Section 19(a) of the Investment Company Act of 1940 (the 1940 Act) generally prohibits a business development company (BDC) or a registered investment company from making a distribution from any source other than its net income (e.g., out of capital), unless that payment is accompanied by a written statement that adequately discloses the source or sources of the payment. Rule 19a-1 under the 1940 Act specifies the information required to be disclosed in the written statement, including that such information be presented on a per share basis.

Over the years, the staff of the Securities and Exchange Commission’s (SEC) Division of Investment Management (the SEC Staff) has advised BDCs and registered investment companies that they could elect to determine whether the provisions of Section 19(a) of, and Rule 19a-1 under, the 1940 Act were implicated in connection with a distribution either on a “GAAP or tax basis.” Because BDCs and registered investment companies generally elect to be treated as regulated investment companies (RICs) for tax purposes and distribute substantially all of their taxable income to their stockholders on an annual basis to qualify as a RIC and avoid certain excise taxes, a large majority of them have chosen to make the Section 19(a) determination on a tax basis. Since the final determination of the tax character of distributions (i.e., ordinary income, capital gains and return of capital) is not known with any great certainty until the end of each taxable year, some BDCs and registered funds have taken the position that IRS Form 1099-DIV (which is provided to their stockholders on an annual basis and delineates the tax character of the distributions paid during the tax year into various categories, including a “nondividend distributions” category) satisfies their obligations under Section 19(a) of the 1940 Act.

However, the SEC Staff recently stated at Eversheds Sutherland's 2018 BDC Roundtable that IRS Form 1099-DIV does not satisfy the requirements of Section 19(a) of the 1940 Act for several reasons, including the requirement that the Section 19(a) notice be sent to stockholders contemporaneously with the distribution payment. Instead, the SEC Staff expects BDCs and registered investment companies that have elected to satisfy the requirements of Section 19(a) on a tax basis to make a good faith estimate of whether each distribution made by them includes a return of capital for tax purposes at the time of the payment thereof and, if so, include an estimate of such amount in a separate notice sent to stockholders along with the distribution. In addition, “if any such estimate is subsequently ascertained to be inaccurate in a significant amount, a correction thereof must be made by a written statement pursuant to Section 19(a) of the [1940] Act or in the first report to stockholders following discovery of the inaccuracy.”¹

To drive the point home on this issue, the SEC Staff cited two SEC Enforcement actions in which the SEC issued cease-and-desist orders to two registered companies for using IRS Form 1099 to satisfy the requirements of Section 19(a) of, and Rule 19a-1 under, the 1940 Act.²
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¹ See Rule 19a-1(e) under the 1940 Act. 

²In the Matter of Gabelli Funds, LLC, Administrative Proceeding File No. 3-13332 (January 12, 2009) and In the Matter of Delaware Service Company, Inc., Administrative Proceeding File No. 3-12403 (August 31, 2006).

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