House Passes Regulatory Reform That Would Loosen Restrictions on BDCs and Other Funds

Transcription

1 Client Alert June 30, 2017 Huse Passes Regulatry Refrm That Wuld Lsen Restrictins n BDCs and Other Funds On June 8, 2017, the U.S. Huse f Representatives, by a vte mstly alng party lines, apprved a bill that wuld repeal many f the Ddd-Frank Wall Street Refrm and Cnsumer Prtectin Act ( Ddd-Frank ) requirements and significantly reduce the regulatry burden fr financial institutins. If enacted in its current frm, the Financial CHOICE Act f 2017 (the CHOICE Act ) wuld als alter the regulatry landscape fr business develpment cmpanies ( BDCs ), investment cmpanies and investment advisers. Amng ther things, the CHOICE Act wuld: Lsen sme restrictins n BDCs cncerning leverage, preferred stck, prxy prcedures and investments; Tighten the burden f prf fr plaintiffs suing investment advisers fr breach f fiduciary duty; Braden the exemptin frm the definitin f an investment cmpany available t venture capital funds; and Streamline the prcess fr investment cmpanies and investment advisers t btain exemptive rders. The CHOICE Act, which passed , was sent t the Senate fr cnsideratin n June 12, Here is a summary f key prvisins f the CHOICE Act that affect BDCs, investment cmpanies and investment advisers. A. BDCs BDC investment in investment advisers. Sectin 436(a)(2) f the bill wuld eliminate a restrictin in Sectin 12(d)(3) f the Investment Cmpany Act f 1940, as amended (the 1940 Act ) that prhibits a BDC frm wning an equity interest in a registered investment adviser. Amng ther things, this prvisin wuld allw BDCs t invest in investment advisers t ther investment cmpanies, r t invest in its wn investment adviser. (Sectin 12(d)(3) f the 1940 Act applies t BDCs by virtue f Sectin 60.) The bill als clarifies that the Securities and Exchange Cmmissin ( SEC ) has the pwer t issue rules t address ptential cnflicts f interest arising ut f the ability f BDCs t invest in investment advisers. Expanded definitin f eligible prtfli cmpany. Sectin 436(b) wuld expand the definitin f eligible prtfli cmpany ( EPC ). A BDC currently must invest at least 70 percent f its ttal assets (excluding ffice furniture and equipment, real estate and leasehld imprvements and certain peratinal facilities) in EPCs. An EPC is a dmestic issuer that either: Des nt have any class f securities listed n a natinal securities exchange, r Has a class f equity securities listed n a natinal securities exchange, but has an aggregate market value f utstanding vting and nn-vting cmmn equity f less than $250 millin and, in each case: 1 Attrney Advertisement

