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 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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.