The U.S. Securities and Exchange Commission on March 20, 2019 proposed a package of reforms to the securities registration, offering and communications requirements under the Securities Act of 1933, applicable to business development companies (BDCs) and registered closed-end funds (CEFs and, together with BDCs, Affected Funds).¹ The SEC’s rulemaking proposal is intended to implement two pieces of legislation signed into law in 2018 – the Small Business Credit Availability Act (BDC Act) and the Economic Growth, Regulatory Relief, and Consumer Protection Act (CEF Act) – which directed the SEC to promulgate rules that would permit Affected Funds to take advantage of the more flexible and efficient registration, offering and communications requirements currently available to operating companies. Notably, the reforms specified by the BDC Act became self-implementing on March 24, 2019. Thus, BDCs may now “deem those revisions to have been completed in accordance with the actions required to be taken by the [SEC]” under the BDC Act, even though the SEC has not yet done so.

The SEC has requested comments on the proposal by June 10, 2019.

Scope of Proposed Reforms

The proposed reforms would apply to all BDCs and CEFs. Interestingly, the CEF Act requires the SEC to implement reforms only with respect to CEFs listed on a national securities exchange or that make periodic repurchase offers pursuant to the “interval fund” rule under the Investment Company Act of 1940. Nevertheless, the SEC exercised its discretion in extending the proposed reforms to all CEFs (thus capturing unlisted CEFs) to enhance investor protection and mitigate potential competitive anomalies among different types of CEFs; in doing so, the SEC acknowledged that certain components of the proposal would be less likely to apply to unlisted CEFs. The SEC has requested comment as to the scope of the proposed reforms, including whether open-end funds should be permitted to rely on any of the more flexible offering or communications rules.

Streamlined Shelf Offering Process

Since 1998, the staff of the SEC’s Division of Investment Management has permitted Affected Funds that are deemed to be “seasoned” to maintain a shelf registration statement on Form N-2 that allows them to engage in securities offerings on a delayed or continuous basis.² The proposed reforms would: codify this right into an SEC rule; and make the shelf offering process significantly less administratively burdensome, by enabling Affected Funds to rely on the streamlined registered offering rules that are available to operating companies. Specifically, the proposal includes the following reforms:

• Short-form registration statement. Seasoned Affected Funds would be permitted to file on Form N-2 a “short-form” registration statement similar to the Form S-3 registration statement used by operating companies. A short-form Form N-2 registration statement would permit Affected Funds to incorporate by reference information from reports they previously filed under the Securities Exchange Act of 1934 (rather than repeat that information in the Form N-2) and incorporate by reference information from their future Exchange Act filings (rather than amend the Form N-2 by post-effective amendment or prospectus supplement to add that information).
• Automatically-effective registration statements. Affected Funds that qualify as “well-known seasoned issuers” (WKSIs) (discussed below) would be permitted to file automatically-effective registration statements and thereby avoid the delay and uncertainty associated with the SEC staff review process.
• Information omitted from base prospectus. Seasoned Affected Funds, together with Affected Funds that qualify as WKSIs, would be permitted to rely on Rule 430B under the Securities Act to omit certain information from the base prospectus included in their Form N-2 registration statements at the time of initial effectiveness. Specifically, Seasoned Funds and WKSI Affected Funds would be allowed to omit information that is unknown or not reasonably available, as well as the identities of selling shareholders and the amount of securities being registered on their behalf. WKSI Affected Funds also would be permitted to omit information relating to: (i) the distribution plan for the securities; (ii) a description of the securities registered (other than an identification of the name or class of the securities); and (iii) whether the offering is a primary or secondary offering, or a mix.
• Prospectus supplements. Affected Funds would be required to file prospectus supplements exclusively under Securities Act Rule 424, rather than Rule 497. Rule 424 allows registrants to file a prospectus supplement on a delayed basis, and only requires filing for material changes to the prospectus (rather than any variation from the prospectus, as required by Rule 497).
• Prospectus delivery requirements. Affected Funds would be permitted to satisfy their obligation to deliver a “final prospectus” to investors prior to or at the time of sale or delivery of securities by simply filing such prospectus with the SEC. This proposed reform should significantly reduce printing, mailing and compliance costs associated with the offering process.

WKSI Eligibility

A WKSI is a seasoned issuer: (i) with $700 million in public float; or (ii) that both (a) has registered and issued at least $1 billion in aggregate principal amount of nonconvertible debt or preferred stock for cash, not exchange, during the past three years and (b) will only offer non-convertible debt or preferred stock in connection with the registration statement for which the WKSI status determination is being made (unless the issuer is otherwise eligible to register a primary offering of its securities).

