Loyalty share programmes, or programmes that encourage shareholders to hold their shares for longer periods of time, have been gaining traction in Europe, but for a number of reasons they remain uncommon in the United States.
"Long-term oriented shareholders, who hold on to their shares during the difficult but critical time the company is facing [will thus be rewarded]." This is how the CEO of Michelin explained the motivation behind the issuance of loyalty shares by his company in 1991. Loyalty shares (typically in the form of additional shares or dividends) that reward shareholders who hold shares for a certain period of time, and other similar programmes, have become increasingly popular in European countries as a way to incentivise long-term shareholding.
They are now slowly making their way into the United States but there are a number of issues US companies should be aware of before launching such a programme.
EUROPEAN LOYALTY SHARE PROGRAMMES
Rewarding long-term shareholding has been subject to regulation by the European Union since 2007 when the European Parliament passed Directive 2007/36/EC to regulate the exercise of certain rights of shareholders in listed companies. The Directive provides a limited framework for encouraging a higher level of monitoring and engagement by institutional investors and asset managers, and leaves these issues in the hands of the individual EU Member States.
France offers several mechanisms to support long-term shareholding, the latest having been implemented in March 2014 with the adoption of the Loi Florange. French listed companies must automatically grant double voting rights to shareholders who hold their shares in registered form for at least two years, and non-listed companies may grant double voting rights to shareholders who hold their shares in registered form for the same period.
Listed and non-listed French companies may also issue L-warrants to certain shareholders, or grant loyalty dividends under certain conditions. These loyalty schemes have been implemented by many major French listed companies, such as L'Oréal, Electricité de France and Crédit Agricole (as a loyalty dividend), or Vivendi, Engie, and Air France KLM (as double voting rights).
Other European countries have adopted similar mechanisms. The Netherlands permits companies to grant multiple voting rights to certain categories of shareholders if the companies register their shares in a Loyalty Register. This scheme was notably used by Ferrari NV in its initial public offering (IPO), and by Fiat Chrysler Automobiles NV upon completion of the cross-border reverse merger by Chrysler-Fiat with and into Fiat Investments NV in 2014.
In Italy, a 2010 Legislative Decree allowed listed companies to pay increased dividends to shareholders that hold common shares for at least one year. In 2014, a reform authorised both listed and non-listed Italian companies to issue shares with multiple voting rights. These schemes have been successful, and many Italian companies, including Campari and Amplifon, have awarded loyalty shares to certain categories of shareholders.
US LOYALTY SHARE PROGRAMMES
Despite the popularity of loyalty share programmes in Europe, US companies have been slow to implement them. The US stock market is generally characterised by "short-termism": a focus on short-term results at the expense of long-term performance, driven in part by the need to report quarterly earnings. US shareholders, many of which are institutional investors, therefore tend to hold their shares for only a short period of time. According to the 2016 New York Stock Exchange (NYSE) Group turnover statistics, the annualised turnover for shares listed and traded on the NYSE at the end of 2016 was 70 per cent, indicating that a majority of shareholders held their shares for less than one year.
The US Securities and Exchange Commission (SEC) attempted to promote long-term shareholding by proposing a rule that would have provided shareholders that held a significant amount of company stock for at least three years the right to include in the company's proxy statement their own director nominees. The rule was ultimately invalidated by US courts, but that did not stop companies from voluntarily, or, in response to shareholder activist demands, adopting their own proxy access bylaws.
Proxy access provisions can now be found in the bylaws of a majority of the Fortune 500 and, generally, they also require at least three years of ownership to be eligible to nominate director candidates for inclusion in the company's proxy statement. The SEC has, however, not yet adopted mechanisms expressly permitting loyalty shares, voting rights and dividends. Given the lack of regulatory framework, loyalty share programmes remain a novelty in the United States.
Some US companies have, however, ventured into these relatively uncharted waters. For example, The J.M. Smucker Company has adopted "time phased voting," allowing each share held for more than four years to have 10 votes per share (instead of one vote) on certain matters, and NexPoint Credit Strategies Fund has offered a 2 per cent match to shareholders who hold the fund's common shares for at least one year.
Other companies have offered warrants to purchase shares that are exercisable at a certain period of time in the future, such as Check-Cap Ltd., an Israeli company that issued warrants to its US IPO purchasers in 2015, permitting such purchasers to acquire common shares at a fixed purchase price if they held their IPO shares for a minimum of one year.
REGISTRATION OF LOYALTY SHARES
If a company decides to pursue a loyalty share programme for its US shareholders, it should consider whether or not the programme constitutes a "sale" or an "offer to sell" a security that requires registration under the Securities Act of 1933.
Depending on the facts and circumstances, the SEC might view a loyalty share as being more similar to a "right" issued in a rights offering, in that the holder can elect to exercise that right by foregoing the legal right to transfer its underlying shares, thereby accepting investment risk in exchange for receiving the loyalty share. Even though there is no exercise price for a loyalty share, there could be "value" flowing back to the company in the form of loyalty, lack of volatility and other indirect benefits that long-term shareholders provide to the company.
The SEC may also take a "remedy-based" approach, by stating that the holder who chose to "register" his "intent" to be loyal is making an investment decision. If he is "penalised" for holding the underlying shares, i.e., the share price drops while he is trying to make it to the loyalty date, he should therefore be entitled to receive, as damages, the "consideration" he "paid" for registering into the loyalty share programme.
Given the novel structure of US loyalty share programmes, and the lack of precedent or specific support for loyalty shares without registration, companies would be prudent to either register such shares or, at a minimum, seek no-action relief from the SEC.
These are only a few of the issues that a company should consider before implementing a US loyalty share programme. Because of the lack of regulatory guidance in the United States, in contrast with Europe, companies should tread carefully if they decide to proceed with such a programme in the United States.
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