The SEC’s Division of Investment Management has clarified which restrictions apply to BDC’s co-investment transactions with limited partners of a partnership that is an affiliated person of the BDC.
This month, the U.S. Securities and Exchange Commission’s (SEC’s) Division of Investment Management (the Division) issued a Guidance Update on business development companies’ (BDCs’) transactions with certain second-tier affiliates. Specifically, the Guidance Update clarified what restrictions apply to a BDC’s co-investment transactions with limited partners of a partnership that is an affiliated person of the BDC.
The Division explained that the Investment Company Act of 1940 (the 1940 Act) places restrictions on transactions between BDCs and their affiliated persons and affiliated persons of such persons (“second-tier affiliates”). With respect to BDCs, the 1940 Act distinguishes between “close affiliates” and “remote affiliates.” Certain transactions between a close affiliate and a BDC are prohibited. However, some transactions may be permitted between a remote affiliate and a BDC, subject to a required majority approval of the BDC’s directors. A second-tier affiliate may be considered either a “close affiliate” or a “remote affiliate,” depending on various factors.
The Guidance Update addressed whether a limited partner of a private fund that is under common control with a BDC is considered a close affiliate of that BDC and, thus, prohibited from engaging in certain transactions with the BDC under the 1940 Act. The Division noted that if, under similar facts, the private fund were organized as a corporation, the limited partner could be considered a shareholder of the private fund and, therefore, be treated as a remote affiliate of the BDC. Recognizing that the SEC Staff has previously acknowledged that, in many circumstances, limited partners and shareholders should be treated comparably, the Division found that where the limited partner is a close affiliate of the BDC solely because the private fund is organized as a limited partnership and the limited partner is seeking to co-invest with the BDC, the limited partner may be treated as a shareholder of the private fund and, as such, a remote affiliate of the BDC. Accordingly, the limited partner may engage in transactions with the BDC, subject to the approval of a required majority of the BDC’s directors.