United States: Defending Maryland Closed-End Funds

Last Updated: January 6 2017
Article by Scott R. Wilson

Closed-end funds trading at a discount to net asset value sometimes are the subject of attack by activist stockholders. Activist focus on short-term gains can be at the expense of the long-term strategy preferred by many retail stockholders. In 2016, several closed-end funds were the subject of campaigns by activist stockholders and corresponding demands that boards of directors liquidate or open-end their funds. This post discusses options available to boards of directors of closed-end funds formed as Maryland corporations. This post is tailored to closed-end funds registered under the Investment Company Act of 1940 (the "'40 Act") and, accordingly, does not address similar options that may be useful to operating companies (e.g., the Maryland Business Combination Act).

Director Duties in Response to Fund Activists

Pursuant to Section 2-405.1(c) of the Maryland General Corporation Law ("MGCL"), a director of a Maryland corporation is required to act: in good faith; in a manner the director reasonably believes to be in the best interests of the corporation; and with the care that an ordinarily prudent person in a like position would use under similar circumstances. This standard of conduct applies to all acts of a director and irrespective of activist stockholder actions. But when considering an activist's demands to liquidate or open-end a Maryland closed-end fund, a board of directors should also take note of the following:

  • Just Say No – The standard of conduct does not require that a director "accept, recommend or respond on behalf of the corporation to any proposal" by a person seeking to acquire control of the corporation.
  • Maximize Value – While directors have a general duty to obtain the best value for stockholders in a change of control or sales transaction, a director of a Maryland corporation is not required to act solely because a proposed action would result in a reduction of the current discount to net asset value or otherwise increase the trading price of the stock of the corporation.
  • Statutory Business Judgment Rule – In Maryland, a director's actions are presumed to satisfy the applicable standard of conduct by statute.
  • No Higher Standard of Review – Unlike Delaware, in Maryland, a director's actions "relating to or affecting an acquisition or a potential acquisition of control of a corporation may not be subject to a higher duty or greater scrutiny than is applied to any other act of a director." This is commonly recognized as a statutory abrogation of the well-known Unocal standard articulated by the Delaware courts.

Defensive Measures

Activist stockholders in closed-end funds frequently seek to arbitrage pricing displacements for short-term gain. To obtain the time necessary to demonstrate the effectiveness of the long-term strategy, a board of directors should consider the following defensive options:

1. Classification of the Board of Directors

While the charters of many Maryland closed-end funds establish classified boards, a Maryland closed-end fund board that is not classified should consider the unique ability in Maryland to classify directors – at any time – without stockholder action. Section 3-803 of the MGCL allows a Maryland closed-end fund with a class of equity securities registered under the Securities Exchange Act of 1934 and at least three independent directors to self-classify directors into three classes without a stockholder vote and notwithstanding a charter or bylaw provision to the contrary. Additionally, the board of directors may then designate existing directors into those three classes prior to the next annual meeting such that only one-third of the current board of directors will stand for election at such meeting. As a collateral benefit, directors of a classified board may only be removed for cause (unless the charter provides to the contrary).

2. Opt-In to Section 3-804(c) Requiring That Directors Fill All Board Vacancies

If the board of directors has not already done so, it should consider opting into Section 3-804(c) of the MGCL, if available. Section 3-804(c) provides that a Maryland corporation with a class of equity securities registered under the Securities Exchange Act of 1934 and at least three independent directors may, by opting into this Section of the MGCL (which can be accomplished by resolution of the board), require that all vacancies be filled by the board of directors. Consequently, an activist would need to succeed in removing the entire board of directors to fill any openings on the board. Additionally, when paired with a classified board, directors so elected to fill vacancies will serve for the remainder of the term of the vacancies and not merely until the next annual meeting of stockholders.

3. Opt-In to Control Share Acquisition Act

The Maryland Control Share Acquisition Act (MGCL § 3-701 et seq., the "MCSAA") provides that "control shares" of a corporation acquired in a "control share acquisition" have no voting rights except to the extent approved by a vote of two-thirds of the votes eligible to be cast on the matter. A control share acquisition occurs when a stockholder, directly or indirectly, acquires outstanding stock in excess of one of three thresholds, beginning at 10 percent. While operating companies are subject to this statute unless they chose to opt-out, a Maryland closed-end fund registered under the '40 Act must opt-in to the MCSAA.

