Monday, June 01, 2020

SEC reverses stance against control share statutes

By Anne Sherry, J.D.

The SEC’s Division of Investment Management reversed its decade-long position against funds’ use of control share statutes to prevent hostile takeovers. By withdrawing its 2010 guidance and replacing it with a no-action position, the staff will allow closed-end funds to use statutes that restrict voting rights for control shares as long as the board does so with reasonable care. The no-action position has no legal force or effect, and the Division is seeking comment on whether the SEC should take further action and what factors it should consider.

The Division’s statement notes that about half the states have enacted control share statutes, including Maryland and Massachusetts, but not Delaware. (The vast majority of listed closed-end funds are organized in one of those three states.) These statutes allow companies, including closed-end funds, to alter or remove voting rights when a person acquires or controls a certain percentage of the company’s voting power. Once stripped, voting rights can typically only be restored by a supermajority vote of other stockholders.

On the other hand, Investment Company Act Section 18(i) requires that "every share of stock hereafter issued by a registered management company be a voting stock and have equal voting rights with every other outstanding voting stock." In the 2010 guidance, the staff clarified its view that a closed-end fund’s use of the Maryland Control Share Acquisition Act to restrict shareholders’ ability to vote control shares would run afoul of Section 18(i). The staff there said the "tactic would discriminate against certain shareholders by denying important voting rights and would contribute to the entrenchment of management."

Following SEC Chairman Jay Clayton’s directive in 2018 to reexamine prior staff statements and documents in general, the Division decided to withdraw the 2010 letter. The staff considered market developments and feedback from market participants. Specifically, the staff found that the number of closed-end funds has declined considerably in the last ten years, although it acknowledged that the 2010 guidance may have had something to do with that. It also considered recent comments on the SEC’s proposed rule on fund of funds arrangements.

The staff’s new position is that it will not recommend enforcement action against closed-end funds that opt into and trigger a control share statute "if the decision to do so by the board of the fund was taken with reasonable care on a basis consistent with other applicable duties and laws and the duty to the fund and its shareholders." Any actions taken by the board will be examined in light of the board’s fiduciary obligations to the fund, applicable federal and state law, and the facts and circumstances surrounding the action. The staff also clarified that its position does not address other defense measures, such as poison pills.

Request for comments. The no-action position is the staff’s view and does not have legal force or effect. The staff is requesting comments on whether the SEC should take additional action to provide more certainty in this area. The staff is particularly interested to hear of the practical and functional impacts when funds trigger control share statutes; the considerations a fund’s board would take into account in determining whether to use a statute; whether the ability to opt in to a control share statute would affect a fund’s compliance with the federal securities laws (other than Section 18(i)); and whether the staff should recommend that the SEC address a closed-end fund’s ability to opt in to a control share statute in accordance with Section 18(i).