FS Credit Opportunities Corp. v. Saba Capital Master Fund, Ltd.

Overview

A case in which the Court will decide whether Section 47(b) of the Investment Company Act creates an implied private right of action.

Facts

Saba Capital is a hedge fund that buys large stakes in closed-end mutual funds, then uses its voting power to pressure management into changing strategy or liquidating. FS Credit Opportunities Corp. and several other closed-end funds fought back by incorporating under Maryland's Control Share Acquisition Act, a state anti-takeover law that strips voting rights from shareholders who accumulate an outsized position unless other shareholders vote to restore them. Saba, blocked from wielding its shares, argued the Maryland law violated a federal rule requiring every share of a closed-end fund to carry equal voting rights. To get those resolutions unwound, Saba reached for Section 47(b) of the Investment Company Act, a provision that says courts "may not deny rescission" of contracts that violate the Act. The question was whether Section 47(b) gives investors like Saba the right to walk into federal court and demand that result in the first place.

Issue

Does the Investment Company Act of 1940 restrict the ability of a closed-end fund's board to implement defensive measures against shareholder-activist conversion campaigns? May activist shareholders use the ICA's voting provisions to compel a closed-end fund to convert to an interval fund structure against the board's wishes?

Rule

Closed-end funds are governed by the Investment Company Act of 1940, which grants shareholders certain voting rights but also vests fund boards with authority over fundamental structural decisions; whether boards may use defensive measures to resist shareholder-driven conversions depends on whether such measures violate the ICA or applicable state law. Shareholder voting rights under the ICA must be balanced against fund boards' fiduciary duties to all shareholders; activist strategies that would force redemptions inconsistent with the fund's investment mandate may be challengeable as inconsistent with ICA requirements.

Analysis

Closed-end funds are a specific kind of investment company. Unlike a typical mutual fund, which expands and contracts as investors buy in and cash out, a closed-end fund issues a fixed number of shares, and those shares trade on the open market just like stock. The fund's managers invest a pool of money according to their strategy. Once the shares are out, investors who want to exit sell to someone else on the market rather than cashing out from the fund.

That structure makes closed-end funds a target for a particular kind of activist investor. A hedge fund can buy up a large position at a discount to the fund's underlying assets, then use its voting power to force a change: convert the fund to an open-end structure (forcing a payout at asset value), liquidate the portfolio, or install new management. The activist wins regardless of whether the change is good for long-term investors. The existing managers and other shareholders lose.

Saba Capital is exactly that kind of activist. It bought a substantial stake in FS Credit and several related funds with this playbook in mind. The Funds responded by invoking the Maryland Control Share Acquisition Act, a state law designed to neutralize exactly this tactic. Under the MCSAA, a shareholder who accumulates shares beyond a certain threshold loses the voting rights attached to those excess shares, unless and until the other shareholders vote to restore them. Saba's position crossed that threshold, and the Funds adopted resolutions implementing the MCSAA's restrictions.

Saba argued those resolutions violated a federal rule in the Investment Company Act: every share of a registered closed-end fund "shall be a voting stock and have equal voting rights with every other outstanding voting stock." The substantive merits of that argument were not before the Supreme Court. What the Court had to decide was narrower: did Saba even have the right to sue under Section 47(b) to force rescission of the resolutions?

Conclusion

The Supreme Court held, 6-3, that Section 47(b) of the Investment Company Act does not give private parties the right to sue for rescission of contracts they believe violate the Act. The provision addresses what courts must do with rescission as a remedy; it is not a grant of standing to sue. Enforcement of the Act belongs to the SEC, and the two private rights of action Congress did create elsewhere in the statute show Congress knew how to write one when it wanted to.