FUND MERGERS AND REORGANIZATIONS OF INVESTMENT ADVISERS

Transcription

1 FUND MERGERS AND REORGANIZATIONS OF INVESTMENT ADVISERS Prepared by Stradley Ronon Stevens & Young, LLP for Mutual Fund Directors Forum Fort Myers, FL January 13-15, 2009 I. FUND MERGERS A. Reasons for Fund Mergers Product rationalization The merging funds may have substantially similar investment objectives (perhaps as a result of the merge of two investment advisers). Lower expenses A merger may achieve economies of scale for funds with greater assets. Better performance A fund may merge because it may not be economically viable on its own or because a merger may otherwise lead to increased assets and economies of scale. Better distribution A fund may merge to be part of a fund complex with greater distribution capabilities. Most often, investment advisers will want to merge funds within the same complex. On occasion, they will want to merge a fund in one complex with a fund in another complex. B. Law Governing Fund Mergers Underlying rationale: Ensure that fund shareholders are treated fairly and that their economic interests are protected. Mergers of affiliated funds: A merger of affiliated funds will be permitted without first obtaining an exemptive order from the U.S. Securities and Exchange Commission ( SEC ) if the merger complies with the provisions of Rule 17a-8 under the Investment Company Act of 1940, as amended ( Investment Company Act ). This Rule requires, among other things: Board determinations. The Board of Directors/Trustees (the Board ) of each fund participating in the merger (the affected funds ), including a majority of disinterested or independent persons, must make certain determinations in connection with the affiliated merger. 1. Best interests. The Boards must determine that the merger is in the best interests of the fund.

2 2. Non-dilution. The Boards must determine that the merger will not dilute the interests of any existing shareholders. 3. Adequate information. The Boards must have requested and fully evaluated sufficient information to make these determinations. Shareholder approval. A vote of any non-surviving fund s shareholders will be required for the merger unless the merger will not result in a new investment decision. To satisfy this requirement, the two funds being merged must have generally the same investment adviser, the same investment objectives, principal policies and risks, and the same (or lower) distribution fees. (State law or a fund s governing documents also may require that the surviving fund s shareholders vote on the merger.) State law requirements: State law generally requires Directors to evaluate the proposed merger of any funds they oversee to determine whether, in their reasonable business judgment, the proposed transaction is in those funds best interests. C. Practical Guidance for Directors Involved with Fund Mergers Factors that Directors should consider in evaluating a merger between two affiliated funds: 1. Comparison of Investment Objectives, Policies, Strategies, Restrictions and Risks How do the merging funds investment objectives, policies, strategies, restrictions and risks compare? Will there be any changes in these areas in the surviving fund? Which fund will survive the merger? Which of the funds portfolio managers will manage the combined fund? What is the experience level and prior performance of the portfolio managers who will manage the surviving fund? Will the adviser have the investment personnel and other resources to manage the combined fund? What is the compliance background of the adviser to the surviving fund? Will the combined fund be too large to achieve its investment objectives? 2. Fund Performance How have the funds performed for the past three to five years? 2

3 3. Distribution and Other Fund Services How do the nature and quality of distribution and other shareholder services provided to each fund compare? Are there any differences in class structure between the funds? 4. Repositioning of Fund Securities Will any repositioning of the portfolio holdings be required and, if so, at what cost? Will it affect the risk profile of the fund? How will the costs associated with portfolio positioning be allocated? How long will it take to sell the securities? Are there special considerations for large positions? Do the securities of the non-surviving fund that will be retained after the merger have unrealized gains or losses? What effect (positive or negative) will this have on shareholders? Will capital losses of the acquired fund be carried over to the acquiring fund, or will they be lost? 5. Direct Costs of the Merger Who will pay the costs of the merger? Will the funds directly or indirectly bear any of the merger s fees and expenses? Will there be any direct or indirect federal tax consequences to the fund or its shareholders as a result of the transaction, including the ability to use tax loss carry-forwards? 6. Fund Fees and Expenses What effect will the merger have on the surviving fund s fees and operating expenses? Will shareholders of the non-surviving fund pay lower fees and expenses overall as a result of the merger? 7. Board Composition How will the merger affect the composition of the surviving fund s Board? Will all members of that fund s Board remain as Directors? Will any members of the non-surviving fund s Board join the surviving fund s Board? 8. Insurance and Indemnification What is available to the non-surviving fund s Board to protect it from future claims? 3

4 9. Alternatives to the Merger Why is the adviser recommending the merger? What, if any, alternatives did the adviser consider? Why is the adviser recommending a particular acquiring fund? Did management consider any alternatives to the proposed transaction? 10. Consideration of Benefits to the Adviser Will any aspect of the transaction impose an unfair burden on the combined funds? 11. Which Fund should be the Survivor D. The Board of each affected fund will be required to take certain actions. 1. Agreement and Plan of Merger. Each Board must consider and approve management s proposed Agreement and Plan of Merger. 2. Shareholder Approval. If a shareholder vote is required, a registration statement on Form N-14 will need to be prepared and filed with the SEC. Each Board must approve the Form N-14. Upon SEC effectiveness of the Form N-14, the non-surviving fund s shareholders must be sent a prospectus/proxy statement that: describes the proposed merger; compares the target funds to the acquiring funds in terms of investment objective, policies, risks, fees, expenses, performance and other key information; and requests the shareholders approval of the merger. The Board should consider the allocation of the costs of any shareholder meeting to approve the merger. 3. Prospectus Supplement II. REORGANIZATIONS OF INVESTMENT ADVISERS A. Background on Adviser Reorganizations Investment advisers combine, reorganize and restructure themselves in order to grow and streamline their businesses. Investment advisers are organized in many different forms, and can be stand alone companies or part of larger businesses. The parent company of an investment adviser similarly may combine with another entity, reorganize or restructure itself, in a manner that can implicate the concerns underlying certain provisions of the Investment Company Act. 4