WKSIs are subject to the least burdensome offering and communication requirements. For example, WKSIs are the only category of issuer permitted to file automatically-effective shelf registration statements and post-effective amendments; make certain oral and written communications (including through the use of a “free-writing” prospectus) before and after filing a registration statement; and defer payment of registration fees until the time of an actual offering (commonly referred to as “pay-as-you-go”). CEFs are currently prohibited from qualifying as WKSIs. Similarly, BDCs were prohibited from qualifying as WKSIs prior to the March 24, 2019 self-implementation of the BDC Act.

The proposed reforms also would revise Securities Act Rule 405 to permit CEFs to, and specifically provide by regulation that BDCs may, qualify as WKSIs in the same manner as operating companies, and thereby enjoy the benefits associated with WKSI status.

As noted in the release, the nature of the WKSI eligibility criteria would generally render it impossible for unlisted Affected Funds to satisfy such criteria. In this regard, the SEC indicated that it had considered imposing a less restrictive or alternative capitalization threshold for Affected Funds. However, the SEC ultimately concluded that any other metric would be inconsistent with the policy underlying the adoption of the original WKSI reforms in 2005, which was to provide streamlined offering and communication rules to companies that are already widely scrutinized by financial analysts, institutional investors and other market participants. Nonetheless, the SEC has requested comment on this aspect of the proposed rules.

Communications

The proposed reforms include amendments that would enable eligible Affected Funds to rely on exemptions from Securities Act restrictions on offering-related communications (known as “gun-jumping” provisions) currently utilized by operating companies. In addition to the benefits available to WKSIs, the reforms would give Affected Funds greater flexibility to publish forward-looking information and factual business information (including through the use of a “tombstone” ad), and would limit the scope of communications subject to prospectus liability under Section 12 of the Securities Act. The reforms also would allow broker-dealers participating in the distribution of an issuer’s equity-related securities to publish or distribute research about the issuer’s debt‑related securities, and vice versa.

Registration Fees for Interval Funds

Interval funds are currently required to pay SEC registration fees at the time of registration – regardless of when or if such securities are ultimately sold. Interval funds are thus at risk of either paying fees on unsold shares or inadvertently selling more shares than the amount registered. Under the proposed reforms, interval funds would be deemed to register an indefinite amount of securities and would pay registration fees annually based on net shares sold, similar to mutual funds and exchange‑traded funds (ETFs).

Disclosure

The SEC also has proposed modifications to various disclosure requirements, in order to further the goal of promoting parity between Affected Funds and operating companies while maintaining appropriate investor protections.

Structured Data

Operating companies and 1940 Act-registered funds (including registered CEFs) – but not BDCs – are currently required to “tag” portions of certain SEC reports using the Inline eXtensible Business Reporting Language (XBRL) structured data format. This format allows investors and other market participants to view and analyze certain core attributes of the filing and compare like issuers in a more systematic manner. The proposed reforms would amend Regulation S-K by removing the exclusion of BDCs from the Inline XBRL requirements. BDCs would thus be subject to the same Inline XBRL tagging requirements that are applicable to operating companies.

Further, the proposal would add several new check boxes to the Form N-2 cover page that also would be subject to XBRL tagging requirements. Among other things, the check boxes would indicate the nature of the filing (e.g., whether it is for an automatic shelf registration statement and whether it is being made pursuant to the proposed new short-form instruction for Form N-2) and the identity of the filer (e.g., type of fund and whether the issuer is seasoned or a WKSI). Additionally, similar to the requirements for mutual funds and ETFs, all Affected Funds would need to tag certain key information in their prospectus (including the fee table, senior securities table, investment objectives and policies, risk factors, share price data and capitalization information). The SEC also proposes to revise its EDGAR Filer Manual to require that interval funds submit Annual Notice of Securities Sold filings on Form 24F-2 in Extensible Markup Language (XML), another structured data format.

Periodic Reporting

In the release, the SEC observed that the proposed securities registration reforms could result in annual and other periodic shareholder reports “becoming a more salient, convenient, and comprehensive source of updated information ... relative to [the] registration statement.” The SEC is therefore proposing that registrants include the following additional information in these reports to ensure that prospective investors and existing shareholders are appropriately informed:

