.htm (Number of Class C shares calculated by adding the number of Class A and Class B Shares and multiplying by 2).

[10]           Complaint at 4, Sjunde AP-Fonden, et. al. v. Facebook, No. 12318- (Del. Ch. filed May 10, 2016).

[11]           Id.

[12]             Stephen Bainbridge, Facebook’s Proposed Issuance of Nonvoting Stock Challenged in Delaware Chancery Court, Professor Bainbridge (May 2, 2016), http://www.professorbainbridge.com/professorbainbridgecom/2016/05/facebooks-proposed-issuance-of-nonvoting-stock-challenged-in-delaware-chancery-court.html.

[13]             Complaint, Sjunde AP-Fonden, et. al. v. Facebook, No. 12318- (Del. Ch. filed May 10, 2016).

[14]          Id, at 32.

[15]             Richard Moroney, Not All Shares Are Created Equal: More Multiclass Stocks to Join Google in the S&P 500, Forbes (July 16, 2014), http://www.forbes.com/sites/investor/2014/07/16/not-all-shares-are-created-equal-more-multiclass-stocks-to-join-google-in-the-sp-500/#3330cc69739e.

[16]             Id.

[17]             Id.

[18]             Tom Hals, Google Settlement Clears Way for New Class C Stock, Reuters (June 17, 2013), http://www.reuters.com/article/us-google-stockplan-settlement-idUSBRE95G0MU20130617.

[19]          Therese Poletti, IPO Investors: Beware of the Dual Class Stock, Marketwatch (April 5, 2012), https://secure.marketwatch.com/story/ipo-investors-beware-the-dual-class-stock-2012-04-05.

[20]          Id.; see also Anna S. Han, The Facebook IPOs Face Off With Dual Class Stock Structure, U. Mich J.L. Reform A50,50-53 (April 11, 2012), https://mjlr.org/2012/04/11/the-facebook-ipos-face-off-with-dual-class-stock-structure-2/#fn-1166-4.

[21]             Id.

[22]             Han supra.

[23]             Id.; see also Dan Bigman, Facebook Ownership Structure Should Scare Investors More Than Botched IPO, Fortune (May 23, 2012), http://www.forbes.com/sites/danbigman/2012/05/23/facebook-ownership-structure-should-scare-investors-more-than-botched-ipo/#5d20c00f4341.

[24]             Jeffrey N. Gordon, Ties that Bond: Dual Class Common Stock and the Problem of Shareholder Choice, Calif. L. Rev. 1,1-12 (1988) n. 4.

[25]             Id.

[26]             Id.

[27]             Tian Wen, You Can’t Sell Your Firm and Own it Too: Disallowing Dual-Class Stock Companies From Listing on the Securities Exchanges, U. PA. L. Rev., 1495-97 (2014); citing NYSE MANUAL, § 303A.00, 01, 04, & 05, http://nysemanual.nyse.com/LCMTools/PlatformViewer.asp?selectednode=chp%5F1%5F4%5F3&manual=%2Flcm%2Fsections%2Flcm%2Dsections%2F.

[28]             Id.

[29]          Complaint at 6, Eric McGinty, et. al. v. Facebook, No. 12282- (Del. Ch. filed April 29, 2016), available at http://blogs.reuters.com/alison-frankel/files/2016/05/zuckerbergdelaware-mcginty.pdf.

[30]             Stephen Bainbridge, Facebook’s Proposed Issuance of Nonvoting Stock Challenged in Delaware Chancery Court, Professor Bainbridge (May 2, 2016), http://www.professorbainbridge.com/professorbainbridgecom/2016/05/facebooks-proposed-issuance-of-nonvoting-stock-challenged-in-delaware-chancery-court.html.

[31]             In re Ezcorp Inc. Consulting Agreement Derivative Litig., No. CV 9962-VCL, 2016 WL 301245 (Del. Ch. Jan. 25, 2016).

[32]             Bainbridge supra n. 16.

[33]           Id.