Covering legal developments and regulatory news for funds, their advisers and industry participants through
April 30, 2020.

RULEMAKING AND GUIDANCE

SEC Grants Additional COVID-19 Relief to Business Development Companies

On April 8, the SEC issued an order granting relief to business development companies (BDCs) by permitting BDCs to issue and sell senior securities and participate in certain joint enterprises or other joint arrangements that would otherwise be prohibited by section 57(a)(4) of the 1940 Act and Rule 17d-1 thereunder. A BDC is a closed-end investment company that elects to be regulated under the 1940 Act.

The SEC issued the relief to permit BDCs to continue to meet their statutory mandate to provide capital to small and mid-market companies. The SEC noted that, in light of the coronavirus outbreak and its effect on the capital markets, a BDC may face certain challenges. In particular, a BDC may be unable to satisfy the asset coverage requirements under the 1940 Act due to temporary mark-downs in the value of its loans to portfolio companies, and certain BDC affiliates may be prohibited from participating in additional investments in the BDC’s portfolio companies due to restrictions in the SEC’s current exemptive order permitting co-investments (Co-Investment Order).

Issuance and Sale of Senior Securities by BDCs

Until December 31, 2020, BDCs can issue and sell senior securities by calculating an "adjusted asset coverage ratio" (AACR) based on portfolio values. Without the relief, BDCs would be required to calculate asset coverage ratios based on portfolio values within the 48 hours (not including Sundays or holidays) preceding the issuance and sale of senior securities.

In order to determine the AACR, a BDC first determines its adjusted portfolio value (APV) using the fair value of the BDC’s individual portfolio investments as of December 31, 2019 for portfolio investments held by the BDC as of that date and for which the BDC is not recognizing a realized loss. The adjustment does not apply to portfolio investments acquired after December 31, 2019 or portfolio investments where a permanent impairment or realized loss is recognized.

AACR is then calculated by reducing the asset coverage ratio calculated using the APV by an amount equal to 25 percent of the difference between the asset coverage ratio calculated using the APV and the unadjusted asset coverage ratio.

The SEC order provides the following example:

A BDC has a 220% asset coverage ratio on December 31, 2019. Its asset coverage ratio declines to 160% on March 31, 2020 under the standard calculation methodology due to temporary markdowns of its portfolio investments, and 200% if calculated with APV. This BDC would have to meet an AACR of 190% (200% minus 10% (25% of the difference between 200% and 160%)).

Reliance on the order for the issuance and sale of senior securities by a BDC is conditioned on:

• board approval of its election to rely on the order
• filing a Form 8-K to announce its election to rely on the order
• for period of 90 days after its election, a relying BDC cannot make an initial investment in any portfolio company in which the BDC was not already invested as of April 8, 2020. Notwithstanding the election, a BDC may continue to make an initial investment in a new portfolio company if the BDC would be permitted to make such an investment under the 1940 Act without the relying on the relief
• board approval of each issuance of senior securities
• at least monthly board review of adviser’s efforts to bring the BDC in compliance with the asset coverage ratio by December 31, 2020 (the end of the exemption period)
• prohibition on payments for distribution.

Expansion of Relief for BDCs With Existing Co-Investment Orders

The SEC also expanded existing relief previously granted to some BDCs to permit certain additional co-investment transactions not currently permitted in these BDCs’ existing Co-Investment Order. Under this relief, a BDC may participate in follow-on investments with one or more regulated funds and/or affiliated funds, provided that

• if the participant is a regulated fund, it has previously participated in a co-investment transaction with the BDC with respect to the issuer, and
• if the participant is an affiliated fund, it either has previously participated in a co-investment transaction with the BDC with respect to the issuer or is not invested in the issuer.

Reliance on the SEC order with respect to co-investments is conditioned upon compliance with the terms and conditions of the BDC’s existing exemptive order and board oversight.

Should you have any questions related to the items discussed in this article or regarding your legal and compliance obligations during the coronavirus outbreak, please do not hesitate to contact any of the authors listed. Pepper Hamilton attorneys remain committed to assisting you through this rapidly developing situation.

The SEC’s order is available at https://www.sec.gov/rules/exorders/2020/ic-33837.pdf.

OCIE Risk Alerts for Reg BI and Form CRS

On April 7, OCIE issued separate Risk Alerts providing firms with information regarding the scope and content of initial examinations for compliance with Regulation Best Interest (Reg BI) and Form CRS following the June 30, 2020 compliance date for each. Reg BI (Rule 15l-1 under the Securities and Exchange Act of 1934 [Exchange Act]) and the related Form CRS were adopted by the SEC on June 5, 2019 in a package of rulemakings and interpretations that, according to the SEC, are intended to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers.

Notably, the Risk Alerts each state that, while the SEC continues to monitor the effects of COVID-19 on market participants, including investment advisers and broker-dealers, as of April 7, 2020, the SEC has not extended the compliance date for Reg BI and Form CRS. It adds that OCIE stands ready to work with firms on issues that may arise in the course of examinations and understands that COVID-19 has created challenges for firms.

Reg BI

Reg BI generally compels registered broker-dealers and associated persons to act in the best interest of their retail customers with respect to recommendations for securities transactions or investment strategies involving securities. The Risk Alert for Reg BI provides notice that OCIE’s initial examinations will be focused on firms’ establishment of policies and procedures designed for compliance with Reg BI and their progress in implementation. Specifically, initial examinations (for the first year following the compliance date) will focus on Reg BI’s four main obligations: disclosure, care, conflicts of interest and compliance, each discussed in further detail below.

