SEC Adopts Securities Offering Reform for Closed-End Investment Companies

Ethan CoreyLegal Insights

SEC Building

 

Introduction and Overview

 

On April 8, 2020, the Securities and Exchange Commission (SEC) adopted Rules to modify the registration, communications and offering processes for business development companies (BDCs) and other closed-end investment companies (CEFs) under the Securities Act of 1933 (Securities Act).1  

  • One set of Rules responds to a Congressional directive and enables BDCs and CEFs to use the securities offering rules that are already available to operating companies.  This set of Rules includes those expanding the definition of “well-known seasoned issuer” (WKSI) to allow BDCs and CEFs to qualify; streamlining the registration process for these BDCs and CEFs, including the process for shelf registration; permitting these BDCs and CEFs to satisfy their final prospectus delivery requirements by filing the prospectus with the SEC rather than sending them to each purchaser of their securities; and permitting additional communications by and about these BDCs and CEFs during a registered public offering. 
  • Another set of Rule and form amendments are intended to tailor the disclosure and regulatory framework to these BDCs and CEFs. 
  • A third set of amendments will conform the method used by closed-end investment companies that operate as ‘‘interval funds’’ to pay securities registration fees with the method currently used by mutual funds and exchange-traded funds and extend the ability to use this payment method to issuers of certain continuously offered, exchange-traded products (ETPs). 
  • A fourth set of amendments expands the ability of certain registered CEFs or BDCs that conduct continuous offerings to make changes to their registration statements on an immediately effective basis or on an automatically effective basis a set period of time after filing. 
  • The final set of amendments adopts certain structured data reporting requirements, including for filings on the form providing annual notice of securities sold under Investment Company Act of 1940 (1940 Act) rules that prescribe the method by which certain investment companies (including mutual funds) calculate and pay registration fees.

Summary of Changes

The tables below summarize the amendments and the entities affected by the Rule and form amendments.2

Table 1
Entity Summary definition
Affected funds “Affected Funds” include all BDCs and registered CEFs, including interval funds.
Seasoned funds1 “Seasoned Funds” are Affected Funds that are current and timely in their reporting and therefore generally eligible to file a short-form registration statement if they have at least $75 million in “public float.”
WKSIs WKSIs are Seasoned Funds that generally have at least $700 million in “public float.”
ETPs “ETPs” are issuers that are not registered investment companies and whose assets consist primarily of commodities, currencies or derivative instruments that reference commodities or currencies; whose securities are listed for trading on a national securities exchange; and that purchase or redeem securities for a ratable share of their assets at NAV.
Table 2

Note: “Affected Funds” includes BDCs, Registered CEFs and Interval Funds

Rule Summary description of Rule Entities affected by changes
Registration Provisions:
General Instruction F.4.a of Form N-2 Requires online posting of information incorporated by reference Affected Funds
Securities Act Rules 424 and 497 Provide the processes for filing prospectus supplements Affected Funds
Investment Company Act Rule 23c-3 Subjects interval funds to the registration fee payment system based on annual net sales Interval Funds
Securities Act Rule 486 Allows continuously-offered unlisted affected funds to make certain filings that are immediately effective upon filing or automatically effective 60 days after filing Continuously-offered unlisted Affected Funds [other than Interval Funds]/not relying on Rule 23c-3]
General Instruction G of Form N-14 Permits certain registrants to incorporate by reference BDCs

 

Rule Summary description of Rule Entities affected by changes
Communication Provisions:
Securities Act Rule 134 Permits issuers to publish factual information about the issuer or the offering, including “tombstone ads.” Affected Funds
Securities Act Rule 163A Permits issuers to communicate without risk of violating the gun-jumping provisions until 30 days prior to filing a registration statement Affected Funds
Securities Act Rules 168 and 169 Permit the publication and dissemination of regularly released factual and forward-looking information Affected Funds
Securities Act Rules 164 and 433 Permit use of a “free writing prospectus.” Affected Funds

 

