On April 8, 2020, the Securities and Exchange Commission (SEC), adopted amendments that would allow business development companies (BDCs) and registered closed-end funds (CEFs), to use the securities offering rules that are available to public reporting companies. In this alert, we refer to all BDCs and CEFs as “Affected Funds.” The amendments implement a number of Congressionally-mandated reforms that will, among other things:
- streamline the registration process to allow “seasoned” Affected Funds, (e.g., exchange-listed Affected Funds, current in their reporting with a “public float” of at least $75 million) to use short-form registration statements on Form N-2 to sell securities “off the shelf” to enable these eligible funds to respond more quickly and efficiently to market opportunities,
- allow seasoned Affected Funds to qualify as “well-known seasoned issuers” or WKSIs under rule 405 of the Securities Act of 1933 (the “Securities Act”),
- allow Affected Funds to satisfy prospectus delivery requirements using the same method as public reporting companies,
- allow Affected Funds to use certain rules available to pubic reporting companies, such as communications safe harbors for factual business information and forward-looking information, “free writing” prospectus and broker-dealer research reports,
- allow Affected Funds that continuously-offer shares to make certain changes to their registration statements on an immediately-effective basis or an automatically effective basis a set time after the filing,
- harmonize the disclosure and regulatory framework applicable to Affected Funds in light of the changes to the offering rules that apply to them, including requirements around structured data to make it easier for investors and others to analyze fund data, new annual report disclosure providing key information in annual reports, a requirement that interval funds pay SEC registration fees using the same method that mutual funds and exchange-traded funds (ETFs) currently use and a provision that will permit certain non-investment company exchange-traded products (ETPs) to elect to pay SEC registration fees in the same manner as interval funds, and
- the proposal to require a Form 8-K filing for registered CEFs was dropped from the Final Release, although these funds may voluntarily file information on Form 8-K to forward incorporate the information into its registration statement or for other purposes (e.g., to publicly disseminate information under exchange rules, as applicable).
The amendments will affect different categories of Affected Funds differently. Some amendments will apply to all Affected Funds (i.e. all BDCs and registered closed-end funds) but some will only apply to subcategories of Affected Funds. Many of the amendments apply to “seasoned” Affected Funds, that is, listed Affected Funds, current in their reporting, who qualify for a short-form registration statement under the amendments and have a “public float” of at least $75 million. Some of the provisions only will apply to seasoned Affected Funds that also qualify as WKSIs, that is, a seasoned Affected Fund that has a public float of $700 million. Regarding unlisted Affected Funds, the final rules provide them with certain benefits provided to their listed counterparts, including certain communication benefits and disclosure benefits as well as the flexibility to make certain filings that become effective either immediately upon filing or automatically after 60 days.
These amendments will be welcome to many and generally are consistent with the Congressional mandates that directed them. Most of the amendments were adopted as proposed. In a departure from the proposal, many of the amendments have been extended to unlisted funds, specifically unlisted CEFs that did not operate as interval Funds. Overall, the amendments will make the registration process more efficient and streamlined for all Affected Funds. Now, Affected Funds will more efficiently be able to access capital markets, in order to take advantage of favorable market conditions. Given that the amendments will impact Affected Funds differently, it is important to carefully review the Final Rules to ensure compliance with the amendments. With that in mind, we summarize the amendments in greater detail below and include a chart in Exhibit 1 that summarizes the new rules and how the new rules apply to each Affected Fund.
In 2005, the SEC overhauled the securities offering and communication process for public reporting companies that are operating companies but specifically excluded all investment companies, including all categories of Affected Funds from the scope of these reforms. Since then, two Congressional mandates have required the SEC to expand its modernization process to include Affected Funds. The Small Business Credit Availability Act (which the SEC calls the BDC Act), enacted in March 2018, allowed BDCs to utilize securities offering and proxy rules that are available to non-investment company issuers that are required to file reports under Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”). The Economic Growth, Regulatory Relief, and Consumer Protection Act (which the SEC calls the “Registered CEF Act”), enacted in May 2018, applied this same principle to any registered CEF that is either exchange-listed or that makes periodic repurchase offers pursuant to Rule 23c-3 under the 1940 Act (Rule 23c-3 being the “interval fund rule”).
