Investors Sue Facebook Over Proposed New Stock Class

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By Michael Greene

May 2 — Investors are challenging Facebook Inc.'s plan to create a new class of non-voting stock, saying that the move would improperly entrench founder and controlling stockholder Mark Zuckerberg.

Two purported class actions—both filed April 29 in the Delaware Chancery Court—similarly alleged that Facebook directors breached their fiduciary duties by supporting the new Class C shares, which provide no voting rights.

If approved by shareholders, the new stock class will create about 5.7 billion new Facebook shares.

In an April 27 preliminary proxy statement, Facebook's board recommended that shareholders approve the new class of stock at the company's annual meeting scheduled for June 20. Under the proposed plan, the company would potentially pay a dividend of two shares of Class C stock for each share of Class A and Class B stock.

“We believe this proposal is in the best interests of the company and all stockholders for the reasons detailed in the Preliminary Proxy Statement,” a Facebook spokesperson said in a statement e-mailed May 2 to Bloomberg BNA.

Zuckerberg's Controlling Interests

Under Facebook's current structure, Class A shares have one vote per share, and Class B shares have 10 votes per share. Zuckerberg, who owns or controls the majority of Class B stock, has over 60 percent of the voting power in Facebook.

The plaintiff investors face an uphill battle in their lawsuits because the directors' decisions will most likely be protected under the deferential business judgment rule, Charles Elson, director of the University of Delaware’s John L. Weinberg Center for Corporate Governance, told Bloomberg BNA. The shareholders didn’t have voting control before the proposed changes so the reclassification doesn’t really take anything away from them, he said.

Elson added that the bigger issue is creating the dual-class stock. Delaware law permits the structure, which imposes distinct voting rights and dividends for different classes of shareholders.

Elson said that such a structure separates the control of the company from its economic interests by creating a class of shareholders with less voting rights. Ultimately, this insulates management from shareholder accountability, he said. “There is no shareholder benefit.”

Equity for Nothing?

In their lawsuits, the investors alleged that the new class of shares was proposed for the sole purpose of ensuring that Zuckerberg remains in control of Facebook.

“The issuance of the Class C stock will, in effect, have the same effect as a grant to Zuckerberg of billions of dollars in equity, for which he will pay nothing,” shareholder plaintiff Eric McGinty's complaint said.

“This distribution of non-voting stock will allow Facebook to use Class C stock to purchase other companies or issue stock to employees without diluting Zuckerberg’s voting power or diminishing his vise-like grip over Company management and operations (which includes the ability to appoint the entire Board of Directors),” shareholder plaintiff Pedro Ramirez Jr.'s complaint said.

Both lawsuits claimed that the special committee of directors that approved the proposal didn't “bargain hard” with Zuckerberg to obtain anything in return for an “extraordinarily valuable benefit.”

The lawsuits also alleged that the directors didn't disclose all material information in connection with the reclassification of stock.

To contact the reporter on this story: Michael Greene in Washington at mgreene@bna.com

To contact the editor responsible for this story: Yin Wilczek at ywilczek@bna.com

For More Information

McGinty's complaint is available at http://src.bna.com/eA4.

Ramirez's complaint is available at http://src.bna.com/eA6.