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The SEC recently proposed significant reforms to the application of the Securities Act of 1933 (the Securities Act) to eligible closed-end funds (CEFs), eligible business development companies (BDCs), and certain Interval Funds.1 These reforms are intended to reduce regulatory burdens in capital raising by these investment companies and require current disclosure of certain events.

In 2018, Congress passed legislation that directs the SEC to amend its rules to permit CEFs, BDCs, and Interval Funds to use short-form registration statements that are currently in use by public operating companies.2 The SEC also proposed additional disclosure requirements for CEFs and BDCs requiring these funds to provide Interval Funds with more real-time disclosure similar to what is required for public operating companies.3 These proposals are summarized below.

Shelf Registration Reforms

The registration statement rule changes would streamline the registration process to permit eligible CEFs and BDCs to use short-form shelf-registration statements. This would allow these funds to offer and sell securities off the shelf in response to market opportunities. Under current SEC rules, only seasoned operating companies can use a short-form S-3 registration statement. An S-3 shelf permits operating companies to register a dollar amount of their securities and take down different types of securities from time to time. S-3 filers can provide specific disclosures and updates to the securities markets in subsequent Securities Exchange Act of 1934 (Exchange Act) filings, prospectus supplements, or post-effective amendments. This is known as "forward-incorporation by reference." Currently, BDCs, CEFs, and Interval Funds are not allowed to use shelf registrations or rely on forward-incorporation by reference to update the market and disclose certain offering terms by filing documents with the SEC as opposed to delivery to investors. The SEC has proposed permitting eligible BDCs and CEFs to file a short-form registration statement on Form N-2 to function as a Form S-3 shelf registration for a seasoned operating company.

To be eligible to use a short-form registration, listed BDCs and CEFs would have to be registered under the Investment Company Act for 12 months, have timely filed all required reports, and have a public float of at least $75 million.4 Interval Funds would not be able to rely on this reform. Interval Funds currently have a mechanism to flexibly offer securities.5 Eligible CEFs and BDCs would be required to specifically incorporate by reference into the prospectus and statement of additional information (SAI) financial statements on Form N-CSR or Form 10-K, as well as all other Exchange Act reports since the end of the fiscal year prior to the filing.

The SEC also proposed to permit large BDCs and CEFs to qualify as "well-known seasoned issuers" (WKSIs). A WKSI's registration statement becomes effective automatically at the time of filing without the issuer having to request effectiveness from the SEC. The proposed offering reforms permit BDCs and CEFs to qualify as WKSIs if they meet a $700 million public float requirement and they have made all timely required SEC filings in the preceding 12 months under the Exchange Act, Securities Act, and Investment Company Act.

Prospectus Delivery Reforms

To create further conformity with operating company requirements, the SEC also proposed to amend the prospectus delivery rules to permit eligible CEFs, BDCs, and Interval Funds to use a relaxed prospectus delivery requirement under rules 172 and 173 of the Securities Act. Section 5 of the Securities Act generally requires that a final prospectus be physically delivered to investors at the time of sale. Securities Act rules 172 and 173 allow operating companies, brokers, and dealers to satisfy the physical prospectus delivery obligation by filing a final prospectus with the Commission as long as certain conditions are satisfied. The SEC has proposed to permit CEFs, BDCs, and Interval Funds to use the same rules and permit these funds to file a final prospectus with the Commission instead of physically delivering a final prospectus.

Offering Communication Reforms

Under offering reforms adopted in 2007 for operating companies, seasoned issuers in registration are permitted under rules 134 and 163A of the Securities Act to communicate relatively freely about an issuer's operations without fear of liability for "gun-jumping" or conditioning the market by "hyping" or promoting a securities offering. Operating company issuers are also permitted to issue "tombstone" ads about an offering. When these rules were reformed in 2007 to allow for more communication, investment companies were excluded. The SEC proposes to amend these rules to include CEFs, BDCs, and Interval Funds.

