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SEC Proposes Registration, Communications and Offering Reform for Closed-End Funds and Business Development Companies

On March 20, 2019, in response to direction from Congress, the Securities and Exchange Commission (SEC) proposed rule amendments that would modify and streamline the securities offering and communication processes for business development companies (BDCs) and other registered closed-end investment companies (CEFs) (collectively, “affected funds”). The proposed rule amendments would extend certain offering reforms that are currently available to operating company issuers to certain affected funds. The proposals would also apply payment methods for securities registration fees similar to those mutual funds use to CEFs that operate as interval funds. The scope of affected funds and the proposed rule amendments are discussed below.

Scope of Affected Funds

The proposed rule amendments would treat certain categories of affected funds differently. For example, some of the rules would apply to only BDCs or only interval funds. Additionally, many of the proposed rules would only affect funds that are current and timely in their reporting and that have at least $75 million in public float (Seasoned Funds). Some of the proposed rules would only apply to well-known seasoned issuers (WKSIs), which are Seasoned Funds that generally have at least $700 million in public float.

Importantly, while not required by the congressional mandate, the scope of the proposed amendments would generally treat unlisted BDCs and unlisted registered CEFs consistently, so that funds such as so-called “tender offer funds” would be allowed to rely on certain of the proposals. A detailed explanation of which rules amendments apply to which category of affected funds can be found in Table 1 of the rule proposal.

 

Proposed Reforms for Affected Funds

Shelf Offering Process and the New Short-Form Registration Statement

The proposed rule amendments would permit affected funds that are eligible to file on Form S-3 to file a short-form registration statement on Form N-2 that will function like a Form S-3 registration statement.  Additionally, the proposed rule amendments would permit affected funds to do the following:

  • Rely on SEC Rule 430B to omit information from the base prospectus and to use the process that operating companies follow to file prospectus supplements; and

  • Include additional information in periodic reports to update their registration statements, provided that this information is identified as included for this purpose.

Ability to Qualify for WKSI Status 

The following rule amendments are proposed:

  • Amend SEC Rule 405 to no longer exclude BDCs and registered investment companies from the definition of WKSI;

  • Add a parallel reference to the registrant requirements of the proposed short-form registration instruction;

  • Amend the definition of “ineligible issuer” to state that a registered CEF would be ineligible if it has failed to file all reports and materials that are required to be filed under section 30 of the Investment Company Act of 1940 during the preceding 12 months; and

  • Amend the definition of “ineligible issuer” to give effect to the current antifraud prong in that definition in the context of affected funds and propose a parallel antifraud prong for affected funds.

 Prospectus Delivery Reforms

The proposed rule amendments would allow affected funds to satisfy their final prospectus delivery obligations by filing their final prospectuses with the SEC, which would be consistent with the alternative delivery method used by operating companies.

Offering Communications Reforms 

The proposed rule amendments would permit affected funds to do the following:

  • Use certain communications that are prescribed by SEC Rule 134 to publish factual information about the issuer or the offering, including “tombstone ads”;

  • Rely on SEC Rule 163A, which provides issuers with a bright-line time period, ending 30 days prior to filing a registration statement, during which they may communicate without risk of violating the “gun-jumping” provisions;

  • Rely on SEC Rule 168, if they are reporting companies, to publish or disseminate regularly released factual business information and forward-looking information at any time, including around the time of a registered offering;

  • Rely on SEC Rules 164 and 433 to use a “free writing prospectus” and

  • Engage at any time, if they are WKSIs, in oral and written communications, including use of a free writing prospectus at any time, subject to the same conditions that are applicable to other WKSIs.

Affected funds could take advantage of the additional flexibility of the proposed rule amendments or they could continue to rely on SEC Rule 482 and other rules that are currently applicable to investment company communications.

Broker-Dealer Research Reports 

The proposed rule amendments would amend SEC Rule 138 to include parallel references to a registration statement that could be filed on Form N-2 and to the reports that registered CEFs are required to file, which would allow affected funds to publish or distribute research about the issuers’ fixed income securities if they publish or distribute that research in the regular course of business.

 Rule 418 Supplemental Information

The rule amendments propose to change SEC Rule 418(a)(3) to add parallel references to registrants that are eligible to file short-form registration statements on Form N-2. The proposed rule amendment would exempt affected funds from having to be prepared to furnish supplemental information to the SEC promptly upon request.

 New Method for Interval Funds to Pay Registration Fees

The rule amendments propose a modernized approach that would amend SEC Rules 23c-3 and 24f-2 to permit interval funds to pay securities registration fees using the same method that mutual funds and ETFs use. Thus, an interval funds could pay registration fees based on its net issuance of shares, no later than 90 days after the fund’s fiscal year end rather than in advance.

