Washington, DC 20549
Mr. Katz,
Pursuant to Rule 192(a) of the SEC Rules of Practice, I hereby file a petition with the Secretary relative to suggested regulation regarding the proposed changes to the fundamental investment policies of closed-end funds.
Specifically, Section 13 of the Investment Company Act of 1940 is very weak; it merely requires a majority of a quorum to approve a change in investment policy, and that is only if the fund specifies that a change in policy requires shareholder approval. I suggest that the SEC require approval by two-thirds of a quorum present at a shareholder meeting to approve such changes regardless of whether such approval is required in the fund's articles of incorporation and by-laws.
Furthermore, should the shareholders approve a change to the fundamental investment policies of the fund, dissenting shareholders should be entitled to receive the greater of fair market value or net asset value with no redemption fees imposed. The following is a summary of my reasons for seeking regulation in this area of investment activity:
I am the president/CEO of an investment management firm that manages more than $600 million. One of our areas of expertise is the closed-end fund market. For over a decade, a significant amount of our clients' assets have been held in these investment vehicles. Many of our accounts are subject to ERISA rules and/or strict investment guidelines established by our clients. These closed-end funds have fundamental objectives, at the time of purchase, that align with each client's objectives.
The recently growing trend for funds to propose changes to their fundamental investment policies greatly concerns me. Such changes have the potential to increase our transaction costs and decrease the market value of our investments. In many cases, due to the constraints within which we operate, the successful approval of these changes will cause our firm (as well as others) to sell our shares in the open market. Any change that does not conform to our clients' objectives, or that would deviate from internal policies, would cause us to sell the security. Many individuals who own shares should have the same concerns.
This creates two costs: additional transaction costs and the loss of market value due to the selling pressure created by the change in the fund's objectives (many of these funds have low trading volume, creating considerable price impact when large amounts are sold). Our stance is that these two costs are real economic risks imposed by changes in fundamental investment policies. These risks are never disclosed to shareholders in the original prospectus nor in the proxy material that they receive. Even the announcement of such proposals has created downward pressure on share prices as investors seek to sell prior to approval of the proposed changes.
The fundamental investment policy and restrictions outlined in a fund's original prospectus should be modified only under extraordinary conditions. When investors decide to invest in a particular fund their decision is based, primarily, on the investment policy of the fund. There are over 8,600 different regulated investment companies. If an investor wants to invest in a balanced fund there are plenty to choose from, there is no reason why a bond fund, for instance, should transform into a balanced fund. There is rarely a case when a board should decide that a fund's policy is no longer valid. Fundamental investment policy and restrictions should be treated as sacred. It has been our experience that many shareholders are not being appraised of the risks of such changes and, therefore, often blindly vote with management and board recommendations.
Changes to a fund's fundamental investment policy have been proposed by a growing number of "closed-end fund raiders" in recent years. These investors often put in proposals to nominate there own directors to the fund's board, with the intention of taking over fund management and collecting the management fee. They view the fund simply as a vehicle to obtain management fees, and once in control of the fund they often change the investment policy to coincide with their management style.
A recent article in the August 9, 2002 edition of the Wall Street Journal highlighted one such raider, Mr. Stewart R. Horejsi. Mr. Horejsi has taken over control of two closed-end funds, the Boulder Total Return Fund and the Boulder Growth and Income Fund, that he now manages. Shortly after gaining control of the board and management of the Preferred Income Management Fund, he submitted proposals to change the fund objective to "total return" and the name to the Boulder Total Return Fund. He followed that with a management fee hike from 1 percent to 1.25 percent. He is currently attempting to take control of the board of the First Financial Fund, the strongest performing closed-end stock fund of the past decade.
Ron Olin, president of Deep Discount Advisors, has done essentially the same thing with the Cornerstone Strategic Value Fund (formerly the Clemente Global Growth Fund). Upon gaining control of the board and management of the fund's assets, he changed the fund's name and investment objective. Currently he is attempting to merge this fund with another fund that he took over, the Progressive Return Fund, and change the name of the remaining fund. Since taking over the fund in September of 1998, both the fund's net asset value and market price have dramatically underperformed its benchmark. The market price return of the fund from January 1, 1999 to July 31, 2002 was -37.26 percent and the net asset value return was -32.41 percent over the same period. This compares with a return of -22.36 percent on the S&P 500 Index.
The best example of what these types of changes can do to a fund's discount to net asset value is takeover of the Board of the EIS Fund (formerly Excelsior Income Shares, Inc.). This small closed-end fund invested primarily in US Treasuries and Agencies and also held some corporate bond issues. The fund was aimed at conservative investors that wanted a little higher income than a traditional Treasury would offer. On July 27, 2001, the date of the last reported net asset value before Mr. Ralph Bradshaw (an associate of Mr. Olin) expressed his interest in EIS, the fund was trading at a 4.94 percent discount. On November 2, the first time the net asset value was reported after the November 1 announcement that Mr. Bradshaw had gained control of the board, the fund was trading at a 8.45 percent discount. By November 30, two weeks after the fund's announcement of a special meeting to change the fund's name and objectives, the fund was trading at a 16.31 percent discount to net asset value. On August 2, 2002, the EIS board announced that it wanted to merge the fund with another Cornerstone fund and again change the fund's name. The surviving fund would be a balanced fund named the "Cornerstone Total Return Fund, Inc.." As of August 16, 2002, the fund was trading at a 16.26 percent discount to net asset value. That is an 11.32 percent widening of the fund's discount since Mr. Olin got involved. It was never disclosed in the proxy materials that equity and balanced closed-end funds tend to trade at wider discounts than closed-end bond funds.
Both Mr. Horejsi and Mr. Olin failed to disclose their intentions when they first nominated directors to seek control of the aforementioned funds.
I propose that the Securities and Exchange Commission consider enacting rules to require an investment company to receive a super majority approval to pass such proposals. In addition, dissenting shareholders should be given the opportunity to exit the fund at net asset value should such proposals pass. In the case of open-end funds, any redemption fees should be waived for dissenting shareholders who wish to exit the fund. In enacting such a rule, the SEC will send a message to fund board members to not tamper with the fundamental policy upon which the fund was established.
Statutory laws exist in several states that protect the dissenter's rights in the event of a private company merger. These laws allow the investor to receive fair value for their shares if they do not support the merger. I feel that investors in publicly traded companies should be given the same protection. It is our researched opinion that dissenters' rights in various states may not apply to fundamental changes for a publicly traded regulated investment company.
The current awareness that shareholders need better protection from management and board members with ulterior motives makes the adoption of such rules urgent. Thank you for your time and consideration. I look forward to your response.
Sincerely,
George W. Karpus
http://www.sec.gov/rules/petitions/petn4-475.htm
