U.S. GOVERNMENT PUBLISHING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Publishing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

96–994 PDF 2016

LEGISLATIVE PROPOSALS TO MODERNIZE 

BUSINESS DEVELOPMENT COMPANIES 

AND EXPAND INVESTMENT OPPORTUNITIES 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND 

GOVERNMENT SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED FOURTEENTH CONGRESS 

FIRST SESSION 

JUNE 16, 2015 

Printed for the use of the Committee on Financial Services 

Serial No. 114–33 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

PATRICK T. MCHENRY, North Carolina, 

Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

DAVID SCHWEIKERT, Arizona 

FRANK GUINTA, New Hampshire 

SCOTT TIPTON, Colorado 

ROGER WILLIAMS, Texas 

BRUCE POLIQUIN, Maine 

MIA LOVE, Utah 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

JUAN VARGAS, California 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES

SCOTT GARRETT, New Jersey, Chairman 

ROBERT HURT, Virginia, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ANN WAGNER, Missouri 

LUKE MESSER, Indiana 

DAVID SCHWEIKERT, Arizona 

BRUCE POLIQUIN, Maine 

FRENCH HILL, Arkansas 

CAROLYN B. MALONEY, New York, 

Ranking Member 

BRAD SHERMAN, California 

RUBE ́ N HINOJOSA, Texas 

STEPHEN F. LYNCH, Massachusetts 

ED PERLMUTTER, Colorado 

DAVID SCOTT, Georgia 

JAMES A. HIMES, Connecticut 

KEITH ELLISON, Minnesota 

BILL FOSTER, Illinois 

GREGORY W. MEEKS, New York 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

PATRICK MURPHY, Florida 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

June 16, 2015 .................................................................................................... 1 

Appendix: 

June 16, 2015 .................................................................................................... 41 

WITNESSES 

TUESDAY, JUNE 16, 2015 

Arougheti, Michael J., Co-Chairman of the Board of Directors, Ares Capital 

Corporation ........................................................................................................... 3 

Brown, J. Robert, Jr., Professor of Law, University of Denver Sturm College 

of Law .................................................................................................................... 11 

Foster, Vincent D., Chairman of the Board, President, and Chief Executive 

Officer, Main Street Capital Corporation, on behalf of the Small Business 

Investor Alliance (SBIA) ...................................................................................... 6 

Gerber, Michael F., Executive Vice President, Franklin Square Capital Partners ........................................................................................................................ 8 

Quaadman, Tom, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce ....................................................................... 9 

APPENDIX 

Prepared statements: 

Arougheti, Michael J. ....................................................................................... 42 

Brown, J. Robert, Jr. ........................................................................................ 48 

Foster, Vincent D. ............................................................................................. 62 

Gerber, Michael F. ............................................................................................ 73 

Quaadman, Tom ............................................................................................... 81 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Garrett, Hon. Scott: 

Letter to Chairman Hensarling from Raymond James Insurance Group, 

dated June 25, 2015 ...................................................................................... 160 

Maloney, Hon. Carolyn: 

Written statement of the Consumer Federation of America and Americans for Financial Reform ............................................................................ 161 

Written statement of the North American Securities Administrators Association, Inc. .................................................................................................... 164 

Mulvaney, Hon. Mick: 

Chart entitled, ‘‘Leverage Across Financial Services Industries’’ ................. 170 

Written statement of Prospect Capital Corporation ...................................... 171 

Arougheti, Michael J.: 

Letter to Chairman Hensarling and Ranking Member Waters from OTG 

Management, LLC ........................................................................................ 179 

(1) 

LEGISLATIVE PROPOSALS TO MODERNIZE 

BUSINESS DEVELOPMENT COMPANIES 

AND EXPAND INVESTMENT OPPORTUNITIES 

Tuesday, June 16, 2015 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 2:17 p.m., in room 

2128, Rayburn House Office Building, Hon. Scott Garrett [chairman of the subcommittee] presiding. 

Members present: Representatives Garrett, Neugebauer, 

Huizenga, Duffy, Stivers, Fincher, Hultgren, Ross, Messer, 

Schweikert, Poliquin; Maloney, Sherman, Hinojosa, Lynch, Scott, 

Himes, Carney, and Murphy. 

Ex officio present: Representative Hensarling. 

Also present: Representative Mulvaney. 

Chairman GARRETT. Greetings. Good morning. I apologize for 

being late. 

This hearing of the Subcommittee on Capital Markets and Government Sponsored Enterprises is hereby called to order. Today’s 

hearing is entitled, ‘‘Legislative Proposals to Modernize Business 

Development Companies—also called BDCs—and Expand Investment Opportunities.’’ 

Without objection, the Chair has the authority to recess the subcommittee at any time. 

Before we go to our panel, we will have opening statements. And 

I yield myself 21⁄2 minutes. 

Again, good morning, and I apologize for being a few minutes 

late. Today’s hearing will continue our important work on considering legislative proposals that would modernize our Nation’s securities laws in order to do what? To foster greater economic activity. 

One of these proposals is a discussion draft that is being circulated right now by the gentleman from South Carolina, Mr. 

Mulvaney. And what would it do? It would modernize the regulation of BDCs, business development companies. 

And what are BDCs? Well, BDCs are closed-end investment 

funds that have a statutory mandate to invest much of their capital 

in small and medium-sized businesses. As new regulations cause 

banks and other lenders to pull back from the small and midsized 

lending market—and we have heard that in other hearings—BDCs 

2 

have played an increasingly important role in our economy and in 

that space. 

While it has been 35 years since their creation, the regulatory regime for BDCs has not been meaningfully updated during that 

time. Mr. Mulvaney’s bill, which includes several provisions that 

this committee has previously considered, would do a couple of 

things. It would enhance the ability of BDCs to deploy capital, and 

therefore create jobs and opportunities, as well, for literally thousands of businesses, and therefore also their employees. 

Now, aside from that bill, we have a second bill. The second bill 

we will consider toady is H.R. 2127, the Fair Investment Opportunities for Professional Experts Act. And that was introduced by the 

gentleman from Arizona, Mr. Schweikert. 

What would Mr. Schweikert’s bill do? It would amend the definition of who qualifies as an accredited investor under the securities 

laws, and is therefore eligible to invest in certain private offerings. 

And while the Dodd-Frank Act directed the SEC to review the 

current income and asset-based definition of what an accredited investor is, there is still substantial concern that the SEC could ultimately take action that would limit the number of Americans eligible to invest in private offerings, a market that right now has actually grown to over $1 trillion in recent years. 

You see, investing in private companies should not be a privilege 

reserved only for the super wealthy. And so, Mr. Schweikert’s bill 

would allow more Americans to have the opportunities to secure 

their financial future. 

Taken together, these two commonsense bills would expand upon 

the previous work of the subcommittee in this very important area. 

And so again, I thank the two sponsors of the legislation, as well 

as the witnesses for the hearing today. 

And with that, my time has expired. I yield to the ranking member for 5 minutes. 

Mrs. MALONEY. Thank you so much, Mr. Chairman. And I thank 

all our panelists for being here today. We are examining two bills 

today: one to modernize the regulations for business development 

companies, or BDCs; and another to revise the definition of an accredited investor. 

The BDC bill is very familiar to all of us in this Congress because we considered a similar bill in depth in the last Congress. 

Since then, I am pleased to say that we have made some very good 

progress on this bill, and the draft that we are considering today 

reflects input from the Democratic side of the aisle, the Republican 

side of the aisle, the SEC, and the BDC community. 

I am hopeful that we all can get to a ‘‘yes’’ on this bill, which 

would increase the availability of capital for small businesses. It is 

an important bill for our economy. 

We will also consider a bill by Mr. Schweikert to revise the definition of an accredited investor. How to draw the line between 

someone who is an accredited investor and someone who is not is 

one of the most difficult questions in all of securities law. 

An accredited investor is someone who, in the words of the Supreme Court, can ‘‘fend for themselves and does not need the protections of the securities law.’’ These sophisticated investors are alVerDate Nov 24 2008 17:59 Feb 05, 2016 Jkt 096994 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 K:\DOCS\96994.TXT TERI
3 

lowed to buy unregistered securities, which are often more complex 

and riskier than public securities. 

Unregistered securities are also less liquid than public securities, 

which makes these investments in unregistered securities harder to 

exit or sell. As a result, these investments are supposed to be limited to investors who can legitimately bear the economic risk involved in buying them. These investors are referred to as accredited investors. 

Current law defines an accredited investor primarily by reference 

to a person’s income or overall net worth. Someone whose annual 

income is greater than $200,000 is an accredited investor. Or if 

someone’s net worth, excluding the value of his house, is greater 

than $1 million. 

So the question really is, does this strike the right balance? Is 

everyone who meets these tests truly able to fend for themselves? 

The SEC’s Investor Advisory Committee recommended a new definition of an accredited investor last year that seeks to more accurately identify investors with enough financial sophistication to 

fend for themselves. And I think this proposal is a very good starting point for this discussion. 

I look forward to hearing a discussion of the benefits and drawbacks of the Investor Advisory Committee’s proposal versus Mr. 

Schweikert’s proposal. This is an important debate to have. 

So I thank Mr. Schweikert for putting it forward. And I would 

also like to thank Chairman Garrett for holding this hearing, and 

to thank all of our panelists. 

Chairman GARRETT. The gentlelady yields back. And I thank the 

gentlelady for her comments. 

At this point, we will turn to our panel. Again, I thank the panel 

for being with us today. And I see some familiar faces. For those 

other-than-familiar faces, let me just remind you that you will be 

recognized for 5 minutes. I think there is a button there in front 

of you to tell you the time to start, and also an indicator in front 

of you of some sort that will go down to 1 minute on the timing 

for that. 

We are in a new room now, so we will see just how well the 

microphones are working. I used to always have to ask the people 

to pull the microphone close to you when you speak. But we will 

see how that works here now. 

And finally, you will be recognized for 5 minutes, but of course 

you have already submitted your testimony, and that will be made 

a part of the record. So now we just yield to you for 5 minutes to 

summarize your testimony. 

Mr. Arougheti, welcome to the panel. And we look forward to 

your testimony. You are recognized for 5 minutes. 

STATEMENT OF MICHAEL J. AROUGHETI, CO-CHAIRMAN OF 

THE BOARD OF DIRECTORS, ARES CAPITAL CORPORATION 

Mr. AROUGHETI. Great. Thank you. 

Chairman Garrett, Ranking Member Maloney, thank you for the 

opportunity to testify today. I am Michael Arougheti, the co-chairman of the board of directors of Ares Capital Corporation, a BDC 

that has invested more than $20 billion in hundreds of small and 

4 

medium-sized companies, creating tens of thousands of American 

jobs. 

By way of reminder, Congress created BDCs in 1980 to encourage capital flows to small and medium-sized companies at a time 

when these businesses had limited options for securing credit. Now 

uniquely, the BDC model allows ordinary investors the ability to 

participate in capital formation for small companies, effectively 

funding Main Street. 

Today, similar to 1980, commercial banks continue to exit the 

middle-market lending space. Perhaps the most striking recent example of this is GE Capital’s exit from the lending space. As the 

seventh largest bank in the United States, this will surely have a 

further significant adverse impact on the small and medium-sized 

businesses who have traditionally borrowed from GE Capital, and 

obviously on the jobs that these businesses have contributed to the 

economy. 

I am here today to express support for the draft of the Small 

Business Credit Availability Act, H.R. 3868, being offered by Mr. 

