The U.S. Securities and Exchange Commission (SEC) Division of Investment Management recently issued a notice with regard to the application for co-investment relief filed by Apollo Investment Corporation and certain of its affiliates. Apollo’s application has been pending for more than six years, and if the order is granted, it would be the first to fundamentally expand on the “standard” co-investment relief typically granted by the SEC to business development companies (BDCs), registered investment companies and their affiliates. However, there is some question on whether similar relief will be available to other investment companies that have already received co-investment relief or those that might seek co-investment relief in the future. Over the past 25 years, the SEC has issued more than three dozen orders permitting BDCs and registered investment companies (together, Regulated Funds) to co-invest in negotiated transactions with their affiliates. Under those orders, the covered co-investing entities must adhere to certain conditions, which have changed little over the past two and a half decades and remain the cornerstone of co-investment relief for Regulated Funds. Thus, the same 13 (and more recently, 14) conditions appear in each of the standard applications (the Standard Conditions) for which an order was granted by the SEC and detail the co-investment process under the order.
Apollo first filed its application for co-investment relief in 2010. From the outset, it attempted to expand on the Standard Conditions in two basic ways: (1) to address problems that large platforms, like its own, face in complying with the Standard Conditions, and (2) to have the relief cover a broader array of transactions. As discussed in more detail below, the order would extend the previously granted relief so that, among other things: (1) the board of directors (board) of a Regulated Fund may establish criteria to limit the universe of co-investment opportunities that must be shared with the Regulated Fund; (2) certain transactions that previously could not be completed in reliance on the order may be completed in reliance on the order through an “onboarding process”; (3) additional types of co-investment transactions may be completed without board approval; and (4) there is an exception to the “same time” requirement for delayed settlement dates.
1. Board-Established Criteria. Large platforms, like the Apollo platform, may have difficulty meeting the fundamental Standard Condition that a Regulated Fund must be advised of, and be given the opportunity to, participate in any co-investment transaction that falls within its investment objectives and strategies. The breadth of these platforms necessarily means that numerous investment opportunities arise through multiple channels daily. As a result, it is a challenge to ensure that portfolio managers for any Regulated Fund on the platform will “see” every opportunity that falls within the Regulated Fund’s investment objectives and strategies. The solution wrought in the Apollo application was the establishment of “Board-Established Criteria.” This means that the board of a Regulated Fund may establish criteria from time to time to describe the characteristics of potential co-investment transactions of which the adviser to the Regulated Fund should be notified in order to comply with the condition, effectively narrowing the universe of potential co-investment transactions required to be presented to a Regulated Fund’s adviser to those transactions more closely aligned with the Regulated Fund’s focus at that time. The Board-Established Criteria would be consistent with the Regulated Fund’s objectives and strategies. If no Board-Established Criteria were in effect, then the Regulated Fund’s adviser would be notified of all potential co-investment transactions that fall within the Regulated Fund’s then-current objectives and strategies. Board-Established Criteria must be objective and testable, meaning that they will be based on observable information, such as the industry/sector of the issuer, the minimum EBITDA of the issuer, the asset class of the investment opportunity or required commitment size, and not on characteristics that involve a discretionary assessment. The adviser to the Regulated Fund may from time to time recommend criteria for the board’s consideration, but Board-Established Criteria would only become effective if approved by a majority of the independent directors of the board.
2. Certain transactions that previously could not be completed in reliance on the order may be completed in reliance on the order through an “onboarding process.” The Apollo application adds additional requirements that, when complied with, would allow a Regulated Fund to rely on the order to complete a negotiated transaction following certain non-negotiated transactions. The Apollo application introduces a concept referred to as an “onboarding process,” through which investments that were not made in reliance on the co-investment order can nonetheless become subject to certain beneficial terms of the order. Pursuant to the Standard Conditions, follow-on investments in, and dispositions of, negotiated investments were only permitted if the securities at issue were acquired in a co-investment transaction that was completed in reliance on the order. For example, if a BDC and an affiliate obtained securities in the same issuer through transactions that were separate in time and not “joint” (and thus, the securities were obtained without reliance on a co-investment order), but negotiation is later required to complete a follow-on investment in, or disposition of, such securities, that transaction previously would not be permitted under the order, and the Regulated Fund and its affiliate would not be able to negotiate the new transaction. However, under the Apollo application, negotiation of the new transaction would be permitted under the order if the requirements were met to “onboard” the investment.
3. Additional types of co-investment transactions may be completed without board approval. Currently, pursuant to the Standard Conditions, all co-investment transactions must be approved by the board, except that pro rata follow-on investments and pro rata dispositions may be completed without board approval if the board has previously approved such practice. The Apollo application adds that no board approval would be required for a disposition if the securities became “tradable” (as defined in the application) and certain other requirements were met, or for a follow-on investment if there were no negotiation involved.
4. Exception to “same time” requirement. The Standard Conditions require that co-investments under an order be made at the same time. The Apollo application added a “Delayed Settlement” concept that permits a Regulated Fund or its affiliate to close on the co-investment transaction up to 10 business days later as long as the commitment date was the same.
While the Apollo application would expand the universe of permitted co-investment transactions, we are holding our applause until others who are not yet in the pipeline for similar relief are given positive feedback that such relief will be made available to them. We believe that the SEC staff may take a wait-and-see approach to granting similar relief to others until they have time to assess the long-term implications of the relief.