Rule Summary description of Rule Entities affected by changes
Prospectus Delivery Provisions:
Securities Act Rules 172 and 173 Permit issuers, brokers, and dealers to satisfy final prospectus delivery obligations if certain conditions are satisfied Affected Funds

 

Rule Summary description of Rule Entities affected by changes
Periodic Reporting Provisions:
Investment Company Act Rule 8b-16 A requirement that funds that rely on paragraph (b) of the Rule describe in the annual report the fund’s current investment objectives, policies and risks, and certain key changes in enough detail to allow investors to understand each change and how it may affect the fund Registered CEFs
Instruction 4.g to Item 24 of Form N-2 A requirement for narrative disclosure about the fund’s performance in the fund’s annual report Registered CEFs
Item 4 of Form N-2; Instruction 10 to Item 24 of Form N-2 Requires disclosure of certain financial information BDCs

 

Rule Summary description of Rule Entities affected by changes
Structured Data Reporting Requirements:
Structured Financial Statement Data A requirement that BDCs tag their financial statements using Inline eXtensible Business Reporting Language (“Inline XBRL”) format BDCs
Prospectus Structured Data Requirements A requirement that registrants tag certain information required by Form N-2 using Inline XBRL Affected Funds
Form 24F-2 Structured Format A requirement that filings on Form 24F-2 be submitted in a structured format Form 24F-2 Filers, including open-end funds and unit investment trusts

 

Rule Summary description of Rule Entities affected by changes
Seasoned Funds
Registration Provisions:
Securities Act Rule 415 Permits registration of securities to be offered on a delayed or a continuous basis Seasoned Funds
General Instructions A.2 and F.3 of Form N-2 Provide for backward and forward incorporation by reference Seasoned Funds
Securities Act Rule 430B Permits certain issuers to omit certain information from their prospectuses at effectiveness Seasoned Funds
Securities Act Rule 418 Exempts some registrants from an obligation to furnish certain engineering, management, or similar reports Seasoned Funds
Regulation FD Rule 103 Provides that a failure to make a public disclosure required solely by 17 CFR 243.100 (Rule 100 of Regulation FD) will not disqualify a “seasoned” issuer from use of certain forms Seasoned Funds

 

Rule Summary description of Rule Entities affected by changes
Communication Provisions:
Securities Act Rule 138 Permits a broker or dealer to publish or distribute certain research reports about securities other than those it is distributing Seasoned Funds

 

Rule Summary description of Rule Entities affected by changes
Proxy Statements:
Item 13 of Schedule 14A Permits certain registrants to use incorporation by reference to provide information that otherwise must be furnished with certain types of proxy statements Seasoned Funds

 

Rule Summary description of Rule Entities affected by changes
Periodic Reporting Provisions:
Instruction 4.h.(2) to Item 24 of Form N-2 A requirement for information about the investor’s costs and expenses in the registrant’s annual report Seasoned Funds
Instruction 4.h.(3) to Item 24 of Form N-2 A requirement for information about the share price of the registrant’s stock and any premium or discount in the registrant’s annual report Seasoned Funds
Instruction 4.h.(1) to Item 24 of Form N-2 A requirement for information about each of a fund’s classes of senior securities in the registrant’s annual report Seasoned Funds
Instruction 4.h.(4) to Item 24 of Form N-2 A requirement to disclose outstanding material unresolved staff comments that remain unresolved for a substantial period of time Seasoned Funds

 

Rule Summary description of Rule Entities affected by changes
WKSIs
Registration Provisions:
Securities Act Rule 462 Provides for effectiveness of registration statements immediately upon filing with the Commission WKSIs
Communication Provisions:
Securities Act Rule 163 Permits oral and written communications by or on behalf of WKSIs at any time WKSIs

 

Rule Summary description of Rule Entities affected by changes
ETPs
Registration Provisions:
Securities Act Rules 415, 424, 456 and 457; Forms S-1, S-3, F-1 and F-3 Permits ETPs to register an indeterminate amount of certain securities and pay registration fees based on annual net sales ETPs

Discussion

Registration Process. 

