Corporate elections and proxy votes - what a sad parody of democracy. If Patrick Henry were alive today, he'd probably turn over in his grave on learning of recent activity at the Liberty All-Star Growth Fund (ASG). This closed-end investment company seeks midcap growth for its @ $100 million in assets by using a "multi-manager" approach, where fund manager ALPS Advisers subcontracts the actual work of picking stocks to three other portfolio management firms. The hope is that three heads will prove better than one, but in practice, both risk and return have been pretty average.
ALPS' annual management fee is 0.8% of fund assets, plus another 0.2% for administration. ALPS in turn pays its chosen sub-managers 0.4% of assets for their work. The spread between the amount ALPS gets from ASG and the amount going to the sub-advisers compensates ALPS for "general management services" and its "overall supervisory responsibility". Nice Work If You Can Get It, as Tom Sawyer might say.
ASG shares have traded at a significant discount to net asset value (currently -9.4%, and as much as -18.2% in the last 3 years), so it has attracted activist investors, who push for action to close the NAV gap through share buybacks, open-ending or liquidation. Such moves tend to reduce fund size, on which management fees are based, and may encounter intense opposition. The problem for the activists is that shareholders have very little control over the funds they own. Proxy resolutions are only non-binding requests, and it takes a majority of all outstanding shares - not just those present and voting - to beat an incumbent director in a proxy fight. And a single victory does not suffice, since directors typically serve staggered 3-year terms with only 1/3rd up for election each year. That leaves the activists with only one pivot point: a "§15(a)" vote.
Section 15(a) of the Investment Company Act of 1940 requires a majority vote by fund shareholders [technically, 50%+ of all shares, or 2/3rds at a meeting with a 50% quorum] to approve new managers, new sub-managers or new contracts. Back in the old days, it seems, investment advisers were considered "fiduciaries" - folks who, for a fee, could be trusted to advance fund investor interests, rather than their own. A profitable contract to manage investments is a valuable asset, which can be bought and sold like other contract rights, and advisory firms themselves may be acquired or merge. However, trust is not a commodity that one fund manager can automatically hand over to another. Section 15(a) restricts "trafficking" in advisory contracts by giving investors the right to ratify or reject such changes.
Liberty All-Star's multi-manager approach means change a-plenty. The primary contract has changed hands five times since the fund was formed as the Charles Allmon Growth Stock Fund back in 1986. And since taking over from Bank of America back in 2006, ALPS has fired one sub-manager, fired its replacement, seen their next choice defeated in a §15(a) proxy fight brought by activist Phil Goldstein's Bulldog Investors, and avoided another §15(a) defeat only by making an existing sub-manager do double duty and run 2/3rds of ASG's portfolio.
Meanwhile, the activists were loading up. By July of 2011, Bulldog owned just under 12% of ASG, and another activist firm, Karpus Investment Management, had acquired 11%. At that point, DST Systems, a NYSE-listed software conglomerate with emphasis on securities recordkeeping and medical claims processing, agreed to acquire closely-held ALPS for @ $251 million. Such a change of ownership triggers §15(a), so ALPS had to seek approval from ASG's shareholders in order to continue managing the fund. Shortly after a special meeting was scheduled for the vote, KIM announced its opposition in a preliminary proxy filing, saying "shareholders who do not wish to see their assets transferred should be afforded the opportunity to exit their investment at or near net asset value."
How awkward for the parties to the ALPS-DST deal, especially since part of the price to be paid the sellers depended on keeping existing contracts and revenues. Let's put on Gwailo's Halloween mask, and join ALPS and friends as they discuss how to solve their proxy vote problems.
"I have it! We'll apply Free Market Principles to the election."
"What do you mean, Baron Samedi?"
"We'll make KIM an offer they can't refuse -- we'll buy a big chunk of their shares at an above-market price, on condition that they vote all their shares for the new contract."
"Voo-doo! What a great idea!"
