On May 27, 2020, the staff of the SEC’s Division of Investment Management (the “Division”) issued a new statement (the “Staff Statement”) addressing the intersection between state control share acquisition statutes and the voting requirements contained in section 18(i) of the Investment Company Act of 1940 (the “1940 Act”). The Staff Statement effectively replaces a no-action position previously taken by the Division in Boulder Total Return Fund (the “Boulder Letter”), which addressed how the Maryland Control Share Acquisition Act (the “Maryland Act”) should be interpreted in light of the requirements of section 18(i) of the 1940 Act.
Background. Based on its review of registration statements filed by closed-end funds, the staff noted that the majority of listed closed-end funds are organized under Delaware, Maryland, or Massachusetts law. Although Delaware has not adopted a control share statute, both Maryland and Massachusetts have done so. In general, state control share acquisition statutes by their terms do not apply to registered open-end investment companies, but may apply to registered closed-end funds. For example, the Maryland Act does not apply to open-end investment companies. On the other hand, the board of directors of a registered closed-end fund formed as a Maryland company may opt in to the provisions of the Maryland Act by board resolution.
Under the Maryland Act, control shares acquired in a control share acquisition have no voting rights unless the right to vote is approved by a two-thirds vote of the stockholders, not including votes cast by the holder of the control shares. “Control shares” generally are shares that, if aggregated with all other shares of stock owned by the acquiring person, would give the acquiring person the power to vote for the election of the company’s directors within three voting ranges (with thresholds of one-tenth, one-third, and a majority). A person who acquires or proposes to acquire shares that fall into one of these voting power ranges loses voting rights with respect to those shares unless: (i) an “acquiring person statement,” including an undertaking by the acquiring person to pay the company’s expenses of holding a special meeting of the stockholders to consider whether such shares will be accorded voting rights, is delivered to the company; and (ii) voting rights are in fact approved at the meeting.
Although registered closed-end funds formed as Maryland corporations can opt in to the Maryland Act, they are also subject to section 18(i) of the 1940 Act, which seeks to protect voting rights and economic interests of fund stockholders. In particular, section 18(i) provides that “[e]xcept as provided in [section 18(a) of the 1940 Act], or as otherwise required by law, every share of stock . . . issued by a registered management company . . . shall be a voting stock and have equal voting rights with every other outstanding voting stock.”
In the Boulder letter, the staff took the view that it would be inconsistent with the equal voting rights requirements in section 18(i) for a registered closed-end fund to opt in to the Maryland Act.
The Staff Statement. The staff, following the direction of Chairman Clayton, re-visited its position in the Boulder Letter and determined to withdraw that position. Accordingly, effective as of May 27, 2020, the staff of the Division will not recommend enforcement action to the SEC under section 18(i) of the 1940 Act against a registered closed-end fund that opts in to the Maryland Act or similar control share acquisition statutes adopted by other states, provided that “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.”
Implications for Registered Closed-End Funds in Maryland. The Staff Statement and the Maryland Act each require action by a fund’s board of directors before a registered closed-end fund can take advantage of the protections offered by the Maryland Act. According to the Division, board action should be preceded by a facts and circumstances based inquiry into the application of section 18(i). The board of a closed-end fund formed in Maryland should therefore consider its decision to opt in to the Maryland Act in light of (1) its statutory duties to the fund, (2) applicable federal and state law provisions, and (3) the particular facts and circumstances surrounding the proposal.
Control share acquisition statutes can be an effective defense against hostile takeovers or accumulations of large positions by activist stockholders. As a practical matter, a hostile bidder is unlikely to acquire shares over the applicable threshold if those shares would not carry the right to vote. Boards should consider, however, that if a closed-end investment company elects to be subject to the Maryland Act, the election would not be effective with respect to a stockholder who holds control shares before the board’s resolution is adopted but only to the extent of shares held prior to the date the applicable board resolution is effective.
A fund’s board should keep in mind that opting into the Maryland Act is not without risk — a person who has made or proposes to make a control share acquisition can compel the board of directors to call a special meeting of stockholders (to be held within 50 days of demand) to consider the voting rights of the shares. This essentially allows the hostile bidder or insurgent stockholder to obtain a stockholder referendum on the control share acquisition in a situation where the bidder or stockholder may not otherwise be in a position to force a vote of the company’s stockholders (e.g., if the stockholders cannot otherwise call a special meeting or act by written consent). The right to compel the calling of a special meeting is subject to the satisfaction of certain conditions, including an undertaking to pay the expenses of the meeting. If no request for a meeting is made, the fund may itself present the question at any stockholder meeting.
If voting rights are not approved at such meeting, or if the acquiring person does not deliver an acquiring person statement as required under the Maryland Act, a fund may redeem for fair value any or all of the control shares, except those for which voting rights have previously been approved, subject to certain conditions and limitations. For these purposes, fair value is determined, without regard to the absence of voting rights for the control shares, as of the date of the last control share acquisition by the acquiring person or, if a meeting of stockholders at which the voting rights of the control shares are considered and not approved is held, as of the date of the meeting. The board would need to consider this requirement under the Maryland Act in the context of its fair valuation obligations under the 1940 Act, keeping in mind how such forced redemption might affect the interests of the fund’s remaining stockholders.
If stockholders approve voting rights for control shares and the acquiring person becomes entitled to vote a majority or more of the stockholders’ voting power, all other fund stockholders would have appraisal rights under the Maryland Act. The fair value of the shares determined for purposes of appraisal rights may not be less than the highest price per share paid by the acquiring person in its control share acquisition.
Conclusion. In light of the defensive measures afforded by the Maryland Act and other state control share acquisition statutes, the Staff Statement offers a closed-end fund board the opportunity to evaluate whether it should adopt a resolution opting in to these provisions, especially in the context of the continuing interest that activist stockholders have demonstrated in listed closed‑end funds. Boards should add this to their agenda and seek the input of qualified Maryland (or applicable state) and 1940 Act counsel in evaluating the potential benefits of relying on state control share acquisition statutes.
 In the Boulder Letter, the SEC staff noted that the MCSAA is similar to other control share acquisition statutes.
 Maryland-organized business development companies (BDCs) are subject to the Maryland Act by default unless the board elects to opt out of its provisions.