The amendments to the registration process are intended to allow Affected Funds to offer and sell securities “off the shelf” more quickly and efficiently in response to market opportunities.  Given that CEFs frequently trade in the secondary market at a discount to their NAV, and that Section 23(b) of the 1940 Act generally prohibits CEFs from selling their shares at a price below NAV except in connection with a rights offering, we expect that these amendments will enable more CEFs to register a secondary offering quickly and thereby enable them to raise more capital without having to go through the expense and inconvenience of structuring a rights offering:

Short-Form Registration on Form N-2:  The SEC’s amendments will permit affected funds to file short-form registration statements on Form N-2.  While an affected fund can file a short-form registration statement to register a shelf offering, other types of offerings will also be eligible for short-form registration statement filings.

Eligibility to File a Short-Form Registration Statement

In order for an Affected Fund to file a short-form registration statement, it must have timely filed all reports and other materials required under the Securities Exchange Act of 1934 (Exchange Act) during the prior year and have a public float of $75 million or more.  In addition, for registered CEFs only, the fund also has been registered under the 1940 Act for at least 12 calendar months immediately preceding the filing of the registration statement and has timely filed all reports required to be filed under Section 30 of the 1940 Act – namely, Forms N-CEN and N-PORT – in addition to timely filing reports required under the Exchange Act – Form N-CSR – during that time.

The SEC determined not to permit interval funds to file short-form registration statements.  The Adopting Release noted that interval funds have a tailored registration process that enable them to raise capital as the opportunity arises.

Information Incorporated by Reference

An Affected Fund relying on the short-form registration instruction will be required to:

  • Specifically incorporate by reference into the prospectus and statement of additional information (“SAI”): (1) the BDC or CEF’s latest annual report filed pursuant to Section 13(a) or Section 15(d) of the Exchange Act that contains financial statements for the BDC or CEF’s latest fiscal year for which a Form N-CSR or Form 10-K was required to be filed; and (2) all other reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act since the end of the fiscal year covered by the annual report (backward incorporation by reference); and
  • State that all documents filed afterwards pursuant to Section 13(a), 13(c), 14, or 15(d) of the Exchange Act prior to the termination of the offering shall be deemed to be incorporated by reference into the prospectus and SAI (forward incorporation by reference).

An Affected Fund filing a short-form registration statement on Form N-2 may satisfy the disclosure requirements for its prospectus or SAI by incorporating the information by reference from Exchange Act reports as well as by directly disclosing the information in its prospectus or SAI.  In addition, the SEC is amending Form N-2’s required undertakings to allow required information to be incorporated by reference into an existing short-form registration statement rather than filing a post-effective amendment to include the required information.  Similarly, the SEC amended Form N-14 to enable a BDC to incorporate by reference to the same extent as a CEF.

Affected Funds’ Use of Rule 415(a)(1)(x) and Automatic Shelf Registration Statements

The SEC amended Rule 415(a)(1)(x) under the Securities Act to clarify that Affected Funds may use the shelf registration system.  The SEC also adopted a new general instruction to permit Affected  Funds that qualify as WKSIs to file an automatic shelf registration statement.  A WKSI can register unspecified amounts of different types or classes of securities on an automatic shelf registration statement.   An automatic shelf registration statement and any amendments to the registration statement will be effective immediately upon filing. 

The SEC intends for WKSI BDCs and CEFs to avail themselves of the flexibility to take advantage of market windows, structure terms of securities on a real-time basis to accommodate investor demand and determine or change the plan of distribution in response to changing market conditions.  The SEC notes that WKSIs using an automatic shelf registration statement are able to pay filing fees at any time in advance of a shelf takedown or on a “pay-as-you-go” basis at the time of each takedown off the shelf registration statement in an amount calculated for that takedown. 

