Clifford J. Alexander, Jennifer R. Gonzalez, and George Zornada are partners at K&L Gates LLP. This post is based on a K&L Gates memorandum by Mr. Alexander, Ms. Gonzalez, Mr. Zornada, Steven B. Levine, Shane C. Shannon, and Jacob M. Derr. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).
In a potentially significant reversal of a prior Securities and Exchange Commission (SEC) staff position that could enhance the ability of closed-end funds to defend against activist shareholders, the Division of Investment Management of the SEC on May 27, 2020, withdrew a 2010 no-action letter that criticized the use by closed-end funds of certain defensive measures permitted under state corporate law. The 2010 letter, issued to Boulder Total Return Fund (Boulder Letter), [1] had long been an impediment to a closed-end fund opting in to state statutes that permit companies to restrict the ability of certain shareholders to vote control shares. The Boulder Letter stated that the SEC staff believed such a statute would be “inconsistent with the fundamental requirements of Section 18(i) of the Investment Company Act that every share of stock issued by [a fund] be voting stock and have equal voting rights with every other outstanding voting stock.”
The statement withdrawing the Boulder Letter (Statement) [2] adopts the position that the SEC staff “would not recommend enforcement action to the Commission against a closed-end fund under [S]ection 18(i) of the [Investment Company] Act for opting in to and triggering 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 generally.” The Statement also requests input as to whether the SEC staff should recommend that the SEC take additional action to provide clarity regarding the applicability of the 1940 Act to a closed-end fund’s decision to opt in to a control share statute. The withdrawal of the Boulder Letter and the latitude apparently offered by the Statement removes an SEC staff interpretation that arguably has had a chilling effect on closed-end funds’ and their boards’ willingness to opt in to, or rely on, control share statutes. States have adopted the control share statutes under corporate statutes primarily to protect public companies incorporated in their jurisdictions. Investment companies established in states without applicable control share statues may have adopted similar provisions in their organizational documents. The SEC staff position in the Boulder Letter also has had a potential chilling effect on their boards’ willingness to rely on these provisions.