While the permissible use of the MCSAA by closed-end funds has been recognized by at least one federal district court, the Securities and Exchange Commission has taken the position that the MCSAA conflicts with Section 18(i) of the '40 Act. Boulder Total Return Fund, Inc., SEC No-Action Letter (Nov. 15, 2010). Because of the SEC's position, many closed-end funds have been hesitant to opt-in to the MCSAA for fear of turning a dispute with an activist into a potential enforcement action. Nevertheless, under existing law, the MCSAA remains a valid defensive measure that a board of directors should consider.

4. Stockholder Rights Plan

A stockholder rights plan, or poison pill, provides rights to existing stockholders that make hostile acquisitions economically impractical for an acquirer. The goal in enacting such a plan is to deter coercive and abusive tactics by hostile bidders to acquire control of a corporation without paying a full and fair price to all stockholders for all of their shares of stock. In Maryland, a board of directors has the authority to authorize and issue stock, options, and warrants that are necessary to implement various types of poison pills. The MGCL expressly recognizes the validity of stockholder rights plans and directors' discretion to establish them. The same provision also expressly validates "slow hand" provisions of stockholder rights plans that prevent future directors from redeeming or terminating such a plan for a period not to exceed 180 days. In addition, the MGCL expressly provides that the duty of directors does not require them to "redeem any rights under, modify, or render inapplicable, a stockholder rights plan."

5. Other Considerations

  • Quorum for Stockholder Meetings – Generally, the presence in person or by proxy of stockholders holding a majority of all votes entitled to be cast at the meeting constitutes a quorum. To reduce solicitation costs in connection with uncontested elections, however, many Maryland closed-end funds reduce their quorum requirement to one-third of the votes entitled to be cast. In a contested setting, this lower threshold – particularly when paired with a plurality director election standard – may no longer be appropriate.

  • Special Stockholder Meetings –The MGCL provides that, unless varied by a corporation's charter or bylaws, a special meeting must be called upon the request of stockholders with 25 percent of votes entitled to be cast. But Section 3-805 of the MGCL provides that a Maryland corporation with a class of equity securities registered under the Securities Exchange Act of 1934 and at least three independent directors may, by opting into Section 3-805 (which can be done by resolution of the board), provide that a special meeting of stockholders will be called only at the request of stockholders with at least a majority of votes. Notably, absent an express provision in the charter, Maryland currently has no procedure for written consent voting by stockholders other than unanimous written consent.

  • Increase Voting Thresholds for Director Elections – The most common voting standards applicable to elections of directors of closed-end funds are: plurality, majority of votes cast, majority of votes cast in uncontested elections with plurality in contested elections and a majority of all the votes entitled to be cast. Unless the charter or bylaws of a Maryland corporation provide otherwise, a plurality of votes cast at a meeting at which a quorum is present is sufficient to elect a director. Although brokers generally may not vote shares on non-routine matters without instruction from beneficial owners, uncontested elections for companies registered under the '40 Act are considered routine matters. Therefore, the applicable standard in an uncontested election is typically not an obstacle to achieve the requisite vote. Nevertheless, many closed-end funds rationally select a plurality standard to minimize solicitation costs incurred by the fund. In a contested election, however, broker non-votes soar as many brokers will not receive instructions from beneficial owners. Accordingly, while a plurality standard increases the likelihood that an activist will prevail in a contested election, any higher standard increases the likelihood that the election will fail. A board of directors will need to balance these considerations. Many will rationally conclude that a change in board composition of a closed-end fund is as fundamental as a decision to merge or dissolve the corporation and, therefore, a majority of the votes entitled to be cast should be required to elect an activist's slate and unseat the incumbent board.

  • Director Qualification Bylaws - Director qualification bylaws can present another hurdle to an activist seeking to nominate directors. Section 2-403(a) of the MGCL provides that "[e]ach director of a corporation shall have the qualifications required by the charter or bylaws of the corporation." The board may amend the bylaws of the corporation and require that future directors of the corporation meet specific qualifications to be permitted to serve as a director.

Be Prepared

There are numerous other considerations that will confront a board of directors responding to an activist stockholder. The board of directors will place itself in a better position to succeed if it starts to prepare before the filing of a Schedule 13D, receipt of Rule 14a-8 proposals or submission of stockholder nominees. In addition to business decisions that may reduce the discount to net asset value, and to make a fund less attractive to activists, the board of directors should analyze the fund's charter and bylaws, review advance notice bylaws, and consider director and officer liability limits and indemnification rights. Successfully defending a closed end fund is a dynamic process and preparation is important, but there is no one-size-fits-all approach to corporate governance. Each individual Maryland closed-end fund should consult its own officers, stockholders, legal advisors and accountants as to its particular circumstances before making any decision. But start early.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions