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PepperHamilton: SEC Modernizes Securities Offering Rules for BDCs and Registered Closed-Ended Funds

April 10, 2020 |

On April 8, the Securities and Exchange Commission (SEC) adopted amended securities offering rules for business development companies1 (BDCs) and registered closed-end funds as mandated by Congress.2 The amendments largely extend the 2005 securities offering reform for operating companies to BDCs and closed-end funds. The amended rules are intended to streamline the registration, offering and investor communications processes for BDCs and closed-end funds. According to the SEC, these changes should enable BDCs and closed-end funds to respond more quickly and at less cost to market opportunities while also benefiting their shareholders.

The amendments “are designed to better align the modern immediately-effective or automatically effective offering process long available to other types of funds with the structures of the newly eligible funds. They also include disclosure requirements and new structured data requirements that will make it easier for investors and others to analyze fund data.”3

The amendments will become effective on August 1, 2020. Some of the key regulatory changes are highlighted below.4

Shelf Offering Process and New Short-Form Registration Statement

Certain BDCs and closed-end funds will be eligible for a streamlined registration process to sell securities “off the shelf” more quickly and efficiently through a new short-form registration statement. Funds will need to meet certain filing and reporting history requirements and have a public float of $75 million or more.

Ability to Qualify for Well-Known Seasoned Issuer (WKSI) Status

Entities that qualify as WKSIs are able to enjoy certain benefits under the securities laws, including a more flexible registration process and more flexibility in market communications. Now, BDCs and closed-end funds will be eligible to qualify for WKSI status based on the same criteria operating companies must meet: certain filing and reporting history requirements and a public float of $700 million or more.

Immediate or Automatic Effectiveness of Certain Filings

Rule 486 will be expanded to apply to additional funds and entities. Currently Rule 486 only applies to closed-end funds that operate as interval funds — funds that commit to periodic redemptions of a percentage of their outstanding securities.

Communications and Prospectus Delivery (Access Equals Delivery) Reforms

The new rules will extend to BDCs and closed-end funds many of the communications rules available to operating companies, including the use of free writing prospectuses and certain broker-dealer research reports. The new rules also extend “access equals delivery” rules to closed-end funds so that closed-end funds will be able to satisfy a final prospectus delivery obligation by filing a prospectus with the SEC.

New Method for Interval Funds and Certain Exchange-Traded Products to Pay Registration Fees

Under the new amendments, closed-end funds that operate as interval funds will be able to register an indefinite number of shares and pay registration fees based on net issuance of shares — an approach similar to mutual funds. Currently, these funds must register a specific amount of shares and pay a registration fee at the time of filing.

Periodic Reporting Requirements

As part of the new short-form registration statement framework, funds affected by the amended rules will be required to include certain prospectus disclosures in annual reports and to disclose material, unresolved comments from the SEC Staff. Closed-end funds will be required to provide management discussion of fund performance in annual reports, similar to those currently required of mutual funds.

Incorporation by Reference Changes

The new amendments eliminate the requirement for funds to provide new investors with all previously filed materials that are incorporated by reference into the registration statement. Instead, funds affected by the new rules will be able to satisfy the obligation to provide these materials to investors by making them available on their website. This change will allow an affected fund to incorporate by reference into its prospectus and statement of additional information (SAI) (1) its most recent annual report filed pursuant to Exchange Act section 13(a) or section 15(d) containing financial statements for the affected fund’s latest fiscal year for which either a Form N-CSR or Form 10-K was required to be filed and (2) all other reports filed pursuant to these sections of the Exchange Act following the end of the fiscal year covered by the annual report (backward incorporation by reference). Additionally, an affected fund will be able to state in its prospectus and SAI that all documents subsequently filed pursuant to Exchange Act sections 13(a), 13(c), 14 or 15(d) before the termination of the offering shall be deemed to be incorporated by reference into the prospectus and SAI (forward incorporation by reference).

Structured Data Requirements

Funds affected by these amended rules will be required to tag certain registration statement information, similar to the requirements for mutual funds. BDCs will be required to submit financial statement information — currently required of operating companies.

The SEC believes these changes will help BDCs and closed-end funds — key players in the asset management industry — to function more smoothly and efficiently, which, in turn, should help promote sound economic activity. As Jay Clayton, chairman of the SEC, stated:

By extending to BDCs and other closed-end funds the modernized registration, offering and communication processes that are currently available to other issuers, today’s rulemaking is consistent with our ongoing efforts to modernize our rules to further all three aspects of our tripartite mission. These benefits should, as Congress intended, promote capital formation with respect to both the funds themselves and the small businesses in which they invest. In addition, thanks to the work of our staff, the communications reforms proposed today should also facilitate the more timely provision of information to investors, maintain market integrity, and enhance investor protection.5

Most of the changes caused by these amendments will take place on August 1, 2020. Certain compliance obligations will have later effective dates.

Endnotes

1 BDCs are closed-end investment companies that elect to be regulated (not registered) under the Investment Company Act of 1940 and primarily invest in small and developing companies.
2 The SEC was required to adopt these amendments by provisions in the Small Business Credit Availability Act and the Economic Growth, Regulatory Relief, and Consumer Protection Act enacted by the United States Congress in 2018 in order to extend the 2005 securities offering reforms for operating companies adopted by the SEC under the Securities Act of 1933 to BDCs and closed-end funds. At the time, investment companies, including BDCs and registered closed-end funds, were explicitly excluded from those reforms. In 2018, Congress passed two bipartisan bills directing the SEC to amend its rules to harmonize the treatment of BDCs and most registered closed-end funds with that of operating companies for purposes of these reforms.
3 See SEC Press Release issued April 8, 2020, https://www.sec.gov/news/press-release/2020-83.
4 The final SEC rule can be found at https://www.sec.gov/rules/final/2020/33-10771.pdf.
5 See Statement at Open Meeting on Securities Offering Reform for Business Development Companies and Closed-End Investment Companies, April 8, 2020, https://www.sec.gov/news/public-statement/statement-clayton-securities-offering-reform-2020-04-08.

AUTHORS:
John M. Ford, Partner
John P. Falco, Partner
• Christopher M. Trueax, Associate

Compliments of Pepper Hamilton LLP – a member of the EACCNY.