Omitting Information from a Base Prospectus and Prospectus Supplements

The SEC amended Rule 424(f) under the Securities Act to enable an Affected Fund to file any type of prospectus enumerated in Rule 424(b) to update, or to include information omitted from, a prospectus or in connection with a shelf takedown.  The SEC also amended Rule 497 under the Securities Act to provide that Rule 424 would be the exclusive Rule for Affected Funds to file a prospectus supplement other than an advertisement that is deemed to be a prospectus under Rule 482. 

The SEC also adopted amendments to Rule 430B under the Securities Act.  Among other things, those amendments enable a WKSI that files an automatic shelf registration statement to omit the plan of distribution and information as to whether the offering is a primary one or an offering on behalf of selling security holders.

Well-Known Seasoned Issuer Status. 

The SEC noted that Affected Funds that qualify as WKSIs will be able to file a registration statement or amendment that becomes effective automatically in a broader variety of contexts than a non-WKSI.  In addition, subject to certain conditions, a WKSI may communicate at any time, including through a free writing prospectus, without violating the “gun-jumping” provisions of the Securities Act.

WKSI Definition. The SEC amended Rule 405 under the Securities Act to enable Affected Funds to qualify as WKSIs. 

WKSI Eligibility. As noted above, a BDC or CEF must be current and timely in its reporting and generally must have at least $700 million in public float in order to qualify as a WKSI.

Ineligible Issuer Definition. 

      • A registered CEF would be ineligible to be a WKSI if it failed to file all reports and materials required to be filed under Section 30 of the 1940 Act during the preceding 12 months.
      • In addition, an Affected Fund would be deemed to be ineligible if within the past three years its investment adviser, including any sub-adviser, was the subject of any judicial or administrative decree or order arising out of a governmental action that determines the investment adviser aided or abetted or caused the affected fund to have violated the anti-fraud provisions of the Federal securities laws.3  

Automatic or Immediate Effectiveness for Filings by Affected Funds Conducting Certain Continuous Offerings

The SEC expanded the scope of Rule 486 under the Securities Act to permit any registered CEF or BDC that conducts continuous offerings under Rule 415(a)(1)(ix) (e.g., a continuously-offered tender offer fund) to file post-effective amendments and certain registration statements that are either immediately effective upon filing under Rule 486(b) or automatically effective 60 days after filing under Rule 486(a).  The Rule currently applies only to interval CEFs.

The SEC noted that the amendments to Rule 486 will enable these funds:  (i) to make material changes to their registration statements on an automatically effective basis 60 days after filing; and (ii) to update their financial statements under section 10(a)(3) or make non-material changes to their registration statements on an immediately effective basis.  The SEC noted that continuously-offered unlisted funds relying on Rule 486 will continue to be subject to Rule 415’s limits on the amount of securities that can be registered in a continuous offering as well as its requirement to file a new registration statement every three years.4    

Final Prospectus Delivery Reforms

The SEC adopted Rule amendments to enable an Affected Fund to satisfy its final prospectus delivery obligations to each investor by filing its final prospectus with the Commission.

Communications Reforms

Offering Communications.  The SEC’s amendments will:

  • permit Affected Funds to use Rule 134 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 time period, ending 30 days prior to filing a registration statement, during which they may communicate without risk of violating the gun-jumping provisions;5 
  • permit Affected Funds that are reporting companies to rely on Rule 168 to publish or disseminate regularly released factual business information and forward-looking information at any time, including around the time of a registered offering.  The amendments to Rule 169 will also permit Affected Funds’ 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;
  • revise Rule 156 to state that nothing in that Rule may be construed to prevent an Affected Fund from qualifying for an exemption under Rule 168 or 169. The contents of any Rule 168 or 169 communication remain subject to the antifraud provisions of the Federal securities laws;
  • permit Affected Funds to rely on Rules 164 and 433 to use a “free writing prospectus”;6  and 
  • 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 operating company WKSIs.

Affected Funds therefore can now take advantage of additional flexibility under the communications Rules as amended or continue to rely on Rule 482 and other Rules currently applicable to investment company communications.

