Examination of Business Development Companies

May 9, 2017

In January, ACA noted that the U.S. Securities and Exchange Commission (“SEC”) had published its 2017 examination priorities. As in previous years, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) identified the examination of private fund advisers as one of its priorities. As result of such examinations, there has been an increased focus by the SEC on business development companies (“BDC”) managed by investment advisers and/or their affiliates. The following is a non-exhaustive list of focus areas that may attract increased scrutiny from the SEC during an examination:

  • Valuation – The fair valuation of client investments can be an area of intense scrutiny during SEC examinations. With a preponderance of Level 3 investments, advisers and the board of directors have a special challenge to ensure that they fulfill their regulatory and fiduciary responsibilities regarding fair valuation. The most critical aspect of a BDC’s financial statement has been, and always will be, investment valuation.
  • Transactions with affiliates – Given their unique nature, BDCs often raise regulatory issues not typically faced by more traditional closed-end registered investment companies under the Investment Company Act of 1940. Advisers must have adequate co-investment and applicable exemptive order policies and procedures that would help ensure that the BDC strictly adheres to its SEC exemptive order, if applicable, and relevant no-action letters.
  • Reviews of allocations of investment opportunities – Certain inherent conflicts of interest may arise when an adviser is allocating investment opportunities between a BDC and the adviser’s other clients. The SEC has indicated that it will apply heightened scrutiny on conflict of interest situations, therefore advisers should be able to identify and carefully mitigate any potential conflicts of interest when allocating investment opportunities.
  • Fees and Expenses – The allocation of shared fees and expenses among the investment adviser and its clients has been an area of SEC scrutiny for the past couple of years and remains one today. While certain conflicts of interest may arise with allocating any expense to clients, additional conflicts may arise when the BDC uses an affiliated administrator or other affiliated service providers. 

How Can ACA Help?
Founded in 2002 by former SEC examiners and state regulators, ACA’s investment company consultants are comprised of former SEC examiners and senior compliance managers from prominent financial institutions. Our investment company practice has worked with many of the largest and most well-known firms that manage BDCs. ACA clients benefit from the unique insight we gather as a result of our extensive exposure to varying challenges related to managing BDCs. Our services take a focused approach to understanding the specifics of your firm via reviews of background materials, interviews, and targeted walk-throughs with leadership and deal personnel. Our findings are customized to help address the inherent risks related to managing a BDC, and upon completion we provide feedback and recommendations via oral or written report for meeting regulatory requirements as well SEC exam staff expectations.

For more information on how ACA can assist you with the above focus areas, please contact Maureen Colligan at (857) 303-7304 or mcolligan@acacompliancegroup.com.