In April 2019, the SEC issued proposed amendments to address both mandates in a similar manner, notwithstanding some differences between the two statutes. Commenters generally welcomed the proposed amendments, which have largely been adopted as proposed, with some exceptions noted below. The SEC also intends to apply many of the amendments to registered CEFs generally and not just to listed CEFs and interval funds. Most of the amendments will become effective on August 1, 2020, while the amendments related to registration fee payments by interval funds and certain exchange-traded products will become effective on August 1, 2021.
Shelf Offering Process and New Short-Form Registration Statement for Seasoned Affected Funds:
Amendments to the Registration Process for Affected Funds. The amendments permit seasoned Affected Funds to file a short-form registration statement on Form N-2 that would operate like a shelf registration statement on Form S-3, which would allow these Affected Funds to be able to register a future sale of securities permitting Affected Funds to sell securities “off the shelf” as market opportunities arise.
Eligibility to File a Short-Form Registration Statement. An Affected Fund is seasoned for this purpose, and eligible to file a short-form registration statement only if it satisfies the following requirements for use of Form S-3:
- Registrant Requirements. Affected Fund has timely filed all reports and other materials required under the Exchange Act during the prior year.
- Transaction Requirements. Affected Fund has a public float of $75 million or more. As certain Affected Funds, including most interval funds and tender offer funds, do not list their securities and do not have a public float, these funds would not satisfy the transaction requirements necessary to file a short-form registration statement on Form N-2.
Also, in the case of an Affected Fund that is a registered CEF (as opposed to a BDC), eligibility requires that the fund (i) has been registered under the Investment Company Act of 1940 for at least the twelve months immediately preceding the filing of the registration statement and (ii) has timely filed all reports required under Section 30 of the Investment Company Act during that period.
Information Incorporated by Reference. The amendments also apply the incorporation by reference rules under Form S-3 to the short-form statement filed on Form N-2. An Affected Fund will be required to:
- Specifically, incorporate by reference into its prospectus and statement of additional information (SAI) (i) its most recent annual report filed pursuant to the Exchange Act Section 13(a) or Section 15(d) containing financial statements for the Affected Fund’s latest fiscal year for which either a Form N-CSR or Form 10-K was required to be filed and (ii) all other reports filed pursuant to these sections of the Exchange Act following the end of the fiscal year covered by the annual report (this is sometimes described as “backward incorporation by reference”); and
- State in its prospectus and SAI that all documents subsequently filed pursuant to Exchange Act Sections 13(a), 13(c), 14 or 15(d) before the termination of the offering are deemed incorporated by reference into the prospectus and SAI (this is sometimes described as “forward incorporation by reference”).
These amendments will permit these Affected Funds to satisfy disclosure requirements of its prospectus and SAI by either providing the required disclosure directly in the prospectus or SAI or satisfy the Form N-2 disclosure requirement using incorporation by reference. Accordingly, the SEC is amending an existing Form N-2 undertaking relating to post-effective amendments to provide that the requirement to undertake to file a post-effective amendment does not apply if the registration statement is filed under the short-form registration instruction and the information required to be included in a post-effective amendment is contained in Exchange Act reports that are incorporated by reference into the fund’s registration statement or is contained in a form of prospectus that is part of the registration statement.
Regarding incorporation by reference in general, among other changes, the SEC also amended Form N-14 to provide BDCs with the same ability to incorporate into Form N-14 filings as CEFs.
Omitting Information from a Base Prospectus and Prospectus Supplements. The amended rules provide that Affected Funds will file their prospectuses under Rule 424(b) instead of Rule 497. Rule 424 provides additional time for an issuer to file a prospectus supplement and requires an issuer to file a prospectus supplement only if the issuer makes substantive changes from, or additions to, a previously filed prospectus. Rule 497 required funds to file every prospectus that varies from a previously filed prospectus. To avoid confusion as to which rule to file under, the SEC amended Rule 497 to provide that Rule 424 would be the exclusive rule for Affected Funds to file a prospectus or prospectus supplement other than an advertisement that is deemed to be a prospectus under Rule 482 of the Securities Act.
