Prominent defenders of closed-end funds (CEFs) have joined their traditional opponents to criticize a New York Stock Exchange (NYSE) proposal designed to reduce the number of opportunities activists get to take over CEF boards.
The NYSE asked the SEC in June to approve changes that would exempt CEFs from the annual shareholder meeting requirement that currently applies to all issuers listed on the exchange. An initial comment period was due to end Aug. 23, but the regulator extended it until Oct. 7 to provide more time for consideration.
The proposal drew harsh criticism from frequent defenders of CEF autonomy, however, including former SEC commissioner Robert Jackson and former CEF attorney Thomas DeCapo, who argued it would insulate CEF boards and advisers from consequences for harming shareholders.
At first glance, the overwhelming majority of the 1,355 public comments supported the proposal; the SEC noted on its website, however, that at least 1,100 comments were identical copies of the same form letter.
Excluding the form letters, fewer than a dozen of the remaining 200 comments supported the proposal. Most of these came from CEF managers at organizations including TIAA, Federated Hermes, and Neuberger Berman, and from the Investment Company Institute (ICI), the Investment Advisers Association, SIFMA and other industry associations.
The breadth and depth of the negative public reaction, combined with the fund industry’s uneasy relationship with the SEC under chair Gary Gensler, may indicate that the CEF managers’ prayers for a regulatory solution to activist threats will go unanswered.
Many supporters echoed the points made in an ICI analysis published in August that called annual meetings an expensive requirement that provided minimal benefit to shareholders and “exposes their money to the impacts of bad actors.”
“[O]ver the course of 20 years and countless shareholder meetings, I recall exactly one instance of a retail shareholder attending an annual shareholder meeting,” according to a letter from George Morriss, an independent director and former closed-end fund committee chair at the Neuberger Berman Funds.
“My experience with retail (and institutional) CEF shareholders not attending annual shareholder meetings, coupled with the fact that I have never received a written question from a shareholder, convinces me that shareholder meetings are not of material interest to retail CEF shareholders,” Morriss wrote.
Supporters also invoked the desperate need to stop activist hedge funds like Saba Capital Management from using annual proxy elections as launchpads for short-term profit-seeking attacks.
“The current requirements effectively allow minority activist shareholders to force liquidity events for their own and their clients’ benefit without regard to the detrimental effects to the CEFs and their long-term shareholders,” according to a letter from Federated Hermes general counsel George Magera.
Many also pointed out that the NYSE proposal would bring CEF governance more in line with that of mutual funds and ETFs, which do not hold annual shareholder meetings.
The Investment Company Act of 1940 only requires registered funds to hold shareholder meetings when seeking shareholders’ approval for specific actions, such as electing new board members or altering the fund’s investment strategy, but most listed CEFs must hold a shareholder meeting periodically because of the listing requirements of the NYSE, on which nearly all CEFs trade.
“This annual meeting requirement is not derived from federal or state law, but rather is a vestige of exchange listing standards that predates the 1940 Act and reflects the bygone thinking that investment companies—which were then in their infancy and not well understood—should be treated as generally akin to operating companies,” according to a letter from ICI general counsel Paul Cellupica and assistant general counsel Kevin Ercoline.
Saba Enlists a Former Foe
Opposition to the proposal came from a broad coalition of retail investors, CEF activists, nonprofit groups, and academic researchers.
Saba, the current top dog in the activist landscape, submitted an extensive refutation of the proposal, but perhaps the most notable dissenter was Jackson, a former Democratic SEC commissioner from 2018 to 2020 who once targeted Saba as a regulator.
Jackson said in 2019 that the SEC should do more to curtail activists like Saba that force CEFs to make short-term payouts at the expense of long-term retail shareholders.
“[Hedge funds’] best argument is ‘why can’t we be free to buy as many shares as we want and redeem them at a higher price?'” Jackson told Business Insider at the time. “And my response to that is that’s not the deal retail investors signed on to when they invested, and I’m here to protect them, not hedge funds.”
Politics makes for strange bedfellows, however, and it now seems that Jackson has made common cause with his erstwhile adversary.
Questions About Objectivity
A comment letter co-authored by Jackson and Harvard Law professor Lucian Bebchuk disclosed that Saba had paid Jackson and Bebchuk to perform an independent economic analysis of the NYSE proposal. The authors maintained, however, that this compensation was “in no way contingent” on the results of their analysis and did not bias their conclusions.
Their letter assailed the NYSE rule changes as not only detrimental to CEF shareholders, but also lacking the justification needed for such a transformative move.
“They would undermine, not support, corporate governance by exempting closed-end funds (CEFs) from exchanges’ annual shareholder meeting requirements—rules that have existed, and applied to CEFs, for decades,” Jackson and Bebchuk wrote.
They argued that the NYSE proposal would allow CEF directors to serve forever without fear of being unseated, forcing investors to shoulder “entrenchment costs” stemming from board incompetence and directors’ lack of incentive to avoid poor performance.
While their letter did not address Saba’s favored tactic of using proxy victories to install itself as a fund’s new manager, it cited evidence suggesting that the mere threat of being voted out can motivate CEF directors to narrow a discount and improve performance.
“The fear of potential replacement gives incumbent CEF directors significant incentives,” Jackson and Bebchuk wrote. “These incumbents recognize that, to minimize or altogether eliminate the possibility of replacement, the best approach would be to avoid underperformance altogether.”
Besides co-authoring the comment letter, Jackson also accompanied Saba executives to meetings with staffers at the SEC’s Division of Trading and Markets on Sept. 5 and with SEC commissioner Hester Peirce on Sept. 6 to discuss the NYSE proposal, according to the SEC’s website.
The website also noted that Peirce met with representatives from the ICI on Aug. 28.
A CEF Defender Preaches Restraint
In another striking illustration of the proposal’s unpopularity, a former CEF attorney urged the SEC to reject it.
Fending off activist investors is not worth eliminating a key plank of fund governance, argued a letter attributed to Thomas DeCapo, who retired in 2022 after spending 30 years defending CEFs against activists as a partner at Skadden Arps Slate Meagher & Flom LLP.
“I did not then, and do not now, agree with some of the objectives and methods of institutional activist investors,” wrote DeCapo, who confirmed the letter’s authenticity to Fund Directions. “But, in my view, these objectives and methods do not justify depriving shareholders at large of the right to vote on management at annual meetings.”
DeCapo rejected the suggestion that CEFs should adopt the governance practices of open-end funds and ETFs, pointing out that CEF investors need additional safeguards because their shares can trade at discounts to NAV.
“Shareholders who try to vote with their feet in a poorly managed closed-end fund may have to sell into the marketplace at a substantial discount from the intrinsic value of their shares, and can be significantly harmed as a result,” he wrote. “It is not an effective substitute for voting directly on the management of the fund through the annual meeting process.”
DeCapo instead called for the SEC to explore ways to make annual meetings more accessible and less costly.
“I believe closed-end funds and closed-end fund investors would benefit significantly from more and easier, not less, involvement in fund governance and the oversight of management, which will foster enhanced accountability,” he wrote.