Broker-Dealer Research Reports

The SEC amended Rule 138 under the Securities Act to enable a broker-dealer participating in the registered offering of an Affected Fund’s common stock and similar securities to publish or distribute research reports about the Affected Fund’s fixed income securities, and vice versa, if it publishes or distributes that research in the regular course of its business.

New Registration Fee Payment Method for Interval Funds and Issuers of Certain Exchange-Traded Products

The SEC will now require that interval funds and ETPs not registered under the 1940 Act register an indefinite amount of securities upon their registration statements’ effectiveness. Like mutual funds and ETFs, interval funds will be required to pay registration fees based on their net issuance of shares, no later than 90 days after the funds’ fiscal year ends.  Issuers that elect to register an offering of an indeterminate amount of securities will be required to file a prospectus supplement when paying registration fees on an annual net basis.

Disclosure and Reporting Parity Proposals

The SEC adopted rule and form amendments to its rules and forms, intended to conform the disclosure and regulatory framework for affected funds as a result of its amendments to the offering rules.

Periodic Reporting Requirements

A seasoned fund filing a short-form registration statement on Form N-2 will be required to forward incorporate all periodic Exchange Act reports into its registration statement.

In addition, Seasoned Funds that register using the proposed short-form registration instruction must include key information in their annual reports regarding fees and expenses, premiums and discounts, and outstanding senior securities that the funds currently disclose in their prospectuses.  The SEC noted that this should not result in duplicative disclosure given that the annual report will be incorporated by reference into the fund’s prospectus. 

Finally, registered CEFs will be required to provide management’s discussion of fund performance (MDFP) in their annual reports to shareholders, BDCs will be required to provide financial highlights in their registration statements and annual reports, and Affected Funds filing a short-form registration statement on Form N-2 will be required to disclose material unresolved staff comments. These provisions are intended to modernize and harmonize the SEC’s periodic report disclosure requirements for Affected Funds with those applicable to operating companies, mutual funds and ETFs.

Fee and Expense Table; Share Price Data and Senior Securities Table

Funds filing a short-form registration statement on Form N-2 will be required to disclose in annual reports information about the costs and expenses that the investor will bear directly or indirectly, using specified captions and a specified tabular format.  In addition, those funds will be required to disclose in annual reports information about the share price of the registrant’s stock as well as information about any premium or discount that the share price reflects, compared to the registrant’s NAV.  Finally, the annual report will be required to include information about each class of a fund’s senior securities, including bank loans. 

Management’s Discussion of Fund Performance

Currently, mutual funds and ETFs are required to include MDFP in their annual reports to shareholders  The Rule amendments extend this requirement to all registered CEFs.  In particular, registered CEFs will be required to:

  • discuss the factors that materially affected their performance during the most recently completed fiscal year, including the relevant market conditions and the investment strategies and techniques used by the fund;
  • provide a line graph comparing the initial and subsequent account values at the 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
  • discuss 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.
Financial Highlights

The amendments will require any BDC, like other Affected Funds, to include financial highlights disclosure summarizing its financial statements in its registration statement and annual report.

Unresolved Staff Comments

The amendments will require that Affected Funds filing a short-form registration statement disclose outstanding staff comments that remain unresolved for a substantial period of time and that the fund believes are material.

The amendment is intended to allow an offering to proceed while informing investors and others about material disagreements between the issuer and the SEC’s staff, so that investors can make an informed judgment about the disagreement. Another commenter recommended, as an alternative, that the Commission publish its staff’s comments and issuer responses.  The amendment parallels the current requirement for operating companies that use the offering Rules.

Current Reporting Requirements for Affected Funds

While the SEC proposed to require registered CEFs to report information on Form 8K, it elected not to adopt the proposed Form 8-K amendments.  However, it will permit a registered CEF that is eligible to file a short-form registration statement to voluntarily file information on Form 8-K to forward incorporate that information into its registration statement or for other purposes (e.g., to publicly disseminate information under exchange Rules, as applicable).  These voluntary Form 8-K filings will not affect a registered CEF’s ability to qualify as a seasoned fund.