Reliance on Rule 430B of the Securities Act. The amendments enable certain Affected Funds to rely on Rule 430B. Rule 430B enables WKSIs and certain issuers eligible to use Form S-3 to omit specified information from their base prospectuses that is unknown or not reasonably available to the Affected Fund at the time the registration statement becomes effective. The Affected Fund can later provide such information in a subsequent Exchange Act report incorporated by reference, a prospectus supplement, or a post-effective amendment. Under the amendments, seasoned funds are permitted to use Rule 430B in parity with operating companies. By relying on Rule 430B, seasoned Affected Funds that qualify as WKSIs are permitted to omit the plan of distribution and information regarding whether the offering is a primary one or an offering on behalf of selling security holders from its registration statement. Additionally, seasoned Affected Funds are permitted to omit the identities of selling security holders and the number of securities to be registered on their behalf from the registration statement, subject to certain conditions.
Additional Information in Periodic Reports. As discussed above, the amendments permit certain Affected Funds to forward incorporate information from their Exchange Act reports. This would allow an Affected Fund to update its registration statement by including information in a periodic report that may not be required to be included in such a periodic report. The proposed amendment would have only permitted this “forward incorporation” if it included a statement in the periodic report identifying information that is included for this purpose to provide context for investors, but the final rules did not include this requirement.
Ability to Qualify for Well-Known Seasoned Issuer (WKSI) Status:
The amendments permit an Affected Fund to qualify as a Well-Known Seasoned Issuer or a WKSI, providing flexibility to issuers regarding communications and registration. A WKSI can register an unspecified amount of different types of securities on a shelf registration statement that becomes effective automatically. An “automatic shelf registration statement” means that the registration statement is not subject to SEC staff review before becoming effective and is available immediately upon filing. The streamlined registration process provides qualifying Affected Funds with the ability to “pre-register” the sales of a range of securities without SEC staff review and comment, providing important flexibility to time securities offerings with market conditions. Furthermore, subject to certain conditions, a WKSI that has filed a registration statement is permitted to make offers and communicate with investors at any time, including through a free writing prospectus, without violating the “gun-jumping” provisions of the Securities Act. This amends Securities Act Rule 405 to include Affected Funds in the WKSI definition as long as the Affected Fund:
- Is able to file a short-form registration statement;
- Has at least $700 million in public float; and
- Is an eligible issuer (the Affected Fund would be an “ineligible issuer” if, for example: (1) the Affected Fund is not current in its Exchange Act reports or (2) the Affected Fund’s investment adviser or sub-adviser was in the past three years subject to any judicial or administrative decree or order arising out of a governmental action that determines that the investment adviser aided, abetted or caused the issuer to have violated the anti-fraud provisions of the federal securities laws).
Immediate or Automatic Effectiveness for Certain Filings, Including for Unlisted Affected Funds:
The amendments expand the scope of rule 486 under the Securities Act. Rule 486 currently applies to certain closed-end investment companies known as interval funds. The amendments will expand Rule 486(b) to apply to certain registered closed-end funds and BDCs that conduct continuous offerings of securities and allow these funds to make certain changes to their registration statements on an immediately-effective basis pursuant to 486(b) or automatically effective basis pursuant to 486(a), depending on the substance of the disclosure. The amendments will enable certain unlisted Affected Funds, such as tender-offer funds, to raise capital without delay by permitting them to more efficiently maintain effective registration statements while they engage in a continuous offering.
Prospectus Delivery Reforms and Communications:
Prospectus Delivery Requirements. The amendments will expand the types of issuers that can rely on rules 172 and 173 to meet prospectus delivery requirements to Affected Funds. Currently, these rules do not apply to Affected Funds. Rule 172 allows certain issuers, brokers and dealers to satisfy final prospectus delivery obligations if a final prospectus is or will be on file with the SEC within the time required by the rules and other conditions are satisfied. Rule 172 provides that a final prospectus will be deemed to precede or accompany a security for sale for purposes of Section 5(b)(2) of the Securities Act as long as the final prospectus is filed with the Commission or it will be filed as part of the registration statement Rule 172 applies only to final prospectuses and not to other documents. Rule 173 requires the delivery of a copy of the final prospectus or, in lieu of a final prospectus, a notice to purchasers stating that a sale of securities was made pursuant to a registration statement or in a transaction in which a final prospectus would have been required to have been delivered in the absence of rule 172.
