Conclusion: Because Cornerstone Strategic Value Fund's (CLM) current rights offering is non-transferable, the board of CLM should choose to distribute to those shareholders electing not to exercise their “rights” a special cash distribution equal to the estimated value of the “rights” in the open market.
Why? Those existing CLM shareholders not electing to exercise their rights are effectively transferring approximately $.27 per share of their value through dilution for each share they fail to exercise that is subscribed by another existing shareholder. If this were a transferable rights offering they’d be able to recoup such value.
Disadvantaging a Certain Group of Shareholders: This seems like unequal treatment for those existing shareholders who do not choose to exercise their rights. This group would likely include retired shareholders who initially purchased the stock seeking an attractive yield, while not knowing that most of the distribution is a return-of-capital, and are now being asked to “pony-up” additional funds—at a 41% premium—or be diluted. While it may be legal it seems unfair.
Insult to Injury: Additionally, CLM has the right to issue an additional 100% of the Offering Shares to existing shareholders to fill oversubscription requests. This would amount to a total transfer of wealth from unsubscribing shareholders to the subscribing shareholders the equivalent to $.43 share. This 100% over-allotment is a whole separate article with dodgy implications.
Inadequate Defense: The defense for this transfer of wealth is: all shareholders have equal opportunity to exercise their “rights”. This is the equivalent of saying that equality under the law forbids both the rich as well as the poor from sleeping under bridges and begging for food in the streets. The claim that the rights offering is anti-dilutive because of the estimated costs of the offering is equivalent to the increase in NAV is a “red herring” (disingenuous) and not based in fact.
Why Did CLM Choose a Non-Transferable Rights Offering? A fellow blogger pointed out that CLM may not have chosen a transferable rights offering as they may “skate” perilously close to being qualified as a Ponzi scheme—whereby, a transferable rights would allow a new investors’ capital to be used to payout CLM’s 90% return-of-capital distribution to existing shareholders which some may say has a tendency to inflate the value of the shares. I’m not a securities lawyer, so I can’t opine.
Notwithstanding, either CLM should convert its rights offering to a transferable rights offering, pay a special dividend to those the value of the rights, or fully disclose the magnitude in the prospectus “Summary” so all investors understand the transfer of value. (See: Why Cornerstone Strategic Rights Offering Makes Little Sense for Shareholders (.pdf) (8/30/10))
Disclosure: No Disclosure, I just think this is a just a silly investment.