Temporary Exemptive Relief for BDCs and Further Custody Rule Guidance

15 April 2020

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Key Takeaways:

  • In a continued effort to support market participants during the COVID-19 pandemic, the SEC announced exemptive relief under the Investment Company Act to enable BDCs to continue to raise capital and invest in their portfolio companies
    • The exemptive relief (1) permits BDCs, under certain conditions, to issue or sell senior securities pursuant to more flexible asset coverage requirements and (2) permits BDCs currently prohibited from engaging in co-investment transactions with certain affiliated persons to make follow-on co-investments with one or more registered and/or affiliated funds.
  • The SEC also issued additional guidance on how to fulfill regulatory obligations relating to the Custody Rule under the Investment Advisers Act. The SEC specifically focused on delays by independent public accountants to complete their examination and submit Form ADV-E and how to safeguard physical certificates that cannot be kept at a qualified custodian at this time.

The Securities and Exchange Commission (the “SEC”) continues its efforts to support investment advisers and investment funds as it continues to assess the impact of the coronavirus outbreak (COVID-19). This Debevoise update discusses new exemptive relief and additional guidance on how to fulfill regulatory obligations.


The SEC, recognizing that business development companies (“BDCs”) in the current environment face challenges raising capital and investing in their portfolio companies due to (i) Investment Company Act of 1940 (the “Investment Company Act”) asset coverage requirements applicable to BDCs and (ii) Investment Company Act restrictions on affiliated transactions applicable to BDC affiliates co-investing alongside BDCs, issued temporary, conditional exemptive relief (the “Order”) allowing BDCs to issue or sell senior securities outside of the asset coverage requirements imposed by the Investment Company Act and participate in certain co-investment transactions that are otherwise prohibited by Section 57(a)(4) of the Investment Company Act and Rule 17d-1 thereunder.

Exemptive Relief—Asset Coverage Ratios

Relief from the Investment Company Act’s asset coverage requirements permits BDCs to incur additional leverage to meet liquidity constraints resulting from disruptions due to the COVID-19 pandemic, subject, however, to a number of considerable conditions.

From April 8 to December 31, a BDC, when issuing a senior security that represents an indebtedness or that is stock (together, the “Covered Securities”), may use values calculated as of December 31, 2019 to calculate portfolio value (the “Adjusted Portfolio Value”) to meet an Adjusted Asset Coverage Ratio, rather than the asset coverage ratio imposed by the Investment Company Act, subject to the conditions below. To calculate the Adjusted Asset Coverage Ratio, a BDC must reduce its asset coverage ratio using the Adjusted Portfolio Value by an amount equal to 25% of the difference between the asset coverage ratio calculated using the Adjusted Portfolio Value and the asset coverage ratio calculated in accordance with Section 18(b) of the Investment Company Act.

A BDC relying on the Order to issue a Covered Security must calculate the Adjusted Portfolio Value for portfolio company holdings (i) that the BDC held at December 31, 2019, (ii) that the BDC continues to hold at the time it issues the Covered Security and (iii) for which the BDC is not recognizing a realized loss.

Prerequisites for Relying on the Order

In order to rely on the Order, the BDC’s board of directors or trustees (the “Board”) must determine that the issuance or sale of Covered Securities is permitted by the Order and is in the best interests of the BDC and its shareholders. In making such determination, the Board must obtain and consider (i) a certification (the “Certification”) from the BDC’s investment adviser that the issuance of Covered Securities is in the best interests of the BDC and its shareholders and (ii) advice from an independent evaluator that the terms and conditions of the proposed issuance or sale of Covered Securities is fair and reasonable compared to similar issuances, if any, by unaffiliated third parties in light of current market conditions. The BDC must receive a Certification that includes the investment adviser’s recommendation and reasoning, including whether the adviser has considered other reasonable alternatives that would not result in the issuance or sale of Covered Securities, and the BDC must preserve the minutes describing the Board’s deliberations, including the factors considered by, and the information, documents and reports provided to, the Board in connection with such determinations. Once approved by the Board, the BDC must make an election that it is relying on the Order on Form 8 K (the “Election”).

