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ICI Submission to SEC on CEF Activists

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ICI Submission to SEC on CEF Activists Recommendations Regarding the Availability of Closed-End Fund Takeover Defenses MARCH 2020 WASHINGTON, DC // LONDON // HONG KONG // WWW.ICI.ORG Recommendations Regarding the Availability of Closed-End Fund Takeover Defenses The Investment Company Institute 1 recommends that the Securities and Exchange Commission issue guidance clarifying the ability of closed-end funds to employ certain defenses against hostile campaigns from “activist” investors.2 In 2010, the Commission’s staff issued a no- action response, Boulder Total Return Fund, Inc.,3 that questioned whether closed-end funds could employ certain takeover defenses available under state law consistent with the Investment Company Act of 1940. Although the defense measure at issue in Boulder was the Maryland “control share” statute, the letter’s reasoning arguably implicates a number of defenses otherwise available to funds organized in various states. As a result, closed-end funds and their boards have been limited in their ability to defend against activists. The activist campaigns have since grown more numerous and sophisticated, harming the interests of long-term fund investors. The conclusions of the Boulder letter are incorrect, and the use of several common takeover defenses authorized by state law are fully consistent with both the language of the Investment Company Act and its underlying purposes. Especially in light of the considerable negative impact of the intensified activist attacks on closed-end funds and their shareholders, we recommend that the Boulder letter be withdrawn, and that the Commission issue guidance clarifying that closed- end funds can employ, among others, the common takeover defenses discussed below consistent with the Investment Company Act. 1 The Investment Company Institute (ICI) is the leading association representing regulated funds globally, including mutual funds, exchange-traded funds (ETFs), closed-end funds, and unit investment trusts in the United States, and similar funds offered to investors in jurisdictions worldwide. ICI seeks to encourage adherence to high ethical standards, promote public understanding, and otherwise advance the interests of funds, their shareholders, directors, and advisers. ICI’s members manage total assets of US$25.2 trillion in the United States, serving more than 100 million US shareholders, and US$7.7 trillion in assets in other jurisdictions. ICI carries out its international work through ICI Global , with offices in London, Hong Kong, and Washington, DC. 2 We use the terms activist investor, activist shareholder, and activist interchangeably throughout this document. 3 Boulder Total Return Fund, Inc. , 2010 WL 4630835, at *1 (S.E.C. No-Action Letter Nov. 15, 2010) ( Boulder ). Table of Contents I. Executive Summary .........................................................................................................3 II. The Negative Impact of Activist Campaigns on Closed-End Funds ................................5 A. How Activists Pursue Their Self-Interested Agenda ...............................................5 B. Growing Intensity of Activist Campaigns ...............................................................9 C. The Negative Effect of Activist Campaigns on Funds and Long-Term Investors ............................................................................................11 III. Takeover Defenses of Potential Use to Closed-End Fund Boards ................................15 IV. Relevant Provisions Under the Investment Company Act .............................................16 A. Section 18(i) .............................................................................................................16 B. Other Investment Company Act Provisions ............................................................21 V. Takeover Defenses Are Consistent with the Investment Company Act ........................23 A. Section 18(i) Does Not Prohibit the Use of Voting-Related Takeover Defenses by Closed-End Funds ................................................................................23 B. Common Takeover Defenses Not Implicating Voting Rights Are Consistent with the Investment Company Act ...................................................25 C. Enabling Independent Directors to Use Takeover Defenses to Prevent Detrimental Arbitrage Efforts Furthers the Purposes of the Investment Company Act ...............................................................................26 D. The Availability of Defenses Against Activist Campaigns Will Not Preclude Other Types of Shareholder Proposals and Initiatives ............................................................................................................30 VI. Enabling Independent Directors to Use Takeover Defense Measures to Ensure the Availability of Closed-End Funds for Retail Investors Promotes the SEC’s Policy Goals ..................................................................................30 VII. The Boulder Letter Should Be Withdrawn, and Commission Guidance Should Be Issued to Make Clear That Common Takeover Defense Measures Are Available to the Directors of Closed-End Funds .....................................31 Appendix A: The Closed-End Fund Market and Survey Results ..........................................32 Appendix B: Examples of Activist Campaigns ......................................................................41 Appendix C: Closed-End Fund Pricing, Activist Shareholder Activity, and Case Studies .......................................................................................................................51 Appendix D: Takeover Defenses Authorized by State Law ...................................................71 Appendix E: Legislative History of Investment Company Act Provisions ............................78 Appendix F: SEC and Court Interpretations of Section 18(i) .................................................86 Appendix G: State Equal Voting Rights Provisions ...............................................................91 -2- I. Executive Summary In recent years, activist investors have intensified their efforts to seize a controlling interest in closed-end funds to pursue a self-interested agenda to extract short-term profits. These arbitrage tactics cause serious harm to funds and work against the interests of their long-term investors, including forcing fundamental changes to the products that are contrary to what stockholders sought when making their investment. Activists also can demand actions that can cause funds to shrink in size or be liquidated altogether, thereby reducing the availability of closed-end funds to investors and increasing costs. Decreasing the number of closed-end funds harms a large demographic of closed-end fund shareholders—including retirees many of whom rely on the dividends from closed-end funds.4 If a closed-end fund board concludes that an activist’s goals are not in the best interests of the fund and its shareholders, the directors may wish to employ one or more of the common takeover defenses authorized under applicable state law. 5 Like registered mutual funds, closed-end funds are governed by both federal and state law, and defensive measures must therefore comply with applicable state law and the Investment Company Act. Defenses that limit a concentrated shareholder’s ability to exercise its votes potentially implicate the share voting requirements in Section 18(i) of the Investment Company Act. Section 18(i) requires that “every share of [fund] stock…be a voting stock and have equal voting rights with every other outstanding voting stock.” The question addressed in the Boulder letter was whether a closed-end fund’s use of Maryland’s control share statute as a takeover defense was consistent with Section 18(i)’s “voting stock” and “equal voting rights” requirements—and the staff concluded that it was not. We believe that the Boulder letter’s reasoning is incorrect. There is no legal basis under the Investment Company Act to restrict closed-end funds’ use of certain common takeover defenses limiting the voting rights of concentrated shareholders. 6 Contrary to the staff’s conclusion in Boulder , neither the language of Section 18(i) nor the purposes underlying the Investment Company Act warrant such a limitation on the discretion of independent directors. Defensive measures limiting the ability of a given stockholder to exercise its votes do not strip the stock itself of its voting rights. Federal and state courts have correctly held that Section 18(i) and similar state law provisions guaranteeing equal voting rights to shares of stock do not limit the use of takeover defenses that differentiate among stockholders. The conclusion in the Boulder letter that Section 18(i) prohibits differentiation among stockholders is contrary to this authority, and is unsupported by the statute’s language and structure. 7 And while this letter focuses primarily on Section 18(i) and Boulder , other common takeover defenses unrelated to the voting rights of concentrated shareholders ( e.g. , requiring a majority of outstanding shares to elect directors, limiting the authority of non-continuing directors) are equally consistent with the language and structure of the Investment Company Act. 4 We discuss the tactics and impact of activists in Section II, and present additional data in Appendices A, B, and C. 5 See Section III and Appendix D. In making these determinations, closed-end fund directors, pursuant to their fiduciary duties, must weigh the activists’ interests,
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