It is unfortunate that the July 15 hearing in the case of Philip Goldstein v. Scudder New Europe Fund (MFMN, 7/26/99 ) remained mired in legal interpretations instead of delving into the real issue at hand. The presiding judge and attorneys focused on interpretations of SEC no-action letters. They never got into a debate on the pros and cons of imposing redemption fees on closed-end funds when they open. Industry observers argue both ways, and it is a debate worth having.
Goldstein, an arbitrageur who holds 150,000 shares in the closed-end fund, wanted Scudder to allow shareholders to vote separately on opening the fund and on imposing a redemption fee.
U.S. District Court of New York Judge Loretta Preska ruled in favor of Scudder Kemper Investments of New York issuing a proxy combining the two issues. Her reasoning was that the fund's board deemed it a business necessity to protect shareholders against wholesale redemptions and excessive tax liabilities. The judge also cited two affidavits Scudder had presented from outside parties supporting this view.
The judge discounted an affidavit saying the fee was not necessary that Goldstein's attorney had presented from Lazard Freres & Co. of New York, the largest shareholder in the fund with 1.1 million shares. The judge said she discounted that opinion because it was not from a disinterested party.
Even if the judge had considered that affidavit, Goldstein's attorney, Gregory Keller, a partner at Silverman, Harnes, Harnes, Prussin & Keller of New York, could still have made a stronger argument for the feasibility of converting closed-end funds without redemption fees.
For example, when the judge asked Keller why redemption fees were not necessary, he replied, "It is obviously possible to separate [the two issues]. . . You don't need a redemption fee to open-end a fund under the 40 Act. Just because this was done this way in the past, it doesn't make it right."
The judge then asked Keller whether a redemption fee would "discourage wholesale redemptions, taking care of tax liabilities to protect all shareholders."
"There are no estimates of the cost of open-ending without a fee," Keller said.
"The fact other funds impose a redemption fee is of some relevance, is it not?" Preska then asked Keller.
"I don't know if it is relevant," said Keller.
In an interview after the hearing, Keller said he felt the judge would not have allowed a debate over the necessity of redemption fees.
"The judge already knew, from one of Scudder's affidavits, that half of the funds that open do not impose redemption fees," said Keller. "The issue, in the judge's mind, was not whether fees are necessary. Management had said the fee is a business necessity and she accepted that. She was not going to allow this debate."
Nonetheless, it still seemed that because the hearing came down to the question of whether fees are inextricably linked to opening a fund, Keller should have pressed the argument that they are not always imposed. He could have noted that a majority of funds do not impose such fees. In 1998, 60 percent of the closed-end funds that opened did not impose a redemption fee, according to Lipper, Inc. of Summit, N.J.
Goldstein's counsel could have presented affidavits from closed-end fund managers who have opted against fees and from third parties, such as Gregg Wolper, a closed-end fund editor with Morningstar of Chicago.
"Such fees are not absolutely necessary when open-ending a fund," said Wolper in an interview. "The goal is to reduce the amount of money moving out of a fund, but there is no proof they succeed in reducing the outflow of money."
"A redemption fee could be reasonable if there is a likelihood of many redemptions," said Robert Zutz, an attorney with Kirkpatrick & Lockhart of Washington, D.C. "But a fund can have no idea how many people will redeem," so it cannot be argued that redemption fees are a business necessity.
"There have been lots of conversions of closed-end funds without redemption fees," said Ron Olin, the chairman of Deep Discount Advisors of Asheville, N.C, a money management firm specializing in closed-end funds. "We believe it would have been proper, reasonable and fair to separate the proposals and let shareholders decide if they want such a fee."
On the other hand, no matter how convincing an argument Keller might have made, it may not have mattered because the judge seemed predisposed in Scudder's favor. Preska even implied Goldstein had made a pest of himself when she said that Goldstein had "bombarded" the SEC on this matter.
It will be interesting to see if the issue is raised again, in court, at an industry conference or in a study comparing the effects of opening closed-end funds with and without fees. If this case becomes a precedent, it would be unfortunate because it never delved thoroughly into this thorny issue.