Mulvaney. We believe that the proposed bill will enable BDCs to 

more easily raise capital and to make loans to middle-market companies, while ensuring that BDCs continue to be appropriately regulated and subject to stringent standards regarding transparency, 

and obviously shareholder protection. 

I think it is important to note that BDCs are not seeking any 

government or taxpayer subsidy or support. 

Many of the challenges that we face as BDCs arise out of our peculiar place in the regulatory framework, regulated as mutual 

funds yet operating as operating companies. The draft bill builds 

on H.R. 1800 and other bipartisan efforts in the previous Congress 

to modernize this regulatory framework, and to ensure that BDCs 

can continue to fulfill their original congressional mandate. 

The proposed bill contains five provisions, each of which we believe will enable BDCs to more effectively fulfill their congressional 

mandate. 

First, the proposed bill contemplates an increase in the BDC 

asset coverage test from 200 percent to 150 percent, subject to the 

satisfaction of shareholder-friendly conditions such as extensive 

public disclosure and transparency, and either a shareholder vote 

or a ‘‘cooling-off period’’ following approval by the independent 

members of a BDC’s board of directors. 

We don’t believe that this introduces more risk. Rather, it will 

allow BDCs to invest in lower-yielding, lower-risk assets that don’t 

currently fit their economic model. In fact, the current asset coverage test may ironically force certain BDCs to invest in riskier 

higher yielding securities in order to meet the dividend requirements of their shareholders. 

We also believe that this change will grant borrowers greater financing alternatives at a reduced cost, and will benefit shareholders with more conservative and more diversified portfolios. 

Further, this change will enable BDCs to lend to a broader portion 

of the already underserved middle-market. 

This proposed change would apply to BDCs the same leverage 

ratio as small business investment companies, but unlike SBICs, 

without putting any government capital at risk. Further, given that 

5 

the House Small Business Committee just last week passed bipartisan legislation increasing the size of the SBIC program, the proposed change certainly seems reasonable. 

It is also extremely modest relative to typical bank leverage in 

our country of 10-to-1 and sometimes greater. Under the current 

asset coverage test, most BDCs operate at leverage significantly 

less than allowed. And any prudent manager would likely continue 

this practice if the asset coverage ratio were to change. 

Second, the proposed bill would allow BDCs to issue multiple 

classes of preferred stock, and solely for qualified institutional buyers, eliminate the requirement that holders of preferred stock have 

board representation. Had BDCs been able to raise capital during 

the post-2008 period by issuing preferred stock, many more loans 

could have been made to cash-starved companies to enable them to 

retain employees, and in some instances to remain in business. 

Third, the proposed bill directs the SEC to make specific technical amendments to certain securities offering rules that make 

raising capital cumbersome and inefficient. And these rule changes 

are not controversial and would merely place BDCs on equal footing with non-BDCs. 

Fourth, the proposed bill would allow BDCs to own registered investment advisers, which is a technical matter that is currently 

prohibited under the 1940 Act. Investments in IRAs enable money 

to be raised from third-party investors, which in turn could be deployed to small and medium-sized companies. 

And fifth, the proposed bill would offer increased flexibility for 

BDCs to invest in a subset of entities currently limited by the 30 

percent basket. Importantly, this provision would not allow the 

amount of the incremental increase in the 30 percent basket to be 

invested in private equity funds, hedge funds, or CLOs. 

So in closing, I am very encouraged by the bipartisan focus on 

this very important initiative. And I look forward to working with 

Representative Mulvaney and Representatives Garrett and Maloney and the rest of the committee in moving these bills forward. 

I would also like to applaud the committee’s efforts to revisit the 

definition of accredited investor, which, like the BDC regulatory 

framework that we are discussing today, could indeed benefit from 

modernization. 

And lastly, as a procedural matter, Mr. Chairman, if I could, I 

would like to introduce a letter into the record from one of our portfolio companies that was referenced in my written testimony. 

[The prepared statement of Mr. Arougheti can be found on page 

42 of the appendix.] 

Chairman GARRETT. If it is part of your written testimony, it will 

be a part of the record. 

Mr. AROUGHETI. Thank you. 

Chairman GARRETT. Thank you. 

From Main Street Capital, Mr. Foster? 

6 

STATEMENT OF VINCENT D. FOSTER, CHAIRMAN OF THE 

BOARD, PRESIDENT, AND CHIEF EXECUTIVE OFFICER, MAIN 

STREET CAPITAL CORPORATION, ON BEHALF OF THE 

SMALL BUSINESS INVESTOR ALLIANCE (SBIA) 

Mr. FOSTER. Good afternoon, Chairman Garrett, Ranking Member Maloney, and members of the Subcommittee on Capital Markets and Government Sponsored Enterprises. I appreciate the opportunity to testify today on behalf of the Small Business Investor 

Alliance or SBIA. SBIA’s members provide vital capital to small 

and medium-sized businesses nationwide, resulting in job creation 

and economic growth. 

My name is Vince Foster, and I am chairman, president, and 

CEO of Main Street Capital Corporation, an SEC-registered BDC 

based in Houston, Texas. We are named Main Street for a reason. 

Main Street is who we are and where we invest. 

As our name makes clear, we have invested in over 400 small 

and midsized companies. That amounts to more than $4 billion invested into growing businesses that were not able to adequately access capital through traditional financing sources. Like many 

BDCs, we focus on smaller businesses. 

We partner with entrepreneurs, business owners, and management teams that generally provide one-stop financing alternatives. 

Currently, we are backing over 70 lower-middle-market companies 

headquartered in 24 States. More than half of these businesses 

have revenues of less than $25 million. 

To illustrate this diversity, we have funded two of the fastest 

growing technology companies in Eugene, Oregon; the largest privately owned jewelry store chain in the Rocky Mountains 

headquartered in Twin Falls, Idaho; one of the largest Goodyear 

Tire retailers in the United States headquartered in Austin, Texas; 

the leading micro-irrigation design and installation company in the 

San Joaquin Valley headquartered in Delano, California; the leading FBO at the Indianapolis Airport; one of the largest fully-integrated precast concrete companies headquartered in San Antonio, 

Texas; and one of the only two independent producers of styrene 

butadiene rubber in the United States headquartered in Baton 

Rouge, Louisiana, just to name a few. 

We have also invested in GRT Rubber Technologies 

headquartered in Paragould, Arkansas, which was founded in the 

1880s and manufactures rubber products including conveyor belts. 

And Bridge Capital Solutions, headquartered in Hauppauge, New 

York, which operates Long Island’s only licensed commercial checkcashing service, serving small businesses in New York. 

Today, Main Street has small business investments in at least 15 

of the 24 States represented by this committee. And we are just 

one of the over 34 BDCs that are a part of SBIA. 

Small and medium-sized businesses need growth capital. BDCs 

are growing to fill that need. BDC loan balances have tripled since 

2008, and are not slowing. Growing businesses are going to continue to need more capital. BDCs will benefit from modernization 

that small businesses will be the ultimate beneficiaries of reform. 

BDCs are highly regulated and highly transparent. The public 

can look up and review every one of our investments. 

7 

The BDC industry is not seeking deregulation or any changes to 

the Dodd-Frank Act. We have earned investor trust and grown 

stronger in the face of economic calamity. We earned our good 

name, and we will work to keep it. 

What BDCs do need is commonsense modernization. I might 

need Mike to help me lift this up. Look at this stack of paper. This 

is our SEC filing to issue stock. Hundreds of pages represent wasted money and manpower. 

Here is what CIT, $50 billion versus our $1.5 billion, has to file 

to get the same result because they can incorporate their other 

SEC filings by reference, but BDCs cannot. Do 4 more inches of 

paper protect better than half an inch? No one is protected by the 

failure to modernize the rules for BDCs. 

This discussion draft would fix this absurdity and make a host 

of other clearly needed reforms. These reforms are overdue and 

worthy of bipartisan support. We encourage the committee to act 

promptly. 

This committee has clearly worked on a bipartisan basis to make 

other reforms and improvements. For example, almost every BDC 

in the industry wants the freedom to access the markets by increasing the regulatory cap on leverage from 1-to-1 to 2-to-1. Not 

everyone will make the change, but they want the freedom to adjust to changes in the market. 

The proposal does this in a very smart fashion that adds meaningful investor protections while adding capacity for investing. The 

draft bill makes other smart reforms that can add investor protections with transparency. 

Currently, BDCs can earn registered investment advisers. But it 

requires SEC exemptive relief. This means BDCs are playing by 

different rules, and the investors are in the dark. 

Standardizing the relief makes a level playing field, and provides 

clarity for investors. This, too, is a smart reform that is worthy of 

bipartisan support. 

The bill includes a number of other reforms. Many are technical, 

but they matter, particularly for smaller and growing BDCs. 

Every section of this bill shows thoughtful collaboration and improvements from previous bills. As the committee works through 

any fine-tuning on the bill, SBIA would encourage the committee 

to continue to keep the process moving and work to get real reform 

signed into law this Congress. 

I would welcome any questions that you may have for me. Thank 

you. 

[The prepared statement of Mr. Foster can be found on page 62 

of the appendix.] 

Chairman GARRETT. Thank you. 

And later on we will hear from the gentleman from Maine about 

whether he has any comments about the less use of paper products 

being produced. But we will wait for his comments later. 

Next, from Franklin Square Capital Partners, Mr. Gerber is recognized for 5 minutes. 

8 

STATEMENT OF MICHAEL F. GERBER, EXECUTIVE VICE 

PRESIDENT, FRANKLIN SQUARE CAPITAL PARTNERS 

Mr. GERBER. Thank you, Chairman Garrett, Ranking Member 

Maloney, and members of the subcommittee. Thank you for the opportunity to testify today. My name is Mike Gerber and I am an 

executive vice president with Franklin Square Capital Partners. 

Franklin Square was founded in Philadelphia in 2007 with the 

mission of offering institutional quality alternative investments to 

mainstream American investors, while leading the industry in best 

practices, transparency, investor protection, and education. To that 

end, we launched the industry’s first-ever non-traded BDC in 2009. 

We successfully listed that fund on the New York Stock Exchange 

in April of last year to create liquidity for our investors. 

Today, we manage four BDCs and have more BDC assets under 

management than any other manager in the industry. Franklin 

Square has investors in all 50 States, and we have portfolio companies in 39 States. Importantly, we have delivered strong risk-adjusted returns for our investors. 

As you all know, the 1980 law that created BDCs was passed 

with strong bipartisan support, and was designed to stimulate investment in U.S. companies by matching mainstream investors’ 

capital with mainstream businesses. Because BDCs are designed 

for retail investors, they are appropriately heavily regulated. 

In fact, whether traded or non-traded, BDCs are among the most 

highly regulated investment vehicles in the marketplace. And because of the extensive public filings, some of which you have seen 

right here, BDCs are fully transparent to regulators and investors 

alike. 

Our culture at Franklin Square is to embrace this regulation. In 

fact, it is part of how we market ourselves to financial advisers and 

investors. Specifically, BDCs register shares under the 1933 Act, 

and elect treatment as a BDC under the 1940 Act. In addition, a 

BDC is subject to the 1934 Act as a public company, meaning it 

must file 10-Qs, 10-Ks, 8-Ks and proxy statements. 

Contained in every Form Q and Form K is a schedule of all of 

our investments, along with details such as the name of the portfolio company, the size of the loan, the rate of the loan, and the 

current mark of the investment. 

Other key protections include mandatory third-party custody of 

all BDC assets; a board of directors, the majority of whom must be 

independent; and board approval of key matters such as management fees and quarterly valuations. In addition, our non-traded 

BDCs are also regulated by FINRA and by the blue sky securities 

regulators in all 50 States. 

