The staff of the Securities and Exchange Commission’s Division of Investment Management (Staff) released a statement on May 27, 2020 (Statement),¹ indicating that the Staff would not recommend enforcement against registered closed-end investment companies (including closed-end investment companies that have elected to be regulated as business development companies), which elect to opt in to control share statutes under state law. This Dechert OnPoint summarizes the Statement and discusses implications for closed-end funds.

As background, many states, including Maryland, the domicile of a number of closed-end funds,² have enacted control share acquisition statutes in an attempt to protect certain business entities from shareholder activism. Generally, these statutes provide that when a shareholder acquires certain threshold amount(s) of fund shares, that shareholder will have no voting rights with respect to those shares unless a certain percentage of the other shareholders vote to allow voting rights. Control share statutes typically apply to closed-end funds, but not to registered open-end funds.

In 2010, the Staff denied no-action relief to a closed-end fund that sought to opt in to Maryland’s control share acquisition statute (Boulder Letter).³ The Staff took the position that, for closed-end funds, opting in to and using state control share acquisition statutes was incompatible with the requirement under Section 18(i) of the Investment Company Act of 1940 that “every share of stock hereafter issued by a registered management company ... shall be a voting stock and have equal voting rights with every other outstanding voting stock.” Under the Staff’s view at the time, allowing closed-end funds to opt in to control share acquisition statutes would disenfranchise shareholders and stand contrary to the mandate of Section 18(i). Since the Boulder Letter was issued in 2010, the Staff has continuously asserted these views and sought compliance with its position in the Boulder Letter through the disclosure review process for closed-end funds.

In the Statement, which withdraws the Boulder Letter, the Staff stated that it would not recommend enforcement if a closed-end fund opts in to and uses state control share statutes so long as “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 generally.” According to the Statement, the board’s decision should be based on facts and circumstances, in light of its fiduciary obligations and applicable state and federal law.

The Staff also requested comments from market participants as to whether the SEC should expand its position further and how the withdrawal of the Boulder Letter will affect investment companies and other market actors. Specifically, the Staff is seeking input on the following issues, among others:

• The impact on management, shareholders and the funds themselves, if closed-end funds opt in to and use control share statutes;
• The effect of other available defensive measures on a fund’s decision to opt in to and use a control share statute;
• The specific facts and circumstances under which a fund board might decide to opt in to or use a control share statute;
• The effect of opting in to a control share statute on the fund’s compliance with other provisions of the federal securities laws; and
• The advisability of the Staff asking the SEC for additional guidance on the topic of control share statutes and compliance with Section 18(i) of the 1940 Act.⁴

In light of the Staff’s Statement, the boards of closed-end funds organized as Maryland corporations may wish to consider whether to opt in to Maryland’s control share acquisition statute.

Additionally, although the Massachusetts control share acquisition statute does not explicitly apply to Massachusetts business trusts, the typical form of organization for closed-end funds in the state, the statute provides that “[n]o provisions of this chapter shall be deemed to limit the power of an association or trust to amend its instrument or declaration of trust to the extent otherwise lawful.”⁵ Thus, because the statute allows Massachusetts business trusts to amend their declarations of trust in a lawful manner, and because the Statement allows closed-end funds to opt in to control share acquisition statutes, closed-end funds organized as Massachusetts business trusts may wish to consider whether to opt in to the state’s control share acquisition statute.

Finally, although Delaware does not have a control share acquisition statute, in light of the Staff’s Statement, closed-end funds organized as Delaware statutory trusts and Delaware corporations may wish to consider whether to adopt provisions in their declarations of trust and certificates of incorporation, respectively, similar to those set forth in the control share acquisition statutes of other states.

Footnotes

1) SEC Division of Investment Management Staff Statement on Control Share Acquisition Statutes, May 27, 2020. See also, SEC Chairman Jay Clayton, Public Statement on Investment Company Act Section 18(i), May 27, 2020. Chairman Clayton thanks the Staff for the Statement and states that he “look[s] forward to reviewing any future [S]taff recommendations that result from that [public] input.”

2) Md. Code Ann., Corps. & Ass’ns § 3-702. The Massachusetts control share acquisition statute applies to “issuing public corporations,” a term that does not include Massachusetts business trusts. Mass. Gen. Laws Ann. Pt. I, tit. XV, Ch. 110D, §§ 1-2, 5, 8. Delaware does not have a control share statute for investment funds.

3) Boulder Total Return Fund, SEC No-Action Letter, Nov. 15, 2010.

4) IM Staff Statement on Control Share Acquisition Statutes.

5) Mass. Gen. Laws Ann. Pt. I, tit. XV, Ch. 110D, § 8.