SEC Puts In Place New Rules For Business Development Companies

by Glen Shapiro, LawAndTax-News.com, New York

30 October 2006

The US Securities and Exchange Commission last week adopted new rules under the Investment Company Act that more closely align the permissible investment activities of business development companies (BDCs) with the purpose that Congress intended when it established BDCs.

These new rules will facilitate small business capital formation by providing added flexibility for BDCs to invest larger amounts in more types of smaller companies, consistent with the purpose of the Investment Company Act.

In 1980, Congress established BDCs as a new type of closed-end investment company for the purpose of making capital more readily available to small, developing, and financially troubled companies that do not have ready access to the public capital markets or other forms of conventional financing.

To encourage investment in these smaller companies, the Investment Company Act requires BDCs to have at least 70% of their portfolio invested in certain assets, including securities of "eligible portfolio companies," at the time they make any new investments.

The Investment Company Act defines eligible portfolio company to include domestic operating companies that, among other things, do not have any class of securities that are marginable under rules promulgated by the Federal Reserve Board. In 1998, for reasons unrelated to small business capital formation, the Federal Reserve Board expanded its definition of margin security to include all publicly traded equity securities and most debt securities.

These 1998 amendments had the unintended effect of reducing the number of companies that met the definition of eligible portfolio company.

The Commission adopted the new rules under the Investment Company Act to address the impact of the Federal Reserve Board's 1998 amendments on the definition of eligible portfolio company.

• Rule 2a-46 defines an eligible portfolio company to include all private companies and companies whose securities are not listed on a national securities exchange.
• Rule 55a-1 conditionally permits a BDC to include in its 70% basket follow-on investments in a company that met the new definition of eligible portfolio company at the time of the BDC's initial investment in it, but no longer meets that definition.
  These new rules will become effective 30 days after publication in the Federal Register.

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