United States

BDC Roundtable in Washington: 7 key takeaways


Business development companies (BDCs) play an increasingly important role in middle market finance, raising the stakes for legislators, regulators and investors seeking to keep pace with the industry. RSM was a presenter and co-sponsor (benefactor) at the 14th annual 2017 BDC Roundtable, held by the law firm Eversheds Sutherland in Washington, which brought together market participants, regulators, consultants, and industry leaders to discuss developments in regulation, cybersecurity and accounting in the BDC industry. Here are six key takeaways from the September 2017 event:

1.    SEC leadership changes

  • Walter “Jay” Clayton, formerly a partner from Sullivan & Cromwell LLP, was sworn in as chairman of the Securities and Exchange Commission (SEC) in May.
  • Clayton has filled several top spots from the private sector, notably Dalia Blass as director of the SEC’s division of investment management, which regulates BDCs, and Jim Curtis, formerly with the SEC.

2.   SEC regulatory updates

  • The SEC has proposed to let advisers to small business investment companies (SBICs) register as “venture capital fund advisers” under the FAST Act, a less onerous process than they now undergo, and would eliminate the $150 million ceiling on assets they manage.
  • The White House exempted the SEC from an earlier executive order requiring two deregulatory actions for every one that costs money, but encouraged voluntary compliance.
  • Despite recent loosening regulations for other entities, BDCs still can’t submit confidential drafts offering registration statements.

3.    Cybersecurity

A consensus is emerging from the patchwork of state and federal cybersecurity regulations for financial firms, according to a panel led by Michael Bahar, Eversheds Sutherland’s head of global security and privacy practice and former deputy legal adviser to the National Security Council in the Obama administration:

  • Rules for broker-dealers and investment advisers adopted by Colorado and Vermont may point the way to a “standard of care” to which courts could look in evaluating liabilities in data breach cases. Keeping in good stead with regulators may help companies, officers and directors in civil litigation.
  • The requirement for a “reasonable” cybersecurity strategy put forth by Colorado and Vermont is less specific than New York’s rules, which include annual penetration tests, biannual vulnerability assessments, encryption and multifactor identification. The New York rules apply to a different set of companies.
  • For SEC-regulated companies, the Colorado and Vermont rules would not represent a major change.
  • Cybersecurity remains one of the top compliance risks for financial firms, according to an SEC risk alert in August 2017.  Firms should be aware that the SEC will come down hard even if no harm results from a breach, as was the case in June 2016 when a large broker-dealer/investment adviser was fined $1 million after an employee transferred 730,000 customer accounts to his personal server, which was then hacked. Also last year, a firm was fined $100,000 for using private email to receive messages containing sensitive client information.
  • Under new FINRA guidance, firms must preserve records of all social media communications, including text messaging. The SEC is conducting more sweep exams related to electronic messaging, including instant and personal messaging.

4.   Legislative relief for BDCs.

On June 8, 2017, the U.S. House of Representatives passed the CHOICE Act, an initiative that would, among other things, relax restrictions on BDC securities offerings and investments.  Congressman Steve Stivers from Ohio was optimistic for passage into law of a pared-down “skinny bill” drafted by the Small Business Investment Alliance (SBIA) that incorporates many of the BDC-related provisions of CHOICE. Some changes under consideration would:

  • Cut paperwork related to securities offerings
  • Let BDCs communicate with investors and allow research to be disseminated in advance of an offering
  • Let BDCs own investment advisers without obtaining costly, time-consuming exemptions, as a number already have done
  • Change the asset-debt coverage limit to 1.5:1 from the present 2:1

5.    New FASB revenue recognition standard

  • A new rule on fee income reporting applies to calendar year BDCs starting in the quarter ended March 2018, but companies they invest in won’t be required to adopt the standard until 2019, creating a mismatch.
  • BDCs underwriting standards and loan covenants will likely need to change, especially where revenue will be recognized differently once the new accounting standard is adopted.
  • Non-routine fees and payments in kind may fall under the “point in time” vs. “over time” revenue recognition evaluation.

6.    Independent auditor report changes

The Public Company Accounting Oversight Board (PCAOB) recently adopted a new standard enhancing the reporting being provided by auditors. The standard requires auditors to provide additional information in their reports on audits of financial statements, including information about critical audit matters (CAMs). A CAM is defined as a matter that was communicated or required to be communicated to the audit committe and that:

  • Relates to accounts or disclosures that are material to the financial statements
  • Involved especially challenging, subjective or complex auditor judgement 

When determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the auditor takes into account certain factors, including the auditor's assessment of the risks of material misstatement.

The communication of each CAM in the auditor's report includes:

  • Identification of the CAM;
  • A description of the principal considerations that led the auditor to determine that the matter was a CAM;
  • A description of how the CAM was addressed in the audit; and
  • Reference to the relevant financial statement accounts or disclosures.

In addition to some formatting changes, the final standard also includes requirements to provide information about auditor tenure (i.e., a statement disclosing the year in which the auditor began serving consecutively as the company's auditor), and a statement that the auditor is required to be independent.

The final standard applies to audits conducted under PCAOB standards. Communication of CAMs is not required for audits of brokers and dealers; investment companies other than business development companies; employee stock purchase, savings, and similar plans; and emerging growth companies. Subject to SEC approval, all provisions other than those related to CAMs will be effective for audits of fiscal years ending on or after December 15, 2017. Provisions related to CAMs will be effective for audits of fiscal years ending on or after:

  • June 30, 2019 for large accelerated filers
  • December 15, 2020 for all other companies to which the requirements apply

If approved the SEC, it will expand the auditor’s report to a number of pages, and will be dependent on how many CAMs are identified.  Expect additional time and expense to be incurred as a result of the revisions to the auditor’s opinion given the changes proposed, as it will warrant additional review and scrutiny from management, board of directors, audit committees and legal counsel.

7.    Fair value estimates

  • Fair value estimates in BDC portfolios continue to draw scrutiny. Under GAAP, cost cannot automatically be considered equivalent to fair value. Management must evaluate similar transactions to demonstrate that no evidence exists to the contrary. However, less weight can be given to such transactions if information on them is not readily available.
  • A new credential for outside specialists, the Certified in Equity and Intangible Valuation (CEIV) designation, seeks to bring more professionalism to fair value estimates.

For more information, visit the 2017 BDC Roundtable site.



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