U.S. District Court Rules That “Control Share Acquisition” Provision of Closed-End Fund Bylaws Violates the Investment Company Act of 1940

A judge for the U.S. District Court for the Southern District of New York ruled that certain closed-end funds (funds) and their trustees violated the Investment Company Act of 1940 (1940 Act) by approving a change to fund bylaws that impaired the voting rights of the plaintiff shareholder.¹ The bylaws were amended to include a “control share acquisition” provision (control share provision), which applied to the acquisition of shares by a shareholder if the acquisition resulted in the shareholder owning 10% or more of fund shares (including the shares already owned by the shareholder prior to the bylaws’ amendment). Under the control share provision, the “control shareholder” was prohibited from voting fund shares acquired after the bylaws’ amendment, unless authorized by the majority of shares of the fund (excluding shares owned by a control shareholder).

The court stated that Section 18(i) of the 1940 Act required that every share of stock issued by a registered investment company “be a voting stock and have equal voting rights with every other outstanding stock.” In granting summary judgment in favor of the plaintiff shareholder and denying the funds’ motion to dismiss, the court determined that the control share provision was inconsistent with the requirements of Section 18(i). The court explained that, under the 1940 Act, stock must “presently” entitle its holder – non-control shareholder and control shareholder alike – to vote, noting that depriving a control shareholder of the ability to vote stock, even temporarily, necessarily means that the stock cannot be considered a “voting security” as defined under the 1940 Act. The court further noted that, under the control share provision, the voting rights of stock owned by control shareholders were inferior to the voting rights of stock owned by non-control shareholders; and that a control shareholder’s stock could completely lose its voting rights if the conditions of the control shareholder provision were not met.

The court rejected, among other things, the funds’ argument that the May 27, 2020 SEC staff statement regarding control share acquisition statutes (Staff Statement)² supported the funds’ contention that the control share provision did not violate the 1940 Act. The court noted that, while the Staff Statement recommends a “no-action” position in response to closed-end funds’ opting into control share statutes, the Staff Statement has “no legal force or effect”; does not contain a legal analysis of Section 18(i); and pertains to control share statutes, not control share bylaws, as does this case.

In granting summary judgment, the court held that the plaintiff shareholder was entitled to a declaratory judgment that the bylaws amendment (control share provision) violated Section 18(i), and was entitled to rescission of the bylaws amendment. Other firms sponsor closed-end funds that have amended their bylaws to adopt control share bylaw provisions, so the decision may have implications for those funds.

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¹ Saba Capital CEF Opportunities 1, Ltd. v. Nuveen Floating Rate Income Fund, 2022 U.S. Dist. LEXIS 29252 (S.D.N.Y. Feb. 17, 2022).

² Control Share Acquisition Statutes, Staff Statement, Division of Investment Management (May 27, 2020), available at https://www.sec.gov/investment/control-share-acquisition-statutes.