Our latest investor alert, “The Supreme Court Pushes Enforcement of the Investment Company Act Away from Investors and Toward the SEC,” examines the U.S. Supreme Court’s 6-3 decision in FS Credit Opportunities Corp. v. Saba Capital Master Fund, Ltd., which held that Section 47(b) of the Investment Company Act of 1940 (the 1940 Act) does not create an implied private right of action.

The case, which resolves a longstanding split among the federal Courts of Appeal, arises from a challenge brought by investor Saba Capital against 16 closed-end investment funds organized under Maryland law.  The funds adopted resolutions opting into the Maryland Control Share Acquisition Act (MCSAA), a state statute that limits voting rights for shareholders holding a disproportionate number of shares unless other shareholders approve to prevent rapid shifts in fund control.  Saba Capital alleged the funds adopted these provisions specifically in response to it and other activist investors acquiring large positions in underperforming closed-end funds with the goal of altering a fund’s investment strategies.

Saba Capital brought claims that the funds violated Section 18(i) of the 1940 Act, which requires that each share of stock carry equal voting rights, and further invoked Section 47(b) of the Act, which provides that a court may not deny rescission of contracts that violate the 1940 Act.  In issuing its ruling, the Supreme Court held that Section 47(b) does not impliedly empower private parties to sue for rescission of contracts that allegedly violate the 1940 Act and emphasized that Congress, not the judiciary, determines who may enforce federal statutes.  The Supreme Court further noted that the SEC bears primary responsibility for ensuring compliance with the 1940 Act and that it has the authority to investigate and pursue enforcement actions for violations.

The authors examine the decision’s implications and offer key takeaways for institutional investors.  Noting that the ruling eliminates what had been a primary vehicle for private parties to challenge contracts that allegedly violate the 1940 Act, they advise that direct legal challenges may become more difficult for institutional investors with significant holdings in closed-end funds, mutual funds, or ETFs to pursue.  Furthermore, because the decision centralizes enforcement authority within the SEC, investors who believe a fund’s contractual arrangements violate the 1940 Act will need to look to the SEC for relief.  Finally, investors who relied on Section 47(b) as a litigation tool may now need to pursue alternative avenues, including state law claims or proxy contests, and should assess whether the shift in enforcement authority alters the balance of power between fund management and shareholders in ways that affect their corporate governance expectations.