On March 5, 2010, a closed-end fund (the “Fund”) filed a complaint against several privately offered funds and their control persons (the “Defendants”), including the individual control person who managed all the voting and investments decisions of the entity Defendants, in the US District Court for the District of Maryland (the “Court”). The complaint alleges that the Defendants acquired shares of the Fund in violation of the anti‑pyramiding (Section 12(d)(1)(A)(i)) and anti-avoidance (Section 48(a)) provisions of the Investment Company Act of 1940. The anti-pyramiding provision prohibits any one investment company from owning, directly or through companies it controls, more than 3% of the voting securities of a registered investment company, such as the Fund. The anti‑avoidance provision makes it unlawful for a person to do indirectly through another person or entity what would be unlawful to do directly.
The complaint alleges that the entity Defendants, under the direction of the individual Defendant, collectively accumulated more that 3% of the Fund’s outstanding voting securities as part of a plan to exert improper, disproportionate undue influence over the Fund at its upcoming June 2010 shareholders’ meeting. The Defendants allegedly use an activist arbitrage investment strategy targeting closed-end funds trading at a discount to their net asset value. In a Schedule 13D filing with the SEC, the Defendants disclosed that they had acquired more than 5% in the aggregate of the Fund’s shares and wanted the Fund’s management to take steps to eliminate or substantially reduce the Fund’s discount to net asset value. If the Fund failed to do so, the Defendants threatened to use their voting power to, among other things, (a) seek board representation by nominating their own candidates (including the individual Defendants) for election to the Fund’s board, (b) alter the Fund’s capitalization, and (c) convert the Fund from a closed-end structure to an open-end structure. Alleging that the Fund and its investors would be irreparably harmed if the Defendants were allowed to carry out their plans, the Fund asked the Court for injunctive and declaratory relief.On April 1, 2010, the District Court dismissed the Fund’s complaint on the grounds that the Fund had failed to satisfy the threshold issue of whether a private cause of action exists under Sections 12(d)(1)(A)(i) and 48(a). In reaching its conclusion, the District Court was guided by the Supreme Court’s decision in Alexander v. Sandoval, 532 US 275 (2001) (“Sandoval”), relating to judicially-implied private causes of action and by subsequent cases that applied Sandoval. The Court concluded that the Fund was not a member of the protected class of the anti-pyramiding provision because this provision was designed to protect individual investors, not investment companies, and that Section 12(d)(1)(A)(i) does not show evidence of a congressional intent to create a private remedy. In dicta addressing whether individual investors in the Fund might have a private right of action under Section 12(d)(1)(A)(i), the Court concluded that there was a “formidable presumption that no private cause of action exists under [Section] 12(d)(1)(A).” Separately, the Court concluded that the Fund had failed to state a claim under Section 48(a) because a claim under the anti-avoidance provision must be predicated upon a violation of some other provision of the 1940 Act, which the Fund had not successfully alleged. Accordingly, the Court dismissed the Fund’s complaint.