The Securities and Exchange Commission recently issued a notice regarding intended exemptive relief (the “Notice”) that would permit an open-end management investment company (referred to herein as an “open-end fund”) registered under the Investment Company Act of 1940, as amended (the “1940 Act”), that is a mutual fund to offer an exchange-traded fund (“ETF”) share class representing an interest in the same series of stock (the shares of which are interests in a distinct investment portfolio) as the mutual fund class or classes. Similarly, an open-end fund that is currently an ETF could offer a mutual fund share class or classes representing an interest in the same series of stock (investment portfolio) as the ETF class. With exemptive relief anticipated, we take this opportunity to remind our clients and friends of the flexibility afforded to open-end funds under both the Maryland General Corporation Law (the “MGCL”) and the Maryland Statutory Trust Act (the “MSTA”).
For Maryland corporations currently offering mutual funds, implementation of ETF share classes within existing investment portfolios will likely require an amendment to the corporation’s charter, which, as discussed in more detail below, may generally be approved by board action alone. In our experience, charters of corporations offering mutual funds do not contemplate issuance and redemption of shares in aggregations of creation units consistent with ETF requirements and may not specifically address redemption in-kind and variations in the form of redemption or other distributions among classes of the same series. It is possible to introduce ETF provisions when establishing new classes in Articles Supplementary, but these provisions will be specific to the classes created in the Articles Supplementary, and it will likely be preferable to amend the charter, given the distinctions between the shares of existing mutual fund classes and the new ETF classes within the same series. A corporation that currently offers ETFs may more easily implement mutual fund classes by Articles Supplementary, but charter amendments may also be preferable.
The MGCL was amended in 2020 to facilitate the operations and transactions of open-end funds by generally limiting the voting rights of stockholders of open-end funds to the election and removal of directors and those matters requiring a vote of security holders under the 1940 Act. The amendments aligned the governance of Maryland corporations that are open-end funds more closely with that of statutory trusts that are open-end funds and for which the governing instrument generally provides flexibility to the board of trustees to take many actions without a vote of the shareholders. Consistent with the foregoing, MGCL Section 2-604 requires that a charter amendment by a Maryland corporation registered as an open-end fund be approved by a majority of the entire board of directors and in the manner and by the vote required under the 1940 Act. The 1940 Act does not generally require that charter amendments be approved by stockholders. Accordingly, the board of directors of an open-end fund will typically have flexibility to amend the charter without stockholder action to implement provisions for an ETF share class of a mutual fund or a mutual fund class of an ETF. In addition to addressing creation units and redemption in-kind, other amendments may be desirable to clarify that there may be differences in declaration dates, record dates and payment dates of dividends and other distributions among the mutual fund classes and the ETF class of the same series.
In addition, the flexibility provided by the MGCL with respect to open-end funds will facilitate taking action if the board of directors determines, as a result of the ongoing monitoring process contemplated under the Notice, that there is a conflict between the mutual fund classes and the ETF class that the board needs to address or that other operational issues have arisen that make the combined mutual fund classes and ETF class unworkable or otherwise undesirable. In this regard, MGCL Section 3-104(a)(4) provides that, unless a corporation’s charter or bylaws provide otherwise (which can be addressed by a board-approved amendment in any event), transfers of assets between or among classes or series of stock of an open-end fund do not require stockholder approval. Accordingly, fund reorganizations that do not require the approval of the holders of voting securities under the 1940 Act may be effected without stockholder action under the MGCL.
Open-end funds formed as Maryland statutory trusts have at least as much, if not more, flexibility to implement ETF share classes. While the MSTA has a select number of default provisions, the governance of a statutory trust is determined almost entirely by its governing instrument, typically consisting of a declaration of trust and bylaws. Indeed, the MSTA specifically provides that it “shall be liberally construed to give maximum effect to the principle of freedom of contract and to the enforceability of governing instruments.” This flexibility distinguishes statutory trusts from trusts formed under common law and other types of entities and has made Maryland statutory trusts the entity of choice for several of our investment company clients for both open-end funds and closed-end investment companies. In our experience, the governing instrument of a statutory trust that is an open-end fund may generally be amended by the board of trustees without shareholder approval, subject to the 1940 Act, and the board of trustees of a statutory trust should be able to address the matters discussed above for ETF and mutual fund share classes without shareholder action under Maryland law.
Notwithstanding the flexibility under the MGCL and MSTA described above, the governing documents of a corporation or statutory trust should always be reviewed carefully in connection with any proposed amendment or extraordinary transaction.
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As always, please do not hesitate to call any of us or any of our colleagues if you have any questions or comments about the foregoing material or any other matter of Maryland law.
This memorandum is not intended to provide legal advice or opinion. Such advice may only be given when related to specific fact situations for which Venable LLP has accepted an engagement as counsel.