• The disclosure obligation requires broker-dealers to provide retail customers with written disclosure of all material facts regarding the scope and terms of the relationship and any conflicts of interest associated with the investment recommendation. OCIE staff will evaluate specific disclosures of facts to retail customers, including the capacity in which the investment recommendation is made, material fees and costs applied to retail customers’ activity, and any limitations to securities or investment strategies recommended to the customer. Examples of documents that OCIE staff may seek to review include schedules of fees and charges and related disclosures for retail customers; sources, methods and types of compensation for the broker-dealer’s registered personnel; disclosures related to monitoring of retail customer accounts and any material limitations on such accounts; and any list of proprietary products sold to retail investors.
• The care obligation requires broker-dealers to exercise reasonable diligence, care and skill when making a recommendation to a retail customer. Examples of documents that OCIE staff may seek to review include any information collected from retail customers to develop their investment profiles; the broker-dealer’s processes for having a reasonable belief that any recommendations for retail customers are in their best interest; how the broker-dealer makes recommendations related to significant investment decisions, such as rollovers and account recommendations, and how the broker-dealer has a reasonable basis to believe that these investment strategies are in a retail customer’s best interest; and how the broker-dealer makes recommendations related to more complex, risky or expensive products and how the broker-dealer has a reasonable basis to believe these such investments are in a retail customer’s best interest.
• The conflict of interest obligation requires broker-dealers to establish, maintain and enforce written policies and procedures reasonably designed to address conflicts of interest associated with their recommendations to retail customers. Examples of documents that OCIE staff may seek to review include those that would indicate whether specific aspects of Reg BI are being addressed in a firm’s policies and procedures, including, among others, policies and procedures addressing conflicts of interest that place the interest of the broker-dealer ahead of the retail customer, conflicts associated with limitations on investment products available to customers, and the elimination of specific conflicts, such as sales contests or quotas.
• The compliance obligation requires broker-dealers to establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. To assess compliance with this obligation, OCIE staff may review the broker-dealer’s policies and procedures and evaluate any controls, remediation of noncompliance, training, and periodic review and testing included as part of those policies and procedures.

Additionally, the Reg BI Risk Alert contains an appendix setting forth a sample request for information and documents that could be requested in an initial examination. A copy of this appendix can be accessed by clicking on the link included at the end of this article.

Form CRS

According to the Form CRS Risk Alert, initial OCIE examinations will focus on firms’ good faith efforts to implement Form CRS requirements. Form CRS provisions, pursuant to Rule 204-5 under the Investment Advisers Act of 1940 and Rule 17a-14 under the Exchange Act, require registered investment advisers and registered broker-dealers (including dual registrants) to deliver a client relationship summary containing certain information about the firm to retail customers, file the relationship summary and subsequent amendments with the SEC, and post the relationship summary on the firm’s website, if the firm maintains one. The Risk Alert advises that initial examinations related to Form CRS will likely focus on the following areas of implementation: delivery and filing of the relationship summary; content of the relationship summary; relationship summary formatting; updates to the relationship summary; and recordkeeping. Each of these areas of focus is discussed further below.

• Delivery and Filing: In initial examinations, OCIE staff may review the following: whether firms have filed their relationship summary and any subsequent amendments and posted the document on their website, if any; the process for delivering the relationship summary to new and existing retail investors; and firms’ policies and procedures with respect to the relationship summary delivery process and dates. Examinations may focus on records indicating the dates when relationship summaries were provided to new and existing retail investors under applicable delivery requirements.
• Content: OCIE staff may review the content of firms’ relationship summaries, may focus on whether they contain all required information, and may focus on whether the information included is true and accurate and does not omit material facts necessary to make the disclosures not misleading. Specific information OCIE staff may review includes descriptions of the relationships and services offered to retail customers, fees and costs, the manner in which specific employees are compensated, relevant conflicts of interest, and legal disciplinary histories involving the firm or its professionals.
• Formatting: OCIE staff may review firms’ relationship summaries to assess whether the formatting is in accordance with the relevant instructions, including incorporation of any required wording and plain English requirements.
• Updates: OCIE staff may review firms’ policies and procedures for updating their relationship summaries, may focus on how and whether they are updated and filed following instances where information becomes materially inaccurate, and may focus on the process for communicating these changes to retail investors within the required time frames, in addition to firms’ processes for highlighting or describing the relevant changes to retail investors.
• Recordkeeping: OCIE staff may review firms’ records regarding delivery of relationship summaries and related policies and procedures for compliance with delivery and recordkeeping obligations.

The Risk Alerts also encourage firms to assess their level of preparedness as the June 30, 2020 compliance date approaches using the guidelines set forth in each alert.

The OCIE Risk Alert regarding Reg BI is available at https://www.sec.gov/files/Risk%20Alert%20Regulation%20Best%20Interest%20Exams.pdf.

The OCIE Risk Alert regarding Form CRS is available at https://www.sec.gov/files/Risk%20Alert%20-%20Form%20CRS%20Exams.pdf.

SEC Modernizes Securities Offering Rules for BDCs and Registered Closed-End Funds

On April 8, the SEC adopted amended securities offering rules for BDCs¹ 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.

SEC Allows Affiliated Purchases of Debt Securities From Registered Open-End Investment Companies

On March 26, the Staff of the SEC granted a request for no action relief to permit certain affiliated purchase transactions involving registered open-end investment companies. The relief, in effect, temporarily extends Rule 17a-9 under the Investment Company Act of 1940 (1940 Act) to all open-end investment companies (each a "Fund"), except for exchange-traded funds, in order to enhance access to liquidity during the market volatility accompanying the COVID-19 pandemic. Rule 17a-9 provides an exemption from the prohibitions under section 17(a) of the 1940 Act to permit affiliated persons of a money market fund (or affiliated persons of such persons) to purchase securities from the money market fund. The rule is explicitly limited to open-end investment companies that hold themselves out as money market funds.

