The Securities and Exchange Commission is wrapping up comments on a proposed rule that could alter how many shares certain acquiring funds – including business development companies – can hold in closed-end funds.
Currently, the statutory maximum is 3 percent of such funds.
“The primary focus of the proposed rule is to liberalise restrictions on BDCs, registered closed-end funds and mutual funds investing in other BDCs, registered closed-end funds and mutual funds,” Harry Pangas, a partner at Dechert that has worked extensively with BDCs, said. He explained that there were multiple exemptive orders issued on the matter throughout the years and this is an attempt to make it uniform.
Among BDCs, the rule is notable, as several activist plays within the BDC space have involved BDCs acquiring 3 percent in other BDCs, one of which included the 2015-16 bid for TICC Capital Corporation by TPG Specialty Lending (TSLX).
TSLX made multiple offers for TICC, seeking an all-out equity merger, competing with several other suitors at the time, including Benefit Street Partners and NexPoint Advisors.
As motive for its bid, TSLX maintained that TICC management had generated poor returns for their shareholders and charged fees that were too high. Ultimately, TICC stayed independent and rebranded as Oxford Square.
When it comes to easing the 3 percent cap though, Apollo Investment Corporation general counsel Joseph Glatt said activism could be limited because the proposed rule dictates how the acquiring funds might vote their shares that could limit activism.
The buying and selling among BDCs today is less hostile, said Wells Fargo senior analyst Finian O’Shea.
“Today what you are seeing more of is an orderly or amicable change of advisory sponsor or contract, and we expect that to continue,” O’Shea said. “Also, I would say the terms are improving for the shareholders. The propositions to the shareholder are becoming more compelling and accounting for the value of a successful BDC manager.”
He added: “There are also often activists that want the manager contract, which is valuable and technically free if the board decides to fire the old manager. It’s a worthwhile endeavour, it’s worth the long shot. It isn’t too costly to simply write a letter.”
The new SEC rules also touch on acquired funds, fees and expenses disclosure, an issue which BDCs have been tackling for some time. The issue, BDC management teams assert, is that mutual funds and other potential institutional shareholders end up double-counting BDC fees and expenses when reporting their costs, dissuading the other funds from purchasing BDC stock.
“In the context of discussing the layering of fees that results from a fund investing in another fund in the rule’s proposing release, the SEC solicits comments on the AFFE disclosure requirement for which the BDC industry has been advocating since 2014,” Pangas said.
In the proposed rule, the acquiring fund would need to determine that the investment is in the best interest of the fund, in light of the SEC’s concern of fees being too high.
“The fees of a BDC are a component of its operating costs, which are already reflected in the net asset value and not directly borne by the acquiring fund,” Glatt said. “BDC fees are analogous to the compensation expense of traditional operating companies.”
Changes to AFFE have been long sought, particularly after BDCs were removed from various indices, including the S&P and Russell.
“These requests for comment offer a glimmer of hope that there may be change afoot on this issue,” Glatt added. “Every BDC will submit a comment arguing for the AFFE rule to be overturned with respect to its application to the acquisition by mutual and other regulated funds of shares of BDCs.”