CEFs lose another tool to deter activists

The SEC has taken yet another defensive weapon away from closed-end funds (CEFs) attorneys looking for ways to keep activist investors at bay – even temporarily.

SEC officials have made clear – according to attorneys working with CEFs – that the option to negotiate fund-complex-wide standstill agreements between CEF sponsors and activist investors is now off the table.

This seems to be either a reversal or a clarification of a longstanding SEC position following years of silence on the issue.

For “decades” fund families have negotiated agreements on behalf of multiple closed-end funds that would allow an activist-requested action in one fund in exchange for a ceasefire on proxy fights for the other funds, according to an attorney who represents CEFs, who requested anonymity to discuss client issues and the SEC.

The attorney said an SEC staff member informed her by phone in late 2023 or very early 2024 that the SEC considered these complex-wide agreements to be “joint transactions” forbidden under Section 17 of the Investment Company Act of 1940.

Colleagues she asked about the ban confirmed they had also been warned off by SEC staff members, who usually reached out by phone after seeing Form 13D or revised 13D filings from activists announcing complex-wide negotiations or agreements with CEF sponsors. “After the ink was dry on the signatures, people were hearing that they weren’t valid,” the attorney said.

“Even though they have been done like this for decades, [the agreements] now need to be negotiated individually, fund by fund, and you essentially can’t have complex-wide standstills anymore,” the attorney said.

Other attorneys independently confirmed that fund boards have in the past been permitted to negotiate trade-offs that would, for example, allow a liquidity event or a tender offer on one fund to placate an activist willing to promise no further action among funds within the same family, typically for a period of between 18 months and three years.

The SEC, which has not published any guidance on the issue, responded to requests for comment on the issue, or confirm its change in stance, with an email saying the agency “would decline to comment.”

It isn’t clear why the SEC has made its new stance known now or which party it seeks to protect by banning complex-wide cease-fire agreements.

The SEC’s stance on complex-wide standstill agreements is curious because there isn’t an aggrieved party on the fund side, said another attorney who works closely with closed-end funds and asked not to be named so that she could discuss her views on the SEC. “Where is the negative impact on the fund side?” she asked. “It seems like an odd application of the rule.”

The attorney said she has not heard directly from the SEC on this topic, but the agency has been making its position known through its comments on draft registration statements. “The SEC frequently will take this approach; it’s a way of regulating on a fast track,” she said. “People pick up the hint and begin to pursue a different line of action.”

Subject to interpretation

With Section 17 and its reference to joint transactions, “the concern with that broad language has always been that you can run a truck through it,” said Deborah Bielicke Eades, an attorney at Vedder Price in Chicago.

The term “joint transactions” in Section 17(d) hasn’t been expressly defined by the SEC, but historically it has been interpreted to prohibit a wide range of investments, including funds investing together on a joint insurance policy or joint repurchase agreement, Eades said. Exemptions have been granted in some cases where the co-investing funds were shown to be participating equally, she said.

The concern of the SEC with the standstill agreements is, apparently, that all the funds aren’t on the same footing, she said.

“I very strongly disagree with the staff view. It’s an unfortunate interpretation that is removing a tool that has been very effective, historically,” Eades said. “That is taking away a very commonly used and effective strategy.”

Eades said she doesn’t read the SEC’s stance on complex-wide standstill agreements as an indication that the agency favors activists overall in their ongoing battle with closed-end funds.

“It’s still evolving how people will react to this,” Eades said.

Changing the tone of negotiations

Removing the possibility of complex-wide agreements “changes the whole tenor of the discussion” between fund boards and activists, according to the first anonymous attorney.

 From the fund board perspective, “You can’t put your nose down and run your funds because you still have the threat of them across your other funds,” she said.

Funds are still negotiating standstill agreements on a fund-by-fund basis, but the terms are less favorable for the funds and their shareholders, the attorney said.

The SEC staff are “protecting the wrong way with this. Rather than saying: ‘Oh wow, those funds get the protection,’ they’re saying: ‘Those funds are disadvantaged by the protection,’” she said.

“It is frustrating in that it reveals deeper beliefs that are out of sync with how fund boards and funds would think of this,” the attorney said, and indicates that the SEC doesn’t understand “the horrible expensive, destructive, distracting mess of having to deal with these activists.”

Some fund families are still negotiating multi-fund standstills that are wrapped into one agreement where all funds are treated similarly, she said. The agreement might apply if all funds agreed to offer their own liquidity event in exchange for an activist agreement ensuring no further action for a set period, for example, she said.

Activists negotiating a cease-fire might agree not to vote against management, recommend alternative candidates for board seats, or introduce new proposals on which shareholders can vote. 

Limited utility option?

For Phillip Goldstein, principal of the activist hedge fund Bulldog Investors, the SEC’s position will have little effect because Bulldog hasn’t negotiated a complex-wide agreement in more than 10 years, he said.

“It’s too limiting; we’re not getting compensated for that,” Goldstein said. “When we did (agree to complex-wide standstill agreements in the past) it was shortsighted.”

The SEC’s position seems to be ironic, considering it doesn’t oppose the idea of directors serving on the boards of all the funds in a fund complex and making other decisions across all of those funds, Goldstein said.

“Obviously, you can’t devote the same attention to all those funds as you could if you were just on the board of one or two of those funds,” he said.

“If you’re going to say that’s OK, you can see why these boards say: ‘Well, we dealt with this problem now; we don’t want to deal with it again with some other fund.’”