The no-action relief comes in response to a request from the Investment Company Institute (ICI) seeking to broaden the applicability of Rule 17a-9 to Funds that are not money market funds or exchange-traded funds. The ICI explained that, due to the national emergency caused by the COVID-19 pandemic, "there is a short-term dislocation in the market for a variety of debt securities" and that "advisers (directly or through affiliates) may wish to purchase these securities from Funds to enhance the Funds’ liquidity and to fund shareholder redemptions, in light of the significant securities market disruptions related to the COVID-19 [pandemic]." The ICI’s request specifically sought relief only for as long as the COVID-19 crisis continues.

The relief permitting Funds to engage in affiliated purchase transactions of their portfolio securities is conditioned upon the following:

1. The purchase price is paid in cash.
2. The price of the purchased debt security is its fair market value under section 2(a)(41) of the 1940 Act, provided that this price is not materially different from the fair market value of the security indicated by a reliable third-party pricing service.
3. If the purchaser thereafter sells the purchased security for a higher price than the purchase price paid to the Fund, the purchaser shall promptly pay to the Fund the amount by which the subsequent sale price exceeds the purchase price paid to the Fund. If the purchaser is subject to sections 23A and 23B of the Federal Reserve Act, this condition does not apply to the extent that it would otherwise conflict with (1) applicable banking regulations or (2) any applicable exemption from such regulations issued by the Board of Governors of the Federal Reserve System.
4. Within one business day of the purchase of the security, the Fund publicly posts on its website and informs the SEC Staff via email to IM-EmergencyRelief@sec.gov stating the name of the Fund, the name of the purchaser, the security(s) purchased (including a legal identifier if available), the amount purchased, and the total price paid.
5. The SEC’s no-action relief shall be in effect on a temporary basis in response to the national emergency concerning the COVID-19 outbreak, which was proclaimed by the President of the United States on March 13, 2020, and will cease to be in effect upon notice from the Staff.

This no-action relief was granted one day after the incoming request from the ICI, and it reflects the numerous steps the SEC is taking to modify some of its rules or otherwise respond to the market disruptions resulting from the COVID-19 pandemic. The SEC has published on its website a list of many of the actions it is undertaking to respond to the pandemic, which it continues to update regularly.

Although many of the conditions to this no-action relief track the conditions required by Rule 17a-9, including the requirement that securities be purchased with cash and the claw back provisions under prong 3 above, there is a notable difference. To take advantage of this no-action relief, a Fund must publicly disclose the fact of, and the details of, such an affiliated purchase transaction on its website (see prong 4 above). Funds presumably will be reluctant to publicly disclose these details because doing so could indicate problems with liquidity. So while this relief is welcome in the face of the ongoing COVID-19 crisis and may be necessary for some Funds to meet their liquidity requirements and satisfy shareholder redemption requests, we expect the majority of Funds will take advantage of this relief as a matter of last resort.

The SEC’s no-action letter is available at https://www.sec.gov/investment/investment-company-institute-032620-17a.

SEC Extends Conditional Exemptions From Reporting for Funds and Investment Advisers Affected by COVID-19

On March 25, the SEC issued two orders stating that it was extending the regulatory relief previously provided to funds and investment advisers whose operations may be affected by COVID-19. For a description of the SEC’s previously granted regulatory relief, see our article titled "SEC Grants Relief to Funds and Advisers Related to COVID-19 Outbreak," which immediately follows this article. The SEC’s new orders supersede and extend the filing periods covered by the original orders issued on March 13, 2020.

The SEC’s orders provide for the following relief:

• The SEC has extended the time period for the waiver of the in-person board meeting requirement until August 15, 2020. The original order was until June 15, 2020. Boards must ratify any actions taken at the next in-person board meeting.
• The SEC has extended the Form N-CEN and Form N-PORT filing deadlines until June 30, 2020. The original order extended the filing deadlines to April 30, 2020. Filings would still need to be made as soon as practicable, but no later than 45 days after the original due date. A fund relying on this relief must include, in its email correspondence to SEC Staff and on its website, a brief description of the reasons why it is unable to file Form N-CEN or Form N-PORT and must provide SEC Staff with an estimated date by which it expects to file the reports.
• The SEC has extended the transmittal deadlines for annual and semiannual reports to June 30, 2020. The original order extended the transmittal deadlines to April 30, 2020. Transmittal would still need to be made as soon as practicable, but no later than 45 days after the original due date. A fund relying on this relief must include, in its email correspondence to SEC Staff and on its website, a brief description of the reasons why it is unable to file its report on a timely basis and must provide the SEC Staff with an estimated date by which it expects to file the report.
• Registered closed-end investment companies and BDCs are temporarily exempt from the requirement to file with the SEC notices of their intention to call or redeem securities at least 30 days in advance, if such companies file a Form N-23C-2 with the SEC fewer than 30 days prior to, including the same business day as, the company’s call or redemption of securities of which it is the issuer. The order would extend the period until August 15, 2020. The original order extended the period to June 15, 2020. To rely on this relief, a fund must notify the SEC by email. In addition, the fund must make sure that such a filing on an abbreviated time frame is permitted under relevant state law and the fund’s governing documents.
• Under certain circumstances related to COVID-19, the SEC will not recommend enforcement action against a registered fund for delaying delivery of its current prospectus to investors. This relief is limited. It does not include relief to new investors who must timely receive their prospectus. It also does not include relief to the registered fund for extending the time period available to update and file with the SEC the prospectus and financial statements. The conditions for relying on the relief include that the investment company (1) notify SEC Staff that it is relying on the relief; (2) publish on its public website that it intends to rely on the relief; and (3) publish its current prospectus on its public website. In addition, the prospectus must be delivered as soon as practicable, but not more than 45 days after the date originally required.
• The Investment Advisers Act relief provided is from the timeliness requirements of Form ADV and Form PF filings, and for Form ADV Part 2 client delivery obligations. The order would extend the obligations to June 30, 2020. The original order extended the transmittal deadlines to April 30, 2020. Filing or delivery, as applicable, would still need to be made as soon as practicable, but no later than 45 days after the original due date.