2 (A) (B) is nt, with limited exceptins, a registered r unregistered investment cmpany; r either: (i) (ii) (iii) des nt have a class f securities that are margin securities, is cntrlled by a BDC and has an affiliated persn f the BDC as a directr r has ttal assets f nt mre than $4 millin and capital and surplus (sharehlders equity less retained earnings) f nt less than $2 millin. The bill wuld expand the definitin f EPC t include issuers that wuld be investment cmpanies but fr the fllwing exemptins under Sectin 3 f the 1940 Act: 3(c)(2) persns that are primarily engaged in the business f underwriting and distributing securities; 3(c)(3) banks and insurance cmpanies; 3(c)(4) persns substantially all f whse business is cnfined t making small lans, industrial banking r similar businesses; 3(c)(5) persns wh are nt engaged in the business f issuing redeemable securities r face amunt certificates r perid payment plans and wh are primarily engaged in ne r mre f the fllwing businesses: Purchasing r therwise acquiring ntes, drafts, acceptances, pen accunts receivable and ther bligatins representing part r all f the sales price f merchandise, insurance and services; Making lans t manufacturers, whlesalers and retailers f, and t prspective purchasers f, specified merchandise, insurance and services; and Purchasing r therwise acquiring mrtgages and ther liens n and interests in real estate; and 3(c)(9) persns substantially all f whse business cnsists f wning r hlding il, gas r ther mineral ryalties r leases and certain related interests. The effect f this prvisin, if adpted, wuld be t braden the categries f unregistered investment cmpanies, including real estate funds and il and gas funds, in which BDCs may invest. Fifty percent requirement fr EPC investments. Sectin 436(c) f the bill wuld lwer t 50 percent (frm 70 percent) the amunt f which a BDC may invest its ttal assets (excluding certain assets described abve in EPCs. This prvisin wuld effective increase a BDC s unrestricted investment bucket t 50 percent frm 30 percent, giving it much mre investment flexibility. BDC leverage. Sectin 437 f the CHOICE Act wuld increase the amunt f leverage that BDCs may use by lwering the asset cverage requirement t 150 percent frm 200 percent under certain circumstances. Sectin 61(a) f the 1940 Act applies the 200 percent leverage limitatin f Sectin 18(a)(1)(A) and (B) BDCs. Sectin 437 wuld lwer the asset cverage requirement t 150 percent, prvided that: The BDC amends its public disclsures in securities filings and its website within five days f adpting the new standard; A publicly traded BDC must include disclsures reasnably designed t ensure sharehlders are infrmed f (i) the amunt f the BDC s indebtedness and asset cverage rati as f recent financial statements and (ii) the risks assciated with the indebtedness; A required majrity f independent directrs apprve the new asset cverage level; 2 Attrney Advertisement

3 Fr nn-traded BDCs, the BDC must agree t repurchase 25 percent f its shares in each f the fur quarters fllwing the apprval date; and At least 50 percent f the vtes cast at a sharehlder meeting apprve the new standard. Preferred stck. Sectin 437(a)(3) wuld authrize BDCs t issue preferred stck. Currently, BDCs can issue mre than ne class f senir security representing indebtedness, r multiple debt bligatins. Warrants, ptins and subscriptin rights. Sectin 437(a)(4) wuld expand the ability f a BDC t issue warrants, ptins and subscriptin rights t any security, prvided the exercise r cnversin price is less than the market value f the securities t be issued, r in the absence f a market value, the net asset value f the securities t be issued. Currently, a BDC may issue these rights nly with respect t vting securities. BDC s senir securities. Sectin 437(a)(5) wuld eliminate prvisins that generally: Require a BDC t allw hlders f senir securities, vting as a class, t have the right t elect tw directrs; Require a BDC t allw a majrity f preferred equity securities t vte n a plan f rerganizatin that adversely affects their securities; Require a BDC t prvide fr a senir security t have cmplete pririty ver any ther class f distributin f assets and payment f cumulative dividends; and Limit the ability f a BDC t issue mre than ne class f indebtedness r stck. These exclusins wuld nt apply t hlders f a BDC s preferred stck wh are nt qualified institutinal buyers. Under Sectin 437(a)(5)(B) f the CHOICE Act, Sectin 61(a)(3)(A) f the 1940 Act wuld n lnger apply with respect t preferred stck issued t a persn wh is nt knwn by the cmpany t be a qualified institutinal buyer. Parity fr BDCs regarding ffering and prxy rules. Sectin 438 requires the SEC t revise its rules t allw BDCs t avail themselves f securities ffering related accmmdatins and prxy rules available t ther issuers that file reprts under Sectin 13 r Sectin 15(d) f the Securities Exchange Act f The prvisin includes a laundry list f specific actins that the SEC must take. Sectin 438(b) wuld als require the SEC t revise Frm N-2, the frm f registratin statement, t allw BDCs t incrprate certain infrmatin by reference t ther filings. Sectin 438(c) entitles BDCs t treat these revisins in Sectins 438(a) and (b) described abve as having been cmpleted if the SEC fails t timely cmplete these revisins within ne year f the date f enactment f the CHOICE Act. B. Investment cmpanies (and BDCs) Burden f prf requirements fr excessive fee cases brught under Sectin 36(b). Sectin 831 f the CHOICE Act wuld revise Sectin 36(b) f the 1940 Act t impse a higher burden f prf fr a plaintiff t successfully claim that an investment adviser t an investment cmpany r BDC has breached its fiduciary duty with respect t its receipt f fees. The prvisin wuld require a cmplaint t state with particularity all facts establishing a breach f fiduciary duty, and, if an allegatin f any such facts is based n infrmatin and belief, the cmplaint shall state with particularity all facts n which that belief is frmed; and such security hlder wuld have the burden f prving a breach f fiduciary duty by clear and cnvincing evidence. Exemptive applicatins. Sectin 848 wuld streamline the applicatin prcess fr SEC exemptive rders by impsing specific time deadlines. Specifically, the prvisin wuld require the SEC t grant r deny an 3 Attrney Advertisement

