Court Says that Fund May Not Change Industry Classifications Without Shareholder Vote
The U.S. District Court for the Northern District Court of California has ruled that a fund may not alter previously stated concentration policies without shareholder approval. In a case against a fund sponsor that allowed a yield plus fund to invest in mortgage-backed securities, plaintiffs argued that the fund, which had defined MBS as an industry, could not alter that categorization without shareholder approval. The fund sponsor argued that the SAI specifically allowed the Board to change industry classifications without shareholder approval. The Court agreed with the plaintiffs, opining that a fund may not lure investors into a fund and then change investment objectives. The Court reasoned: “The industry definition would have been understood by reasonable investors to be an integral part of the concentration policy represented to be inviolate without shareholder approval.”
OUR TAKE: We will not comment on whether the fund sponsor should have allowed the fund to invest more than 25% of its assets in MBS. However, we believe the Court has mis-applied Section 13(a), especially since the fund sponsor explicitly stated that it could change industry classification without shareholder vote. The Court’s argument that investors were lured into the fund ignores that such investors could have redeemed as soon as the fund changed its industry classifications.