The SEC’s orders are available at https://www.sec.gov/rules/other/2020/ia-5469.pdf and https://www.sec.gov/rules/other/2020/ic-33824.pdf.

SEC Grants Relief to Funds and Advisers Related to COVID-19 Outbreak

As a result of the current and potential effects of COVID-19, the SEC has relaxed certain requirements of the Investment Company Act of 1940 and the Investment Advisers Act of 1940 and rules under the Acts.

Specifically, on March 13, 2020, the Commission issued an order that temporarily eliminates in-person board meeting requirements, and permits a fund to delay certain filing obligations and prospectus delivery requirements under the Investment Company Act of 1940 (the ICA Order), and an order temporarily delaying deadlines for filing Forms ADV and Forms PF by investment advisers and exempt reporting advisers under the Investment Advisers Act of 1940 (the Advisers Act Order).

Pepper Hamilton attorneys are monitoring regulatory developments closely, and remain committed to assisting our clients through this time. Do not hesitate to contact any of member of our investment management team.

Relief Under the Investment Company Act

In-Person Board Meeting Requirements

Until June 15, 2020, a registered investment company or BDC and any investment adviser of or principal underwriter for such registered investment company or BDC is exempt from certain requirements that votes of boards of directors be cast in person.⁶ Specifically, the relief relates to the following sections of and rules under the Investment Company Act:

• Section 15(c) - relating to approval of investment advisory and underwriting contracts
• Section 32(a) - relating to selection of auditors
• Rule 12b-1(b)(2) - relating to approval of distribution plans in which an investment company acts as a distributor of its own securities, and
• Rule 15a-4(b)(2)(ii) - related to approval of interim investment advisory contracts.

Reliance on the ICA Order with respect to in-person meeting requirements is subject to the following conditions:

1. Reliance on the ICA Order is necessary or appropriate due to circumstances related to current or potential effects of COVID-19
2. The votes required to be cast at an in-person meeting are instead cast at a meeting in which directors may participate by any means of communication that allows all directors participating to hear each other simultaneously during the meeting, and
3. The board of directors, including a majority of the directors who are not interested persons of the registered management investment company or BDC, ratifies the action taken pursuant to this exemption by vote cast at the next in-person meeting. 

Additional 45 Days to File Form N-Port and Form N-CEN Filings

Until April 30, 2020, a registered fund that is required to file Form N-CEN pursuant to Rule 30a-1 under the Investment Company Act, or Form N-PORT pursuant to Rule 30b1-9 under the Investment Company Act, is temporarily exempt from such form-filing requirements.

Reliance on the ICA Order with respect to Form N-Port or From N-CEN is subject to the following conditions:

1. The registered fund is unable to meet a filing deadline due to circumstances related to current or potential effects of COVID-19

2. Any registered fund relying on the ICA Order promptly notifies the Commission staff via email at IM-EmergencyRelief@sec.gov stating:

a. That it is relying on the ICA Order

b. A brief description of the reasons why it could not file its report on a timely basis, and

c. The estimated date by which it expects to file the report

3. Any registered fund relying on the ICA Order includes a statement on the applicable registered fund’s public website briefly stating that it is relying on the ICA Order and the reasons why it could not file its reports on a timely basis

4. The registered fund required to file such Form N-CEN or Form N-PORT files such report as soon as practicable, but not later than 45 days after the original due date, and

5. Any Form N-CEN or Form N-PORT filed pursuant to the ICA Order must include a statement of the filer that it relied on the order and the reasons why it was unable to file such report on a timely basis.

Additional 45 days to Transmit Annual and Semi-Annual Reports by Investment Companies

Until April 30, 2020, a registered investment company is temporarily exempt from the requirements of Section 30(e) of the Investment Company Act and Rule 30e-1 thereunder to transmit annual and semi-annual reports to investors.

Reliance on the ICA Order with respect to transmittal of annual and semi-annual reports is subject to the following conditions:

1. The registered fund is unable to prepare or transmit the report due to circumstances related to current or potential effects of COVID-19

2. Any registered fund relying on ICA Order promptly notifies the staff via email at IM-EmergencyRelief@sec.gov stating:

a. That it is relying on this order

b. A brief description of the reasons why it could not transmit its report on a timely basis, and

c. The estimated date by which it expects to transmit the report

3. Any registered fund relying on ICA Order includes a statement on the applicable registered fund’s public website briefly stating that it is relying on this order and the reasons why it could not prepare and transmit its reports on a timely basis, and

4. The registered fund transmits the reports to shareholders as soon as practicable, but not later than 45 days after the original due date and files the report within 10 days of its transmission to shareholders.

Reduced Notice Period for Share Repurchases

Until June 15, 2020, closed-end funds and BDCs are temporarily exempt from the requirement to file with the Commission notices of their intention to call or redeem securities at least 30 days in advance under Sections 23(c) and 63, as applicable, of the Investment Company Act and Rule 23c-2 thereunder, if such company files a Form N-23C-2 (Notice) with the Commission less than 30 days before, including the same business day as, the company’s call or redemption of securities of which it is the issuer.