• Key fund attributes. Seasoned Affected Funds that file a short-form registration statement would be required to include in their annual report certain key disclosures appearing in their prospectus, including the fee and example table, share price performance (i.e., premium or discount to net asset value) and outstanding senior securities table.
• Narrative discussion of fund performance (CEFs). In a manner comparable to mutual funds and ETFs, registered CEFs would be required to include in their annual reports management’s discussion of fund performance (MDFP).³ As with the existing requirement under Form N-1A, registered CEFs would be required to include in the new MDFP section narrative disclosure regarding: factors that materially affected the fund’s performance during the reporting period (including relevant market conditions and investment strategies/techniques); graphical representations of historical fund performance; and the impact of fund distribution policies.
• Financial Highlights (BDCs). BDCs would be required to include a “financial highlights” table (i.e., a tabular summary of the financial statements) in their annual shareholder reports and registration statements.⁴
• Unresolved SEC staff comments. Similar to operating companies, Affected Funds would be required to disclose in their annual report and registration statement SEC staff comments that remain unresolved for 180 days and are deemed to be material by the registrant. In the proposing release, the SEC observed that eliminating the requirement for Affected Funds to annually file post-effective amendments would diminish the incentive to resolve staff comments in a timely manner. The proposed requirement is meant to restore this incentive.

Current Reporting

Operating companies and BDCs are required to disclose on Form 8-K current information regarding the occurrence of certain material events (e.g., new material definitive agreements, earnings announcements, significant financial obligations, director changes). Form 8-K generally must be filed within four business days of the date of the triggering event. Under the proposal, the requirement to file current reports on Form 8-K would be extended to registered CEFs. Most CEFs that trade on an exchange are subject to similar current reporting requirements under applicable exchange listing manual provisions. Nevertheless, the SEC believes that subjecting all registered CEFs to Form 8-K reporting would benefit investors by standardizing the format for current disclosures and making such disclosures accessible in a central location.

The SEC also is proposing to revise Form 8-K to include two new triggering events applicable solely to Affected Funds, given their unique structure as investment companies. First, Affected Funds would be required to disclose any material change in their investment objectives or policies. This could include changes in the types of securities in which an Affected Fund may invest or the predominant investment practices or techniques employed by the Affected Fund. The Affected Fund would have the ability to voluntarily disclose additional information relating to the change, including associated risk factors. The SEC has requested comment as to whether the new reporting requirement should include a specific materiality threshold based on, for example, the change in the percentage of an Affected Fund’s total assets invested in a particular industry, asset type, geography or credit quality.

Second, Affected Funds would be required to report a material write down of any portfolio holding comprising more than 10% of the Affected Fund’s total assets and those of its consolidated subsidiaries. An Affected Fund would be required to aggregate different investments in the same issuer for purposes of this item. The proposed item is meant to parallel a comparable requirement that operating companies disclose a material charge resulting from the impairment of one or more assets under GAAP. Similar to that item, an Affected Fund would not be required to file a report if the determination to write down the portfolio holding was made in connection with the preparation, review or audit of the Affected Fund’s periodic financial statements.

Importantly, the failure to timely file current reports pursuant to the proposed new Form 8-K items would not cause an Affected Fund to lose its seasoned status.

Conclusion

Placing Affected Funds on an equal footing with operating companies in terms of access to flexible offering and investor communication rules should significantly reduce the costs and uncertainty that Affected Funds face in seeking to access the capital markets. However, for Affected Funds that are unlikely to rely on the streamlined rules (i.e., interval funds, unlisted registered CEFs, and listed registered CEFs whose shares consistently trade at a discount to net asset value), the incremental legal and compliance costs associated with the proposed disclosure requirements – particularly the new current reporting requirements for registered CEFs – may substantially outweigh any potential benefits. Notably, many of the proposed disclosure requirements are discretionary in nature (rather than congressionally mandated by the BDC Act or the CEF Act) and thus may be more susceptible to change based on industry input.

Footnotes

1) Securities Offering Reform for Closed-End Investment Companies, Release Nos. 33-10619; 34-85382; IC-33427; File No. S7-03-19 (Mar. 20, 2019), available at https://www.sec.gov/rules/proposed/2019/33-10619.pdf.

2) See Nuveen Virginia Premium Income Municipal Fund, SEC No-Action Letter (pub. avail., Oct. 6, 2006); Pilgrim America Prime Rate Trust, SEC No-Action Letter (pub. avail., May 1, 1998). An Affected Fund is generally considered “seasoned” if it satisfies the eligibility requirements for Form S‑3 (i.e., it is current and has been timely in its Exchange Act reporting for a period of at least 12 calendar months immediately preceding the filing of the registration statement) and has at least $75 million in “public float” (i.e., common equity held by unaffiliated persons).

3) BDCs are subject to similar requirements (which are also applicable to operating companies) to disclose “management’s discussion and analysis” in their annual report on Form 10-K.

4) As noted in the SEC release, it is currently a market practice for BDCs to voluntarily disclose financial highlights in their annual reports.