Lawyers have become clear beneficiaries of fights over the performance of closed-end funds and it is the shareholders of closed-end funds who are primarily paying for the lawyers' good fortunes.
The fairness of this has been disputed in proxy fights in recent months involving at least two closed-end funds: the Bull & Bear U.S. Government Securities Fund and the Emerging Germany Fund. Now, however, in a third dispute, the issue has taken on a new twist.
It appears that shareholders in the closed-end Emerging Mexico Fund are destined to pay at least a portion of the legal bills both for the lawyers who defended the fund and the lawyers who sued the fund and its directors in class action suits over how best to remedy a persistent discount to the $67 million fund's net asset value (NAV). Last year that discount averaged 18.15 percent. In both the cases of the Emerging German and Bull & Bear funds, the funds only paid the legal fees of the funds' own lawyers.
The dispute which has generated the legal bills is nearly resolved- the board of Emerging Mexico recommended in a proxy statement filed with the SEC Jan. 29 that the fund be liquidated, citing the NAV discount as a principal reason. Shareholders are scheduled to vote on the proposal at a meeting March 30.
But before the fund's assets are sold off and the proceeds returned to investors, Emerging Germany's shareholders will pay legal fees of as much as $350,000 for the lawyers who sued the fund, according to the proxy statement. The lawyers for the dissident shareholders say the fees are reasonable and even possibly below the norm for comparable disputes. A federal court judge must approve the fees.
Class action law suits provide one of the very few ways for investors to challenge a fund adviser over allegedly abusive practices, closed-end fund investors said last week. Class action lawyers usually take cases on a contingency fee basis. Without such representation, no individual investor could afford to pick a fight with a fund, the investors said. And without the fight, Emerging Germany might still be a closed-end fund with a nagging discount, lawyers and shareholder activists said.
"As a result of our litigation efforts ... we have basically caused a corporate transaction that will result in shareholders getting NAV," said Greg Keller, a lawyer for hedge fund manager Phillip Goldstein who fought Emerging Germany over the fund's practices.Keller and other closed-end fund investors and lawyers said the suits also benefit corporate governance practices throughout the mutual fund industry and as a result serve a wide range of investors.
The class action situation poses a dilemma for some investors, however. Ronald Olin, president of an Asheville, N.C. investment firm that has pressed for changes at closed-end funds, agreed that class actions help investors get representation that otherwise would not be available. But Olin expressed reservations about lawyers in such cases being paid out of fund assets.
"The only problem is the class action lawyers are paid by the shareholders and that's a big problem," Olin said.
Indeed, Olin's firm, Deep Discount Advisors, at a meeting last month of the Emerging Germany Fund, proposed that the fund's adviser and not the fund itself pay part of the fund's legal expenses. The proposal, in the form of a non-binding recommendation, failed. A spokesperson for Emerging Germany's adviser, Dresdner RCM Global Investors, was not available for comment.
In December, another closed-end fund found itself in a proxy fight in which the fairness of fund legal expenses was an issue. The board of Bull & Bear U.S. Government Securities Fund responded angrily to charges that the legal fees the fund had incurred responding to the suit of an unhappy shareholder were "outrageous" and unfair to shareholders. The board said the investment advisory firm which had pressed the fight, Karpus Investment Management of Pittsford, New York, was driving up fund expenses by picking legal fights.
"KARPUS IS WASTING THE FUND'S MONEY," (sic) the board said in a Dec. 4 proxy statement. Karpus's "continued feuding" with the fund was to blame for escalating legal expenses, not the fund, the board said.
But, Scott Nasca, director of equity investments for Karpus, said last week that it was the adviser who had used litigation to frustrate efforts to improve the fund's performance. Nasca said the dispute is particularly frustrating because the fund's assets are too low, at roughly $11 million, for class action lawyers to find the case worth the cost and risk of litigating.
The fund adviser "can hide behind the expenses of the fund to cover their legal costs" while Karpus has had to bear its own expenses, Nasca said.
"It's not a fair fight as far as activists are concerned," Nasca said.
The closed-end fund industry dismisses such arguments. "Activist" shareholders frequently are institutions conducting closed-end fund arbitrage, said Brian M. Smith, executive director of the Closed End Fund Association, a trade group. Litigation and proxy fights against funds essentially are an investment tactic for institutional shareholders trying to maximize the return on their investments, he said.
And while funds do pay the legal expenses of their lawyers defending against shareholder actions, they are guided by the interests of long-term shareholders and not just arbitragers, Smith said.
"The real eye here ought to be (kept) on the long-term shareholder," Smith said. When arbitragers "start to squeal, that's unfair," he said. Arbitragers have "significant resources" in their own right, he said.
But those resources pale in comparison to the money available to a fund board and its adviser, said Goldstein, the hedge fund manager from Pleasantville, N.Y. who has been outspoken in his criticism of practices at several closed-end funds. Goldstein cited the public record of expenses for Emerging Mexico as evidence of the expense the fund incurred in fighting him. The fund's annual reports on file with the SEC showed legal and audit fees increased from approximately $183,000 in 1997 to $588,000 in 1998 for the year ending June 30.
The fund's lawyers "should be throwing me a party," Goldstein said.
The reports did not break out expenses between legal and audit fees, nor do they identify legal expenses on an item-by-item basis. A spokesperson for Santander Management, Emerging Mexico's investment adviser, did not return a call for comment.
Nevertheless, Goldstein was circumspect about the nature of these disputes. While convinced that fund advisers had served their own interests ahead of shareholders in many instances, class action lawyers face a dilemma of their own, Goldstein said. The lawyers want both the best possible recovery for their clients but they also want to be paid for their work and the risk they take in bringing a case.
"Everybody in the world has a conflict of interest," Goldstein said.