Taken together, these laws and regulations ensure that BDCs 

are extremely transparent, minimize conflicts of interest, and provide investors with a high level of protection. 

One of the key mandates under the law requires BDCs to invest 

at least 70 percent of their assets in U.S. private and small cap 

companies. As a result, our BDCs at Franklin Square provided a 

significant amount of capital to middle-market job-creating companies. 

Middle-market businesses employ more than 47 million people, 

or one out of every three workers in the private sector. In fact, beVerDate Nov 24 2008 17:59 Feb 05, 2016 Jkt 096994 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\96994.TXT TERI
9 

tween 2008 and 2014, middle-market firms grew jobs by 4.4 percent versus 1.6 percent for big businesses, and unfortunately a 0.9 

percent decline with small businesses. 

And now 39 percent of middle-market companies say they expect 

to grow and add more jobs in 2015. Middle market lenders like 

BDCs, therefore, must be poised to provide the capital necessary to 

help fuel this anticipated growth. 

Currently, there are 84 BDCs representing approximately $70 

billion in investments. At Franklin Square we have deployed $27 

billion since inception, including $10 billion in directly originated 

loans. 

The primary tool offered by Mr. Mulvaney’s legislation that 

would help BDCs support more job-creating middle-market companies is the increase in the debt-to-equity ratio from 1-to-1 to 2-to1. We believe this increase in leverage is modest and makes sense 

for three reasons. 

First, BDCs would have more capital available to meet the demand of middle-market firms, while keeping all of our investor protections in place. Second, this would permit BDCs, as Mr. 

Arougheti explained, to build safer portfolios, delivering the same 

or higher returns, while taking on less risk. And third, even with 

the proposed increase, 2-to-1 leverage would still be quite low when 

compared to other lenders in the capital markets. 

For example, banks today are levered anywhere from 8-to-1 to 

15-to-1, and hedge funds are levered in the mid-teens to low 20s. 

We believe it would be good public policy to increase the lending 

capacity of BDCs, and promote the more heavily regulated, more 

transparent BDC model. 

The discussion draft contains several additional provisions which 

I address in my written testimony, and I would be happy to cover 

in Q&A. I would like to close by thanking Representative Mulvaney 

for his work on this legislation. And I look forward to answering 

questions from the committee. 

[The prepared statement of Mr. Gerber can be found on page 73 

of the appendix.] 

Chairman GARRETT. Thank you. 

Now from the Center for Capital Markets Competitiveness, Mr. 

Quaadman, welcome back to the panel. You are recognized for 5 

minutes. 

STATEMENT OF TOM QUAADMAN, VICE PRESIDENT, CENTER 

FOR CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER 

OF COMMERCE 

Mr. QUAADMAN. Thank you, Chairman Garrett, Ranking Member 

Maloney, and members of the subcommittee. 

Markets provide investors with the opportunity for return, and 

businesses with the potential to grow. Markets must have an even 

playing field and certainty in order to achieve these purposes. But 

we also live in a global economy. 

So this past February, the Chamber released a report entitled, 

‘‘International Markets: A Diverse System is the Key to Commerce,’’ which was written by Professor Anjan Thakor of Washington University. 

10 

And what the report found was two things: first, for businesses 

to operate in this global economy, they need to have diverse forms 

of financing; and second, capital will go to those markets that are 

most efficient, and businesses will go to where the capital is. 

Therefore, in this global competitive environment, we have to 

keep in mind that the United States is not the only destination for 

capital. Indeed others, including the European Union today, are 

currently considering proposals to make their market-based financing more efficient in order to spur their capital formation. So these 

bills and the hearings that the subcommittee has been holding this 

year are very timely. 

The business development corporations are filling a void for the 

midsized businesses and provide an alternative means to raise capital as other options have dried up over the years. We want to 

thank Mr. Mulvaney for introducing the Small Business Credit 

Availability Act, and we support it. 

While BDCs have only been in operation since 1980, it is only in 

the last few years that they have become an attractive means of 

capital formation for businesses. Indeed, the Chamber has supported past bipartisan efforts to increase BDC activity. And we believe that this bill addresses the concerns that were raised in prior 

legislative debates, as well as by the SEC. 

This bill will provide greater capital and flexibility investments 

while still having BDCs as a regulated entity. BDCs will increase, 

but still on a limited basis. 

The Chamber also supports robust disclosures and investor protections of BDCs so that retail investors have both the opportunity 

to understand the upside, as well as the risk of investing in BDCs. 

We believe that the Mulvaney draft bill achieves that purpose. 

I would also like to address the H.R. 2187, the Fair Investment 

Opportunities for Professional Experts Act. We need to have limits 

to allow sophisticated investors to invest in private companies and 

to access complex investment vehicles. We need to do this to ensure 

that unsophisticated investors are not harmed. 

The Chamber supports objective tests such as asset and income 

thresholds to determine accredited investors. Mr. Schweikert has 

thoughtfully pointed out that there may be some on the periphery 

who should be allowed in. And we have some suggestions on how 

to improve the bill. 

First, those who are licensed and certified to sell securities 

should be considered to be a sophisticated investor, but with caps 

to ensure that their investments match their financial wherewithal. 

Secondly, we understand the intent behind the FINRA test and 

think it is an innovative way to get at the solution. However, the 

test is also subjective. 

We would prefer that the SEC be authorized to study the issue. 

What are the characteristics of a sophisticated investor? What are 

some of the innovative ways to bring those in, in a safe manner? 

And then to have the SEC report back to this committee as to what 

those innovations should be. And that those should be brought in 

under limited circumstances. 

Additionally, we have concerns on the language regarding the 

use of financial intermediaries conveying an accredited investor 

status to retail investors. While we understand the intent behind 

11 

that provision, we are concerned that the exception will subsume 

the rule, that it will also place some unsophisticated investors at 

harm, as well as increase liability for financial intermediaries. But 

we think this is a good step forward, and we are happy to work 

with Mr. Schweikert to make the bill a reality. 

The Chamber feels that these bills will enhance the competitiveness and increase opportunities for return, growth, and job creation. We look forward to working with the sponsors of this legislation, both bills, with the subcommittee, and to improve them as 

well as to include these vehicles into a JOBS Act 2.0 that we hope 

can become law in this Congress. Thank you. 

[The prepared statement of Mr. Quaadman can be found on page 

81 of the appendix.] 

Chairman GARRETT. Thank you. 

Finally, last but not least, Professor Brown. You are recognized 

for— 

Mr. BROWN. ‘‘Jay’’ is fine. 

Chairman GARRETT. There you go. 

STATEMENT OF J. ROBERT BROWN, JR., PROFESSOR OF LAW, 

UNIVERSITY OF DENVER STURM COLLEGE OF LAW 

Mr. BROWN. Chairman Garrett, Ranking Member Maloney, and 

members of the subcommittee, it is a privilege to be here today. 

In addition to my position at the University of Denver Sturm 

College of Law, I also serve as the Secretary to the SEC’s Investor 

Advisory Committee (IAC). The remarks I make, however, are my 

own, and do not necessarily reflect the views of the other members 

of the IAC. 

With respect to H.R. 2187, the Fair Investment Opportunities for 

Professional Experts, and the definition of accredited investor, let 

me give a bit of context. The SEC’s definition of accredited investor 

for individuals was set out in 1982. While the dollar amounts have 

largely remained unchanged, the financial landscape has undergone a tectonic shift. 

The markets have of course grown in complexity. But most significantly has been the shift from pension plans to defined contribution plans. Almost everyone with retirement savings today has 

a 401(k) or an IRA. The result has been what I believe is a dramatic increase in individual responsibility for managing the retirement nest egg. 

Likewise, the number of retirees is increasing rapidly. Every day, 

10,000 Baby Boomers reach the age of 65, a trend that will continue until 2030. Many of these older investors are unsophisticated 

and lack, as one study put it, ‘‘even a rudimentary understanding 

of stock and bond prices, risk diversification, portfolio choice, and 

investment fees.’’ 

With the end to the ban on general solicitations, our retirees and 

other investors can now be offered unregistered investments 

through indiscriminate forms of mass marketing, including blast 

emails, ads on the Internet, infomercials, and seminars. So imagine 

our 85-year-old parent or uncle or friend who gets the unsolicited 

phone call or the pitch at a free lunch to invest in pre-IPO shares, 

or—I am from Colorado—the marijuana business. If that doesn’t 

12 

work, how about a children’s television network or a company that 

is making a grandchild-safe alternative to the Internet? 

All of this brings me to the definition of accredited investor. The 

definition needs to include those who are sophisticated and exclude 

those who are not. 

In reforming the definition, I believe there is more agreement 

than disagreement. There is agreement that it should be changed 

to include the people who are, in fact, sophisticated. The recommendation of the SEC’s Investor Advisory Committee has set 

out standards for when this should occur, basing sophistication on 

education, experience, and testing. 

The dollar thresholds also need reexamination. It may mean increasing the amounts. It also may mean changing the way the 

amounts are calculated. Maybe some portion of retirement assets 

should be excluded from the calculation. 

Even people who oppose changes to the numerical thresholds, I 

believe, are mostly worried that a sudden increase in the dollar 

amount will significantly reduce the number of accredited investors. But if the definition is reformed simultaneously to make the 

income and net worth standards a better predictor of sophistication 

and allow individuals to also qualify on the basis of education, experience, and testing, I believe that all sides in the debate will benefit. 

With respect to H.R. 2187, my written testimony has a more 

complete critique. But let me just offer these observations. First, 

the draft legislative proposal does not deal with our 85-year-old 

parent or uncle or friend who is in fact unsophisticated and qualifies as accredited because of the net worth test. 

Second, the bill treats as accredited whole categories of individuals, such as lawyers. Lawyers are not invariably rendered sophisticated as a result of education or practice area. Extending the definition to persons who are not sophisticated is of particular concern 

since these individuals are not required to meet the numerical 

thresholds and may not be in a position to withstand the loss. 

Finally, a serious risk is that regulators charged with implementing this legislation will stop other efforts. The bill leaves out 

other groups that ought to qualify as accredited as a result of experience and education. 

The SEC is working on a study in this area that ought to include 

some recommendations. The Commission is in a good position to 

achieve the grand bargain that I think is needed, and should be allowed to complete the process without legislative intervention. 

Very quickly with respect to business development companies, I 

think that the increase in leverage proposed under the legislation 

will raise the risk profile for at least some of these companies. But 

disclosure is an appropriate method of addressing the issue. 

My most significant concern is with the changes that would allow 

BDCs to redeploy a higher percentage of their assets away from operating companies to financial firms. In 1980, Congress, in adopting the legislation creating BDCs, sought to provide additional 

funding and managerial advice to operating companies. 

Why these companies? As the House report said then, the committee is well aware of the slowing of the flow of capital to AmerVerDate Nov 24 2008 17:59 Feb 05, 2016 Jkt 096994 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\96994.TXT TERI
13 

ican enterprises, particularly to smaller growing businesses, that 

has occurred in recent years. 

The importance of these businesses to the American economic 

system in terms of innovation, productivity, increased competition, 

and the jobs they create is of course critical, hence the need to reverse this downward trend is a compelling public concern. 

I suspect that this is no less true today than it was in 1980, and 

that these companies remain critically important to our economy 

and the creation of jobs. I think that any reform in this area should 

not change the framework in a manner that may disadvantage the 

very kinds of companies that the legislation was originally intended to assist. 

Thank you again for providing me with the opportunity to be 

here today. 

