The Division of Investment Management Clarifies Certain Positions Regarding the Applicability of Rules 3-09 and 4-08(g) of Regulation S-X to BDCs

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The  U.S. Securities and Exchange Commission (“SEC”) Division of Investment Management recently published written guidance (see link below) on rules that require that certain financial information be included pertaining to unconsolidated subsidiaries to portfolio companies of business development companies (“BDCs”). The relevant provisions are found in Rules 3-09 and 4-08(g) of Regulation S-X. Rule 3-09 generally addresses whether separate financial statements of an unconsolidated subsidiary of an SEC registrant should be included in its SEC filings, while Rule 4-08(g) generally covers whether summarized annual (and, indirectly, interim) balance sheet and income statement information must be included in a note to an SEC registrant’s financial statements for its unconsolidated subsidiaries. Both rules look to the three significance tests set forth in Rule 1-02(w) of Regulation S-X, though with different thresholds applied for Rules 3-09 and 4-08(g), respectively.

The Division of Investment Management has now clarified, through informal discussions, certain positions relating to the applicability of Rules 3-09 and 4-08(g) to BDCs under certain circumstances. In particular, the Division of Investment Management has clarified the following positions:

  • For purposes of the definition of “subsidiary” set forth in Rule 1-02(x) of Regulation S-X, “control” should be tested by reference to the definition set forth in the Investment Company Act of 1940, as amended (the “1940 Act”), which includes holding 25% or more of an entity’s voting securities.
  • Rules 3-09 and 4-08(g) can be applied, as applicable, to any BDC portfolio company, regardless of the nature of its business.
  • Rule 3-09 should only be applied to majority-owned portfolio companies that are not consolidated.
  • All three significance tests set forth under Rule 1-02(w), including the investment, asset and income test, should be applied using a 20% threshold when evaluating the applicability of Rule 3-09 to any majority-owned portfolio company.
  • All three significance tests set forth under Rule 1-02(w), including the investment, asset and income test, should be applied using a 10% threshold when evaluating the applicability of Rule 4-08(g) to any BDC portfolio company that would qualify as a “subsidiary.”
  • As opposed to Rule 3-09 which applies to majority-owned portfolio companies, Rule 4-08(g) can apply to any BDC portfolio company that would qualify as a “subsidiary” (i.e., where a BDC is deemed to “control” such portfolio company, as that term is defined under the 1940 Act).
  • It would be inappropriate to utilize investment structures that appear to be designed to technically avoid the applicability of either Rule 3-09 or Rule 4-08(g). 

The original written guidance issued by the Division of Investment Management is provided as a reference.

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SEC

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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