Facebook hit by lawsuit after Mark Zuckerberg proposed new stock scheme to keep him in control

The plan to amend Facebook's stock structure will have the same effect as a grant to Zuckerberg of 'billions of dollars in equity', lawyers argued


Zlata Rodionova
Tuesday 03 May 2016 11:03
 Facebook’s founder has vowed to give 99% of his wealth to charity during his lifetime in December last year
Facebook’s founder has vowed to give 99% of his wealth to charity during his lifetime in December last year

Facebook has been hit by lawsuit just days after Mark Zuckerberg proposed to create a new class of common shares that will enable him to have a tighter control over his company.

The proposed class-action lawsuit, filed in Delaware on April 29, argues that Zuckerberg’s plans to amend Facebook's stock structure is unfair to shareholders and serves only to benefit its founder.

“The issuance of the Class C stock will have the same effect as a grant to Zuckerberg of billions of dollars in equity, for which he will pay nothing,” the lawsuit said.

But Facebook said the plan “is in the best interests of the company and all stockholders” as keeping Zuckerberg in control would ensure the company’s future success.

“This proposal is designed to create a capital structure that will, among other things, allow us to remain focused on Mr. Zuckerberg's long-term vision for our company and encourage Mr. Zuckerberg to remain in an active leadership role at Facebook,” the company said.

Most companies are run on a principle of one share, one vote, meaning that the founder and CEO of the company could get fired if other shareholders thought someone else could do a better job.

Facebook has a structure to avoid this situation as Zuckerberg’s Class B shares give him 60 per cent of the vote on the major issues for the social network. This is already down from 67 per cent two years ago and Facebook’s founder has vowed to give 99 per cent of his wealth to charity during his lifetime in December last year. This means his voting power could drop below 50 per cent, releasing his control over the company.

Facebook’s new class of C shares, announced together with the company's first quarter results last Wednesday, would have the same economic rights as other shares but wouldn’t have voting rights. This means that, if approved by shareholders, Facebook will be allowed to distribute them to employees and acquisitions without diluting Zuckerberg’s control of the company.

"It is not uncommon for a company to issue various classes of shares to investors, with different rights attached to each class. Non-voting shares are issued where a company wishes to raise funds but retain control. This is what Zuckerberg is doing. In doing so, Facebook receives investment, and simultaneously, Zuckerberg retains control," Catherine Gannon, managing partner at law firm Gannons told the Independent.

Shareholders are scheduled to vote on the proposal at the company’s annual meeting on June 20.

Stephen Diamond, associate professor of law at Santa Clara University, told the Financial Times that the plan represents “the worst practice in corporate governance” as it separates cash from control.

But some investors said they were not concerned that Zuckerberg would have increasing control because of the company's consistent ability to grow and exceed expectations.

“I honestly don’t think that anyone cares if he has more power, since he’s done everything right since they went public,” said Michael Patcher, Wedbush Securities analyst.

Facebook has beaten expectations for its first quarter pushed by its robust mobile advertising business and a growing number of users. On Wednesday it reported earnings of $1.51 billion (£1bn) up from $512 million in the same period a year earlier. Facebook’s user rank grew to 1.65 billion from 1.44 billion in the first quarter last year.

Google settled a lawsuit in 2013 that cleared the way for the company to execute a similar plan.

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