SEC Staff Withdraws Prior No-Action Letter on Control Share Acquisition Statutes
Requests Feedback on Control Share Statutes & CEFs
On May 27, 2020, the staff of the Division of Investment Management (IM) of the Securities and Exchange Commission (SEC) issued a statement (IM Statement) withdrawing a previous letter that interpreted Section 18(i) of the Investment Company Act of 1940 (1940 Act) as pre-empting the ability of closed-end funds to opt into state law control share acquisition statutes (Control Share Statutes).1 Control Share Statutes typically enable a company to prevent or restrict certain changes in control by altering or removing voting rights when a person acquires, directly or indirectly, the ownership of, or the power to direct the vote of, control shares as defined in the specific Control Share Statute. The IM Statement replaces the withdrawn letter with no-action relief if a closed-fund opts into and triggers a Control Share Statute as long as the fund board’s decision to do so was taken with reasonable care on a basis consistent with other applicable duties and laws and the duty to the fund and its shareholders generally. The IM Statement indicates that any future action concerning a closed-end fund’s ability to trigger a Control Share Statute should come from the SEC and not from its staff.
The IM Statement was accompanied by a statement from SEC Chairman Jay Clayton (Chairman’s Statement).2 The Chairman’s Statement reiterated the IM Statement’s position that the SEC, rather than the staff, should take any further action in the area. The IM Statement and the Chairman’s Statement represent another chapter in the SEC staff’s continuing review of prior staff statements and documents to determine whether they should be modified, rescinded, or supplemented in light of market or other developments.
Prior Interpretation – Withdrawn Letter
In 2010, IM issued a letter (Withdrawn Letter) interpreting whether Section 18(i) of the 1940 Act would preempt a closed-end fund from opting into the Maryland Control Share Acquisition Act (MCSAA).3 The Withdrawn Letter notes that the MCSAA enables Maryland corporations to take away the ability of certain shareholders to vote so-called “control shares.” Under the MCSAA, once holders of control shares lose their voting rights, they may not vote their control shares unless and until the corporation’s stockholders vote to approve the restoration of the voting rights associated with the shares by a supermajority vote at a special meeting called for that purpose.
IM noted that Section 18(i) of the 1940 Act generally requires that every share of stock issued by a closed end fund be a voting stock and have equal voting rights with every other outstanding voting stock. The Withdrawn Letter stated that a principal purpose of Section 18(i) was to help prevent entrenchment of insider control. The Withdrawn Letter stated that “equal voting rights” meant more than that the characteristics of the share – including any contingent loss of voting rights – are identical when issued. Rather, the Withdrawn Letter stated that “equal voting rights” for purposes of Section 18(i) meant that a shareholder could never be stripped of its ability to vote its shares. Because the MCSAA would enable a closed-end fund to take away the voting rights of holders of control shares, the Withdrawn Letter took the view that opting into the MCSAA is not permitted under Section 18(i).
IM Statement
The IM Statement noted that SEC Chairman Clayton had instructed IM to review prior IM statements and documents to determine whether any such “statements and documents should be modified, rescinded or supplemented in light of market or other developments.” IM noted that it reviewed the Withdrawn Letter as well as market developments since the Withdrawn Letter was issued and recent feedback from affected market participants.
PRACTUS NOTE: The IM Statement cited comments on its proposed Fund of Funds Rule as recent feedback from affected market participants. While the staff did not elaborate in the IM Statement on the particular comments received, we note that commenters on that rule proposal discussed the disparate impact of the provision of the proposed rule that would require mirror voting when a registered fund purchased more than three percent of the shares of a closed-end fund but would not impose similar restrictions on private fund purchases of more than three percent of the shares of a closed fund.
We also note that requiring mirror voting or pass-through voting is itself a form of stripping voting rights from a shareholder, as the shareholder cannot exercise its own judgment on how to vote its shares.
The IM Statement stated that as a result of its review, it determined to withdraw the Withdrawn Letter. The IM Statement also stated that IM would not recommend enforcement action against a closed-end fund under Section 18(i) for opting in to and triggering a Control Share Statute if the decision to do so by the closed end fund’s board “was taken with reasonable care on a basis consistent with other applicable duties and laws and the duty to the fund and its shareholders generally.” The IM Statement cautioned market participants “that any actions taken by a board of a fund, including with regard to control share statutes, should be examined in light of (1) the board’s fiduciary obligations to the fund, (2) applicable federal and state law provisions, and (3) the particular facts and circumstances surrounding the board’s action.” (emphasis added)
The IM Statement then specifically requested feedback from market participants regarding the following issues:
- What are the practical and functional impacts on closed-end funds, their management, and their shareholders when funds opt-in and trigger Control Share Statutes? How are those impacts affected by the availability of other defensive measures? Relatedly, in what circumstances would the availability of other defensive measures affect a fund’s decision to opt-in to and trigger a Control Share Statute?
- What considerations would a fund’s board take into account in determining whether to opt-in to and trigger a Control Share Statute, particularly with regard to benefits to shareholders and compliance with the board’s fiduciary duty? Under what specific facts and circumstances would a board decide to opt-in to and trigger a Control Share Statute (or decline to do so)?
- Apart from Section 18(i), which turns on the meaning of “equal voting rights,” explain whether the ability to opt-in to and trigger a Control Share Statute would have a practical or functional impact on a fund’s compliance with other provisions of the federal securities laws, such as Section 12(d)(1)(E) of the 1940 Act, which requires pass-through or mirror voting for certain fund of funds arrangements, or Rule 13d-1 under the Securities Exchange Act of 1934, which limits the ability of certain shareholders to vote based on the size of their holding.
- Should the staff recommend that the Commission address the ability of a closed-end fund to opt-in and trigger a Control Share Statute in accordance with Section 18(i)?
PRACTUS NOTE: The IM Statement cited the decline in the number of listed closed end funds as an example of a market development since the Withdrawn Letter was issued. However, the IM Statement did not specifically seek comment on the possible impact of a closed end fund opting into a Control Share Statute on any premium or discount from its net asset value. While one request does focus on considerations that a fund’s board would take into account in determining whether to opt-in to and trigger a Control Share Statute, particularly with regard to benefits to shareholders and compliance with the board’s fiduciary duty, it is curious that a factor that is as important to listed closed-end fund shareholders as premium or discount to net asset value is not explicitly recognized.Conclusion
The IM Statement represents a significant change in the manner in which IM approaches issues under Section 18(i). On a practical level, it will make it easier for closed-end fund boards to defend against hostile takeovers. On an interpretive level, it may represent a recognition that the position taken in the Withdrawn Letter was difficult to harmonize with the proposed requirements elsewhere that certain fund shareholders pass through or mirror vote their shares. However, any closed end fund board that is asked to authorize its fund to opt in to a Control Share Statute will need to exercise care in its deliberations and decision making so that any such determination reflects a decision that can be readily defended as in the best interests of the fund and its shareholders rather than simply a transparent attempt to entrench fund management (and itself).1 Control Share Acquisition Statements, Staff Statement, Division of Investment Management (May 27, 2020) (https://www.sec.gov/investment/control-share-acquisition-statutes) (visited June 10, 2020).
2 Investment Company Act Section 18(i), Public Statement, SEC Chairman Jay Clayton (May 27, 2020) (https://www.sec.gov/news/public-statement/clayton-control-share-statutes-2020-05-27) (visited June 10, 2020).
3 Boulder Total Return Fund, SEC No-Action Letter (pub. avail. Nov. 15, 2010) (https://www.sec.gov/divisions/investment/noaction/2010/bouldertotalreturn111510.htm).
