I previously posted about an anti-activist bylaw at a closed end fund, meant to head off Saba Capital. The bylaw provided that an activist who obtained more than 10% of the fund’s voting power would not be able to vote the excess, unless the remaining fund shareholders voted to permit it. The Second Circuit found that bylaw ran afoul of the Investment Company Act.

Eaton Vance came up with a new tactic. Funds, unlike operating companies, have a large retail shareholder base. And retail shareholders often don’t cast ballots at all.

For ordinary director elections, retail lack of participation isn’t a huge problem. The directors are elected by a plurality standard, so you don’t need a majority of shares to vote in favor. And that means when an activist like Saba comes along, Saba can defeat the sitting directors under a plurality standard.

So! Eaton Vance funds passed a bylaw that provided for majority – not plurality – voting, but only if a director election is contested. And further, the bylaw provided that if no candidate receives a majority, then the sitting directors get to maintain their seats as holdover directors.

Which functionally means that, in a contested election, the activist is subject to a higher voting threshold than the incumbent nominees. A threshold that, due to lack of retail participation, is unlikely to be met.

Saba challenged the bylaw in court, and after a bench trial, the Massachusetts Superior Court upheld the bylaw. The court agreed that if the bylaw made it impossible for a challenge to succeed, it would violate both the terms of the Trust – which was functionally a contract – and the Investment Company Act. But, the court found as a factual matter that the bylaw did not make it “impossible or impracticable” to elect challenger nominees.

I know very little about closed end funds; the Investment Company Institute, unsurprisingly, defends them and accuses activists of taking advantage of market dislocations that cause the funds to trade below their NAV. Meanwhile, the Working Group on Market Efficiency and Investor Protection in Closed-End Funds concludes that these “market dislocations” are ubiquitous and activism in closed end funds is important to protect investors.

But what interests me here is that nothing in the Massachusetts opinion discusses fiduciary obligations. The only questions the court addresses are whether the bylaw is a violation of statute or contract. Apparently, at some point earlier in the case, Saba did argue that the bylaw breached the Trustees’ fiduciary obligations, citing Delaware law; for whatever reason, the court did not address that argument in its final ruling.

I don’t know Massachusetts trust law, but in Delaware, we’d of course say that inequitable action does not become permissible simply because it is legally possible; the actions of Delaware corporate directors are “twice tested”: first for legal validity, and second for compliance with fiduciary obligation. But I find it very difficult to believe that Delaware, anyway, would conclude that a bylaw that imposes different voting thresholds for challengers and sitting directors (with shifting thresholds depending on the existence of a contest) comports with fiduciary obligations. If nothing else, the incumbents would have to identify a “threat” justifying a defensive measure, and “shareholders might vote for a policy I think is bad” is not a cognizable threat.

And finally, the latest Shareholder Primacy podcast is up.  This week, Mike Levin talks with Harvard Law’s Ben Bates about his paper on advance notice bylaws, forthcoming in the NYU Law Review.  Available at Apple, Spotify, and YouTube.