Conditions of Reliance

A BDC that seeks to rely on the Order is subject to a number of additional conditions, including:

  • Limits on New Investments. For 90 days following the Election, a BDC cannot make an initial investment in any portfolio company in which the BDC was not already invested as of April 8, 2020 (except where, at the time of such investment, the BDC’s asset coverage ratio complies with the Investment Company Act).
  • Prohibitions on Transaction Fees and Other Compensation. Except in limited circumstances, no affiliated person of the BDC, nor any affiliated person of such a person, can receive any transaction fees (including break-up, structuring, monitoring or commitment fees) or other remuneration from an issuer in which the BDC invests in reliance of the Order.
  • Ongoing Reporting and Compliance. While relying on the Order, the BDC and its investment adviser must make efforts towards achieving compliance with the BDC’s applicable asset coverage requirements under the Investment Company Act. To assess progress, the Board must receive and review, no less frequently than monthly, reports by the BDC’s investment adviser assessing such efforts. The BDC must preserve these reports, including copies of all other information provided to or relied upon by the Board.
  • Requirements at the End of the Exemption Period. Upon expiration of the Order, any BDC not in compliance with its applicable asset coverage requirements must immediately make a filing on Form 8-K that includes: (i) the BDC’s current asset coverage ratio, (ii) the reasons why the BDC was unable to comply with the asset coverage requirements, (iii) the time frame within which the BDC expects to come into compliance with the asset coverage requirements and (iv) the specific steps that the BDC will be undertaking to bring itself into compliance with the asset coverage requirements.

Exemptive Relief—Co-Investments

Relief from the Investment Company Act’s affiliated transactions prohibitions expands existing BDC co-investment relief to allow new private fund affiliates to co-invest in existing deals.

From April 8 to December 31, any BDC that is currently prohibited from co-investment transactions in portfolio companies with certain affiliated persons may make a Follow-On Investment with one or more funds registered under the Investment Company Act (“Regulated Funds”) and/or Affiliated Funds (generally, private funds affiliated with a BDC) under the following conditions: (i) if such participant is a Regulated Fund, it has previously participated in a Co-Investment Transaction with the BDC with respect to the issuer, and (ii) if such participant is an Affiliated Fund, it either (a) has previously participated in a Co-Investment Transaction with the BDC with respect to the issuer or (b) is not invested in the issuer (existing co-investment orders prevent an Affiliated Fund from participating in a Follow-On Investment with a BDC if it was not part of the initial co-investment with the BDC). Follow-On Investments (including any Non-Negotiated Follow-On Investments) would remain subject to review and periodic reporting requirements under the BDC’s existing co-investment orders.


In light of further COVID-19 developments and related questions as to how to comply with obligations under Rule 206(4)-2 (the “Custody Rule”) under the Investment Advisers Act of 1940 (the “Advisers Act”), the SEC continues to update its Frequently Asked Questions providing additional guidance on Custody Rule matters.

Form ADV-E Delays

The SEC reassured advisers that it will not recommend enforcement action against an adviser for being in violation of the Custody Rule if its independent public accountant did not complete its examination and submit Form ADV-E to file its certificate of accounting within 120 days after the date chosen by the independent public accountant so long as (i) the adviser reasonably believed that such independent public accountant would complete its examination and make the required submission within the deadline, but the independent public accountant failed to do so solely because of logistical disruptions due to COVID-19, and (ii) the independent public accountant makes the requisite filings as soon as reasonably practicable but no later than 45 days after the original due date.

Custody of Physical Certificates

Under the Custody Rule, physical certificates (such as those received by investing in privately issued securities such as collateralized loan obligations) do not meet the criteria for “privately offered securities” due to the existence of a physical certificate and must therefore be maintained at a qualified custodian. In light of COVID-19, certain custodians have announced that they will not be accepting physical certificates at this time. In response to this, the SEC stated that it will not recommend enforcement action against advisers for not maintaining physical certificates with a qualified custodian if (i) the certificates can only be used to effect a transfer or to otherwise facilitate a change in beneficial ownership of the security with the prior consent of the issuer or holders of the outstanding securities of the issuer; (ii) ownership of the security is recorded on the books of the issuer or its transfer agent (or person performing similar functions) in the name of the client; (iii) the certificates contain a legend restricting transfer; (iv) the physical certificates are appropriately safeguarded by the adviser and can be replaced upon loss or destruction; and (v) the adviser makes and keeps (in accordance with the terms of Rule 204-2) a record of the custodian’s closure.

The SEC continues to assess the impacts of COVID-19 on market participants and may consider providing additional guidance and/or relief (including extensions to existing relief) as necessary or appropriate.