Broker-Dealer Research Reports on CEFS and BDCs

Securities Act rules 138 and 139 permit broker-dealers that participate in an underwriting of an operating company's common stock to publish or distribute research reports on that issuer's fixed income securities. Alternatively, if a broker-dealer is underwriting fixed income securities for an issuer, the broker-dealer can publish research on that issuer's common stock. Rules 138 and 139 currently exclude investment companies. The SEC has proposed to allow broker-dealers to publish research in the same manner for CEFs, BDCs, and Interval Funds. 

Registration Statement Fee Payment Reform for Interval Funds

Currently, mutual funds and exchange-traded funds (ETFs) pay SEC registration fees annually on a net basis. Because these funds offer an indeterminate amount of securities and continuously offer and redeem shares, these funds are permitted to pay Securities Act registration fees on a net issuance basis. This means that mutual funds and ETFs can subtract the shares redeemed from shares issued to calculate fees owed. Interval Funds are currently not permitted to pay registration fees this way. The SEC has proposed to amend rules 23c-3 and 24f-2 of the Investment Company Act to permit Interval Funds to pay fees on a net issuance basis.

Inline XBRL for Financial Statements and Notes

Since 2009, operating companies have been required to submit and tag financial data from financial statements in a structured, machine-readable computer format called XBRL (eXtensible Business Reporting Language). XBRL allows institutional investors and research analysts to easily compare financial data. XBRL filing is also required for most registered investment companies but not for BDCs. The SEC has proposed that XBRL filing requirements apply to BDCs, including tagging and disclosure on the Form N-2 cover page. 

Management Discussion of Fund Performance by CEFs

Currently, mutual funds and ETFs must include an annual narrative disclosure of fund performance known as Management's Discussion of Fund Performance (MDFP).6 These funds are required to describe the factors that materially affected the fund's performance during the most recent fiscal year, including a discussion of market conditions and investment strategies and techniques. This disclosure is based upon the disclosure obligation of public operating companies under Item 303 of Regulation S-K, Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A). Currently, BDCs are required to include MD&A disclosure, but CEFs are not required to include MD&A or MDFP disclosure. The SEC has proposed to amend Form N-2 to require CEFs to include MDFP disclosure.

Form 8-K Reporting for CEFs and Other Form 8-K Amendments for BDCs 

Public operating companies and BDCs must report on specified Form 8-K material events generally within four business days of occurrence to provide the market with timely information about certain material events. Form 8-K disclosure is not currently required for CEFs. Publicly traded CEFS generally provide real-time disclosure through press releases. The SEC proposes to provide parity for CEFS, BDCs, and operating companies by requiring registered CEFs to comply with Form 8-K. The SEC also proposes to amend the application of Form 8-K to include a new Section 10 applicable to BDCs and CEFs that would require 8-K disclosure of a material change in a CEF or BDC fund's investment objectives or policies or a material write-down in the fair value of a significant investment.

Timeline for New Rules

The SEC comment period on the proposed rules recently closed, and we expect the rules to become final soon.

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[1] An Interval Fund is a closed-end fund that makes periodic repurchase offers under Rule 23c-3 of the Investment Company Act of 1940.
[2] The Small Business Credit Availability Act directs the SEC to permit BDCs to use relaxed securities offering rules that are currently available to publicly reporting operating companies. The Economic Growth, Regulatory Relief and Consumer Protection Act directs the SEC to provide similar relief to CEFs and Interval Funds.
[3] The rulemaking proposal can be found at: https://www.sec.gov/rules/proposed/2019/33-10619.pdf.
[4] Public float generally means the market value of outstanding voting and non-voting common equity held by non-affiliates.
[5] Interval Funds can currently rely on Securities Act rule 415(a)(1)(xi) in combination with Rule 486(b) that permit these funds to have post-effective amendments and offerings automatically effective. 
[6] Item 27(b)(7) of Form N-1A.

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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

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