By Richard Fiesta
March 27, 2020 at 5:00 am ET
The current volatility in the financial markets has many Americans doing a double-take at the sight of their retirement investment accounts. While the up-and-downs of IRAs, 401Ks, and pension funds are to be expected at this time, everyday Americans might not be aware of a lesser-known threat to their nest eggs. Largely unnoticed, a group of activist investors has been reaping massive profits by shuttering funds that more than 3 million Americans depend on for retirement income.
The investments under attack are closed-end funds (CEFs). CEFs are similar to mutual funds but trade on an exchange and have a fixed number of shares outstanding. CEFs typically pay a monthly distribution to shareholders. A well-established and reliable investment vehicle for Main Street investors, CEFs are commonly used by retirees and soon-to-be retirees as a source of steady income.
The Securities and Exchange Commission already has the authority to protect CEFs and the older Americans who rely on them, but has so far failed to take action. The uncertainty they are experiencing today should only further galvanize the SEC to step in and protect retirement investors.
Over the last decade, the number of closed-end funds has declined precipitously due to the tactics of activist investors. Motivated by greed and self-interest, these activists exploit a regulatory loophole to force CEFs to liquidate — reducing the availability of these reliable income generators important to the financial stability of many Americans in their retirement years. It is past the time to protect honest investors by eliminating this scheme.
Closed-end funds can provide stable and regular returns for investors. They often offer higher distribution rates than mutual funds. Sangeeta Marfiata, a senior closed-end fund analyst at financial firm UBS, noted the benefits of closed-end funds clearly: “If you are a retiree and you are counting on monthly income, CEFs may fit perfectly in your portfolio.”
Three and a half million Americans invest in closed-end funds, and nearly 4 in 10 of those are retirees.
Activist investors like Saba Capital Management have discovered that they can use these funds to generate short-term profits for themselves — at the expense of retirees and other Main Street investors. First, they identify CEFs that are trading at a price that is at a discount to the fund’s net asset value. Then, they buy significant shares of those funds. Once activists have amassed a large-enough voting share, they force management changes under the guise of corporate governance to benefit their own interests, without regard to other investors. Ultimately, they seek to force a liquidation of the fund to receive a large payout.
These predatory tactics have taken a toll on the number of closed-end funds available to investors. In 2007, the country had more than 650 closed-end funds. By 2018, that number plunged to roughly 500.
These closures deprive hard-working Americans of much-needed retirement options — with little to no warning, and at a time when about half of all seniors living alone are struggling to make ends meet, according to a new study from the Center for Social and Demographic Research on Aging. Cutting off a reliable source of income introduces yet more financial uncertainty for retirees.
Existing federal law should prevent such predatory tactics. The Investment Company Act of 1940 limits a registered fund from owning more than 3 percent of a target funds’ shares. But activist investors have dodged enforcement by creating multiple controlled hedge funds and then using their combined influence to force funds to liquidate.
While the SEC has yet to take any action on this, retail investors found an ally in former Commissioner Robert Jackson. Jackson, when asked by Rep. Gregory Meeks at a congressional hearing about the activist investors’ arbitrage, correctly stated that retirees “bought the fund with the understanding that it wouldn’t be attacked in just this way.” And in a recent interview with Business Insider, Jackson lamented that activist groups were cheating everyday Americans out of the investments they signed up for.
Now, it’s critical that we end this exploitation and give back retirees more investment choices. The SEC should analyze the shrinking number of closed-end funds and how that affects retirees. They can begin to remedy this ongoing injury to retail investors by issuing guidance to clarify that the 1940 Act was intended to prevent what CEF activists are doing. In addition, they should also consider issuing new regulations to end these unfair tactics. Meanwhile, lawmakers shouldn’t wait for the SEC to act. Congress must close the 3 percent loophole. They can start by holding hearings on the impact of activist investors on closed-end funds and bringing more awareness to these abuses.
For too long, CEF activists looking to make a quick buck have been allowed to destroy a key source of reliable income for retirees. It’s about time that changes.
Richard Fiesta is the executive director at the Alliance for Retired Americans.
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