On June 8, 2012, the Next Steps for Credit Availability Act (“H.R. 5929”) was introduced in the House of Representatives. This bipartisan bill focuses on promoting capital raising by small- and mid-sized companies by (i) making capital more readily accessible for business development companies (“BDCs”) to invest in their target companies and (ii) reducing regulatory burdens on BDCs. Currently, H.R. 5929 sits in the House Committee on Financial Services awaiting a favorable report.
BDCs were created by Congress in 1980 to encourage the formation of public vehicles that invest in private equity in order to increase the flow of capital to small, growing businesses that have limited access to traditional capital markets. BDCs operate as a hybrid between traditional closed-end funds and public operating companies. As a form of closed-end fund, BDCs are subject to some of the requirements under the Investment Company Act of 1940, as amended (the “1940 Act”), including limitations on the amount of debt a BDC may incur, prohibitions on certain types of affiliated transactions and regulation and regular examination by the Securities and Exchange Commission (“SEC”). Unlike traditional closed-end funds, BDCs are required to register a class of securities under the Securities Exchange Act of 1934 (the “1934 Act”), which obligates them to file annual and periodic reports and comply with the other requirements under the 1934 Act. BDCs are also required to register securities offerings under the Securities Act of 1933 (the “1933 Act”). BDCs, however, are not afforded certain privileges of other 1934 Act operating companies with respect to their registration statements such as the ability to incorporate by reference. As a result of this hybrid regulatory structure, certain regulations governing BDCs limit their ability to maximize investments in small- and mid-sized companies and raise capital.
If enacted in its current form, H.R. 5929 would amend Sections 60 and 61 of the 1940 Act and require the SEC to amend existing 1933 Act rules to:
- Relax the 1940 Act leverage limits applicable to BDCs by reducing the asset coverage requirements for indebtedness, facilitating the issuance of multiple classes of “senior securities,” and removing certain limitations for preferred and other senior stock;
- Permit BDCs to own interests in registered investment advisers; and
- Streamline the securities registration and reporting process by allowing BDCs to take advantage of certain offering and reporting requirements already available to many other public reporting companies.
Relaxing Leverage Limits Applicable to BDCs
A BDC is subject to the asset coverage requirements of the 1940 Act, which currently prohibit a BDC from borrowing or issuing any senior security unless, immediately following such borrowing or issuance, the BDC has asset coverage (total assets divided by total debt) of at least 200 percent. If passed, the asset coverage requirement for a BDC would be reduced from 200 percent to 150 percent. This reduction would permit a BDC to incur additional leverage and raise additional assets to make investments.
Additionally, this piece of legislation would facilitate the issuance of multiple classes of “senior securities,” which includes both preferred stock and indebtedness. Currently, the 1940 Act treats preferred stock similar to indebtedness by including it within a 200 percent asset coverage requirement at issuance and prohibiting the declaration of certain dividends and distributions unless every class of senior securities of the BDC has 200 percent asset coverage after such dividend distribution.
H.R. 5929 would facilitate the issuance of senior securities that constitute “stock,” such as preferred stock. In particular, H.R. 5929 would eliminate the asset coverage requirements described above and permit BDCs to issue multiple classes of preferred stock. Even with this concession, however, preferred stock would continue to be treated as a senior security for the asset coverage requirement applicable to those senior securities that constitute indebtedness. Depending on the sequence of security issuance by BDCs, results under the asset coverage test would continue to vary.
Owning Interests in Registered Investment Advisers
Currently, the 1940 Act prevents BDCs from owning any interest in a registered investment adviser. H.R. 5929 would carve out BDCs from this prohibition. This proposed change is especially significant in light of the Dodd-Frank Act, which repealed the registration exemption for “private advisers,” and required BDCs to seek exemptive relief in order to own interests in a registered investment adviser.
Leveling the Playing Field for 1933 Act Registration
Although BDCs are governed by the 1933 Act and the 1934 Act, unlike many other registrants, BDCs are currently unable to take advantage of certain conveniences provided by the federal securities laws. For example, BDCs are excluded from the definition and benefits of a well-known seasoned issuer (“WKSI”) and obligated to register on a Form N-2, which is not included in the definition of “automatic shelf registration statement.” This exclusion results in a full SEC review of routine BDC registration statement filings. In addition, BDCs are prohibited from incorporating prior SEC filings into a registration statement by reference. Such prohibition results in additional time and expense as BDCs are obligated to include and undergo review of information in their 1933 Act documents that is already publicly available pursuant to 1934 Act requirements.
If enacted in its current form, H.R. 5929 would streamline the SEC registration and reporting requirements applicable to BDCs by allowing BDCs to utilize many of the same rules that are available to other reporting companies. For example, H.R. 5929 would require the SEC to amend existing 1933 Act rules to:
- Allow BDCs to qualify as WKSIs. WKSIs have less stringent disclosure and communication requirements. BDCs that meet the WKSI requirements would be able to file automatic shelf registration statements (which become effective upon filing, expediting the registration process);
- Allow BDCs to communicate to potential investors through free writing prospectuses (written or electronic communications relating to an offering), under certain conditions, without violating the gun-jumping provisions of the federal securities laws;
- Permit BDCs to incorporate by reference in their registration statement information previously filed with the SEC under the 1934 Act. This would streamline the registration process making it more efficient and providing BDCs more control over timing for security offerings;
- Give BDCs more flexibility in communicating with the investor community by allowing them to release factual business information, press releases and advertisements with more certainty; and
- Allow more flexibility for brokers and dealers to provide research and analysis of BDC securities.
The passage of H.R. 5929 would allow BDCs to increase the amount of leverage BDCs may incur, more easily issue preferred stock and other senior securities, and provide many of the same registration and reporting conveniences available to other reporting companies. While the impact of H.R. 5929 is clearly favorable to the BDC industry, its enactment remains uncertain.