June 22, 1989
TO: CLOSED-END FUND COMMITTEE NO. 19-89
SEC RULES COMMITTEE NO. 30-89
RE: ISSUES CONCERNING CLOSED-END FUND TENDER OFFERS
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Several closed-end funds have conducted or have disclosed
in their prospectuses their intention to conduct issuer tender
offers in an effort to provide liquidity to shareholders or, if a
secondary market exists for the fund shares, to seek to prevent
the shares from trading at a discount. In March several members
of the ICI staff met with representatives of the Divisions of
Corporation Finance, Market Regulation and Investment Management
to discuss various issues that the staff raised in connection
with closed-end fund tender offers. A summary of the issues
discussed at the meeting was then distributed. (See Memorandum
to Closed-End Fund Members No. 17-89, dated April 7, 1989.) Set
forth below are the issues that we believe are of significance
and should be further considered:
All Holders Rule. One way to avoid participation by
arbitrageurs in a closed-end fund tender offer is to establish a
record date for shareholders that may participate in the tender
offer. The SEC staff contends that this is prohibited under the
"all holders rule" under Rule 13e-4(f)(8)(i) of the Securities
Exchange Act of 1934 which requires that a tender offer be open
to all shareholders and therefore investors who purchase fund
shares after the commencement of the tender offer must be
included in the offer.
Odd Lot Tender Offers. With respect to "odd lot tender
offers" permitted under Rule 13e-4, i.e., tender offers made only
to holders of fewer than 100 shares, the staff raised the issue
that such offers may not be permitted under Section 23(c)(2) of
the Investment Company Act of 1940. Section 23(c)(2) requires
that closed-end fund tender offers be made to all shareholders of
the class of securities to be purchased. Generally, the purpose
of odd lot tender offers is to enable the issuer to reduce the
high costs of servicing small shareholder accounts.
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Best Price Rule. The "best price rule" under Rule
13e-4(f)(8)(ii) requires that the highest consideration paid for
tendered shares be paid to all shareholders. The staff believes
that this rule prohibits funds from waiving sales-related charges
for certain affiliated persons of the fund, e.g., officers and
employees, that may be imposed as a result of tendering their
shares. The staff has also raised the concern that the best
price rule may prohibit an issuer from imposing a flat fee on
tendering shareholders as opposed to a fee that varies based on
the number of shares tendered.
Financing of Tender Offers. Rule 13e-4(f)(5) requires
that "prompt" payment be made for shares tendered pursuant to an
issuer tender offer. Prompt payment has been interpreted as gen-
erally meaning within five business days. The staff is concerned
that closed-end funds, especially those tendering for all of
their shares, may not have sufficient cash on hand or liquidity
of assets to make prompt payment for tendered shares. This issue
raises several additional concerns such as the fact that the 1940
Act includes certain restrictions with respect to borrowing, that
a fund may be in violation of a fundamental investment objective
if it is holding an excessive amount of cash or cash equivalent
assets and that a fund that tenders for only a portion of its
shares may, if too many shares are tendered and the fund does not
intend to purchase tendered shares on a pro rata basis, have to
extend the tender offer period resulting in additional costs and
administrative burdens.
Tax Issues. In addition to the securities law issues
discussed above, there is a possible tax issue with respect to
periodic tender offers. Under Internal Revenue Code Section
305(b)(2), a distribution of a corporation's stock is taxable to
its recipients if the distribution results in (a) the receipt of
property by some shareholders, and (b) an increase in the
proportionate interests of other shareholders in the assets or
earnings of the corporation. It has been suggested that the
regulations under Code Section 305(c) indicate that as a result
of periodic tender offers, non-tendering shareholders may receive
a "deemed distribution" of fund shares which may be treated as a
taxable dividend even though they did not, in fact, receive a
distribution. The triggering of the constructive distribution
rule also may, under this interpretation, result in the payments
to tendering shareholders and the deemed distribution to non-
tendering shareholders being treated as preferential dividends.
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We would appreciate receiving your views as to which of the
above issues, or any other issues relating to closed-end fund
tender offers, the Institute should pursue with the SEC staff or
the IRS. In addition, please let me know if you think it would
be beneficial to hold a meeting to further discuss these issues.
My direct number is (202) 955-3523. Please provide me with your
views by July 14, l989.
Amy B. Rosenblum
Assistant General Counsel