Fifth Street Finance Corp (FSC) stockholder, RiverNorth Capital Management, has sent a letter to the board of directors of the business development company (BDC) highlighting concerns over management and performance of the vehicle. The firm demanded that new independent board members be appointed to make strategic changes. If not adhered to, RiverNorth said it will submit a proposal to terminate the investment advisory agreement at an upcoming meeting of FSC stockholders.
“We have grown increasingly concerned about the direction of the company and the leadership of the board,” said a statement from RiverNorth yesterday (16 November). “We believe the company’s external manager, Fifth Street Asset Management, has been focused on its own wealth creation at the expense of FSC stockholders. We believe true stockholder representation on the board is required immediately to ensure that stockholders’ best interests are appropriately represented,” the statement continued.
Chicago-based RiverNorth owns 6 percent of FSC shares. A statement from FSC today (17 November) said that RiverNorth only begun acquiring FSC shares in recent weeks to build such a large stake and that it hasn’t responded to FSC’s invitation for a meeting. “FSC believes that the RiverNorth press release was inflammatory and misleading. Since its founding 17 years ago, Fifth Street has created a long-term track record as a middle market credit-focused asset manager with strong underwriting and portfolio management expertise,” said a statement from Fifth Street. “We agree with RiverNorth's assertion that we have built a solid portfolio that has been undervalued by the market. Additionally, we are disappointed that RiverNorth disregarded FSC's invitation for a meeting and launched its initiative without making a good-faith effort to learn the facts,” FSC’s statement continued.
RiverNorth’s concerns point to what they call “appalling historical performance” where FSC has lost 28.2 percent for the one year through 30 October, 27.9 percent for the three years, 16.5 percent for the five years and 8.8 percent since its IPO in June 2008. The returns fell far below all relevant indices including the Wells Fargo BDC index, the S&P 500 and high-yield bonds.
RiverNorth also remarked on the “questionable reputation of the external manager”. Fifth Street Asset Management (FSAM) and several of its key executives including Len Tannenbaum (pictured), Bernard Berman, Alexander Frank, Todd Owens, Ivelin Dimitrov and Richard Petrocelli have recently been named defendants in several securities class-action lawsuits. The lawsuits allege that the defendants engaged in a fraudulent scheme to artificially inflate FSC’s assets and income at the time of taking FSAM public in October last year.
RiverNorth also points to a “deeply troubling mis-alignment of interests” where FSC’s book value per share has declined 31 percent since its 2008 IPO, while the quarterly fees paid to the external manager have increased by 6.3 times. “In the past twelve months alone, the external manager has charged the company’s stockholders base and incentive fees totaling $85.4 million,” RiverNorth’s statement said. “We believe it is clear that the external manager has benefited from running a larger portfolio while stockholders have suffered from uneconomic growth. The declining book value, net investment income and distributions per share demonstrate this troubling discrepancy,” the statement continued.
The statement also highlights the fact that FSC’s stock is trading at the highest discounts to book for comparable BDC’s of its size (FSC was trading at 34 percent below NAV as of last week). “There is no other BDC with a market capitalization greater than $500 million with a lower price to book valuation,” RiverNorth said.
The mutual fund firm takes issue with the fact that four FSC’s board members including Dimitrov, Owens and Berman, as well as Sandeep Khorana, are also senior employees at the external manager and the board is therefore conflicted.
RiverNorth is suggesting nominating three new director candidates: Randy Rochman, Fred Steingraber and Murray Wise, to the board at FSC’s 2016 Annual meeting of stockholders. Rochman is the chief executive of West Family Investments. Steingraber is the chairman of board advisors, a consulting firm. Wise serves as the chief executive of Murray Wise Associates, an advisory firm.
“RiverNorth’s director nominees, if elected, would represent the best interests of stockholders, including taking decisive action to materially improve the valuation of FSC shares,” the firm said. RiverNorth is suggesting reducing the management and incentive fees, saying the “current 2/20 fee structure is absurd” applying a total return high water mark to net investment income and incentive fee calculation and significantly increasing the stock buyback programme.
“If FSC works with us to reconstitute the board and fully implement the strategic changes we require, then we would be willing to withdraw our proposal to terminate the investment advisory agreement at the 2015 annual meeting,” RiverNorth said.