Friday, July 08, 2016

Deutsche’s closed-end funds may not omit shareholder proposals seeking declassified boards

By Jacquelyn Lumb

The Division of Investment Management has advised closed-end funds Deutsche Strategic Income Trust and Deutsche Multi-Market Income Trust that it does not concur with their view that they may omit a shareholder proposal which seeks the declassification of their boards of directors. Western Investment, LLC submitted an identical proposal to both funds in which it sought the annual election of directors to improve board accountability and fund performance. The funds sought to omit the proposals on the basis that the supporting statements contained materially false and misleading information. The staff was unable to conclude that the funds had objectively demonstrated that the cited portions of the supporting statements were false and material in violation of Exchange Act Rule 14a-9.

Staggered boards and majority votes. The boards of both funds are currently divided into three classes that serve staggered three-year terms. Western said that a classified board protects incumbents, which limits their accountability to shareholders. Western also maintained that, in addition to requiring a near impossible absolute majority of shares outstanding to elect directors rather than a majority of the shares voting, the funds used other undemocratic tactics, including the failure to hold timely annual meetings.

The current investment manager has overseen significant losses at the two funds and their other sister funds, according to Western, six out of seven of which have or are scheduled to be liquidated or converted to open-end funds. If the proposal is adopted by the board, all of the directors would be subject to annual elections after the phase-in period, so that unexpired terms would not be affected.

The funds accused Western of attempting to impugn the character, reputation, and integrity of the investment manager by suggesting that the investment manager blocked shareholder rights with the absolute majority voting requirement. The funds noted that the by-laws establish the voting requirements, not the investment manager, and they also took issue with Western’s view that obtaining an absolute majority of shares is nearly impossible, claiming it has no basis.

Western noted that the investment manager has selected each of the board members, which are the same individuals for many Deutsche-sponsored funds. The investment manager has accepted the by-laws during its many years of operating the funds. Western also noted that in contested elections where discretionary voting by brokers is not permitted, obtaining a quorum can be difficult, let alone receiving a majority of outstanding votes.

Western noted that its proposal to declassify the board at another Deutsche fund passed with 68 percent of the vote in 2010, but the board took no action. After a no-confidence vote by shareholders at another of the funds in 2008, the fund declined to hold an annual meeting in 2009. This fund did not schedule a shareholder meeting in 2010 until Western compelled it to do so by filing a lawsuit. The majority vote standard at the Deutsche funds is designed to make contested elections fail, in Western’s view, and are also in contradiction to ISS corporate governance standards.

The funds also stated that it was materially misleading of Western to imply that by reclassifying the board, the net asset value and/or market value of the funds would increase, citing a lack of evidence to support its statement. Western advised that it was referring to the level of discount and the net asset value in its statement. In Western’s view, there is ample evidence that shareholder engagement and influence can lead to a more optimal valuation.

Staff response. The staff said it was unable to assure the funds that it would not recommend enforcement action if they omit the proposals or portions of Western’s supporting statements from their proxy materials in reliance on Rule 14a-8(i)(3).

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