Offering Communications. Previously, Affected Funds operated under a separate framework that limited offering communications until after a registration statement became effective. These “gun-jumping” provisions of the Securities Act provide that unless otherwise permitted:
- Before an issuer files a registration statement, all offers are prohibited;
- After the issuer files a registration statement but before it has become effective, the only written offers that are permitted are those made using a preliminary prospectus that meets the requirements of section 10 of the Securities Act, which must be filed with the Commission; and
- Even after the registration statement is declared effective, offering participants still may make written offers only through a statutory prospectus, except that they may use additional written offering materials if a final prospectus that meets the requirements of Securities Act section 10(a) is sent or given prior to or with those materials.
The SEC has previously adopted rules allowing operating companies and underwriters increased flexibility in offering communications without violating the “gun-jumping” provisions. The amendments aim to change various Securities Act rules so that Affected Funds may utilize the same flexibility available to operating companies and underwriters when it comes to offering communications. Specifically, the amendments will:
- Permit Affected Funds to use rule 134, which allows issuers to publish factual information about the issuer or the offering, including “tombstone ads.”
- Permit Affected Funds to rely on rule 163A, which provides issuers a bright-line period, ending 30 days prior to filing a registration statement, during which they may communicate without risk of violating the gun-jumping provisions.
- Permit Affected Funds that are reporting companies to rely on rule 168, which allows reporting issuers to publish or disseminate regularly released factual business information and forward-looking information at any time, including around the time of a registered offering. Affected Funds will also be able to rely on rule 169, which permits continued publication or dissemination of regularly released factual business information that is intended for use by persons other than in their capacity as investors or potential investors.
- Permit Affected Funds to rely on rules 164 and 433, which allow issuers to use a “free writing prospectus” in order to offer to sell or purchase securities that are or will be registered.
- Permit Affected Funds that are WKSIs to engage at any time in oral and written communications, including use at any time of a free writing prospectus (before or after a registration statement is filed), subject to the same conditions applicable to other WKSIs.
Currently, Affected Funds are subject to rule 482 of the Securities Act, which requires that investment company communications may only be used by a fund that is proposing to sell securities after the fund has filed a registration statement. In addition, rule 482 communications are prospectuses subject to prospectus liability under section 12 of the Securities Act. While rule 482 ads will continue to be available to Affected Funds, the amendments will provide additional flexibility to communicate before the registration statement is filed, and additional flexibility in using communications that are not subject to prospectus liability under section 12.
Broker-Dealer Research Reports. The amendments will expand rule 138 of the Securities Act to included Affected Funds. Rule 138 permits a broker-dealer participating in the registered offering of an eligible issuer’s common stock and similar securities to publish or distribute research reports about that issuer’s fixed income securities, and vice versa if it publishes or distributes that research in the regular course of its business.
Currently rule 138 does not exclude Affected Funds from coverage. However, it only includes references to shelf registration requirements filed under Form S-3, and not Form N-2. The amendments would include a parallel reference to Form N-2 under the short-form registration instruction. Rule 138 provides that if a research report covering an issuer is published in reliance on the rule, the issuer must file reports, and must have filed all periodic reports required during the preceding twelve months (or such shorter time that the issuer was required to file such reports), on Forms 10-K and 10-Q. Because Affected Funds do not file 10-Ks and 10-Qs, the amendments will include parallel references to reports that registered CEFs file, i.e., reports on Forms N-CSR, N-Q, N-CEN, and N-PORT.
Other Rule Amendments:
Rule 418 Supplemental Information. Affected funds that are eligible to file a short-form registration on Form N-2 will be exempt under amended rule 418(a)(3) from having to furnish recent engineering, management or similar reports or memoranda relating to broad aspects of the business, operations or products of the registrant to the SEC on request. Currently, operating companies that are eligible to file a short-form registration statement on Form S-3 are exempt from having to furnish certain supplemental information on request.