5 B. Governing Law as Source of Directors Role When Advisers Reorganize Underlying rationale: Prevent trafficking in investment advisory contracts, and protect investors in situations in which an investment adviser or its parent makes a profit on the sale of the adviser. The regulatory concern is that an investment adviser will seek to recoup its costs in acquiring another adviser in a manner that will detriment the clients of the acquired adviser. The Law: Under the Investment Company Act, when investment advisers combine their businesses, the advisory contracts with their client can terminate. Assignments. For instance, Section 15(a)(4) of the Investment Company Act requires that investment advisory agreements automatically terminate in the event of an assignment. Assignment is defined broadly to include, among other things, transfers of advisory contracts and the acquisition by a person of voting control of another person. For instance, there is a presumption under the law that when a person beneficially owns 25% or more of a company s voting securities, the person controls that company. If the person sells that 25% interest, there may be a transfer of a controlling block of voting securities and an assignment of all of the company s advisory contracts. Automatic Contract Termination. Once an assignment has occurred, the adviser s advisory contracts will automatically terminate, and shareholder approval will be required in order for the adviser to continue to serve as the investment adviser. To minimize adverse consequences to a fund from the automatic termination of its advisory agreement, Rule 15a-4 allows the Board s independent directors to approve an interim investment advisory agreement for up to 150 days, during which time the adviser can obtain shareholder approval of a new investment advisory agreement. In some circumstances, the regulatory provisions relating to assignments are triggered, even though the trafficking concerns are not raised in connection with the transaction. A great deal of time may be spent trying not to trigger the assignment provisions of the Investment Company Act in connection with an adviser reorganization. In certain instances, a fund may determine not to seek shareholder approval in reliance on an opinion of counsel that there has been no assignment. Those opinions may be supported by Rule 2a-6 under the Investment Company Act, which states that a transaction which 5

6 does not result in a change of actual control or management of the adviser is not an assignment. Sale of an adviser: Section 15(f) of the Investment Company Act provides a safe harbor that allows an investment adviser or its parent to makes a profit on the sale of the adviser, but also imposes requirements designed to protect shareholders from the burdens that could result from such a transaction. If these requirements are not satisfied, the adviser risks disgorgement of its profit from the sale. Not all investment adviser reorganizations entail a profit upon sale of the adviser. 1. Disinterested directors for three years. For a period of three years after the transaction, at least 75% of the Board must be comprised of Independent Trustees. Independent Trustees are those persons who are not: an affiliated person of the fund; an immediate family member of such a person; any person who, in the fund s last two completed fiscal years, has acted as legal counsel for the fund; any partner or employee of such a person; any person or affiliated person of such a person involved in certain activities within the preceding six months; or any person who, in the fund s last two completed fiscal years, has had a material business or professional relationship with the fund, its principal executive officer, any other fund having the same adviser or principal underwriter or the principal executive officer of such other fund. 2. No undue burden for two years. For a period of two years after the transaction, no undue burden can be imposed on the fund due to the transaction. Any arrangement during the two-year period pursuant to which the former or new adviser receives any compensation either in connection with the purchase or sale of securities to or from the fund or from such company or its security holds for other than bona fide investment advisory or other services would be considered an unfair burden. This generally means there can be no increase in fees. C. Practical Guidance for Directors Involved with Adviser Reorganizations Understand the economic impetus for the reorganization to determine the degree of the trafficking concerns, if any. Understand the terms and structure of any new investment advisory entity. Consider the long term effects on the funds will fund Boards eventually be asked to combine? 6

7 The Board generally has no vote in or control over an investment adviser s decision to reorganize, rather the Board will evaluate the effect of the reorganization, if any, on the funds. D. Board Actions Board Approval of the Advisory Agreement. However, the Board, including a majority of the independent directors, must approve any new investment advisory agreement (and/or subadvisory agreement) with the new investment adviser resulting from such a decision. The legal requirements for approving such new investment adviser are the same as the requirements for any other investment adviser under Section 15(c) of the Investment Company Act. Accordingly, the Board should consider how best to address the new investment advisory agreement, which may be identical to the one that terminated. Shareholder Approval of the Advisory Agreement. The fund s shareholders will also need to approve the new investment advisory agreement at a shareholders meeting. The Board will need to set a meeting date and a record date for determining shareholders eligible to vote at the meeting. The Board should consider whether the adviser should bear some of the costs of the shareholder meeting, which could be substantial. The Board also will need to authorize the preparation of a proxy statement that will be both filed with the SEC and mailed to shareholders. Approval of Changes to the Fund s Other Service Providers. Some adviser mergers may entail the use of new service providers. To the extent that a fund s other service providers are affiliated with a particular investment adviser, the reorganization of the adviser may be accompanied by a proposal to make other changes relating to the other service providers. For example, the Board may be presented with a new agreement for distribution of fund shares, fund administration, or custodial or transfer agent services. The Board will need to consider these new agreements, taking into account all pertinent information regarding the new service providers and the terms of the new agreements. 7