Reliance on the ICA Order with respect to Form N-23C-2 is subject to the following conditions:

1. The closed-end fund or BDC (Company) relying on the ICA Order:

a. Promptly notifies Commission staff via email at IM-EmergencyRelief@sec.gov stating that it is relying on the ICA Order, and

b. A brief description of the reasons why it needs to file a Notice fewer than 30 days in advance of the date set by the Company for calling or redeeming the securities of which it is the issuer

2. Ensures that the filing of the Notice on an abbreviated time frame is permitted under relevant state law and the Company’s governing documents

3. Files a Notice that contains all the information required by Rule 23c-2 before:

a. Any call or redemption of existing securities

b. The commencement of any offering of replacement securities, and

c. Providing notification to the existing shareholders whose securities are being called or redeemed.

Additional 45 Days to Deliver Prospectuses

The Commission stated that it would not provide a basis for a Commission enforcement action if a registered fund does not deliver to investors the current prospectus of the registered fund where the prospectus is not able to be timely delivered because of circumstances related to COVID-19 and delivery was due during the limited period specified below, provided that the sale of shares to the investor was not an initial purchase by the investor of shares of the registered fund.

Reliance on the ICA Order with respect to prospectus delivery requirements is subject to the following conditions:

1. The registered fund:

a. Notifies Division of Investment Management staff via email at
IM-EmergencyRelief@sec.gov stating:

i. That it is relying on this Commission position

ii. A brief description of the reasons why it or any other person required could not deliver the prospectus to investors on a timely basis, and

iii. The estimated date by which it expects the prospectus to be delivered

b. Publishes on its public website that it intends to rely on the Commission position and briefly states the reasons why it could not deliver the prospectus on a timely basis

c. Publishes its current prospectus on its public website, and

2. Delivery was originally required on or after March 13, 2020 but on or before April 30, 2020, and the prospectus is delivered to investors as soon as practicable, but not later than 45 days after the date originally required.

Relief Under the Advisers Act

Suspension of Form ADV Amendment and Delivery Requirements

The Advisers Act Order provides a temporary exemption from certain requirements. Specifically, subject to certain conditions, for filings due from March 13, 2020 but before April 30, 2020:

• A registered investment adviser is exempt from the requirements:
  • Under Rule 204-1 of the Advisers Act to file an amendment to Form ADV, and
  • Under Rule 204-3(b)(2) and (b)(4) related to the delivery of Form ADV Part 2 (or a summary of material changes) to existing clients
• An exempt reporting adviser is exempt from the requirements under Rule 204-4 under the Advisers Act to file reports on Form ADV, and
• A registered investment adviser that is required by Section 204(b) of and Rule 204(b)-1 under the Advisers Act to file Form PF is exempt from those requirements.

Additional 45 Days to File Annual Form ADV

Registered investment advisers or exempt reporting advisers that rely on the Advisers Act Order must satisfy certain requirements:

• The adviser is unable to meet a filing deadline or delivery requirement due to circumstances related to current or potential effects of COVID-19
• The adviser, with respect to the filing of Form ADV or delivery of its brochure, summary of material changes, or brochure supplement, promptly provides the Commission via email at IARDLive@sec.gov and discloses on its public website (or if it does not have a public website, promptly notifies its clients and/or private fund investors of) the following information:
  • That it is relying on the Advisers Act Order
  • A brief description of the reasons why it could not file or deliver its Form ADV on a timely basis, and
  • The estimated date by which it expects to file or deliver the Form
• The adviser, with respect to Form PF, must promptly notify the Commission via email at FormPF@sec.gov stating:
  • That it is relying on the Advisers Act Order
  • A brief description of the reasons why it could not file its Form on a timely basis, and
  • The estimated date by which it expects to file the Form
• The adviser files the Form ADV or Form PF, as applicable, and delivers the brochure (or summary of material changes) and brochure supplement, as soon as practicable, but not later than 45 days after the original due date for filing or delivery, as applicable.

* * *

The ICA Order is available at https://www.sec.gov/rules/other/2020/ic-33817.pdf.

The Advisers Act Order is available at https://www.sec.gov/rules/other/2020/ia-5463.pdf.

SEC Proposes Rule Changes to Harmonize, Simplify and Improve the Exempt Offering Framework

On March 4, the SEC proposed a set of amendments to its rules under the Securities Act of 1933 (Securities Act) to "harmonize, simplify, and improve" the framework governing securities offerings that are exempt from registration under the Securities Act. The amendments were proposed in response to public comments the SEC received regarding its June 2019 concept release on the harmonization of securities offering exemptions. If the SEC adopts these proposed rules, the exempt offering framework will remain fundamentally the same, but the changes would be anticipated to expand access to capital formation and investment opportunities.

The proposed amendments are organized around four main themes:

Integration. The proposals would, through one broadly applicable rule, clarify whether multiple securities offerings should be integrated into, or considered as, part of the same offering. The rule would be based on a facts-and-circumstances approach, and it is intended to supplant the current patchwork of SEC rules and guidance. The SEC also proposed four nonexclusive safe harbors from integration:

• Timing. Any offering made more than 30 calendar days before the commencement of any other offering or more than 30 calendar days after the termination or completion of any other offering would not be integrated with another offering, provided that, for an exempt offering for which general solicitation is not permitted (such as an offering pursuant to Rule 506(b) of Regulation D), the purchasers either were not solicited through the use of general solicitation or had established a substantive relationship with the issuer prior to the commencement of the offering for which general solicitation is not permitted.
• Employees and Offshore Transactions. Offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S would not be integrated with other offerings.
• Registered Offerings. An offering for which a Securities Act registration statement has been filed with the SEC will not be integrated with another offering if the registered offering is made subsequent to (1) a terminated or completed offering for which general solicitation is not permitted; (2) a terminated or completed offering for which general solicitation is permitted and the offering was made only to qualified institutional buyers and institutional accredited investors (i.e., in a manner that would comply with existing "test the waters" communications); or (3) an offering that terminated or completed more than 30 calendar days prior to the commencement of the registered offering.
• General Solicitation. Offers and sales made in reliance on an exemption for which general solicitation is permitted would not be integrated with another offering if made subsequent to any prior terminated or completed offering.