[The prepared statement of Professor Brown can be found on 

page 48 of the appendix.] 

Chairman GARRETT. I appreciate your comments. 

I thank the panel. And at this point, I will recognize myself for 

5 minutes for questions, and I will go in reverse order. 

And again, I thank the gentleman from Arizona for his work on 

the accredited investors change of definition. I guess our one 

takeaway from Professor Brown is that lawyers are not sophisticated. Will we have consensus on that from everybody on the panel 

that lawyers are not sophisticated? Okay. 

So, moving on from that degree of consensus, on the issue of accredited investors, isn’t it somewhat an issue of fairness too, as far 

as having drawn a distinction in class as to who is allowed to have 

the opportunity to these investors versus which class of people in 

the country don’t have the opportunity? 

What I was thinking as I heard the professor talk was that those 

people that you were defining, the retiree or what have you, currently probably don’t fit into that definition of accredited investor. 

But they have the opportunity to do all sorts of other investments 

with their money. 

Mr. Foster showed the disparity between BDCs and public companies. And those public companies are available on all the exchanges and what have you. 

And the unsophisticated investor can be making life-changing investments in all of those. Of course in most of those investments, 

you don’t necessarily see the rate of return that you sometimes see 

in a BDC. I see some nods on that. 

So is this—maybe I will throw it out to Mr. Gerber. Is this an 

issue of degree of fairness as far so this distinction that will be allowing those who should be able to have the opportunity to get into 

these investments who currently are precluded simply by law? 

Mr. GERBER. Thank you, Mr. Chairman. Just a point of clarification— 

Chairman GARRETT. I should probably not have thrown that to 

Mr. Gerber. 

Mr. GERBER. No, that is okay. But I just think it may be important to mention this on behalf of the BDCs. To invest in a publicly 

traded BDC, a person does not need to be an accredited investor, 

number one. 

14 

Number two, to invest in a non-traded BDC, investors—that 

transaction is regulated by the blue sky laws in each of the States. 

And all of the States have their own suitability standards that 

apply to whether or not an investor is appropriate for— 

Chairman GARRETT. So let me throw it over to Mr. Quaadman 

as far as the rest of the investment field. 

Mr. QUAADMAN. Sure. Chairman Garrett, you raise a very good 

question, because we have a robust private company market. 

Most businesses in the United States are private. So what we 

need to do is ensure that we have capital flows into those private 

companies to ensure that they have the liquidity to grow and operate. 

What is also important is that with public companies, we have 

a vast amount of disclosure with the notion that investors can go 

in there and make whatever decisions they want because they can 

access the information. 

What we want to do with the private companies is ensure that 

you have people with the knowledge base and the wherewithal to 

go in there and to invest in companies. 

Chairman GARRETT. Let me stop you there and go back to Mr. 

Gerber then because he was saying that these are not—which is 

correct. It was with regard to accredited investors in BDCs. 

Satisfy for me then that there is enough transparency, information, and the like for that class of non-accredited or non-sophisticated in that realm. 

Mr. GERBER. With respect to BDCs, as I mentioned in my testimony, Mr. Chairman, we fall under the 1933 Act, the 1934 Act, 

and the 1940 Act. So in the BDC context, there is a load of transparency and a ton of information that is provided to investors, just 

the same as a publicly traded company. 

Chairman GARRETT. So who is it when you are trading in these 

and—where has that information actually gotten to? In other 

words, where the investment is certainly done through your broker 

or what have you, in the securities in the street name, is that actually getting back to me as the nominal investor in that situation? 

Mr. GERBER. It certainly can be. It is available on the SEC Web 

site EDGAR. It is available on all of our Web sites. So it is easily 

accessible. 

Chairman GARRETT. So what about—and I will throw this to 

anybody else to talk about the BDCs. What about what is in Mr. 

Mulvaney’s bill as far as changing the leverage ratio—the ratio? As 

far as getting sufficient transparency there back to the actual investor who may not actually be in the—may not actually be the 

street name investor? Anyone who wants to chime in on that? 

Mr. AROUGHETI. Yes. I think we talked about this proposed legislation relative to prior attempts to increase the asset coverage 

ratio, I think the combination of a form of shareholder vote and a 

‘‘cooling-off period’’ provides the adequate shareholder protection. 

So as this bill contemplates, the independent board of directors 

would make a determination that they would like to access the increased asset coverage ratio. And then under the securities regulations, an 8-K would need to be filed publicly to make public notice 

of the intention. 

15 

And then obviously the shareholders will have 12 months of a 

cooling-off period to effectively vote with their feet. So even in the 

event that there wasn’t a shareholder vote— 

Chairman GARRETT. Right. 

Mr. AROUGHETI. —it would give people free time to determine 

whether or not they wanted to stay within that investment. 

Chairman GARRETT. Okay. Great. Thanks. I appreciate that. 

I have some other questions with regard to the testing requirements, but I will throw it to the gentlelady from New York. 

Mrs. MALONEY. Thank you, Mr. Chairman, for calling the hearing. And I thank all the panelists. 

I would like to ask Mr. Arougheti about the additional leverage 

that the BDC bill would allow. Of course, we are still talking about 

very low levels of leverage. 

The bill would only increase the maximum leverage ratio from 1- 

to-1 to 2-to-1. But it is still a higher leverage. What would your 

company do with the higher leverage that this bill would permit? 

Mr. AROUGHETI. I think, as Mr. Gerber said in his testimony, it 

is not abundantly clear that every company will actually take advantage of the incremental asset coverage ratio. 

I think one of the wonderful things about the BDC industry is 

that it services all types of companies from venture finance companies all the way through two larger middle-market companies. And 

even on this panel you have companies who focus on the lower middle-market with more equity orientation through to folks like ourselves who focus more on larger market senior secured loans. 

So what Ares would likely do would be to increase the scope of 

its lending activities, probably become more senior secured and 

therefore less risky in our investment positioning, and use the increment to leverage, back to Mr. Gerber’s commentary, to drive the 

same, if not higher returns to our investors but taking less risk at 

the asset level. 

Mrs. MALONEY. So how much of the additional money would go 

to increase investments in the so-called 70 percent bucket for small 

businesses? It would give you more money to—more liquidity to put 

out to these smaller businesses. 

Mr. AROUGHETI. Right. So, all of that capital should theoretically 

find its way to small business. 

Maybe addressing at least for Ares the 30 percent basket as we 

use it has two concentrated positions in it today. One is called the 

senior secured loan program, which is a joint venture that we had 

with GE Capital that we used to actually make middle-market 

loans. And the second is in the form of a company that we call Ivy 

Hill Asset Management, which similarly is in the business of making middle-market loans. 

So at least from the Ares strategic perspective, we have been 

using our ‘‘30 percent basket’’ to in fact make middle-market loans 

to small companies. 

Mrs. MALONEY. I would like to ask you and also Mr. Foster about 

the discussion draft of the BDC bill, which would allow BDCs to 

invest more of their assets in finance companies. And as Mr. Foster 

testified, the intent of the first BDC bills was to direct these monies towards goods and services that are really underfinanced and 

need this help. 

16 

Are you concerned that this change could change how BDCs are 

viewed by investors and analysts? And what is your feeling about 

being able to invest more in finance companies as opposed to goods 

and services? 

And I would like first to hear from Mr. Foster and Mr. 

Arougheti. But also any comments from anybody else on the panel 

on this question of allowing the finance companies. 

Mr. FOSTER. Sure. 

The BDCs in the SBIA have generally been polled by the staff. 

And in general there is a consensus with respect to the BDCs, the 

34 BDCs in the SBIA—not 100 percent, but a general consensus is 

that this additional flexibility would be nice. It is not a priority at 

all. 

And I don’t think many of us would take advantage of it. We personally would not take advantage of it. I think you would do so at 

your own risk to the degree you alienated some of your shareholders or what have you by changing your business plan. 

On the other hand, we are permanent vehicles for capital. And 

there is a constantly changing array of investment opportunities 

out there. And the credit cycle goes up and down. 

So to me, it is kind of like the swimming pool in the backyard. 

I really don’t use it, but it is nice to know it is there if I ever want 

to use it. And I think that is the general consensus of the SBIA. 

Mrs. MALONEY. Mr. Arougheti, do you— 

Mr. AROUGHETI. Yes. I think about this two ways, one just in the 

context of modernization. 

And as we sit here today talking about legislation that was 

passed 35 years ago, while many things are still similar in terms 

of the capital void for middle-market companies, the structure of 

the financial markets has changed. And things like small ticket 

leasing, things like factoring, things like receivables financing, all 

exist today in a way that they didn’t exist 30 years ago. 

So as one example in our portfolio, we have a leasing company 

that makes office equipment leases to small business— 

Mrs. MALONEY. Okay. My time has almost expired and I would 

like to hear Mr. Foster’s reaction to it, too. I only have 7 minutes 

left. Excuse me—Mr. Brown’s— 

Mr. BROWN. My biggest concern is that there will be funds redirected away from operating companies and to these financial firms. 

I don’t know if financial firms need the funds in the same way 

that operating companies do. But there is a defined need here for 

operating companies. And I think before the legislation allows for 

the redirecting of funds away from those companies, it should have 

a stronger empirical basis for determining that, which is a more 

appropriate use of funds. 

Chairman GARRETT. Thank you. 

The gentleman from Texas is recognized for 5 minutes. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. Thanks for holding 

this hearing. 

Mr. Arougheti, Mr. Brown had said that increasing the leverage 

ratio would be harmful to—has the potential to be harmful to the 

investors. But what I heard you saying is that you would use that 

leverage in a way that enhances shareholder value, wouldn’t you? 

17 

Mr. AROUGHETI. Yes, I would. I believe, and I think it is just 

common knowledge in the investment business that the introduction of leverage could amplify risk the same way it could amplify 

returns. 

So I would be remiss to say that there is not the possibility that 

it could theoretically improve risk. But what I believe Mr. Brown 

also said is that the benefits, provided there is adequate disclosure, 

which this legislation provides for, far outweigh those potential 

risks. 

One thing I think is worth highlighting is that the structure of 

the market already accommodates the leveraging of lower risk assets. 

In fact, within the BDC industry, where we borrow from banks 

they give us a schedule of investments identifying how much they 

are willing to leverage our various investments. And from that list, 

starting with common equity all the way up through senior secured 

loans, what you will see is a market’s unwillingness to leverage equity investments and a market’s willingness to leverage senior secured loans well in excess of the proposed 2-to-1. 

So, outside of the BDC construct, the idea of risk-based leverage 

is pretty well-established. And even within the BDC framework, 

the existing leverage facilities are already in place to accommodate 

that changing leverage requirement if the 1-to-1 overlay were widened. 

Mr. NEUGEBAUER. So, if this bill passes and becomes law, you 

don’t see this big rush out to all these companies to leverage up 

because basically it is going to—you have a business model and 

there is certain amount of opportunity out there to determine how 

you can best fund that. 

Mr. AROUGHETI. Yes. I think that is exactly right. And again, one 

of the things that we have seen over the last decade is that BDCs 

have grown. 

As I mentioned, there are various business models. There are 

certain BDCs who lend exclusively to venture-backed companies 

who may be pre-revenue or pre-cash flow. And those will attract a 

certain amount of de minimis leverage. 

And then there are people like ourselves who would probably be 

moving into lower risk senior secured leverage and attract a different balance sheet profile. So I think that is one of the nice 

things about the bill. 

Mr. NEUGEBAUER. So do you see this, the growing of the BDC 

market increasing as the—as we see the diminished participation 

in the banking community? 