Structured Data Requirements 

The rule amendments propose the following requirements:

  • BDCs, like operating companies, submit financial statement information using Inline XBRL format;

  • Registered CEFs and BDCs include structured cover page information in their registration statements on Form N-2 using Inline XBRL format;

  • Certain information required in an affected fund’s prospectus be tagged using Inline XBRL format; and

  • Filings on Form 24F-2 be submitted in XML format.

Periodic Reporting Requirements 

The rule amendments propose to require funds filing a short-form registration statement on Form N-2 to include key information in their annual reports that they currently disclose in their prospectuses:

  • The Fee and Expense Table;

  • Share Price Data; and

  • The Senior Securities Table.

Additionally, the rule amendments propose the following requirements:

  • Registered CEFs to provide management’s discussion of fund performance in their annual reports to shareholders;

  • BDCs to provide financial highlights in their registration statements and annual reports; and

  • Affected funds filing a short-form registration statement on Form N-2 to disclose material unresolved staff comments.

Current Reporting Requirements 

The proposed rule amendments would require registered CEFs to report information on Form 8-K. The rule amendments would also propose the following amendments to Form 8-K:

  • Add new reporting items for affected funds on (i) material changes to investment objectives or policies, and (ii) material write-downs of significant investments; and

  • Tailor the existing reporting requirements and instructions to affected funds.

Incorporation by Reference Changes

The proposed rule amendments would allow affected funds to incorporate by reference the information required under Item 13 of Schedule 14A, including financial statements and other information for proxy statements containing specific proposals.

In addition, the proposed rule amendments would remove the requirement that a fund deliver to new investors information that it has incorporated by reference into the prospectus or SAI, and instead require the fund to make its prospectus, SAI, and incorporated materials readily available and accessible on a website.

Finally, the proposed rule amendments would streamline Form N-2’s current provisions regarding disclosure requirements for incorporation by reference to mirror the disclosure requirements of Form S-3.

Comment Period and Compliance Date

The SEC has requested comments on the proposed rule amendments. The comment period for the proposed rule amendments will end 60 days after publication in the Federal Register. The SEC is also proposing a transition period after the publication of a final rule in the Federal Register regarding the following four proposed new requirements.

  Compliance Date

Form 8-K

Affected funds that would be eligible to file a short-form registration statement would be required to comply with the full scope of Form 8-K as proposed, including the new Form 8-K items for affected funds, by the earlier of two dates:

  1. One year after the publication of a final rule in the Federal Register; or

  2. The date that a fund first files a short-form registration statement under General Instruction A.2 of Form N-2.

All other affected funds would be required to comply within 18 months after the date of the publication of a final rule in the Federal Register.

Management’s Discussion of Fund Performance 

Any annual report that a registered CEF files one year or more after the publication of a final rule in the Federal Register would be required to include the proposed management’s discussion of fund performance disclosures.

 Structured Data Requirements

Affected funds subject to the financial statement or prospectus structured data reporting requirements that would be eligible to file a short-form registration statement would be required to comply with those provisions no later than 18 months after the date of publication of a final rule in the Federal Register.

All other affected funds subject to those requirements would be required to comply within 24 months after publication of a final rule in the Federal Register.

All filers on Form 24F-2 would be required to comply with the proposed structured data format for this form no later than 18 months after the publication of a final rule in the Federal Register.

Rules 23c-3 and 24f-2

The proposed amendments to Rules 23c-3 and 24f-2 would become effective one year after the publication of a final rule in the Federal Register.

Practice Points and Tips

The proposed rule amendments generally represent welcome improvements that would help to streamline and modernize offering and communication processes for affected funds. Advisers to and Boards of the affected funds should consider the impact that the rule amendments, if adopted, would have on the affected funds that they manage and oversee. 

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About this Author

Joshua B. Deringer, Investment Management, Attorney, Drinker Biddle, Law firm
Partner

Joshua B. Deringer counsels a wide range of national and international financial service companies involved in all aspects of the investment management industry, including registered investment companies, hedge funds and other alternative investment vehicles, as well as investment advisers. He is chair of the Investment Management Practice Group and a managing partner of the firm.

Josh has extensive experience in organizing, counseling and reorganizing open- and closed-end investment companies. His clients include multi-series...

215-988-2959
Gloria Liu,Investment attorney, Drinker Biddle
Associate

Gloria Y. Liu counsels clients in the investment management industry, including investment companies and investment advisers. She has prepared registration statements and has handled securities filings and other compliance matters.

During law school, Gloria interned with the Enforcement Division of the SEC. She was also a summer associate with Drinker Biddle in 2017 and served as a judicial intern through the Sonia and Celina Sotomayor Judicial Internship Program in Brooklyn, NY. Prior to law school, she was a corporate accountant with a Pennsylvania-based registered investment advisor. Gloria is a certified public accountant and is a native Mandarin Chinese speaker.

(215) 988-6842