The staff of the SEC's Division of Investment Management said that it would not recommend enforcement action if a business development company (BDC) reorganizes into a master-feeder structure. The relief will also be available to future Feeder Funds in the same structure. Other BDCs that wish to utilize a master-feeder structure, however, may not rely on this relief. The staff indicated that it was "willing to consider similar requests from other BDCs."
The Structure
Under the proposed arrangement, a Feeder Fund will offer its shares in a continuous public offering for a finite term between 5 and 25 years. The Feeder Fund will invest all or substantially all of its assets in a Master Fund. Additional Feeder Funds may be offered in the future.
The Master Fund will invest primarily in privately negotiated loans to private middle market U.S. companies and will continuously offer its common shares on a private placement basis. It will have an indefinite life and will not list its shares on a securities exchange. The Master Fund intends to offer a quarterly share repurchase program. The Master Fund has elected to be treated as a BDC.
Each Feeder Fund will invest substantially all of its assets in the Master Fund and will offer a quarterly tender for a certain amount of its outstanding shares. Each Feeder Fund's quarterly tender offer will be conducted in parallel with that of the Master Fund. As the Feeder Fund approaches the end of its finite term, the Feeder Fund's board of trustees will authorize its liquidation and dissolution. The Feeder Fund will affect the dissolution by selling to the Master Fund all of the Master Fund's shares owned by the Feeder Fund.
The Relief
The SEC staff granted relief from Section 2(a)(48) of the 1940 Act to enable a Feeder Fund to elect to be treated as a BDC notwithstanding that the Feeder Fund's investment in the Master Fund would not be an investment in an eligible portfolio company and a Feeder Fund would not make significant managerial assistance available to the issuers of securities held by the Master Fund. In addition, the staff granted relief from Section 55(a) of the 1940 Act, which generally prohibits a BDC from acquiring additional assets unless, at the time of acquisition, at least 70% of its total assets are held in "qualifying assets" including eligible portfolio companies.
Because the Feeder Fund will invest only in shares of the Master Fund it may not satisfy the definition of a BDC in Section 2(a)(48). In that case, a Feeder Fund might be in violation of Section 7(a) of the 1940 Act, which generally prohibits an investment company, unless it is registered under Section 8 of the 1940 Act, from offering to sell, selling or delivering after sale any security. Section 8 does not apply to BDCs, and, accordingly, neither the Master Fund nor any Feeder Fund will register under Section 8. Nonetheless, the staff stated that it would not recommend enforcement action against the Feeder Funds under Section 7(a) if the Feeder Fund elect to be regulated as a BDC.
Section 54(a) of the 1940 Act provides that only a company that meets the Section 2(a)(48) definition of a BDC may elect to be treated as a BDC. Since the Feeder Fund will invest only in the shares of the Master Fund it could not elect to be treated as a BDC absent the requested relief. The staff confirmed that it would not recommend enforcement action under Section 54(a) if a Feeder Fund invests only in shares of the Master Fund and thus only indirectly holds interests in the types of securities described in Sections 55(a)(1)–55(a)(3) of the 1940 Act but nevertheless elects to be treated as a BDC.
Since each of the Feeder Funds will have a finite term, the planned liquidation of each Feeder Fund will require the Master Fund to purchase its shares from a liquidating Feeder Fund for cash. In general, such purchase will be made in compliance with Rule 23c-1, except that the Master Fund will comply with the asset coverage requirements applicable to BDCs (i.e., 200%) rather than the asset coverage requirements included in Rule 23c-1 (i.e., 300%). In addition, Rule 23c‑1 requires that the seller of a security may not, to the knowledge of the issuer, be an affiliated person of the issuer. Since each Feeder Fund will be an affiliated person of the Master Fund, the purchase of Master Fund shares from a liquidating Feeder Fund would not be consistent with Rule 23c-1. The staff said that it would not recommend enforcement action under Section 23(c) and Rule 23c-1.
For a more detailed review of the no-action relief, see our recent client alert.
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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