Mr. AROUGHETI. Yes, I do. I think the growth in the BDC market 

has been significant, but not nearly enough to keep pace with the 

growing capital void. So I would hope that this legislation would 

in fact spur capital formation. 

Mr. NEUGEBAUER. And from the panel—these are some thoughtful ideas—are there other things in that space that we need to be 

thinking about that is under-addressed in this legislation that 

would encourage the BDC activity and help—more importantly 

help small businesses access capital? 

Mr. Foster, you look like you— 

18 

Mr. FOSTER. Thank you. Yes. The first thing that is going to happen, all three of us, our investment grade rated by the S&P, we are 

the most creditworthy of the BDCs out there. 

And the first thing we are likely going to do if the legislation 

passes is sit down with the rating agencies and talk about their reaction, if any, to it. And they probably won’t have a reaction—just 

because we can have more leverage doesn’t mean they are going to 

allow us to have more leverage. And I don’t think any of us are 

going to take on more leverage if it means a ratings downgrade. 

Similarly, like Mr. Arougheti said, we will sit down with our 

banks and say what, if anything, are you willing to provide us now 

that we have the ability to have slightly more leverage? And so 

there is a lot of self-correcting mechanisms, the way we all operate, 

where you are not going to see a huge amount of immediate 

leveraging. 

You are going to sit down with your constituents. You are going 

to figure out what makes sense. But I think the shareholders are 

the winners at the end of the day. And I think that there are businesses out there that we can’t reach that we are going to be able 

to reach. But I think that it will be selective and I think it will 

take some time. 

Mr. NEUGEBAUER. Mr. Quaadman? 

Mr. QUAADMAN. Sure, Chairman Neugebauer. Just two points I 

wanted to make with that. 

One is if this bill were to pass, become law, we would see the activity move forward. I think this is also a great example of something that should be taken up by Mr. Hurt’s retrospective review 

bill that was raised in the last hearing, that the SEC can come 

back in 5 years and take a look at the activity to see if anything 

needs to be changed, or how BDC activities can be changed more 

to become a better capital formation facilitator in the marketplace. 

The other point I just wanted to raise, too, and this goes back 

to the last question with the 50 percent cap, my recollection is with 

the previous bills that were under consideration the last Congress, 

there was no such cap. So this 50 percent cap in the Mulvaney bill 

actually provides a low or potentially lower level to financial companies, which I think actually helps operational companies in that 

regard. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. 

Chairman GARRETT. The gentleman’s time has expired. 

The gentleman from California? 

Mr. SHERMAN. Thank you. 

Mr. Brown, one definition that would be added is for accredited 

investors or those who have retained or used the services of various 

advisers. As you understand the legislation, would that mean that 

an investor could just retain the advice of an adviser who is affiliated with, selected by, or compensated by the issuer? 

Mr. BROWN. I don’t think there is anything in the legislation that 

prevents that. It defines categories and all you have to be is in one 

those categories of people in order to be considered someone who 

can provide the services that transform you into an accredited investor. 

Mr. SHERMAN. So, if I had a product I wanted to get investors 

in, and let’s say I have a perverse interest in selling to those who 

19 

couldn’t even afford the risk, I could just have a CPA or lawyer on 

staff and say you could advise each investor, and I will pay you to 

do it. And/or you will earn a commission with regard to the investment. 

I don’t see any of the other witnesses anxious to contradict that. 

So I hope we would correct that in the legislation and say that if 

you are going to be an accredited investor because you have a good 

adviser, that adviser better not be affiliated with, selected by, or 

compensated by the issuer. Nor should his or her compensation depend upon whether the investor chooses to make the investment. 

We have—back when I was in the business world, which was a 

long time ago, we established this million-dollar rule; a million dollars now isn’t even a good house in many parts of my district. And 

this $200,000 income used to be those who were really rolling in 

money. 

I would point out that even Members of Congress would be mak- ing $200,000 if we hadn’t legislated to prevent ourselves from getting cost-of-living increases. And I would hope that we would take 

a look at this. 

If we are going to liberalize the rule by saying well, you are 

going to get good advice, you don’t have to be a millionaire. We 

would realize in today’s world a millionaire is somebody who has 

at least a couple million bucks. 

To say that somebody is a millionaire because they have a net 

worth of a million ignores the inflation over the last 20 or 30 years. 

As to leverage for the BDCs, what we have in our economy now is 

all the money is locked in banks and other very risk-averse investors. 

If you want to get a prime loan or a prime plus 1 loan, you can 

get 10 banks to bid on it. You get all the money and they beg you 

to take more and you say no. If the U.S.—if the German government wants to borrow money, you have to pay them to take it. 

So, those that are—the money is locked up. And if we can get 

some of that money lent to BDCs and then through BDCs, extend 

it to the companies that really need it and that are growing and 

that—or might grow. And then have some risk; that is moving the 

money from this little sheltered world where it only gets lent to 

sovereign governments and et cetera and gets out. 

Which is why I am a bit reluctant to—I think Mr. Brown commented on this—to see the BDC money then go to financial institutions. It is the financial institutions that already have enough 

money. 

Does anyone here—I will address this to Mr. Foster, but anybody, have any economic analysis that said not as good for investors? And you do have to be here just for your investors. But that 

it is good for the economy to create another pipeline so that investment money goes to those in the financial sector. 

Mr. FOSTER. Sure. Well, yes. We have investments. And Mr. 

Arougheti has one too. We have—and probably Mike as well. We 

have investments in leasing companies that might have to occupy 

a small role in our 30 percent bucket. And would it be nice to not 

have to worry about that if another leasing company came in because the leasing company’s equipment leasing companies, they are 

helping operating businesses, right. So just because— 

20 

Mr. SHERMAN. And in a lot of ways, they are your business. 

Mr. FOSTER. Yes. We— 

Mr. SHERMAN. They are financing the same people you are financing. 

Mr. FOSTER. Yes. But I think our members think that the 30 percent bucket is adequate to deal with those. We welcome it. It would 

be nice if it were bigger. But I just don’t see it as a priority to— 

Mr. SHERMAN. Should all financial— 

Chairman GARRETT. The gentleman’s time— 

Mr. SHERMAN. My time has expired. 

Chairman GARRETT. Mr. Huizenga is now recognized for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. 

And actually I will kind of continue on the line of questioning 

that my friend from California had. And I might add, while I might 

question your judgment on things on occasion, politically I would 

view you as a qualified investor. I would hope that reasonably educated people who can go do this would be able to go in and make 

these types of decisions. 

So I am kind of curious about this—sort of this fiduciary issue 

that seemed to be the pursuit, and about compensation. And Mr. 

Gerber, when the little exchange was happening you had a very 

contemplative look on your face. I am curious if you were looking 

to try to respond to that or any of the others. 

And then Mr. Quaadman, you had mentioned that from your perspective, quickly, at the end of I think it was Mr. Neugebauer’s 

questioning about you believe that this could help operational companies. And I wanted to expand on that a little bit. 

And then Mr. Arougheti, you had talked a little bit about adequate protection. So that is kind of that direction I would like to 

go. 

And Mr. Gerber, I don’t know if you care to lead off, if you had 

something to say about that fiduciary element? 

Mr. GERBER. I am not sure exactly which period of the discussion 

you are referencing. But I think what— 

Mr. HUIZENGA. I think it was like the time of compensation for 

someone who was giving advice, where that compensation would 

come from. 

Mr. GERBER. Yes. The thought that was crossing my mind at the 

time, because there are some related issues between these two 

bills, and the gentleman from California was asking questions 

about conflicts of interest. And that has come up with some of the 

provisions in the BDC legislation as well where there could theoretically be an adviser-issuer conflict. 

And that is something that Congressman Mulvaney has tried to 

address in the BDC legislation by ensuring that the SEC would 

have an opportunity to review those types of conflicts. And I think 

that is an improvement over the legislation, the BDC legislation. 

And again, it is not a priority for Franklin Square, but it is something that we think is important to consider on behalf of the industry and on behalf of investors in the BDC industry. And we were 

pleased to see that addressed in Mr. Mulvaney’s draft legislation. 

Mr. QUAADMAN. Sure. Chairman Huizenga, the point I was trying to make is in the previous BDC legislation that was considered 

21 

in the last Congress, there was no such 50 percent cap on financial 

companies. So, theoretically, a lot more than just 50 percent could 

have gone in. 

The current draft actually provides a ceiling. So theoretically, 

with that ceiling you would have a certain amount that would have 

to go to operational companies. 

Frankly, if you take a look at the BDC model historically, they 

are going to be investing in operational companies anyway. But I 

think this creates a ceiling where there hadn’t been one before. 

Mr. HUIZENGA. And the vast majority of your investments, right, 

the gentleman that actually are involved in the BDCs here, they 

do go into operational companies. Correct? 

Mr. GERBER. Absolutely. 

Mr. QUAADMAN. Okay. Mr. Arougheti, you had the microphone 

there for a second. Why don’t you talk a little bit about the adequate protections that you thought were in there for those investors? And that seems to go back a little bit ago, so I don’t know 

if you remember uttering that, but I do— 

Mr. AROUGHETI. Yes. It is interesting because I think people 

have been focused appropriately on regulation and shareholder protection. 

I will just reiterate some of the things that Mr. Gerber said in 

his testimony that as far as financial services models go, you can’t 

get more transparent than a BDC. 

We have a quarterly schedule of investments where we delineate 

every investment in the portfolio. If you juxtapose that with a bank 

balance sheet, as an example, it would be very difficult for anybody 

in this room to actually open up a public filing for a bank and figure out exactly what they own. 

Now, they are under a completely different regulatory regime, so 

that is not to say that they are bad investments. But I think it is 

important that we always get re-grounded in the transparency and 

the regulatory framework under which we operate. 

Vis-a-vis the increase in leverage, a very positive change in the 

new legislation being introduced is this idea of shareholder protection through a cooling-off period. 

I personally believe that the investor community will welcome 

this change and it will actually create a significant amount of renewed interest in the BDC space from both retail and institutional 

investors. 

But the idea of giving the retail investor the opportunity over a 

prolonged period of time to vote with their feet I think is a very 

innovative way to give them the adequate protection that certain 

people are trying to give them. 

Mr. HUIZENGA. Okay. Any concerns, anybody, about whether 

there might be leveraged money allowed to be leveraged again in 

this if you were changing that ratio? That had been—someone had 

brought up to me that sometimes these investors into the BDCs are 

using leveraged money. 

So my time has expired. But thank you. 

Chairman GARRETT. Thank you. 

Mr. Hinojosa is now recognized for 5 minutes. 

Mr. HINOJOSA. Thank you, Chairman Garrett. And thank you, 

Ranking Member Maloney, for holding this hearing. 

22 

It seems to me that when it comes to innovation the United 

States is the envy of the world. And we are the envy not only because our economy values and rewards entrepreneurship and hard 

work, but because our markets are transparent, safe, and liquid. 

My first question goes to Professor Brown. The discussion draft 

of the Small Business Credit Availability Act creates multiple 

classes of preferred stock, each with different shareholder rights. 

With different characteristics and rights, do the new classes of preferred stock pose risk to retail investors? 

Mr. BROWN. I think that there are advantages to multiple classes 

of preferred stock. And of course operating companies today have 

that authority. 

I think that this draft legislation eliminates some investor protections that are associated with preferred shares. And I think that 

is of concern. I think the idea that this legislation would limit the 

purchase of those shares to qualified institutional buyers is a helpful way to approach that. 

