Several key regulatory developments and reforms have the potential to significantly help business development companies (closed-end investment management companies that are specially regulated by the Investment Company Act of 1940). This article addresses those developments and how they are expected to impact the BDC industry.

BDCs provide capital to, and invest in, small and middle-market companies in the U.S. As a result of this special investment purpose, BDCs are exempt from certain regulatory constraints imposed by the 1940 Act on traditional investment companies and generally benefit from pass through tax treatment.

Given the limited access to, and availability of, financing from traditional bank lenders, BDCs have recently played an important and increasing role as a crucial source of capital and liquidity to small and mid-sized companies that may not be able to otherwise obtain financing or do so at attractive rates.

Proposed Securities Offering Reforms

Communication Reforms Now Effective

The securities offering and offering-related communication reforms that were included in the Small Business Credit Availability Act became automatically effective on March 23, 2019 because the Securities and Exchange Commission did not issue final rules prior to the one-year anniversary of the Act. While the communications safe harbors and securities offering related accommodations for well-known seasoned issuers have been available to corporate issuers for more than a decade, BDCs are now allowed to similarly rely on the following provisions:

  • BDCs may now qualify as a well-known seasoned issuer or WKSI (this permits, among other things, the use of automatically effective shelf registration statements and free writing prospectuses).
  • BDCs may now incorporate by reference (backwards and forwards) in their registration statements from other filings.
  • BDCs may now rely on access equal delivery rules (this removes the requirement to "print and deliver" prospectuses).
  • BDCs may now rely on expanded communication safe harbors (this permits the release of factual and forward-looking business information).

These changes should provide cost savings to BDCs and lead to greater efficiencies in connection with securities offerings undertaken by BDCs.

Modernizing Provisions and Safe Harbors

The SEC proposed rule amendments on March 20, 2019 to address the mandate in the Act that the SEC modernize the offering-related provisions and the communications safe harbors available to BDCs under the Securities Act of 1933. The SEC also proposed accompanying amendments to Form N-2, which is the form BDCs must use to offer securities. Certain of the proposed rule amendments revise provisions that became automatically effective on the Act's one-year anniversary as described immediately above.

Although these provisions became automatically effective without rule amendments it is difficult to rely on certain securities offering related provisions because the SEC has not formally provided approved guidance. These proposed amendments are welcome given that historically the offering process for these entities has been cumbersome and has affected access to capital formation.

Proposed Registration Exemption Changes

While the majority of BDCs have a class of equity securities that is listed on a national securities exchange, many have elected to remain private. A private BDC offers and sells its securities in a private placement to accredited third-party investors without registering the offer of its securities under the Securities Act.

Expand Accredited Investor Definition

The SEC voted on Dec. 18, 2019 to approve a proposing release for public comment that would amend the definition of "accredited investor," as well as amend the definition of "qualified institutional buyer." These amended definitions would broaden the potential universe of individuals and entities that might qualify as accredited investors. In particular, the proposed amendments to the accredited investor definition would add new categories of natural persons based on professional knowledge, experience or certifications and would leave intact the current net income and asset tests.

The proposed amendments would also add new categories of entities, including a "catch-all" category for any entity owning in excess of $5 million in investments and would similarly expand the definition of a "qualified institutional buyer" to include additional entities, which would allow private BDCs to access a greater number of investors in exempt offerings.

Harmonize Exempt Offerings

The SEC issued a concept release on June 18, 2019 on ways to "simplify, harmonize, and improve the exempt offering framework to expand investment opportunities while maintaining appropriate investor protections and to promote capital formation." The concept release sought public comment on a wide range of issues, including potential changes to the existing exempt offering framework and the accredited investor definition (consistent with the SEC's proposed amendments described immediately above). Securities of private BDCs are typically offered pursuant to private placement exemptions with accredited investors making up a very substantial proportion of private BDC investors. Certain registration exemptions (such as Regulation A) are not available to BDCs under current law. The SEC's request solicited comments as to whether the eligibility to rely on certain registration exemptions should be extended to BDCs and whether there are regulations that discourage, or have the effect of discouraging, participation by BDCs in exempt offerings.

Adopted Reforms

Testing-the-Water Communications

On Sept. 26, 2019, the SEC adopted new Rule 163B and related amendments under the Securities Act to expand the permitted use of "testing-the-waters" communications to all companies regardless of size or reporting status, including BDCs. The new rule enables any BDC, including one that is not an emerging growth company or any person authorized to act on the BDC's behalf, to make oral and written offers to qualified institutional buyers and institutional accredited investors before or after the filing of a registration statement to gauge investors' interest in an offering of securities by the BDC.

No Quiet Period

The SEC approved the Financial Industry Regulatory Authority, Inc. amendments to FINRA Rule 2210 (Communications with the Public) and FINRA Rule 2241 (Research Analysts and Research Reports) on Aug. 16, 2019. FINRA's amendments eliminate the "quiet period" restrictions on publishing a research report or making a public appearance concerning a BDC and create a filing exclusion for BDC research reports. Under the FINRA exception, the quiet period requirements do not apply to a research report or a public appearance following any offering of BDC securities that are the subject of a research report. The FINRA amendments align with the SEC's amended rules and are expected to reduce obstacles that previously prevented investors from accessing research reports relating to BDCs.

Remote Voting

The staff of the Division of Investment Management issued a no-action letter on Feb. 28, 2019 to the Independent Directors Council permitting board members of a BDC to vote by telephone, video conference or other remote means in certain circumstances. This modernized position softens, but does not eliminate, the unnecessary burden for BDCs and their boards to adhere to certain in-person voting requirements. For example, the 1940 Act and rules promulgated thereunder provide that the approval or renewal of an advisory contract requires the vote of directors at an in-person board meeting.

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