Highland to convert open-end fund to closed-end

Unique move aims to help fund digest massive settlement it expects from Credit Suisse

Sep 29, 2017 @ 5:59 pm

By John Waggoner

You've probably heard of closed-end mutual funds converting to open-end funds. But Highland Floating Rate Opportunities Fund (HFRAX) is hoping to go in the other direction, thanks to a potentially massive legal settlement it's expecting from Credit Suisse dating back to the financial crisis.

If all goes as planned, the fund will convert from a conventional open-end fund to a closed-end fund later this year.

The backstory: Credit Suisse marketed loans to Lake Las Vegas and other luxury real estate developments that were subsequently financed from nonbank sources like Highland. But the Las Vegas property – along with other developments – went bankrupt, resulting in losses for the lenders. Credit Suisse claimed the bankruptcies were a consequence of the crisis itself.

Highland contended that Credit Suisse committed fraud in selling the loans, and took the investment bank to court. The U.S. District Court in Dallas took Highland's side, and ordered Credit Suisse to pay $279 million in damages and restitution to the fund. Credit Suisse has appealed the case, and a ruling is expected Oct. 18. If it loses that appeal, Credit Suisse could also appeal to the Texas Supreme Court.

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For the $940.4 million Highland fund, a $279 million award is a big gain to swallow. The company fears speculators could pile in and dilute shareholders' gains. Their solution: Convert the fund to a closed-end structure, which includes only a set number of shares.

If it were still an open-ended fund when demand increased, it would issue new shares to accommodate new investors, diluting the potential impact of the payment from Credit Suisse. A closed-end fund, in contrast, would simply see its share price rise.

Although Credit Suisse has appealed the federal court's ruling, Highland says it has enough anecdotal evidence from its sales team that interest in the fund is starting to mount.

"We believe that the judgment, if confirmed, should benefit long-term shareholders rather than speculators seeking to profit from the fund's successful litigation," the fund said in its proxy statement.

Fund management also worries that a "liquidity mismatch" could occur if the fund has to book the judgment in its net asset value and the actual payment rolls in somewhat later.

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"By converting the fund to a closed-end structure, the fund would not be required to redeem shares immediately following the recording of the award as an asset of the fund, when the fund may not be able to readily convert the award into cash," the proxy said.

Highland filed its proxy with the Securities and Exchange Commission on Monday.

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