My concern is actually not with the purchase of preferred shareholders, but the common shareholders. This bill would strip away 

the obligation to have voting rights on those shares. But it would 

also allow for things like super-voting stock, at least as I read the 

legislation. 

There is no legislation of voting rights anymore if this bill passes 

as is. So in theory, a board of directors could transfer voting rights 

away from the common stockholders and to the preferred shareholders. 

I actually have a suggestion in my testimony as a way that I 

think that should be fixed. I don’t think that authority should be 

allowed. 

Mr. HINOJOSA. Mr. Brown, as you know, H.R. 2187 would classify 

brokers, investment advisers, accountants, and lawyers as accredited investors. The legislation assumes that these persons or entities by nature of their profession are sophisticated enough to understand the private securities offerings under Regulation D. Do 

you have any concerns for these classes of persons being deemed 

sophisticated under the law? 

Mr. BROWN. Congressman, I sure do. And as I mentioned in my 

testimony, I know lawyers, obviously the best. I teach them. I am 

around them all the time. They are not an inherently sophisticated 

group of people, at least when it comes to investments. 

The education—we have plenty of lawyers in this room. In your 

law school education, you are not taught about the intricacies of 

complex investments. We are lucky if students take corporations or 

securities at all. And then those courses don’t really prepare you. 

So unfortunately, the way this is drafted right now it doesn’t 

take into account age. It doesn’t take into account experience. And 

really you can’t really rely on education as a way of saying that 

they are sophisticated. So I am concerned about those categories. 

Mr. HINOJOSA. Thank you. 

My next question is to Vincent Foster. 

Pursuant to Section 413 of Dodd-Frank, the SEC is currently 

working on a study of whether it needs to redefine its current accredited investor definition. Rather than jumping in with a legislaVerDate Nov 24 2008 17:59 Feb 05, 2016 Jkt 096994 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 K:\DOCS\96994.TXT TERI
23 

tive fix, do you think we should wait to see how the SEC comes 

out on any changes to the definition? 

Mr. FOSTER. I don’t think the SBIA really has a position on that 

because we are dealing exclusively with either SBIC funds that 

have as their investors accredited investors, or SEC-registered companies that have as their investors retail and institutional shareholders, which is accompanies by extensive disclosure and generally full liquidity for the shares. And so I don’t think we really 

have a position on that. 

Mr. HINOJOSA. Okay. 

Next question is for Mr. Arougheti. In your testimony you have 

indicated that commercial banks and other traditional financing 

sources continue to retrench the business of providing loans to 

small and medium-sized companies. Can you elaborate on your prepared testimony and provide us some insights into why you think 

this retrenchment is happening? And what, if anything should be 

done to ensure that those small and medium-sized businesses have 

adequate access to capital? 

Mr. AROUGHETI. Sure. I will try to be brief. It looks like we are 

pressed for time. But I think it is important to put this in historical—I’m sorry, Mr. Chairman. Should I—? 

Chairman GARRETT. You can finish. 

Mr. AROUGHETI. To put it in a historical context, because the 

shift from banks to nonbanks, or what we would call parallel 

banks, has actually been occurring for about 25 years. And it started in the late 1980s with a big wave of bank consolidation in this 

country. 

So I just think it is important that we clear the misperception 

that this is a post-Great Recession issue. This has been happening 

in this country for 25 or 30 years. I think it has accelerated post 

the Great Recession for a whole host of market-based and regulatory reasons. But I don’t think there is any one issue. 

I think something that has gotten some discussion is also just 

talent. I think a lot of the folks like ourselves who are classically 

trained within bank credit programs have frankly fled the banking 

industry and now reside in firms like BDCs. And I think that is 

part of it. 

Mr. HINOJOSA. Thank you. I yield back. 

Chairman GARRETT. Thank you. 

Mr. Stivers, you are recognized for 5 minutes. 

Mr. STIVERS. Thank you, Mr. Chairman. 

Chairman GARRETT. Thank you. 

Mr. STIVERS. Thank you, Mr. Chairman. I appreciate you holding 

this hearing on this very important issue of access to capital and 

capital formation in our economy. And as the Chair of the Middle 

Markets Caucus, I know how important middle-market companies 

are, not only in Ohio, but throughout our country. 

They represent about 200,000 businesses, about a third of our 

economy. They employ 47 million Americans, and BDC loans in 

that middle-market marketplace have tripled, in fact, over the 

last—since 2008, I believe, so a lot of money. Currently BDCs net 

about, I think, and somebody can correct me if I am wrong about 

this, $70 billion of outstanding middle-market loans. 

24 

So my first question is for Mr. Arougheti. Can you please help 

this committee and everybody understand how this bill would help 

impact capital access to these very important middle-market firms 

by allowing BDCs to have greater access to capital and leverage? 

Mr. AROUGHETI. Sure. I think a real-life example, but just to understand why BDCs are so attractive as capital providers. We are 

permanent capital vehicles. So we have many of our portfolio companies who view us as their bank, their lender of choice. And we 

try to service them throughout their entire lifecycle. 

So we have 250 portfolio companies, a number of whom we have 

been lending to for 10-plus years in a whole variety of different 

ways. It all comes down to scale and product capability. 

And the broader our product set, i.e., if we can service those 

same clients and customers with senior secured asset based loans 

that currently don’t meet the economic requirements of the BDC, 

that will be a good thing for those underlying companies. 

To the extent that the banks can provide some of that marginal 

credit, I think that is a good thing as well, because that just promotes more competition and more healthy cost of capital to the investors. But I think it is really about the increasing mandate that 

the asset coverage test would provide us. 

Mr. STIVERS. I appreciate that. And clearly BDCs add value to 

the economy, are adding a lot of value to these middle-market companies that are in many cases family-owned, and in a lot of cases 

fast-growing and employing as I said 47 million Americans. So I 

want to thank all of you for your willingness to do that. 

I do want to quickly hit on transparency and protections because 

I think that is important. With regard to transparency, I think, Mr. 

Gerber, you said it really well when you talked through the quarterly reports you have to do where you do a whole review of your 

portfolio by company, by amount. No bank does that. No other financial institution in the capital markets has that kind of transparency, do they? 

Mr. GERBER. That is right, Congressman. And I think that is one 

of the reasons why we are all very comfortable making the recommendations we are making. It is because of the power of the 

transparency behind the model of the BDC. 

And you are right. When you compare us to other lenders, even 

if we were to go to 2-to-1 leverage, it would still be far less leverage. 

And I think Mr. Arougheti addressed this in his comments, far 

less leverage than the other lenders against which we compete. 

And I mentioned it earlier as well. Banks are anywhere from 8-to 

15-to-1. Hedge funds are in the mid-teens. We are just talking 

about 2-to-1. But it is 2-to-1 in a far more transparent model. 

So as Mr. Arougheti said, you cannot go to a bank’s balance 

sheet or filing and find a schedule of investments like you can in 

a BDC. And we all know you certainly can’t do that in a private 

fund, whether it is a private credit fund or a hedge fund that is 

engaging in lending. 

So it is the most transparent form of lending in the marketplace. 

And we are—even if we go to 2-to-1, it is one of the lowest levels 

of leverage. 

25 

Mr. STIVERS. And I would like to just give you a second to expand upon that because today you are absolutely the lowest leverage at zero. But if you went to 2-to-1 leverage, that would be between 4 and 10 times less leverage than your competitors in the 

marketplace employ. 

Mr. GERBER. That is right. 

Mr. STIVERS. Thank you. 

And the last thing I do want to hit on is protections with regard 

to accredited investors. We all did laugh at the lawyer joke. And 

I think we should cut all their bills by about 50 percent because 

of how unsophisticated they are. 

But I do think that—I was in the investment adviser business. 

If you pass a Series 7, you are pretty sophisticated, I would argue. 

If you pass—my sister is an accountant and their exams are really 

hard. You are pretty sophisticated if you are an accountant. 

We can all debate the attorneys, I will give you that. But clearly 

most people in those professional educations are way more sophisticated than just being worth a million dollars—would you say that 

makes somebody more sophisticated than just being worth $1 million, regardless of how they got it, Mr. Gerber? 

Mr. GERBER. I don’t consider myself an expert on this one— 

Mr. STIVERS. Okay. 

Mr. GERBER. —Congressman. 

But what I would like to say to you is that when you just look 

at arbitrary numbers, I don’t think you are getting into a substantive consideration. And I think the proposal before us is driving at the notion that we ought to be considering something other 

than just arbitrary numbers. 

And I don’t know that anybody on this panel would disagree that 

sometimes the substance of someone’s background may be more 

meaningful in terms of their level of sophistication than just the 

assets that they have in their possession. 

Mr. STIVERS. Thank you. 

Thank you all. I am out of time. I yield back the balance of my 

time. But thanks for being here. 

Chairman GARRETT. Thank you. The gentleman yields back. 

The gentleman from Massachusetts, Mr. Lynch, is recognized for 

5 minutes. 

Mr. LYNCH. Thank you, Mr. Chairman. And I want to thank the 

members of the panel. You have been helpful. 

Let’s drill down on that a little bit, though. Under the terms of 

the bill right now, H.R. 2187, a personal injury attorney with no 

other requirements would be able to self-certify as an accredited investor. Isn’t that right, Mr. Quaadman? 

Mr. QUAADMAN. I believe you are correct, and that is one of the 

reasons why we said there should be an SEC study to see exactly 

what those characteristics are. 

Mr. LYNCH. Right. 

Mr. QUAADMAN. So we think Mr. Schweikert is going down the 

right path. But maybe it is also good to have the SEC look at it 

and then report back as to what some of those substantive different 

changes should be. 

Mr. LYNCH. Right. I totally agree. 

26 

And I think for the CPA side of this, someone who does your 

taxes once a year doesn’t necessarily know what we are talking 

about in many cases—27 of these BDCs are private, they are nontraded. So they are rather opaque investments. 

And I don’t think the average tax attorney or personal injury attorney, excuse me, would necessarily be able to drill down and 

make a good determination whether or not that investment is right 

for themselves or for others. 

The bill also says that as long as you hire a registered brokerdealer, that allows you to make that investment as well in a BDC 

that might not have the information public. Mr. Brown, does that 

create a problem? 

Mr. BROWN. I certainly believe that it does. 

If we go back to my 85-year-old parent or uncle or friend, and 

we were to say if they happen to have a lawyer who maybe was 

their estate planner or a CPA, as you say, who was doing their tax 

returns, and those two people gave them some investment advice, 

is that person really suddenly transformed into someone who is sophisticated just by virtue of the relationship? Not necessarily. 

Mr. LYNCH. Okay. I want to ask you something else. 

Professor Brown, as you are aware, Congress passed and the regulators have finalized the Volcker Rule to prohibit banks from 

using their taxpayer-backed deposits to make proprietary trades. 

The final rule accomplished this by requiring banks to divest from 

certain assets. 

However, BDC funds were excluded from that definition. And for 

purposes of defining affiliation as well, BDCs were not considered 

to be affiliated with a bank so long as the bank’s ownership of the 

fund was under 25 percent. 

Recently, Goldman Sachs took a BDC public. They retained a 20 

percent share in the company. Credit Suisse has also formed a 

BDC. I am not sure what their retention is. Should we be concerned now that even before the Volcker Rule is effective we are 

already tinkering with an asset class that may enable banks to reengage in proprietary trading? 

Mr. BROWN. I can say that it concerns me. And my concern is— 

there are a couple of them. But one of the ones is that banks, when 

they form these other entities, especially when it is the big commercial banks, the market just judges them differently. 