Online Availability of Information Incorporated by Reference

The SEC is removing the requirement that a fund deliver to new investors information that it has incorporated by reference into the prospectus or SAI.  Instead, a fund will be allowed to make its prospectus, SAI, and the incorporated materials readily available and accessible on a website identified in the fund’s prospectus and SAI.  In addition, affected funds will be required to provide incorporated materials upon request free of charge. 

Amendments to Certain Registered CEFs’ Annual Report Disclosure

Although Rule 8b-16(a) generally requires registered investment companies to update their registration statements annually, Rule 8b-16(b) currently allows registered CEFs to forgo an annual update if they disclose in their annual reports certain key changes that have occurred during the prior year.  The SEC amended Rule 8b-16(b) to require funds that rely on Rule 8b-16(b) to describe certain key changes in enough detail to allow investors to understand each change and how it may affect the fund.  In addition, the SEC will now require any Affected Fund that relies on Rule 8b-16(b) to describe the fund’s current investment objectives, investment policies, and principal risks in its annual report, even if there were no changes in the past year.  The SEC is encouraging funds to describe principal risks in order of importance, with most significant risks appearing first (i.e., not listing risks in alphabetical order).

Effective and Compliance Dates

In general, the SEC’s rule and form amendments will take effect on August 1, 2020.  However, the amendments to Rules 23c-3, 24f-2 and Form 24F-2 will take effect on August 1, 2021 to give the SEC sufficient time to modify its systems.  The compliance date for including MDFP in annual reports will also be August 1, 2021. 

Conclusion

In 1998, the SEC proposed far-reaching reforms of the securities offering process for operating companies, which was called the Aircraft Carrier.  Eventually, most aspects of the Aircraft Carrier release foundered, and while the SEC adopted significant reforms in 2005, CEFs and BDCs were left behind.  To our knowledge, no one has used any nautical terminology to describe the disclosure reforms that the SEC adopted for CEFs and BDCs.  Nonetheless, these reforms are quite significant and will extend many of the 2005 reforms to CEFs and BDCs.  We believe that it is reasonable to predict that these offering reforms, together with the staff’s recent determination to withdraw its prior position prohibiting CEFs from opting into state anti-takeover statutes,7  will increase the attractiveness of CEFs to investment advisers. 


1 Securities Offering Reform for Closed-End Investment Companies, Investment Company Act Rel. No. 33836 (Apr. 8, 2020), 85 FR 33290 (June 1, 2020) (Adopting Release).

2 Id., 85 FR at 33292-94.

3 The SEC rejected commenters’ suggestions that a fund should not be deemed to be ineligible if it has terminated its investment adviser or sub-adviser that aided, abetted or caused the violation.  The SEC instead noted that “[t]he specific facts and circumstances relating to a particular issuer’s WKSI status under the ineligible issuer definition may, however, be considered through the Commission’s process under Rule 405 for granting waivers of ineligible issuer status.”  Id., 85 FR at 33303.

4 Id., 85 FR at 33304 and n. 139.  The SEC also amended Rule 486 to permit funds making these types of amendments to take effect immediately or automatically.  Id.

5 The “gun-jumping provisions” in the Securities Act restrict the types of offering communications that issuers or other parties subject to the Securities Act’s provisions may use in connection with a registered public offering.  The gun-jumping provisions were intended to make the statutorily mandated prospectus the primary means for investors to obtain information regarding a registered securities offering.  Id., 85 FR at 33306.

6 “Free writing prospectuses” are written communications (other than statutory prospectuses) that constitute offers to sell or solicitations of offers to buy securities.

7 We examine this development in more detail in our Legal Insight: SEC Staff Withdraws Prior No-Action Letter on Control Share Acquisition Statutes, Requests Feedback on Control Share Statutes and Closed-End Funds.