The Supreme Court has recently made a significant ruling that will impact how activist investors navigate legal strategies. In a landmark decision on June 11, the Court determined that Section 47(b) of the Investment Company Act of 1940 does not allow private parties to file lawsuits to rescind contracts that allegedly violate the Act. This ruling reshapes the legal landscape, favoring fund operators over activists.
What was the case about? This case was not solely an isolated event affecting one fund or one rule. It originated from a challenge posed by Saba Capital Master Fund, a well-known activist investor. Saba contested the control share bylaws of closed-end funds under Maryland law, arguing these bylaws limited the voting rights of shareholders who owned over 10% of a fund's shares, a move counter to the requirements outlined in Section 18(i) of the Investment Company Act. The fund’s defense claimed that while there might be a conflict, Saba could not pursue legal action on that premise.
Previously, the Second Circuit sided with Saba, indicating that Section 47(b) allowed for legislative intent where contracts made in violation of the ICA could be voided in court. However, this interpretation has now been overturned by the Supreme Court. The majority opinion articulated that declaring specific contracts void does not equate to granting private entities access to federal court.
Why is this ruling significant? The implications of this ruling resonate well beyond one institution’s legal battle. It resolves a notable discrepancy known as a circuit split, in which different judicial circuits interpreted Section 47(b) differently. With the Second Circuit advocating for implied private rights and the Third and Ninth Circuits opposing this interpretation, the Supreme Court’s decision establishes a clear precedent: there is no private right of action under Section 47(b).
What does this mean for investors? The ruling is particularly critical for those involved in closed-end funds, which operate differently than traditional open-end mutual funds. Closed-end funds do not redeem shares at the request of shareholders, and this characteristic may lead to trading at persistent discounts relative to net asset value. Activist investors frequently purchase shares to influence changes and close such valuation gaps. Control share bylaws served as a defensive strategy for fund managers to limit activist influence by restricting voting power.
While Saba Capital and similar investors previously viewed litigation as a viable strategy, now such paths are effectively blocked on a national scale. Investors who perceive violations of the Investment Company Act must resort to filing complaints with the SEC and hope for enforcement actions, rather than pursuing remedies through the courts. Moreover, the decision raises critical questions concerning ongoing cases that relied on the earlier Second Circuit interpretation, as funds with previously rescinded restrictive bylaws may attempt to re-establish them.
Overall, this ruling signifies a notable shift in the balance of power between fund operators and activist shareholders, emphasizing the importance of understanding the legal avenues available to investors in this complex landscape.