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Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Wednesday, May 7, 2008

SEC's Investment Management Proposes Change to BDC Regulations

The SEC's Division of Investment Management has prepared a recommendation for consideration by the Commission to increase the availability of capital to certain smaller companies that do not have ready access to the public capital markets or other forms of conventional financing.  The Division has recommended that the Commission adopt an amendment to a rule that defines the types of companies in which business development companies (BDCs) may invest most of their assets. Congress in 1980 established BDCs, which are publicly traded investment companies, to help make capital more readily available to small developing and financially troubled businesses.  The SEC's release explains that:

The Investment Company Act requires a BDC to have at least 70 percent of its portfolio invested in certain assets, including securities of "eligible portfolio companies," which are often small or developing businesses, at the time it makes any new investments. The proposed amendment would expand the definition of eligible portfolio company to include certain companies that list their securities on a national securities exchange.

The Investment Company Act defines eligible portfolio company to include a domestic operating company that, among other things, does not have any class of securities that are marginable under rules issued by the Federal Reserve Board. In 1998, for reasons unrelated to small business capital formation, the Federal Reserve Board amended its margin rules to include all publicly traded equity securities and most debt securities. These 1998 amendments had the unintended consequence of substantially reducing the number of companies that met the definition of eligible portfolio company.

In 2006, the Commission adopted new rules under the Investment Company Act to address the effect of the Federal Reserve Board's 1998 amendments on the definition of eligible portfolio company. The Commission adopted Rule 2a-46, which defines eligible portfolio company to include all private companies and public companies whose securities are not listed on a national securities exchange. The Commission also adopted a rule that conditionally permits a BDC to include in its 70 percent basket any follow on investments in a company that met the new definition of eligible portfolio company at the time of the BDC's initial investment in it.

When the Commission adopted Rule 2a-46, it also proposed to amend the rule to further expand the definition of eligible portfolio company to include certain smaller companies that list their securities on a national securities exchange. The amendment was designed to facilitate small business capital formation by providing added investment flexibility to BDCs, consistent with the purpose of the Investment Company Act. The Commission sought comment on three alternative ways to amend the rule, and received comments on the proposal.

The Division has submitted a recommendation that the Commission adopt an amendment to Rule 2a-46.

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