Amendments to Incorporation by Reference into Proxy Statements. Affected funds that are eligible to file a short-form registration on Form N-2 will be permitted to incorporate by reference certain required information for relevant proxy proposals to the same extent that operating companies meeting the requirements of Form S-3 (as defined in Note E to Schedule 14A) may use incorporation by reference under the same circumstances.
Rule 103 of Regulation FD. The amendments provide that an Affected Fund’s failure to make a public disclosure required solely by rule 100 of Regulation FD will not affect the fund’s eligibility under Form N-2’s short-form registration instruction. Rule 100 of Regulation FD generally requires an issuer to make either simultaneous or prompt public disclosure of any material nonpublic information regarding the issuer or its securities in the event of a non-intentional selective disclosure.
New Method for Interval Funds to Pay Registration Fees:
Currently, CEFs and BDCs register a specific amount of shares and pay registration fees at the time when the registration statement is filed. The amendments will allow CEFs that operate as “interval funds” to register an unlimited amount of shares and pay fees based on net sales of those shares. That is, when calculating registration fees, interval funds can offset sales with redemptions. This fee calculation method is similar to that used by mutual funds and exchange-traded funds, as provided under rule 24f-2.
The amendments will also permit continuously offered exchanged-traded products (as defined under amended rule 405) that are not registered under the Investment Company Act to use a similar process under the new Securities Act rule 456(d).
Disclosure and Reporting Parity:
Structured Data Requirements. Currently, under Item 601 of Regulation S-K, operating companies are required to provide financial statement information in eXtensible Business Reporting Language (XBRL) as supplemental data file exhibits to registration statements. Under the amendment to Item 601, BDCs also would use XBRL tagging and would no longer be exempt from this requirement.
Under amended rule 405 of Regulation S-T and General Instruction of I.1 of Form N-2, Affected Funds will be required to tag all of the data points that appear on the cover page of Form N-2, except the Calculation of Registration Fee table, using Inline XBRL format. Examples of such information include the company name, the Act or Acts to which the registration statement relates and checkboxes relating to the effectiveness of the registration statement. In addition, the amendments will add new checkboxes to the cover page of Form N-2 to more readily identify types of issuers and securities.
Under amended Rule 405 of Regulation S-T, and General Instruction of H.2 of Form N-2, Affected Funds also would be required to tag the following items using Inline XBRL format: Fee Table, Senior Securities Table, Investment Objectives and Policies, Risk Factors, Share Price Data and Capital Stock, Long-Term Debt and Other Securities.
Under the Inline XBRL regime, Affected Funds will be required to submit “Interactive Data Files” (i.e., machine-readable computer code that presents information in XBRL format) for any registration statements and post-effective amendments, any prospectus filed pursuant to rule 424, and any Exchange Act report that a seasoned fund filing a short-form registration statement on Form N-2 is required to tag using Inline XBRL format.
The amendments will require submission of filings by mutual funds, ETFs and interval funds on Form 24F-2 in a structured XML format.
Periodic Reporting Requirements. Since the amendments are creating a new format for short-form registration statements, certain key information must be disclosed in annual reports (including fee and expense tables, share price data and senior securities tables).
Affected Funds will be required to provide a management discussion of fund performance (MDFP) on Form N-2 , a requirement that currently applies only to mutual funds, exchange-traded funds and BDCs. Specifically, registered CEFs will need to disclose:
- The factors that materially affected performance during the most recent fiscal year, including relevant market conditions and investment strategies used by the fund;
- A line graph comparing the initial and subsequent account values end of each of the most recently completed ten fiscal years of the fund and a table of the fund’s total returns for the 1-, 5- and 10-year periods as of the last day of the fund’s most recent fiscal year; and
- The effect of any policy or practice of maintaining a specified level of distributions to shareholders on the fund’s investment strategies and per share NAV during the last fiscal year, as well as the extent to which the registrant’s distribution policy resulted in distributions of capital.
Currently, BDCs, unlike other Affected Funds, are required only to include full financial statements in their prospectus. Amended Form N-2 will require BDCs to include financial highlights disclosure summarizing financial statements in the registration statement and annual report.
