Keywords: hostile takeover, Business development companies, SEC, Closed-end funds
(Amar Singh is a II year, B.A. L.LB student at Gujarat National Law University, GNLU)
INTRODUCTION:
When one company acquires another against the target company’s wishes, it is termed as a hostile takeover. This can be accomplished in either of 3 different ways:
- Toehold acquisition: an offer to buy stock from the existing shareholders, or
- Tender offer: buying majority of shares from the open market, or
- Proxy fight: shareholders of the target are convinced to assign their voting rights to the acquiring company so that it can boot out the management opposing the takeover and take control.
While there are various defences available to ward off a hostile takeover until recently one of them called the “Control Share Statute” under U.S. state corporate laws which is a powerful statutory anti-takeover defense was unavailable to Business Development Companies (“BDC”) and Closed-End Funds (“CEF”) which were regulated under the Investment Company Act of 1940 (“1940 Act”).
On 27th May 2020 the Securities Exchange Commission (“SEC”), which is the federal agency of United States Government, reversed its decade-old stance by withdrawing its 2010 no-action letter that prevented BDCs and CEFs regulated under the 1940 Act to exercise the Control Share Statute.
The 2010 letter (“Boulder Letter”) had stated that the SEC staff believed such a statute would be,
On 27th May 2020 the Securities Exchange Commission (“SEC”), which is the federal agency of United States Government, reversed its decade-old stance by withdrawing its 2010 no-action letter that prevented BDCs and CEFs regulated under the 1940 Act to exercise the Control Share Statute.
The 2010 letter (“Boulder Letter”) had stated that the SEC staff believed such a statute would be,
“inconsistent with the fundamental requirements of Section 18(i) of the 1940 Act that every share of stock issued by a fund ( A fund is a company under Section 2(8) of the 1940 Act) be voting stock and have equal voting rights with every other outstanding voting stock.”CIRCUMSTANCES LEADING TO THE ISSUE OF THE BOULDER LETTER:
Section 18(i) of the 1940 Act, as amended states that every share of stock issued by a registered investment company shall be a voting stock with equal rights. A defensive measure that limits the voting rights attached to a share potentially implicates the share voting requirements in Section 18(i) of the 1940 Act. A Control Share Statute generally prohibits an acquirer of “control shares” from voting its control shares unless or until its voting rights are reinstated by a vote of the disinterested shareholders.
In a 2007 opinion, the U.S. District Court for the District of Maryland, inter alia applied the terms of the Maryland Control Share Acquisition Act (“MCSAA”) to shares acquired by a stockholder after the fund had opted in to the statute. In a 2009 speech, however, the director of the SEC’s Division of Investment Management expressed the view that a closed-end fund’s reliance on control share statutes “constitutes a denial of equal voting rights and may violate the fundamental requirement that every share of fund stock be voting stock.” Subsequently, the Boulder letter was issued.
CRITICISM OF THE BOULDER LETTER:
Recently, the Investment Company Institute submitted a report (“the ICI Report”) to the SEC that criticized the Boulder Letter’s stand on the issue. The ICI Report stated that the letter misreads the plain language of Section 18(i) because it pertains to the voting rights of each share of stock, rather than the voting rights of a particular stockholder.; The use of defensive measures, including a control share statute that impact the voting rights of a particular stockholder does not change the stock’s voting rights and thus, does not violate Section 18(i) of the 1940 Act.
In addition, if a disinterested shareholder vote restores an investor’s ability to vote control shares, or that investor sells or otherwise reduces his holdings below the applicable statutory threshold, that investor would again be permitted to vote on all his shares, and none of these events would change the voting rights of those shares. The ICI Report also argued that enabling the use of such takeover defenses to prevent activist shareholders from taking control of a fund for their own benefit at the expense of the fund and the other shareholders furthers the purposes of the 1940 Act.
REVERSAL OF SEC's STAND AND WITHDRAWAL OF BOULDER LETTER:
In 2018, SEC Chair Jay Clayton issued a statement noting that the “staff statements are nonbinding and create no enforceable legal rights or obligations of the Commission or other parties” and stating that the SEC’s divisions and offices “have been and will continue to review whether prior staff statements and staff documents should be modified, rescinded or supplemented in light of market or other developments.” Without commenting specifically on the several arguments that have been raised since 2010 regarding the Boulder Letter, in the statement the SEC staff announced that based on this review, as well as market developments since the Boulder Letter’s issuance and recent feedback from affected market participants, the Boulder Letter shall be withdrawn effective immediately.
The Statement also provides that the SEC staff:
“would not recommend enforcement action to the Commission against a closed-end fund under Section 18(i) of the 1940 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 SEC staff cautioned that any inquiry into the application of Section 18(i) of the 1940 Act to a fund’s decision to opt in to a control share statute would be based on the facts and circumstances. In this regard, the SEC staff reminded market participants that any actions taken by a board of a fund, including with regard to control share statutes, should be examined in light of:
- the board’s fiduciary obligations to the fund,
- applicable federal and state law provisions, and
- the particular facts and circumstances surrounding the board’s action.
The 27th May 2020 statement adopts the position that the SEC staff “would not recommend enforcement action to the Commission against a closed-end fund under Section 18(i) of the 1940 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 inputs as to whether the SEC staff should recommend that the SEC take an 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.
CONCLUSION:
For BDCs and CEFs this is good news since now they can freely utilize the defense available to them under the state laws which they were previously hesitant to use since the SEC staff statement though not binding did have an effect on the willingness of the board to rely on the Control Share Statutes.
The statement also requests inputs as to whether the SEC staff should recommend that the SEC take an 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.
CONCLUSION:
For BDCs and CEFs this is good news since now they can freely utilize the defense available to them under the state laws which they were previously hesitant to use since the SEC staff statement though not binding did have an effect on the willingness of the board to rely on the Control Share Statutes.
-by Amar Singh
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