Size of Offerings. The proposals would increase the maximum offering size under Regulation A, Regulation Crowdfunding, and Rule 504 of Regulation D, as well as revise certain individual investment limits. These revisions would be as follows:

• Regulation A. The proposals would increase the maximum offering amount under Tier 2 of Regulation A from $50 million to $75 million and increase the maximum offering amount for secondary sales under Tier 2 of Regulation A from $15 million to $22.5 million.
• Regulation Crowdfunding. The proposals would increase the maximum offering amount from $1.07 million to $5 million and amend the investment limitation for investors by (1) not applying any investment limits to accredited investors and (2) revising the calculation method for investment limitations for nonaccredited investors to allow them to rely on the greater of their annual income or net worth when calculating the limit on how much they can invest.
• Rule 504 of Regulation D. The proposals would increase the maximum offering amount from $5 million to $10 million.

"Test the Waters" Communications. The proposals are intended to help expand the scope of permissible communications in private offerings. The proposed rules would allow for expanded "test the waters" communications for issuers, similar to the rule currently enjoyed by emerging-growth companies. The proposed rules would also allow "demo day" communications, which, subject to some restrictions, would not be considered general solicitation or general advertising by the SEC.

Disclosure and Eligibility. The proposals seek to harmonize disclosure requirements and eligibility requirements under existing private exemptions to reduce differences between existing exemptions. The proposed amendments would:

• change the financial information requirements that must be provided to nonaccredited investors in Rule 506(b) private placements to align with the financial information that issuers must provide to investors in Regulation A offerings
• add a new item to the nonexclusive list of verification methods in Rule 506(c)
• simplify certain requirements for Regulation A offerings and establish greater consistency between Regulation A and registered offerings
• harmonize the bad actor disqualification provisions in Regulation D, Regulation A and Regulation Crowdfunding (which are currently similar, but not identical).

Comments were due by June 1, 2020.

The SEC’s June 2019 concept release on the harmonization of securities offering exemptions is available at https://www.sec.gov/rules/concept/2019/33-10649.pdf.

The SEC’s proposed rules are available at https://www.sec.gov/rules/proposed/2020/33-10763.pdf.

SEC Requests Comment on Fund Names Rule, Seeks to Eliminate Misleading Fund Names

On March 2, the SEC published a request for comment (the Request) seeking engagement from funds, their advisers, investors and other market participants regarding Rule 35d-1 under the Investment Company Act of 1940 (the Names Rule). The SEC is seeking specific feedback on whether the Names Rule’s current requirements are effective and whether there are viable alternatives that the SEC should consider.

The Names Rule, adopted in 2001, generally requires a fund to invest at least 80 percent of its assets in the type of asset suggested by its name. In the Names Rule’s 2001 adopting release, the SEC noted that the purpose for adopting the Names Rule, among others, was to guard against the use of misleading investment company names and to provide an investor greater assurance that the fund’s investments will be consistent with its name. The Request notes that a fund’s name is often the first piece of fund information investors see and can have a significant impact on their investment decision.

The Request notes that the Names Rule has not been amended since its adoption in 2001, and, since then, the SEC Staff and industry participants have identified various challenges to the application of the Names Rule, including the following:

• The Names Rule’s asset-based test may not be suitable for funds using derivatives and other financial instruments that provide leverage, where the security’s market value may be small relative to its potential exposure.
• The increased use of hybrid financial instruments, such as convertible securities that may be more or less consistent with a fund’s name depending on market conditions.
• The growth of index funds, whose indices are not subject to the Names Rule.
• The growth of funds (most prominently, funds that include environmental, social and governance-oriented considerations, e.g., "ESG" funds) with investment mandates involving criteria requiring assessment of certain characteristics and where some ambiguity exists among the funds’ advisers as to whether the Names Rule applies.
• With a proliferation of new funds, funds may be incentivized to differentiate and attract assets by using unique fund names, which may be inconsistent with the Names Rule.

As such, per the Request, the SEC is seeking input on the following issues, among others:

• how fund names are selected — for marketing purposes or to convey information about investments and risks
• whether the Names Rule is effective at preventing funds from using deceptive or misleading names
• whether the Names Rule should be repealed and, if so, why
• with respect to the Names Rule’s 80 percent asset-based test — whether the 80 percent threshold is still appropriate and whether the asset-based approach continues to be appropriate, considering some funds’ use of derivatives
• how funds determine whether a portfolio investment is part of a particular industry and what degree of flexibility in this determination is appropriate
• the current inapplicability of the Names Rule to the use of terms that suggest an investment strategy (such as "growth" or "value"), rather than a type of investment, and whether this policy requires revisiting
• whether the Names Rule applies to certain terms in fund names, including those with ESG components, or funds whose names include the terms "global," "international," "tax-managed" and "long-term," among others
• whether registered closed-end funds or BDCs should be treated differently from open-end funds under the Names Rule, and why
• any other concerns or challenges regarding the Names Rule, or ways in which the Rule could be modified to better protect investors.

Comments to the Request were due by May 5, 2020.

The SEC’s Request for Comment is available at https://www.sec.gov/rules/other/2020/ic-33809.pdf.

SEC Agrees to Blackstone In-Person Sub-Adviser Meeting Relief

In a significant change to normal practice, the SEC on February 19 granted exemptive relief to Blackstone Alternative Investment Fund (the Fund) and its adviser, Blackstone Alternative Investment Advisors LLC, to permit, under certain conditions, the Fund’s board of trustees to approve new sub-advisory agreements or materially alter existing sub-advisory agreements without conducting in-person meetings.