4 applicatin within 45 days after filing, r require the applicant t either prvide additinal supprting dcumentatin r withdraw the applicatin and resubmit it with additinal required material. C. Exemptin frm the definitin f investment cmpany Venture capital funds. Sectin 471 wuld allw a qualified venture capital fund t rely n the exceptin frm the definitin f investment cmpany prvided by Sectin 3(c)(1) if its utstanding securities are beneficially wned by fewer than 500 persns. Currently, all issuers relying n Sectin 3(c)(1) can have n mre than 100 beneficial wners (subject t certain lk-thrugh prvisins and ther requirements). The prvisin wuld define a qualifying venture capital fund as any venture capital fund (as defined pursuant t Sectin 203(l)(1) f the Investment Advisers Act f 1940, as amended) with n mre than $50,000,000 in aggregate capital cntributins and uncalled cmmitted capital, as such dllar amunt is annually adjusted by the SEC t reflect the change in the Cnsumer Price Index fr All Urban Cnsumers published by the Bureau f Labr Statistics f the Department f Labr. D. Other prvisins The CHOICE Act wuld significantly mdify r repeal many aspects f Ddd-Frank. This memrandum addresses nly the main prvisins that affect investment advisers, investment cmpanies and BDCs. The ther prvisins are beynd the scpe f this memrandum. Our take The CHOICE Act s BDC prvisins wuld significantly lsen many f the restrictins that currently apply t BDCs and, if adpted, wuld make BDCs much mre attractive investment vehicles. It remains t be seen hw these changes wuld affect the market fr pled vehicles, and whether BDC assets wuld grw significantly at the expense f mutual funds and ther clsed end funds. The prvisins designed t tighten the burden f prf fr excessive fee cases were presumably added in respnse t the increasing number f cases brught under Sectin 36(b), ntwithstanding the fact that few, if any, plaintiffs succeed at trial. Tightening the burden f prf may discurage plaintiffs frm filing these cases, which are very cstly t try and are generally directed at deep pcket fund cmplexes in hpes f a settlement. The chances f the Senate passing the CHOICE Act as prpsed are nt certain at this time; hwever, many f the prvisins f the CHOICE Act that are applicable t BDCs have been the subject f standalne bills that met with sme bipartisan supprt. 4 Attrney Advertisement

5 Cntacts Oliver Ireland Washingtn D.C. (202) Anna Pined New Yrk (212) Abut Mrrisn & Ferster We are Mrrisn & Ferster a glbal firm f exceptinal credentials. Our clients include sme f the largest financial institutins, investment banks, and Frtune 100, technlgy and life sciences cmpanies. We ve been included n The American Lawyer s A-List fr 13 straight years, and Frtune named us ne f the 100 Best Cmpanies t Wrk Fr. Our lawyers are cmmitted t achieving innvative and business-minded results fr ur clients while preserving the differences that make us strnger. This is MF. Visit us at Mrrisn & Ferster LLP. All rights reserved. Fr mre updates, fllw Thinkingcapmarkets, ur Twitter feed: Because f the generality f this update, the infrmatin prvided herein may nt be applicable in all situatins and shuld nt be acted upn withut specific legal advice based n particular situatins. 5 Attrney Advertisement