The SEC staff issued a December 2014 IM Guidance Update (the “BDC Guidance Update”) clarifying the restrictions that apply to co-investment transactions made by Business Development Companies (“BDCs”) with certain second-tier affiliates, specifically, limited partners of a limited partnership that is an affiliated person of the BDC. The staff noted that the 1940 Act distinguishes between prohibited BDC transactions involving “close affiliates” (persons that fall within section 57(b) of the 1940 Act) and BDC transactions involving “remote affiliates” (persons that fall within section 57(e) of the 1940 Act). Transactions with remote affiliates may be permitted under Section 57(f) and, among other things, can be effected with the approval of a majority of the BDC’s disinterested directors. Transactions with close affiliates, on the other hand, generally require SEC exemptive relief unless some other exception applies.
The BDC Guidance Update focuses on the question of whether a limited partner of a BDC-affiliated private fund organized as a limited partnership, which owns more than 5% but less than 25% of the private fund, would be a close affiliate of the BDC. Because a limited partner is a “partner” of the private fund, it is deemed to be a close affiliate of the BDC. However, under the same facts, if the BDC-affiliated private fund were organized as a corporation, the limited partner would be a “shareholder” of the private fund and, as such, would be deemed a “remote” affiliate of the BDC. Presumably, this interpretation also would extend to a limited partner that owns less than 5% of the private fund.
The BDC Guidance Update clarifies the SEC staff’s view that, where a limited partner is a close affiliate of the BDC solely because the private fund seeking to co-invest with the BDC is organized as a limited partnership rather than a corporation, the limited partner may be treated as if it were a shareholder of the private fund for purposes of determining whether it is a close affiliate or a remote affiliate of the BDC.
The BDC Guidance update is analogous to the SEC staff’s position taken with respect to limited partnership interests and registered investment companies that are not BDCs. In First Financial Fund, SEC No-Action Letter (June 5, 1997), the SEC staff stated that it would not recommend enforcement action if certain registered investment companies did not treat a named director of each of the investment companies as an “interested person” under section 2(a)(19) of the 1940 Act, despite the fact that the director owned limited partnership interests in private funds of which the general partner was an affiliated person of the investment companies’ investment adviser. In First Financial Fund, the staff noted the director’s role as a passive investor in the limited partnerships was, and should be treated as, comparable to that of a shareholder owning less than 5% of the outstanding voting securities of a corporation or trust.