Judge Rules for Scudder, Against Arbitrageur
July 26, 1999
NEW YORK - Scudder Kemper Investments of New York successfully thwarted an attempt by arbitrageur Phillip Goldstein to stop a shareholder vote that combined the issues of whether to open a fund and impose a redemption fee on those cashing out of the newly-opened fund.
Phillip Goldstein of Opportunity Partners of Pleasantville, N.Y., sought an injunction against the holding of a proxy vote, scheduled for July 20, on the combined issues. But, a U.S. District Court judge in New York denied the injunction on July 15.
The proxy asked investors to approve opening the $327 million Scudder New Europe Fund along with assessing a two percent redemption fee on investors who cashed out of the fund within its first year of being open-ended. The approval of the proxy last week means the fund will become open-ended Sept. 1.
Goldstein had wanted Scudder to have investors vote on the two issues separately.
U.S. District Judge Loretta Preska ruled in a hearing July 15 that Scudder had the right to combine both questions in its proxy because the issues of opening the fund and imposing a fee are "inextricably intertwined." The fee will prevent investors from suddenly redeeming their shares at the higher price they will reach once the fund is opened, said Judge Preska. If many investors make such redemptions, the remaining investors would be saddled with excessive capital gains taxes, she said.
"A redemption fee is a business and financial necessity in the interest of all shareholders," she said.
Preska based her conclusion on the fund's own proxy statement and two affidavits Scudder had provided from mutual fund consultant Geoffrey Bobroff of Bobroff Consulting of East Greenwich, R.I., and from Edmund Bergen, general counsel for the fund distribution unit of Alliance Capital Management of New York.
Preska said Goldstein's lawyer had "not demonstrated unbundling the fee is possible or irrelevant" to changing its status from closed- to open-ended.
"The plaintiff has brought this issue to the attention of the SEC no fewer than four times in the past few months, and after being bombarded by the defendant, the SEC has taken no action to require unbundling of these issues," Preska said. "The SEC's inaction may be accorded some weight."
Goldstein's lawyer, Gregory Keller of Silverman, Harns, Harns, Prussin & Keller of New York, had argued that the issues should be treated separately due to a 1992 no-action letter from the SEC urging funds to offer shareholders as many separate voting items as possible.
Scudder's attorney, Mitchell Ouslander of Wilke, Farr & Gallagher of New York, said, however, that in a subsequent letter in 1995, the SEC said separate voting items were not necessary when business issues are "inextricably intertwined and it is impracticable to separate them." Opening a fund with a redemption fee is "a business necessity," said Ouslander.
"The nub of Goldstein's issue is he doesn't like the two percent fee," said Ouslander. "If he doesn't like it, he can vote to kick the board of directors out of office."
Redemption fees are necessary when opening a fund to protect long-term investors from short-term investors who buy closed-end funds at a discount "as an opportunistic trade," said Bobroff in an interview. Because many closed-end funds trade at discount to their net asset value and rise to their full value once they are open, they have become popular among aribitrageurs, he said.
A fund's investors can suffer "significant tax consequences" if there is a mass sell-off once a fund is opened, said Brian Smith, executive director of the Closed-End Fund Association of Kansas City, Mo., in an interview.
However, in 1998, only 40 percent of the closed-end funds that switched to an open format imposed redemption fees, according to Lipper Inc. of Summit, N.J.
"Burying the fee into this vote is coercion," said Goldstein in an interview before the hearing. "They know there would be significant votes against the fee if they separated the issue, which would be very embarrassing to Scudder."
Goldstein said he owns 150,000 shares of Scudder New Europe, which invests in equity securities of companies traded on small and emerging European markets. As of July 14, when the fund was trading at $21.06 a share, the value of Goldstein's holdings was $3,159,000.
Morningstar lists the fund's net asset value at $22.57 a share. Should the fund's value rise to this level once it is opened, as is typical of most conversions, Goldstein's holdings would rise to $3,385,500 for a profit of $226,500. However, a redemption fee would cost him $67,710, reducing his profit by 29 percent to $158,790.