So KIM got $11 million for shares with a market value of $10 million, DST became the proud owner of 2,775,000 shares (9.2%) of ASG, and ALPS just barely got enough votes to continue managing the fund.
And at Patrick Henry's grave, the ground began to tremble.
Pesky shareholders! SEC rules let them put their own resolutions on fund proxies, and though not binding, they can be embarrassing. For the 2012 annual meeting, some ASG shareholder proposed:
"RESOLVED: the Shareholders request that the Board promptly initiate a self-tender under which the Fund shall offer to repurchase all of its outstanding Shares for cash at 98% of net asset value per Share."
With a supporting statement that said everyone should be offered a deal as good as the one that KIM got. "Ha!" said Fund Counsel, "Here's a chance to rack up some billable hours writing 13 pages of objections to putting this on the proxy. Worthless objections, to be sure, but we've a lot of mouths to feed here at Vholes & Vholes." [The objections are here, starting at p. 3, right after the SEC's mercifully brief rejection letter.]
"OK, boss, now how do we get ASG shareholders to vote against getting a deal as good as the one we gave KIM? And Bulldog still owns 11%, and that Goldstein guy's mad as a Brooklyn hornet at being shut out."
"Well, we'll have to give up some management fees…"
[Sound of wolves howling in the background.]
"Hear me out! We'll have ASG offer to buy back 25% of its shares -- but only for 95% of net asset value. That will undercut the shareholder proposal, give Bulldog a chance to cash out, and add to the NAV of the remaining shares - such as those owned by our friends at DST."
"So we toss a bone to the Bulldog, eh?"
"Right! And then we set the annual meeting date with only two weeks lead time, so by the time Mr. and Mrs. Average Investor open their mail, the meeting date will have passed. And as for the happy folks who had their shares bought back - let's let them vote anyway."
"So we cancel the buyback shares on July 24, but count them at the meeting on July 30? Isn't there something spooky about that?"
"What scares you most - ghosts, or shareholders? The law doesn't say we can't do this, and we've an election to win."
Patrick Henry is more and more upset. The prospect of zombies voting dead shares troubles him. Is this the Liberty he was once prepared to die for?
"And just to make sure, we'll 'forget' to put one of the directors on the proxy ballot. Then when everyone is confused, we'll adjourn the meeting and rustle up another bunch of votes, because:
'After careful review, the Board of Directors, including all of the independent directors, wishes to amend Proposal 1 to include an additional Director, Edmund J. Burke, for re-election.'"
"Brilliant, boss. No one will ever figure out whether this is blazing incompetence or Machiavellian subtlety. Or both."
The meeting results have still not been announced. Meanwhile, ALPS has decided to rid itself of this annoying §15(a) vote requirement once and for all. On July 2 Fund Counsel petitioned the SEC for a blanket exemption from voting on sub-manager changes, and also from disclosing how much ALPS pays each sub-manager. The petition points to similar relief recently given to some open-end multi-manager mutual funds, whose investors can get their shares redeemed at NAV on request. However, closed-end funds like ASG do not stand ready to buy back shares. "If you don't like a new sub-manager", says Fund Counsel, "just sell your shares". Who will buy them? At what price? Fund Counsel sayeth not.
Two weeks ago ALPS made its latest move. It seems that TCW, the outfit that now runs 2/3rds of ASG's portfolio, is being acquired by the Carlyle Group -- so yet another §15(a) vote is being set for a special meeting in December.
"And as long as we're mailing out proxies, why not include one more proposal at the end? Purely routine, you understand, and very efficient. Even though the SEC hasn't granted the exemption yet, on conditions yet to be decided, let's have our shareholders vote now to approve giving up their rights to vote in the future."
"No," screams Patrick Henry's unquiet ghost. "I can take no more of this. If this be Liberty - then give me Halloween!"
'Gwailo 10/31/2012 Long ASG (< 0.5% of portfolio)
Disclosure: I am long ASG.