Sometimes the market thinks that the big bank is making an implicit guarantee of backing that company even if they only own less 

than 25 percent. 

Mr. LYNCH. Right. 

Mr. BROWN. That other company gets a break on—the company 

can borrow at a cheaper rate. I might be able to do things that 

other BDCs can’t do. So I worry very much when banks get into 

space like this that it may dramatically change the nature of that 

market. And it frankly may give them a competitive edge that 

other BDCs don’t have. 

Mr. LYNCH. Okay. Thank you very much. 

Mr. Chairman, I yield back. 

Chairman GARRETT. Thank you. The gentleman yields back. 

The gentleman from Arizona, Mr. Schweikert, the author of the 

legislation before us today, is now recognized. 

27 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. And we will walk 

through a couple of the things, and maybe if one or two of the misunderstandings and then work through—work a little backwards 

from there. 

First of all, I think for all of us here there is an understanding 

that we have both the societal problem and some other mechanical 

problems. My understanding is that of our 318 million population 

right now we have only about 600,000 Americans who have gone 

through the process who are qualified investors. 

We know that half of our Baby Boom population is moving into 

retirement with very, very little savings. So part of our goal here 

is how do we move more of our population into the investment 

class, and do it in a safe and rational fashion? And so I actually 

have been working on this bill for a while, but quite open to any 

brilliant suggestion. 

I do want to go over a couple of things, just because one I think 

was sort of a misunderstanding, a misstatement. Under current 

legislation right now, under a current law 506, if you are the lawyer, if you are the CPA, if you are the registered broker-dealer, you 

get to certify someone as being a qualified investor. It doesn’t make 

you a qualified investor. 

The second part of that is the way the bill is drafted right now, 

if you were to hire one of those people for guidance, it would allow 

you to invest in some of these products. Maybe that is where it 

needs to be tightened up. 

And my first question, Mr. Chairman, and it was actually to Mr. 

Brown, just one quick one. You are actually on the SEC’s committee that has been somewhat looking at the definitions of qualified investor? 

Mr. BROWN. Yes, sir, I am. 

Mr. SCHWEIKERT. Would I be pushing the limit of getting too 

complicated and too, I will use the word ‘‘sophisticated,’’ to also 

look at it as saying a 30-year-old who just happened to do really 

well that year who has $50,000 of risk capital is a lot different 

than your 80-year-old mother example? 

Would you be also willing to support an idea that also would put 

some time as part of one of the kind of counterbalancing—or age 

as one of the counterbalancing factors? 

Mr. BROWN. Absolutely. And when I read your draft, there is no 

question in my mind that was a good-faith effort to try to address 

a problem that the Investor Advisory Committee agrees is there, 

which is how to let people who are sophisticated in fact, actually 

sophisticated, irrespective of the dollar amounts, to invest. The definition should allow for that. 

We are in complete agreement. I should say I am, but the committee’s recommendation. 

I do think, for example in the testing area, in your language in 

the bill I think there should be a provision in that says the test 

only lasts for so long. I think if somebody is 30 and then they— 

I don’t want them to have taken it once and then at 80, that is fine. 

There should be some— 

Mr. SCHWEIKERT. But for those of us who do really well on multiple guess tests, we like that. 

28 

Mr. Quaadman, what would you suggest in the world of—is it 

a—would you be comfortable with a world where a broker-dealer 

could provide advice to someone to invest in what today is limited 

to only qualified investors? And if not, how would you tighten it 

up? What would make you comfortable? 

Mr. QUAADMAN. My concern there is you could take an unsophisticated investor and effectively use the accredited investor patina 

of the broker-dealer and then transfer it over to that unsophisticated investor. And that is why I think there are some issues 

where, even though there is advice that has been given, the unsophisticated investor, just by definition, may not necessarily understand the risks that are involved. 

Mr. SCHWEIKERT. If we created sort of an A-B test in the legislation, something that also demonstrates some risk capital or something of that nature, would that create a— 

Mr. QUAADMAN. Yes, and that is where I think we need to get 

to is that you need to ensure that the investor has a level of knowledge where they can understand what the risks are that they are 

undertaking. And then you also want to have something else underneath to make sure that the risks that they are taking are commensurate with their financial experience. 

And you can take the flipside too, because if you take a look at 

the bright line test, right, what is interesting there—because I 

talked to somebody who was at the SEC in 1982. They picked those 

tests because they couldn’t really figure anything else out at the 

time. 

Mr. SCHWEIKERT. Mr. Chairman, in the last 30 seconds, and I 

think all of us have come across this experience, I have a very good 

friend, P.H. Dean Electrical Engineering had some friends that had 

started a business. He is an absolute international expert in this 

subject, except he wasn’t allowed to invest in it. 

How do we reward people, both from their risk tolerance, where 

they are in their lifecycle of investing, but also their knowledge 

base, and get rid of the sort of arbitrary that you have made it in 

like—you get to continue to make it in life. Because you are on this 

side of the ledger, you don’t get to participate. We are quite open 

to any brilliant ideas that will come our way. 

With that, I yield back, Mr. Chairman. 

Chairman GARRETT. The gentleman yields back. I am looking forward to more brilliance from Arizona on the legislation then. 

We now go to Connecticut. And Mr. Himes is recognized for 5 

minutes. 

Mr. HIMES. Thank you, Mr. Chairman. 

And I thank you all for being here for the duration. I am encouraged by what is a robust and substantive bipartisan conversation. 

I do have, though, a couple of—and by the way I appreciate Mr. 

Mulvaney’s offer. I have a couple of concerns that I would like to 

have addressed here. The first and most important pertains to the 

levels of leverage that would be permitted under the Mulvaney proposal. 

Specifically if you start to do the math on the 30 percent bucket 

where, as you know, there are plenty of firms out there that are 

holding equity tranches in CLOs which themselves are seven, 

eight, nine, 10 times levered. 

29 

When you start to do the math on going to 2-to-1 leverage in 

these instruments, on investments in financial companies which 

may themselves have 3 or 4 times leverage, investing in instruments which themselves may have 7, 8, 9 times leverage, you pretty quickly get to some pretty stratospheric leverage numbers. It is 

not hard to get up into the sort of 70x leverage numbers if you just 

work through that math. 

And of course if you then expand the 30 percent bucket into 50 

percent, you have conceivably, and I understand that there will be 

some prudence exercised by some players in the industry, but you 

potentially have a very highly leveraged vehicle here. 

So I wonder—and let me just start with Mr. Gerber since he is 

in the business. And then I would welcome comments. But am I 

right to be concerned that if we permit this degree of leverage, you 

have essentially a very, very volatile instrument? 

I don’t need to tell you that at 50x leverage, a tiny fluctuation 

in the value of underlying asset puts this instrument completely 

underwater and eliminates the investment of a lot of retail investors for whom this product is created. So, Mr. Gerber, make me feel 

more comfortable on that issue. 

Mr. GERBER. I will make my best effort. I think in the question 

you are raising, there are really two issues that are distinct, but 

at the same time, when brought together you have to consider it 

as a whole. So on one hand, it is increasing leverage going from 1- 

to-1 to 2-to-1 in our debt-to-equity ratio. 

On the other hand, it is the redefinition of an eligible portfolio 

company, moving something out of the 30 percent basket that we 

talk about into the 70 percent basket. And I think what you are 

getting at is if you combine the two, what is happening to a term 

that we all are familiar with, effective leverage. 

You are looking at three of the BDCs in the space that have lowest levels of effective leverage. And you can—different people have 

different ways of defining effective leverage and doing different calculations. And I think when you look at any lender, whether you 

are looking at a hedge fund or you are looking at a bank, you have 

to ask the same questions. 

And so what you are essentially looking at is the multiplier effect, if you will. And in our— 

Mr. HIMES. Well, that is the math I was doing. And again, I get 

that you guys are prudent, but— 

Mr. GERBER. Yes. But if I may just finish— 

Mr. HIMES. On the less prudent side—I want to check my math 

first. 

Mr. GERBER. Yes. 

Mr. HIMES. Again, you could very quickly see very high degrees 

of leverage in this instrument. 

Mr. GERBER. Yes. I think so. And that is why you hear some expressions of concern up here at the panel. And I think that is one 

of the areas of legislation where we still have some more work to 

do as an industry. And the members of the committee, and I think 

we are all committed to doing that work together. 

But what I wanted to mention is earlier when Mr. Arougheti was 

talking—and I referenced this concept as well about—would all of 

the BDCs be able to access more leverage, and the answer is no, 

30 

they won’t. And they won’t whether it is because of the rating 

agencies that Mr. Foster talked about. 

They won’t because of the covenants that the banks require—I’m 

sorry, the regulators require the banks to have in their loans to us. 

They won’t because the analyst community and the investor community is going to look at the substance of those portfolios. 

And so if you see mission creep, if you will, or if you see growth 

in the overall BDC in fin co investments, you are going to see 

downgraded ratings. You are going to see BDCs potentially violating existing covenants. 

So there are these natural governors in place. And I think as we 

work through this language and think about the full impact of it, 

we have to keep in mind those natural governors that are in the 

system. 

Mr. HIMES. Could the industry—and I don’t have a lot of time— 

live with a modification whereby those investments in companies— 

in the small businesses for which this instrument was created, 

were allowed to lever 2-to-1 as is proposed, but in the 30 percent 

bucket or in the financial bucket, the 1-to-1 ratio obtained. Is that 

a reasonable proposal? 

Mr. GERBER. Yes. I think we have heard that. I think it would 

be somewhat complicated to sparse it out like that, money is fungible. So I think in effect what you really would be saying is instead of going to 2-to-1, you are going to 1.75 and 1, or something 

along those lines. But whether or not there is a practical way to 

ensure that any increase in leverage isn’t being applied to some 

subset of investments, I think would be somewhat difficult. 

Chairman GARRETT. Thank you. 

Mr. HIMES. Thank you. Thank you, Mr. Chairman. 

Chairman GARRETT. Mr. Poliquin is recognized for 5 minutes. 

Mr. POLIQUIN. Thank you, Mr. Chairman, very much. I appreciate it. 

And thank you gentlemen for all coming today. If we all as a 

country look at the state of our economy, where it has gone and 

where it is going, in the last 5 or 10 years, my understanding is 

that about 80 percent of the new job hires in this country were in 

the small-to medium-sized business space. So we want to make 

sure that we do everything humanly possible to help our small 

businesses grow. 

I just looked at a survey a short time ago saying something like 

42 percent of business executives believe that the lack of financing 

is one of the key reasons that they just don’t have the confidence 

to hire more workers and grow their business. 

So I know that Dodd-Frank is a smothering regulation that is reducing the available credit among lots of players in your space. 

And so I salute you folks for trying to fill that void. 

I just heard something, Mr. Gerber, a short time ago that I want 

to drill down with you a little bit if I may, something that for a 

non-traded BDC like you folks that the information that is provided tends to be opaque. Now, we want to make sure that investors who are investing in these sort of financial products, that they 

have all the information they need to go forward. Could you address that, sir? 

Mr. GERBER. Sure. Thank you, Congressman. 

31 

It is often a misconception with non-traded because when you 

hear the term non-traded, it just sounds different. But non-traded 

BDCs follow all the same regulatory processes and procedures as 

traded BDCs. 

So, non-traded BDCs are in the 1933 Act, the 1934 Act, and the 

1940 Act. We have all the same public disclosures as traded BDCs. 

At Franklin Square we manage both traded and non-traded BDCs. 

And we manage more non-traded BDCs than any other manager. 

And I can just tell you the hours that our legal staff and accounting folks put into those filings is significant. 