Current Reporting Requirements. Currently, only operating companies and BDCs are required to promptly report certain events on Form 8-K. Based on comments to the proposal, the amendments will not adapt the current Form 8-K to include registered CEFs. The proposed amendments would have required registered CEFs to report current information on Form 8-K, in order to create parity with BDCs and operating companies. Commenters suggested that registered CEFs should not be subject to Form 8-K reporting requirements because: (i) existing registered CEF disclosure is sufficient; (ii) Form 8-K reporting would be costly for CEFs; (iii) parity with operating companies and BDCs is unnecessary in the context of Form 8-K reporting and (iv) investors, analysts and regulators have not previously indicated that registered CEF disclosure is inadequate. While registered CEFs will not be required to report on Form 8-K, eligible registered CEFs may voluntarily file in order to forward incorporate that information into their registration statements or for other purposes, such as to publicly disseminate information under exchange rules, as applicable. Similarly, the SEC will not adopt other proposed amendments to Form 8-K, such as proposed reporting items regarding material changes to investment objectives or policies and material write-downs.
Online Availability of Information Incorporated by Reference. Currently, Form N-2 requires new funds to provide a copy of all previously-filed materials that the funds incorporated by reference into the prospectus or SAI to all new purchasers. However, registered CEFs and BDCs currently can backward incorporate financial information from previously-filed Exchange Act reports into their prospectuses or SAIs. The amendments will remove the requirement for Affected Funds to deliver to new investors such information that it has incorporated by reference. The amendments will allow Affected Funds to make prospectuses, SAIs and incorporated materials available on a website identified in those documents.
Amendments to Certain Registered CEFs’ Annual Report Disclosure. Rule 8b-16(b) generally requires registered investment companies, except registered CEFs, to provide certain information in an annual update to their registration statements: (1) information about the fund’s dividend reinvestment plan; (2) material changes in the fund’s investment objectives or policies that have not been approved by shareholders; (3) any change concerning the fund’s control provisions that has not been approved by shareholders; (4) material changes in the principal risk factors associated with an investment in the fund and (5) any portfolio manager changes.
The amendment to rule 8b-16(b) will require that Affected Funds relying on rule 8b-16(b) describe any changes in enough detail to allow investors to understand each change and how it may affect the fund. The following example is provided in the release to the extent that a fund’s principal investment objectives, investment policies or principal risks have changed, the fund should describe its objectives, policies or risks before and after the change. Such disclosures must be prefaced with a legend clarifying that the disclosures only provide a summary of certain changes that have occurred over the last year, which may not reflect all of the changes that have occurred since the investor purchased the fund.
In addition, the amendments to rule 8b-16(b) will require Affected Funds relying on the rule to describe current investment objectives, investment policies and principal risks in their annual reports. The release notes that funds can increase the effectiveness of this disclosure by presenting the information concisely and in “plain English” with regard to organization, wording and design. The release also encourages funds to tailor disclosures to how they individually operate, as opposed to relying on generic disclosures on funds’ investment policies and risks and encourages that risks be listed in descending order of importance (i.e., the most significant risk appears first).
Effective and Compliance Dates:
The final rule will become effective on August 1, 2020, and will apply to all aspects of the final rule, except for the following:
- Rules 23c-3, 24f-2 and Form 24F-2. The amendments to rules 23c-3, 24f-2 and Form 24F-2346 will become effective August 1, 2021 (one year after other aspects of the final rule take effect).
- Rules 456 and 457 and Forms S-1, S-3, F-1 and F-3: The amendments to rules 456 and 457 and Forms S-1, S-3, F-1 and F-3 under the Securities Act will become effective August 1, 2021.
In addition, the SEC noted the following compliance dates in order to provide a sufficient transition period:
- August 1, 2021: Registered CEFs will be required to include a management discussion of fund performance in their annual reports to shareholders.
- February 1, 2022: Form 24F-2 filers (including existing filers) will be required to file reports on Form 24F-2 in XML.Inline XBRL structured data reporting requirements for financial statements, registration statement information and prospectus information have the following compliance dates:
- August 1, 2022, for Affected Funds that are eligible to file a short-form registration statement; and
- February 1, 2023, for all other Affected Funds subject to the structured data reporting requirements.