Update on Multi-Class Exemptive Applications for BDCs
Investment Management Update
Date: February 12, 2019
FS Investments, a prominent sponsor of non-traded alternative investment vehicles, including business development companies (BDCs), recently filed with the Securities and Exchange Commission (SEC) an amendment to its application for exemptive relief that would permit its non-traded BDCs to issue multiple classes of shares (Application). This filing may indicate that the SEC is close to granting the exemptive relief requested by the Application, which has been pending since 2014. If the exemptive relief is granted, it could serve as precedent for future exemptive relief for other non-traded BDCs wishing to offer multiple classes of shares. The availability of multi-class exemptive relief for BDCs would be a historic development, as it would provide non-traded BDCs the flexibility (already enjoyed by continuously offered closed-end funds (CEFs) and mutual funds) to offer multiple classes of shares tailored to different distribution channels.
Section 18 of the 1940 Act generally prohibits funds from issuing multiple classes of equity. (Section 61(a) of the 1940 Act makes Section 18 applicable to BDCs for this purpose.) A share of stock or beneficial interest is considered a separate “class” if it receives different allocations of income or expenses or has unequal voting rights compared to other shares. Funds with multiple share classes have class-specific expenses allocated to the appropriate class, which results in unequal dividend payments, and restrict voting on class-specific matters to the relevant class. Unlike mutual funds that can rely on an exemptive rule under the 1940 Act (Rule 18f-3), unlisted continuously offered CEFs with discretionary or mandatory repurchase features typically receive individualized exemptive relief to offer multiple share classes based on the rationale that such funds are sufficiently comparable to mutual funds to have such relief. CEF relief is typically conditioned on the CEF’s compliance with Rule 18f-3 as if it were a mutual fund.
Highlights of the Application
The Application was filed on behalf of FS Investment Corporation IV (FSIC IV), which is currently operating but has only one class of shares issued and outstanding, and FS/KKR Advisor, LLC (a joint venture between FS Investments and KKR & Co. L.P.) (Adviser), but requests relief for any current or future unlisted continuously offered closed-end management investment company that elects to be regulated as a BDC for which the Adviser or any entity controlling, controlled by or under common control with the Adviser acts as investment adviser and which periodically offers to repurchase its shares pursuant to Rule 13e-4 under the Securities Exchange Act of 1934, as amended, and Section 23(c)(2) of the 1940 Act (Funds). Like the multi-class application precedents for continuously offered CEFs that came before it, the Application makes the case for treating each Fund the same way a mutual fund is treated for this purpose. The Application indicates that a Fund would comply with Rule 18f-3 as if it were a mutual fund and that its shareholders stand to benefit from increased economies of scale as a result of the Fund’s ability to raise capital through multiple distribution channels. By making periodic repurchase offers, a Fund would give its shareholders liquidity opportunities that are similar to, though not as extensive as, mutual fund shareholders’ redemption rights.
In contrast to CEF application precedents, the Application would not require the Funds to comply with Financial Industry Regulatory Authority (FINRA) Rule 2341, which by its terms only applies to mutual funds and interval funds. Instead, the Funds would continue to comply with FINRA Rule 2310 (applicable to “direct participation programs” (DPPs)), as non-traded BDCs fall within that rule’s definition of a DPP.
Finally, the Application represents that if a share class of a non-traded BDC is listed on an exchange, “all other then-existing classes of Shares of the listing Fund will be converted into Shares of the class to be listed.”
If the exemptive relief is granted and becomes precedent for future exemptive relief from the SEC for other non-traded BDCs, it would represent a significant step in the evolution of non-traded BDCs from niche DPP products to products that more closely resemble continuously offered CEFs. Sponsors that may want to offer non-traded BDCs with separate share classes in the future (or add additional classes to existing non-traded BDCs) should follow the Application’s progress to be able to take advantage of this option if and when it becomes available.
FOR MORE INFORMATION
For more information, please contact:
Christopher D. Carlson
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 Amendment No. 2 to the Application Pursuant to Section 6(c) of the Investment Company Act of 1940, as amended (the “1940 Act”), for an Order Granting Exemptions from Sections 18(a)(2), 18(c), 18(i) and 61(a) of the 1940 Act, filed by FS Investment Corporation IV and FS/KKR Advisor, LLC (File No. 812-14383) (Feb. 1, 2019), available at https://www.sec.gov/Archives/edgar/data/1637417/000119312519025806/d670670d40appa.htm.
 See the Application at n. 24 on page 15.