Business development companies (BDCs) are closed-end investment management companies that are specially regulated by the Investment Company Act of 1940, as amended (the 1940 Act). This Lexis Practice Advisor® market trends article covers recent commercial and regulatory trends affecting BDCs, particularly focusing on various types of securities offerings by public and private BDCs.

Read our Market Trends 2018/19: Business Development Companies article.

This Lexis Practice Advisor® market trends article identifies Brexit-related disclosures that offer detailed discussions of its effects, including how Brexit might impact the company, its employees, management, operations, and prospects. The company name, its industry, and the type of filing are also provided in each sample disclosure for reference. This article concludes with recommendations on how to enhance Brexit-related disclosures and how to make them consistent with SEC’s expectations.

Read our Market Trends 2018/19: Brexit Disclosure article.

At today’s open meeting, the Securities and Exchange Commission adopted a final Regulation Best Interest, as well as additional guidance.

Final action relating to the broker-dealer standard of conduct had been anxiously anticipated.  The Commission noted that Regulation Best Interest enhances the standard of conduct beyond the current broker-dealer suitability standard.  In addition, the Commission adopted a requirement for a Form CRS Relationship Summary.  The Form CRS will require registered investment advisers and broker-dealers to provide retail investors with a plain English explanation about the relationship with the financial professional.

In its Fact Sheet, the Commission also noted that it “also issued an interpretation to reaffirm and, in some cases, clarify the Commission’s views of the fiduciary duty that investment advisers owe to their clients under the Advisers Act.  The interpretation reflects how the Commission and its staff have applied and enforced the law in this area, and inspected for compliance, for decades.  By highlighting principles relevant to the fiduciary duty, investment advisers and their clients will have greater clarity about advisers’ legal obligations. Finally, the Commission issued an interpretation of the ‘solely incidental’ prong of the broker-dealer exclusion under the Advisers Act, which is intended to more clearly delineate when a broker-dealer’s performance of advisory activities causes it to become an investment adviser within the meaning of the Advisers Act.  This interpretation confirms and clarifies the Commission’s position, and illustrates the application in practice in connection with exercising investment discretion over customer accounts and account monitoring.”

The adopting release can be found here for Regulation Best Interest and here for Form CRS.  Additional guidance are expected to be released shortly.

The rules and forms will be effective 60 days from publication in the Federal Register and the interpretations will be effective upon publication in the Federal Register.  By June 30, 2020, registered broker-dealers must begin complying with Regulation Best Interest and broker-dealers and investment advisers registered with the Commission will be required to prepare, deliver to retail investors, and file a relationship summary.

Additional analysis will follow.

In previous blog posts, we have discussed PCAOB Staff Guidance on the basics of critical audit matters (CAMs), the determination of CAMs and the methodologies for CAMs compliance. In a recent PCAOB Staff Guidance, “Implementation of Critical Audit Matters: A Deeper Dive on the Communication of CAMs,” the Staff focuses on CAM communications. There are four aspects of the CAM communications requirements: (i) identification of the CAM, (ii) principal considerations relating to the auditor’s determination that a matter constitutes a CAM, (iii) description of how the CAM is addressed and (iv) reference to financial statement accounts or disclosures relating to the CAM. The language used to communicate a CAM must provide the CAM definition, the period(s) as to which CAMs relate, and indicate that CAMs do not alter the auditor’s opinion. Auditors should not imply they are providing a separate opinion on the CAM or on the accounts or disclosures to which the CAM relates. If the auditor determines there are no CAMs, the auditor must provide the CAM definition and indicate that there are no CAMs.

In the Staff FAQs, the Staff provides detailed guidance on how an auditor should describe the considerations leading to the determination of a CAM, descriptions of audit procedures as part of the CAM communication and other CAM communication recommendations.

The Securities and Exchange Commission posted an Open Meeting Agenda for June 5, 2019, when the Commission will vote on whether to adopt Regulation Best Interest, the related Form CRS Relationship Summary and a standard of conduct for registered investment advisers (“RIAs”). The agenda is available at: https://www.sec.gov/news/openmeetings/2019/agenda060519.htm.  It is not known whether the final Regulation Best Interest, Form CRS and the standard of conduct will be significantly revised based on comments received since their original proposal.

Regulation Best Interest, as originally proposed, would require broker-dealers to act in the best interests of their retail customers, although the proposed rule did not define the term “best interest.”  The proposed rule would require that certain conflicts of interest between a broker-dealer and his or her customer be either disclosed or, in some cases, eliminated. The proposed rule would also require broker-dealers and RIAs to provide a short form to their customers, summarizing salient facts about their relationship.

A competing, and stricter, rule, imposing a fiduciary standard on broker-dealers and RIAs for sales to retirement plans and originally proposed by the Department of Labor (“DOL”), but held unenforceable by the Fifth Circuit, is once again on the DOL’s agenda. The DOL’s Spring 2019 regulatory agenda lists a notice of proposed rulemaking for December 2019 for the “Fiduciary Rule and Prohibited Transaction Exemptions.” The regulatory agenda is available at: https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201904&RIN=1210-AB82.

