The SEC’s Division of Investment Management has advised Boulder Total Return Fund, Inc., a closed-end management investment company, that the use of the Maryland Control Share Acquisition Act to restrict the ability of certain shareholders to vote "control shares" would be inconsistent with the fundamental requirements of Investment Company Act Section 18(i) that every share issued by the fund must be voting shares with equal voting rights. The fund asked for guidance under Section 18(i) in connection with its consideration of whether to opt in to the provisions of the MCSAA.

Boulder expressed concern that, in light of the decision of the U.S. district Court in Neuberger Berman Real Estate Income Fund Inc. v. Lola Brown Trust No. 1B, 342 F. Supp. 2d 371 (D. Md. 2004), the Act, when implemented as an anti-takeover measure, might result in a violation of Section 18(i). The Act eliminates the voting rights of shareholders to the extent that they acquire in excess of 10% of the outstanding voting shares of a target company.

The staff noted that the issue has been the subject of a vigorous debate and that it has benefited from comments by industry participants. The staff addressed a number of arguments raised in those comments in addition to those raised by Boulder. The staff said that it appreciated the difficult balance that closed-end funds face in connection with potential takeover attempts and is aware that funds have increasingly considered whether to opt in to state control share statutes. Funds, shareholders, directors and members of the investment management bar have raised concerns about whether this action would be consistent with the Investment Company Act, given the absence of staff guidance or settled case law.

When the staff has learned that a fund has opted in to the MCSAA or has proposed to do so, it has alerted them that the action would be inconsistent with the provisions of Section 18(i) and has consistently taken this view when reviewing registration statements on Form N-2. The staff welcomed this opportunity to provide the requested guidance.

The use of MCSAA would discriminate against certain shareholders by denying important voting rights and would contribute to the entrenchment of management, according to the staff. This may be permitted for operating companies under state law, but the Investment Company Act, with its unique regulatory approach, demands a different result for investment companies, the staff advised.

Maryland adopted the MCSAA in 1989 as an anti-takeover device in an effort to compel prospective acquirers to deal directly with management rather than obtaining significant voting power through market purchases. Under the Act, if a prospective acquirer obtains more than 10% of the voting shares of a target company, it will not be able to vote the shares unless approved by the board or by a two-thirds vote of the other shareholders.

The MCSAA applies to certain Maryland corporations. It is not applicable to registered open-end management investment companies. Closed-end funds are excluded by default, but may elect to opt in to the provisions. Business development companies are subject to the Act by default, but may elect to opt out of its provisions. The staff expressed its view that it would be inconsistent with Section 18(i) for a BDC organized under Maryland law to fail to opt out of the Act.

Some commentators argued that the acquisition of control shares is a voluntary act that should be treated similarly to other voluntary shareholder actions that may restrict the voting of shares, such as the granting of proxies. The staff said this view ignores the fact that the Investment Company Act proscribes actions by investment companies, not shareholders, and underestimates the significant difference between surrendering voting rights freely and without coercion, on the one hand, and losing them due to a fund’s provisions or actions, on the other.

The Commission acknowledged in In the Matter of the Solvay American Corporation (27 SEC 971, 973 (April 12, 1948)) the possibility of varying interpretations of what constitutes equal voting rights. Some degree of flexibility may be warranted in the case of multi-class open-end funds because Congress adopted the equal voting rights mandate of Section 18(i) before it contemplated permitting these funds to issue senior securities. Congress did not revisit the issue in the context of newly sanctioned multi-class closed-end funds, according to the staff.

The staff has provided no-action assurances in a number of instances involving differential voting rights between separate classes of shares, but in each case, its position was supported by the fact that the differences in voting rights followed logically from the differences between the share classes. In some cases, the differences were required under state law in order to protect the interests of a class. In this respect, the staff said that Solvay and the various no-action letters are readily distinguishable from the application of the MCSAA to a single class of open-end fund shares.

The staff also addressed an argument that the disability triggered by a share control acquisition under the MCSAA is intended to attach to the holder of the control shares and not the shares themselves. This argument is without merit, in the staff’s view. Section 18(i) clearly prohibits discrimination between or among both shares and shareholders, the staff advised.