The SEC Issues Formal Guidance Involving Financial Information Requirements for Certain Portfolio Companies of BDCs

by Eversheds Sutherland (US) LLP
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The U.S. Securities and Exchange Commission (SEC) Division of Investment Management recently published formal guidance (see link below) applying rules that require the inclusion of certain financial information on unconsolidated subsidiaries to portfolio companies of business development companies (“BDCs”). The Division of Investment Management has been informally applying this position to BDCs in connection with their Form N-2 registration statement filings for the last year or so.

The relevant provisions are found in Rules 3-09 and 4-08(g) of Regulation S-X. Rule 3-09 requires that separate annual audited financial statements of an unconsolidated subsidiary of an SEC registrant be included in its SEC filings if the unconsolidated subsidiary meets any of the three tests applicable to “significant subsidiaries” set forth in Rule 1-02(w) of Regulation S-X. The Division of Investment Management is applying Rule 3-09 to a portfolio company of a BDC if, among other things, the portfolio company satisfies the income and/or investment tests at a 20% or greater level (i.e., two of the significance tests set forth in Rule 1-02(w)). Specifically, this provision applies to situations where the BDC’s equity investment in a portfolio company exceeds 20% of the BDC’s total assets as of the end of the last fiscal year, or where the change in the fair value of the BDC’s equity investment in a portfolio company during the most recently completed fiscal year exceeds 20% of the BDC’s income for the most recently completed fiscal year. If a portfolio company triggers any of the tests at the end of a completed fiscal year, then, in addition to the annual audited financial statements required by Rule 3-09, the BDC would be required by other SEC rules to include certain updated interim financial information for the portfolio company in its other SEC filings.

Rule 4-08(g) requires summarized annual and interim balance sheet and income statement information in a note to an SEC registrant’s financial statements for each of its unconsolidated subsidiaries that meet any of the three significance tests set forth in Rule 1-02(w) of Regulation S-X. The Division of Investment Management is applying Rule 4-08(g) to a portfolio company of a BDC if, among other things, the portfolio company satisfies the income and/or investment test at a 10% or greater level. As a result, this provision applies to situations where the BDC’s equity investment in the portfolio company exceeds 10% of the BDC’s total assets as of the end of the last fiscal year, or where the change in the fair value of the BDC’s equity investment in a portfolio company during the most recently completed fiscal year exceeds 10% of the BDC’s income for the most recently completed fiscal year.

Based on Sutherland’s interactions with the staff of the Division of Investment Management relating to its application of Rule 3-09 and 4-08(g) to BDCs over the last year as well as a statement contained in  the text of the formal guidance, it does not appear that BDCs need to combine or aggregate equity investments in their portfolio companies in connection with determining whether the 10% income and/or investment test under Rule 4-08(g) is triggered, as is required by Rule 4-08(g).

The guidance from the Division of Investment Management may be found on their website.

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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