Section 15(c) of the 1940 Act requires that investment advisory agreements, including sub-advisory agreements, be approved by a majority of a fund’s independent trustees at an in-person meeting. Although Blackstone stated that the Fund’s board of trustees typically meets in person on a quarterly basis, market events can dramatically change in a two- or three-month period, which could necessitate changes in strategies or sub-advisers.

The SEC granted the exemptive relief subject to the following conditions:

• The independent trustees would be able to approve any sub-adviser change at a non-in-person meeting provided that the trustees participate by any means of communication that allows the trustees to each hear and be heard by the other trustees.
• The materials provided to the board of trustees for the non-in-person meeting must include the same information the board would have received if the sub-adviser change would have occurred in person.
• The notice of the non-in-person meeting should explain the need for considering the change to a sub-advisory agreement and must give trustees the opportunity to object to considering any change at a non-in-person meeting.
• The Fund must disclose its ability to rely on the exemptive relief in its registration statement.

A copy of the SEC’s notice of exemptive order is available at https://www.sec.gov/rules/ic/2020/ic-33748.pdf.

Agencies Propose Changes to Modify ‘Covered Funds’ Restrictions of Volcker Rule

On January 30, the Office of the Comptroller of the Currency, Federal Reserve System, Federal Deposit Insurance Corporation, Commodity Futures Trading Commission, and SEC (the Agencies) issued a rule proposal that would amend the regulations implementing section 13 of the Bank Holding Company Act (the Volcker Rule). The Volcker Rule generally prohibits any banking entity from engaging in proprietary trading with, or from acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with hedge funds or private equity funds (Covered Funds).

In November 2019, the Agencies adopted rules that revised the implementing regulations relating to the proprietary trading prong of the Volcker Rule. In that rulemaking, the Agencies noted that future rulemaking would address the Covered Fund prong.

In broad overview, the Covered Fund prong of the Volcker Rule is intended to prevent covered banking entities from engaging in any practice indirectly through a fund structure that they could not engage in directly as a result of the restrictions on proprietary trading.

The proposal includes four new exclusions from the definition of a Covered Fund and simplifies three existing exclusions. In addition, the proposal would expand the scope of permissible relationships that a banking entity may have with Covered Funds, codify existing guidance related to certain foreign funds, and clarify issues surrounding ownership interests and permissible parallel investments by a banking entity and its employees.

New Exclusions

Credit Funds. Funds that raise capital to engage in loan originations or extensions of credit, or purchase and hold debt instruments that a banking entity would be permitted to acquire directly, may be Covered Funds under the Volcker Rule. As a result, banking entities currently face limitations on sponsoring or investing in credit funds that engage in traditional banking activities — activities that banking entities are able to engage in directly outside of the fund structure. The proposal would allow banking entities to invest in or sponsor credit funds that meet certain eligibility criteria.

Venture Capital Funds. Currently, venture capital funds that invest in small businesses and startup businesses may be Covered Funds subject to the restrictions of the Volcker Rule. The proposal seeks to exclude certain venture capital funds from the definition of a Covered Fund, which would allow banking entities to acquire or retain an ownership interest in, or sponsor, those venture capital funds to the extent the banking entity is otherwise permitted to engage in such activities under applicable law. This new exclusion is intended to reflect the congressional understanding that venture capital funds are less connected with the public markets and therefore may have less potential for systemic risk.

Family Wealth Management Vehicles. The proposal would exclude from the Covered Fund definition certain family wealth management vehicles. Family wealth management vehicles commonly engage in asset management activities, as well as estate planning and other related activities. By specifically excluding family wealth management vehicles, the proposal would allow banking entities to offer services to and engage in transactions with family wealth management vehicle customers, and increase the number of banking entity counterparties providing traditional client-oriented financial and asset management services.

Customer Facilitation Vehicles. The proposal would generally permit a banking entity to offer financial products to its customers through a fund structure in situations where the banking entity could otherwise enter into a contract directly with a customer to provide the same economic exposure to the underlying assets. Banking entities and clients commonly use special purpose vehicles to accommodate exposure to securities, transactions and services for a variety of legal, counterparty risk management and accounting factors. As a result of the Volcker Rule’s restrictions, some banking entities have been unable to engage in traditional banking and asset management services with respect to vehicles provided for customers, even though banking entities are otherwise able to provide these exposures and services to customers directly.

Revisions to Existing Exclusions

While the Volcker Rule explicitly excludes certain types of funds from the meaning of Covered Fund, the contours of the Volcker Rule’s various exclusions did not always comport with established market practices. Since the adoption of the Volcker Rule, reconciliation of the law with market realities was largely accomplished though guidance issued by the staffs of the Agencies, such as FAQs. The proposal seeks to codify this guidance and implement new revisions to existing exclusions for loan securitizations, foreign public funds and small business investment companies.

Loan Securitizations. The proposal seeks to amend two aspects of the eligibility criteria for the existing loan securitization exclusion. First, the Agencies are proposing to codify the 2014 FAQ explaining that assets other than permitted securities can be "servicing assets" for purposes of the loan securitization exclusion (e.g., mortgage insurance policies supporting the mortgages in a loan securitization). Second, the proposal seeks to permit loan securitizations to hold a small amount of nonloan assets, up to 5 percent of the total assets of the securitization.

Foreign Public Funds. In order to provide consistent treatment between U.S.-registered investment companies and their foreign equivalents, the Volcker Rule excludes foreign public funds from the definition of a Covered Fund. Certain aspects of the definition of a foreign public fund, however, made it difficult for certain funds to qualify and were unnecessary.

