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BDC Reform Bills Face Uncertain Future

Posted in BDCs

Three bills introduced in the House of Representatives that would ease leverage restrictions on business development companies (BDCs) face an uncertain future in light of concerns expressed by the Chair of the Securities and Exchange Commission.  BDCs are closed-end investment companies that invest in small- and medium-sized private companies.

H.R. 1800, the Small Business Credit Availability Act, introduced in April 2013, would:

  • reduce from 200 percent to 150 percent the asset coverage requirements that apply to BDCs;
  • allow BDCs to invest in shares of investment advisers to BDCs;
  • eliminate certain protections for holders of preferred stock issued by BDCs; and
  • amend certain SEC rules and forms to allow BDCs to use streamlined securities offerings provisions that are available to other public companies.

H.R. 31, introduced in January 2013, is substantially similar to H.R. 1800, except that it does not require the SEC to revise certain rules, including certain provisions of Regulation FD.

H.R. 1973, the Business Development Company Modernization Act, introduced in May 2013, would allow BDCs to buy and hold interests of registered investment advisers and would expand the definition of “eligible portfolio companies” in which BDCs may invest, including certain private funds, such as hedge funds and private equity funds.

The House Subcommittee on Capital Markets and Government Sponsored Enterprises of the House Financial Services Committee held hearings on October 23, 2013.

BDCs’ investments typically take the form of loans, because these companies often are unable to obtain traditional bank financing.  Since Congress created BDCs in 1980, they have grown in popularity because, among other things, they are available to retail investors, and they are exempt from a number of significant provisions of the Investment Company Act of 1940, which allows them to pay a higher rate of return than traditional investment companies.  These exemptions also allow BDCs to pay higher management fees to their sponsors.

In a letter dated October 21, 2013, to the Subcommittee, SEC Chair Mary Jo White expressed concern that easing restrictions on BDCs “raises potential investor protection concerns, as it would allow non-accredited investors to invest in a BDC comprised entirely of private funds.  As such, BDCs would be used to circumvent the general prohibition on selling interests in private funds to retail investors.”

One witness who testified in support of the proposed legislation noted that BDCs are considered an emerging asset class that is growing swiftly, and that legislation modernizing the regulatory framework would allow BDCs to tap the capital markets more quickly, as they play “an increasingly important role in financing underserved small and mid-sized U.S. companies.”  Another witness, a former state regulator, testified against parts of the proposed legislation that would ease leverage because of the potential for increased risk to “unsophisticated retail investors.”

It is not clear how much support these bills will receive in Congress, especially since some believe that the bills would increase leverage and potentially increase risk to retail investors.