On October 31, 2018, the Securities and Exchange Commission (the “SEC”) adopted new property disclosure requirements for mining company registrants. The new rules, codified in Subpart 1300 of Regulation S-K, aim to replace the SEC’s thirty-year-old Industry Guide 7 by providing investors with a more comprehensive disclosure of a public company’s mining properties. Changes include: closer alignment with the Committee for Reserves International Reporting Standards (“CRIRSCO”), disclosure of mineral resources using technical report summary, disclosure of exploration results and responsibilities and potential liabilities for “qualified persons.” Additionally, the new rules adopted a two-year transition period during which a mining registrant is not required to comply with the new rules until its first fiscal year beginning on or after January 1, 2021.

While the EDGAR reprogramming changes are being completed, the SEC stated in a notice dated May 7, 2019, that a mining registrant may elect to voluntarily comply with the new rules as long as it satisfies all of Subpart 1300’s provisions and existing EDGAR requirements. Before EDGAR reprogramming is completed, registrants electing early compliance should file a technical report summary under Item 601(b)(99) of Regulation S-K or Exhibit No. 15 of Form 20-F; and once EDGAR reprogramming is completed, such report should be filed under Item 601(b)(96) of Regulation S-K. On the other hand, registrants not electing early compliance should continue their compliance with Industry Guide 7 until they are required to comply with the new rules.

The SEC announced an upcoming roundtable (date and details to come) that will focus on the causes of short-termism, including the role of quarterly disclosures.  At the end of 2018, the SEC had published a request for comment regarding the timing of earnings releases and quarterly reports by public companies.  The statement regarding the roundtable identifies potential topics for discussion, including the following:

  • The role, if any, that short-termism plays in the declining number of public companies. In particular, examining how the pressure on public companies to take a short-term focus in our markets may discourage private companies from going public could provide valuable insight into how to make our public markets more attractive and increase investment options for Main Street investors.
  • The SEC’s ability to reduce burdens for companies while facilitating better disclosure for long-term Main Street investors. For example, SEC Chair Clayton noted he was interested in exploring whether the information typically included by companies in earnings releases could be allowed to satisfy certain quarterly reporting obligations and whether there are ways that quarterly disclosures could be streamlined. This is particularly the case in the first fiscal quarter when the the quarterly report often comes closely on the heels of the annual report.
  • The potential for certain categories of reporting companies, such as smaller reporting companies, to be given flexibility to determine the frequency of their periodic reporting.
  • Market practices that could be oriented to encourage longer-term thinking and investment at public companies. For example, it would be informative to explore the extent to which certain activist practices, such as “empty voting” (e.g., acquiring voting rights over shares but having little or no economic interest in the shares), are factors that drive short-term focus.

A recent research piece published by UBS Financial Services discusses the significant variations in IPO winners and losers.  The report notes that after five years about 60% of all IPOs had negative returns.  Variation in long-term performance appears to be correlated with specific IPO characteristics.  Companies with revenues in excess of $1 billion and those backed by growth capital performed better over a three-year period than smaller and venture-backed companies. First-day IPO returns are not a good predictor of long-term returns.  The average first-day return for IPOs in the United States has been 18% over the past 40 years.  First-day returns also vary in statistically significant ways based on certain attributes.  Returns are lower for larger companies based on revenues in the pre-IPO year–8.6% if revenues were greater, and 18.6% otherwise.  Larger companies require less underpricing.  Similarly, the first-day returns for companies that received growth capital were lower than those with venture funding, which are generally smaller and earlier stage companies.  Recent IPOs have performed well.  According to the report, an index of recent IPOs is up 33% year to date versus the S&P 500, and the average first-day return for IPOs in 2019 to date is 14.7%.

A partnership (or LLC) can go public in a highly tax-efficient manner by using an “Up-C” structure.  An Up-C structure is composed of two entities: (1) a parent company, a C corporation (“PubCo”) which will be organized as a holding company, and (2) PubCo’s subsidiary, which is the partnership or LLC.  The Up-C structure makes it possible for the partnership/LLC to undertake an IPO while maintaining its partnership status, principal assets and operating business.  It also allows the founders and the new public shareholders to save future taxes.  Our latest On point discusses the Up-C structure and its benefits.  It also discusses what is needed to achieve a successful IPO of an Up-C business.

In May, the Public Company Accounting Oversight Board (“PCAOB”) posted a preview of its staff’s observations made in relation to audits conducted in 2018. The PCAOB highlighted several common deficiency areas that auditors should focus on improving, including Internal Control over Financial Reporting, Risk Assessment and Revenue, and Accounting Estimates. The PCAOB focused on instances where it believes auditors should use more “professional skepticism,” such as evaluating bias in the data reported by managers and identifying potential material misstatements or fraud.

The PCAOB also outlined “good practices” for improving the quality of audits. Among the tips included are revising training programs, establishing a network of auditors to address emerging risks, and expanding accountability to those in leadership positions.

The text of the preview is available on the PCAOB’s website.