Specifically, the requirement that the fund be authorized to be offered and sold to retail investors in the fund’s home jurisdiction (the home jurisdiction requirement) disqualifies certain funds that are organized in one jurisdiction but only authorized to be sold to retail investors in another jurisdiction. Moreover, the requirement that a fund be sold "predominantly" through one or more public offerings may cause certain compliance and monitoring difficulties for covered banking entities where a fund is sponsored by or distributed through a third party.

To address these concerns, the proposal seeks to replace those two requirements with a single requirement that the fund be authorized to offer and sell ownership interests, and the interests are offered and sold, through one or more public offerings.

Small Business Investment Companies. In order to give appropriate effect to the statutory exemption for small business investment company (SBIC) investments, the proposal would clarify that an SBIC could remain eligible for the exclusion from the Covered Fund provisions during a wind-down period (during which time it may surrender its license), provided it makes no new investments after surrendering its license.

Other Revisions: Low-Risk Transactions, Foreign Excluded Funds, Ownership Interests and Co-Investments

Permissible Low-Risk Transactions. The proposal seeks to modify the regulations implementing portions of the Volcker Rule to permit covered banking entities to engage in a limited set of covered transactions with Covered Funds for which the banking entity serves as investment manager, investment adviser or sponsor, or that the banking entity organizes and offers (Related Covered Funds). Specifically, the proposal would allow a banking entity to enter into transactions with a Related Covered Fund that would be permissible for a banking entity to enter into with an affiliate under section 23A of the Federal Reserve Act. The proposal would also allow a banking entity to enter into short-term extensions of credit with, and purchase assets from, a Related Covered Fund in connection with payment, clearing and settlement activities. In addition to permitting these certain low-risk transactions to the extent permitted by section 23A of the Federal Reserve Act, the proposal would eliminate conflicts between that section and the portions of the Volcker Rule that are themselves inconsistent as to the permissibility of such transactions.⁷

Foreign Excluded Funds. Extraterritorial application of the Volcker Rule has led, in some instances, to situations in which certain funds offered and sold outside of the United States are excluded from the Covered Fund definition but still could be considered banking entities as a result of control of the funds by foreign banking entities. As a result, such a fund would be subject to the requirements of the Volcker Rule, including restrictions on proprietary trading, restrictions on investing in or sponsoring Covered Funds, and compliance obligations. The proposal seeks to exempt the activities of qualifying foreign excluded funds.

Ownership Interests. The implementing regulations define an "ownership interest" in a covered fund to mean any equity, partnership or "other similar interest." Currently, some loans by banking entities to Covered Funds could be deemed to be ownership interests based on standard covenants. The proposal would change the definition of "ownership interest" to clarify that a debt relationship with a Covered Fund would typically not constitute an ownership interest.

Co-Investments. The proposal would add a new rule of construction to clarify that banking entities are not required to treat certain types of direct investments alongside a Covered Fund as an investment in the Covered Fund, so long as certain conditions are met.

Comments on the proposal were due on or before April 1, 2020.

A copy of the proposal is available at https://www.sec.gov/rules/proposed/2020/bhca-8.pdf.

LITIGATION AND ENFORCEMENT

BlackRock Credit Allocation Income Trust v. Saba Capital Master Fund Ltd.

On January 13, the Delaware Supreme Court issued its decision in BlackRock Credit Allocation Income Trust v. Saba Capital Master Fund, Ltd. The court found that the BlackRock Credit Allocation Income Trust and the BlackRock New York Municipal Bond Trust, separate closed-end funds each advised by BlackRock Advisors, LLC (BlackRock), were not required to count votes for trustees nominated by Saba Capital Master Fund, Ltd. (Saba Fund), an activist shareholder of the trusts advised by Saba Capital Management, L.P. (Saba), at each trust’s annual meeting.

The Saba Fund, which is advised by Saba, an SEC-registered investment adviser, had previously submitted nominations for trustees to each trust’s board in connection with upcoming annual shareholder meetings. Pursuant to each trust’s advance notice bylaw provisions, the Saba nominees were requested to complete supplemental information questionnaires seeking a broad range of information. The trusts’ advance notice bylaw provisions set forth a deadline for responses to the supplemental information questionnaires of five business days, though the communications providing the supplemental questionnaires to Saba representatives did not specifically reference the deadline. Seven business days after the distribution of the supplemental information questionnaires, Saba had not responded to the request in any way and was informed that its nominations had been invalidated.

Saba subsequently sought injunctive relief in the Delaware Court of Chancery to permit its nominees to stand for election at the trusts’ annual meetings and allow for the counting of any votes cast in their favor. In finding for Saba on one of the counts asserted, the Delaware Court of Chancery said that the trusts’ questionnaire was overbroad in the scope of information sought regarding whether Saba’s nominees met the enumerated requirements for nomination.

On appeal, the Delaware Supreme Court affirmed in part, reversed in part and remanded to the Chancery Court for further proceedings. In particular, the Supreme Court agreed with the trusts’ claim that the Chancery Court erred by issuing a mandatory injunction requiring the trusts to count votes for Saba’s nominees, contrary to the plain and unambiguous language of the bylaws. The Supreme Court added that Saba had an obligation to respond to the supplemental information request before the expiration of the deadline. It added that, while portions of the requested questionnaire were not tied to the nominee qualifications under the bylaws, Saba’s failure to provide any response to the questionnaire, including to the questions that both Saba and the trusts agreed directly related to the nominees’ qualifications under the bylaws, or object before the five-business-day deadline, precluded it from obtaining the injunctive relief provided by the Chancery Court.

The Delaware Supreme Court’s decision is available at https://courts.delaware.gov/Opinions/Download.aspx?id=300380.

Endnotes