How Facebook silences its investors

The latest round of scrutiny and outrage over Facebook’s (FB) business practices has lots of fingers pointing in Mark Zuckerberg’s direction. But one important voice has long been muffled at the company: shareholders.

The way Facebook stock is structured, Zuckerberg essentially has complete veto power over other shareholders when it comes to the company’s shareholder votes. Just this year alone, Zuckerberg has been able to beat back efforts by other shareholders who have asked the company to report both on its efforts to combat child sexual exploitation through its products and on its efforts to fight its use as a home for disinformation, hate speech, and the incitement of racial violence.

Investors often don’t think about it, but shareholders are the owners of a company. A chief executive officer--even as a founder--is just as much an employee of the company as anyone else who shows up to work. That’s why there are corporate boards, which are supposed to act as elected shareholders' representatives. (At Facebook, Zuckerberg is both CEO and board chair, a situation that shareholders have tried to change, but he also voted that down.)

Shareholders get to voice their opinions of company management and key business issues through proxy voting. At most companies, one share equals one vote.

But at Facebook, it’s a different story. Some shareholders--mainly Zuckerberg--are “more equal than others,” as George Orwell once wrote.

The Facebook shares that you and I, along with big investors like mutual funds, can buy are Class A shares, of which there are roughly 2.4 billion in the market. We get one vote for each share. But Zuckerberg and a select group of others own Class B shares, which afford them 10 votes per share. There are roughly 440 million Class B shares.

Zuckerberg personally owns nearly 360 million Class B shares, and through agreements with other Class B shareholders, controls the vote of another 32 million. That gives him control of some 392 million Class B Shares, some 90% of the total.

Here’s how it plays out when it comes to proxy voting.

Facebook isn’t alone in having super-voting rights on some share classes. The ranks of those companies include Warren Buffett’s Berkshire Hathaway (BRK.A), Alphabet (aka Google) (GOOGL), and Lyft (LYFT).

But Jackie Cook, Morningstar’s director of investment stewardship research, calls Facebook “an extreme example” in disenfranchising other shareholders.

One way to see the impact Facebook’s share class structure has in silencing shareholders is to consider how the results on shareholder resolutions would have looked without the Class B share votes.

Take the proposal that asked the Facebook board to assess the risk of increased child sexual exploitation as the company develops additional privacy tools such as end-to-end encryption. This proposal was filed last year by shareholder-advocacy firm Proxy Impact on behalf of Lisette Cooper, the vice chairman of Fiduciary Trust International, a unit of Franklin Templeton. Cooper has shared that her daughter was groomed by a predator on Facebook.

When all votes were counted, the proposal only received 17% support, with 980 million votes in favor and 4.7 billion against. That would seem to be a clear rejection of that proposal. However, if the Class B shares are excluded--remember Zuckerberg controls 90% of them--the resolution would have received majority support at 56%.

Proxy Impact is expected to refile its proposal.

Sustainalytics’ corporate governance analyst Denisa Ghita notes that Facebook goes even further than most other companies with that share class structure, with provisions limiting board independence and shareholder rights that kick in should the voting power of Class B shares drop below 50%. Should that happen, the board of directors becomes classified, meaning the company will no longer have annual board elections and shareholders will have the right to remove directors only for “cause.” Plus, stockholders would be deprived of what is known as the right to act by written consent, which allows for shareholder action outside of a shareholders’ meeting. Should they come into play, these provisions would “make the current governance structure even less shareholder-friendly,” Ghita says.

Cook notes that the argument is sometimes made that super-voting rights help certain types of young companies avoid short-term earnings pressures while pursuing growth early on after their IPOs. The Council of Institutional Investors, she notes, has said that, while a single class of shares is the optimal, it is reasonable to have a maximum seven-year sunset provision in place on dual class share structures. Even under that scenario, Facebook would have ended its dual class structure in 2019.

Another response to share class structures like those at Facebook is: “If you don’t like it, then don’t own the stock.”

That’s a simplistic way to look at the question and ignores one obvious problem: Facebook, because of its size, is a major holding in many index funds, where selling the company’s stock is not an option. In fact, based on holdings data in Morningstar Direct, roughly 18% of Facebook stock is held in index-tracking fund strategies around the world. (That percentage doesn’t include index-based strategies held in other kinds of accounts, such as institutional portfolios.)

In the United States, for example, six of the 10 largest mutual fund holders of Facebook shares are index funds.

In fact, just Vanguard and BlackRock combined hold about as many shares as Zuckerberg. But the share class structure effectively nullifies the voice of their investors.

From a broader, stock investors' perspective, senior equity analyst Ali Mogharabi writes that, “Our main knock on Facebook’s management is its use of multiple class structures that may limit the voice of minority shareholders. This has become more of an issue given how Facebook is addressing data privacy and security, which has led to some shareholders wanting to reduce Zuckerberg's control of the company. Some continue to believe that Zuckerberg's control of Facebook may result in significant conflict of interest depending on his future strategies and whether they generate exceptional returns for shareholders, as they have in the past.”

For now, Mogharabi believes that negative headlines over its policies will likely keep Facebook under pressure, but from a valuation standpoint, shares are currently undervalued.

The share class structure has deterred at least one shareholder activist for now. Jonas Kron, chief advocacy officer at Trillium Asset Management, who has introduced a number of shareholder proposals to separate Facebook's chairman and CEO roles, says Trillium is no longer a shareholder--it once held $12.8 million worth of the stock--partly because Zuckerberg and his voting bloc, "has been resolutely opposed to any meaningful governance reforms." He notes that Zuckerberg has repeatedly apologized for the company's failures and said that it is his responsibility to fix them, but he has failed to do so. “Relinquishing control is a cornerstone of the company moving forward."