The operational efficiencies created by reorganizing a fund in Maryland or Delaware often come at a cost to shareholders who lose some of the power they may have had under other states' fund governance laws, according to industry lawyers and analysts.
"You can be certain that if fund companies are moving their state incorporation, they are not doing it to promote shareholder interest," said Ted Siedle, a federal securities lawyer and former official with the division of investment management of the Securities and Exchange Commission. "They are doing it to cut costs or dilute the rights of shareholders. Show me one case of a mutual fund company that has done anything strategic like this to enhance shareholder rights. It's unheard of."
"It gives fund boards a tremendous amount of power," said Erin McNally, an analyst with Institutional Shareholder Services, a proxy voting service and consultant owned by Thomson Financial, the publisher of this newsletter.
In the past two to three years, there has been an increase in the number of funds filing proxies seeking to reorganize in either Maryland or Delaware because those states tip the balance of power toward the fund company, she said.
A total of 18 fund families were reorganized into Delaware business trusts in 1999 and 2000, according to Institutional Shareholder Services.
In Maryland, all shareholder proxies must be submitted to the fund's board of directors for review at least 90 days before the proxy is issued, McNally said. In most states, the maximum amount of notice required is 90 days, and in some states it is as little as 60 days. Maryland's law gives fund boards an advantage in proxy fights with shareholders because it allows them to prevent last-minute proposals and dissident nominations, McNally said.
While Maryland's laws were designed to curtail shareholder activism in closed-end funds, open-end shareholders lose the same rights that closed-end stock owners lose when their funds reorganize in Maryland, she said.
Phoenix Investment Partners of Hartford, Conn. was one of the families that reorganized as a Delaware business trust in the last two years. Phoenix decided to reorganize all of its funds into Delaware business trusts in order to create operational efficiencies, said Sharon Bray, a spokesperson for the company. Phoenix added a number of funds through acquisitions the firm made in the late 90's, Bray said. By domiciling the funds in Delaware, the funds are not required to issue annual proxies and trustees have the power to amend, merge or consolidate funds without shareholder approval, Bray said. (MFMN 8/24/00) Phoenix funds had been domiciled in a variety of states because Phoenix had built its fund lineup through acquisitions. The recently-acquired Duff & Phelps funds had been domiciled in Massachusetts.
Incorporating in either Maryland or Delaware also provides certain tax advantages, said Jim Hanks, a partner with Ballard, Spahr Andrews & Ingersoll. In Maryland, for instance, funds do not have to pay a franchise tax that can amount to as much as $150,000 a year in expenses, he said. Most other states have such a tax, he said. Also, board directors have broader indemnification from being held liable for even gross acts of negligence in Maryland, he said.
Open-end fund investors are not being disenfranchised by Maryland's and Delaware's governance rules because those investors' primary interest is protection of principal, their funds' abilities to redeem on demand and protection against a discount to net asset value, he said.
Both Maryland and Delaware have a long tradition of passing lenient fund governance laws in an effort to attract fund companies, said John Collins, a spokesperson for
the Investment Company Institute of Washington, D.C. However, state laws cannot supercede federal regulations and are, in fact, designed to harmonize with the Investment Company Act of 1940, he said.