But just because we are non-traded does not mean we are 

opaque. It does not mean that we are not providing the same level 

of disclosure that traded BDCs provide. We absolutely do. 

Mr. POLIQUIN. Okay. So contrary to what was said here today by 

a member of this committee is that an investor will have the same 

type and same amount and detailed information if I am buying a 

traded or non-traded BDC, is that correct, sir? 

Mr. GERBER. That is, and actually more. And let me explain to 

you why. Because when a firm like Franklin Square distributes a 

non-traded BDC, we also fall under FINRA and blue sky regulations. 

So, all 50 States are regulating our products. We are filing in all 

50 States. We have to meet the suitability standards in all 50 

States. The advisers and brokers that put their clients in our funds 

have to get a wet signature from their clients, our investors. 

So the reality is the non-traded investor probably has more opportunity to understand the investment than even an investor in 

our traded BDC. So it is I would say even heightened for the nontraded investor—more disclosure, more transparency. 

Mr. POLIQUIN. Thank you for clarifying that, Mr. Gerber. I appreciate it very much. 

Mr. GERBER. Thank you. 

Mr. POLIQUIN. You bet. 

Now, I want to pivot a little bit here. And we only have a couple 

of minutes left. I will start with you, Mr. Arougheti. 

You folks, and all you folks in the financial industry space live 

under this net, this Dodd-Frank net, which was intended for a 

small number of money center banks that really have tentacles 

throughout our economy that could cause a problem if something 

happens, but are certainly not designed for everybody. 

I want to know if you could wave a wand, what one regulation 

now within the Dodd-Frank net would be best to remove, repeal, 

or reform such that you folks are able to grow your portfolio companies and hire more workers? 

Mr. AROUGHETI. Yes. I will answer. 

We are not Dodd-Frank-regulated, so for us we are not focused 

on Dodd-Frank. As we have said numerous times, we are heavily 

regulated under the 1933 Act, the 1934 Act, and the 1940 Act. I 

think Representative Mulvaney has done a wonderful job putting 

forward legislation that would actually advance the industry. 

Mr. POLIQUIN. What about you folks possibly being regulated by 

the DOL or by the Federal Reserve or the SEC? How does that 

make you feel? 

32 

Mr. AROUGHETI. It comes with a different set of regulations and 

a different set of opportunities. So as I highlighted earlier, if we 

were a bank and we were levered 10-to 15-to-1 and we took depositor money we would be subject to a separate set of regulations 

versus the 1940 Act closed-end fund who is taking retail and institutional investments. 

So again, I, for better or worse haven’t put myself in that theoretical construct. We are focused on the regulatory regime that we 

are subject to. 

Mr. POLIQUIN. Okay. 

Mr. Foster, do you want to add anything to that? 

Mr. FOSTER. Sure. I asked our lead investment bank Raymond 

James if the DOL rule that is about to come out would impact 

them because a lot of our shareholder are individuals but they invest through IRAs and 401(k)s. And they canvassed their system 

and did not think it would be significant. But you think it could 

be. 

Mr. POLIQUIN. Thank you. 

Mr. Quaadman, would you like to respond in my waning seconds 

here? 

Mr. QUAADMAN. Yes. Just to—investment advisers are extremely 

concerned about the fiduciary duty role that it is going to have a 

very significant impact on their ability to invest. 

In fact, we issued a study last week that 9 million small businesses in the United States are going to be prevented or severely 

crimped in their ability to provide retirement vehicles for their employees if that rule goes through. 

Mr. POLIQUIN. Thank you, Mr. Chairman, for the additional time. 

I yield back. Thank you. 

Chairman GARRETT. Thank you. The gentleman yields back. 

Mr. Carney is recognized for 5 minutes. 

Mr. CARNEY. Thank you, Mr. Chairman, and Ranking Member 

Maloney for holding this hearing today. And thank you to Mr. 

Mulvaney and Mr. Schweikert for these proposals. 

I would like to—I have to admit I don’t know a lot about BDCs. 

And so I found your testimony very interesting. And I just have 

really two questions. 

One is to you, Mr. Foster. On page five, I would like to understand a little bit about how these BDCs are operating in my area. 

I am the Representative from the State of Delaware, the whole 

State, which is a very small place. 

But I notice on here that it has a pretty big number under it on 

your map on page five, particularly relative to States that are 

much, much larger. Can you explain that? Is that a function of our 

fact that we are the State to incorporate your business? Does that 

have anything to do with that? Or is that a function of greater 

BDC activity in my State? 

Mr. FOSTER. I can’t really explain why there is—I guess it says 

a billion five— 

Mr. CARNEY. Yes. We are doing better than New Jersey— 

Mr. FOSTER. Oh yes. 

Mr. CARNEY. —Connecticut and Maryland, just about. 

Mr. FOSTER. Maybe one of the two Michaels— 

33 

Mr. CARNEY. Anybody else? Mr. Gerber, you are from our region, 

right? 

Mr. GERBER. Yes. I think what Mr. Foster wanted to say is it is 

the excellent representation in Congress that is driving the heavy 

investment— 

Mr. CARNEY. All right. 

Mr. GERBER. I think you hit the nail on the head. 

Mr. CARNEY. Flattery will get you everywhere. 

Mr. GERBER. At Franklin Square we have a portfolio company, 

it is U.S. coatings acquisition. I do think it is in part because of 

the corporate laws in Delaware and the number of firms that are 

headquartered there— 

Mr. CARNEY. It is more a question that these are domiciled in 

some kind of way. 

Mr. GERBER. I think that is exactly right. Now in our case, our 

investment has more to do with just the work that is done at the 

portfolio company. But I think the phenomenon you referenced is— 

Mr. CARNEY. Can you—obviously you are located in our region. 

Is most of your activity in the region? 

Mr. GERBER. No. As I mentioned, sir, earlier in my testimony, we 

have deployed capital in 39 of the 50 States. And between the 3 

of us, our entire industry, we have invested in companies in all 50 

States. I think it probably depends on the scale of the BDC. In our 

case we have the largest platform. We have national reach. So we 

are sourcing deals all over the country. 

Mr. CARNEY. I think this is a pretty reasonable approach to updating regulations from BDCs. I do share Mr. Himes’ concern about 

the leverage question. 

So I would like to kind of follow up where he left off, which was, 

is there a way—Mr. Gerber, you started to respond to how you 

might consider addressing that concern. Would you like to follow 

up on that, or Mr. Arougheti, or Mr. Foster, would you like to address that? 

Mr. AROUGHETI. I will make a couple of comments. 

Mr. CARNEY. Please. 

Mr. AROUGHETI. And it harkens back to some of my earlier comments— 

Mr. CARNEY. It just gives us a little heartburn. 

Mr. AROUGHETI. Yes. I think anybody here would struggle to actually get leverage on the types of investments that you are expressing concern over. 

So first and foremost, the draft legislation, as I read it, excludes 

CLOs. And Representative Himes— 

Mr. CARNEY. He mentioned that. 

Mr. AROUGHETI. —mentioned CLOs. That is excluded. 

However, Ares is actually one of the larger CLO managers in the 

broadly syndicated market. And getting leverage on a CLO equity 

investment is not possible in the market. So it goes back to some 

of the natural governors that exist in both the banking sector and 

the investment grade bond sector that regulate what can and can’t 

be leveraged. 

So if we put together a portfolio that was 50 percent CLO equity, 

even though it is excluded, but for arguments sake, if we did and 

we took that portfolio to the rating agencies and the bank, we 

34 

would not have an investment grade rating and we would not be 

able to get a loan on it. So— 

Mr. CARNEY. There are market-based controls on that, is that 

what you are saying? 

Mr. AROUGHETI. Yes. Market-based, bank and capital markets. 

Mr. MULVANEY. Will the gentleman yield for a second? 

Mr. CARNEY. Sure. Absolutely. 

Mr. MULVANEY. Very briefly, and I appreciate the question, just 

because I was hoping to get to this while Mr. Himes was still here. 

But the draft legislation specifically excludes investments in CLOs, 

hedge funds, and private equity. So some of the examples he gave 

would not have been permitted under the draft legislation. 

Mr. CARNEY. Great. Anybody else? 

Mr. FOSTER. I will add, I think it is—we have given some 

thought to it. I think it is theoretically attractive to provide the 1- 

to-1 to the 70, but not the 30. But if the 30 gets bigger, then the 

bill begins to lose its effectiveness. 

And I do—I am concerned because most of us are on—all of us 

are owned primarily retail investors. And they get 1-to-1 or they 

get 2-to-1. But when you start explaining the baskets and how we 

are going to report that to them and how we are going to monitor 

it, and what it does to this, I don’t think it is a practical solution. 

Mr. CARNEY. So maybe what we could do is get some feedback 

to those Members who have concerns. I am looking at the sponsor 

just to give us some level of comfort. That is great. 

I yield back. Thank you. 

Chairman GARRETT. Thank you. Thank you, gentlemen. 

It looks like our last two questioners are Mr. Hultgren and then 

Mr. Mulvaney. And then we vote, I think. 

Mr. HULTGREN. Thank you, Mr. Chairman. 

Thank you all for being here. 

Chairman GARRETT. But not on your bill. You looked as if we are 

ready to vote on your bill, but no, on the Floor. 

Mr. MULVANEY. I thought you could pull some strings, Mr. Chairman. I usually look at you in a confused fashion most of the time— 

that is nothing new. 

Chairman GARRETT. That is kind of a normal look. 

Mr. HULTGREN. Thank you all. I appreciate you being here. I do 

want to thank all of you for your input and the work that you are 

doing. 

Thanks, Mr. Gerber, for your clarification too. I think there were 

some inaccuracies that I had heard in some statements on the 

other side with some of the non-traded BDCs, and some statements 

that those were less than transparent. And I really appreciate you 

clearing that up, that there is an incredible amount of transparency and accountability available there. And that was very 

helpful. 

I want to shift gears just a little bit if that is all right. And I 

think I will address this first one to Mr. Gerber, but then also, Mr. 

Foster and Mr. Quaadman, I would appreciate your thoughts on 

this as well, and maybe Mr. Arougheti, as well. 

But I have heard a great deal about access to capital, and its role 

in creating jobs. I wonder, could you tell me a little bit more about 

35 

the reality of how your business, Mr. Gerber, helps with job creation in the middle-market? 

Mr. GERBER. Sure. In its really most basic form companies are 

coming to us, looking to grow or looking to stay in business and in 

need of capital. And when we provide that capital, and as Mr. 

Arougheti explained, sometimes because of the permanent nature 

of our funds we can be long-term partners and provide managerial 

assistance to these firms. 

We are helping them stay in business and we are helping them 

grow. And it does have a direct impact on jobs. In your State, Congressman, Franklin Square alone has 10 portfolio companies. We 

have deployed over $380 million. And to firms that represent over 

33,000 jobs. 

Across our entire portfolio we have invested in over 300 companies, representing more than a million jobs. And you heard earlier 

in our testimony and some of the comments from some of the members of the subcommittee, we are lending primarily to small middle-market all the way up to large middle-market firms. 

And they now represent a third of the private sector workforce. 

So there is a direct correlation between the work that we do in deploying capital and the growth of the middle-market and the job 

creation in the middle-market. 

Mr. HULTGREN. That is fantastic. I appreciate it. The number one 

thing we continue to talk about is job creation and how do we get 

this economy growing, and growing more quickly. And so that is 

great news, especially for my State of Illinois. We are looking for 

good news, so it is nice to hear about jobs being created there. 

Mr. Quaadman, any thoughts from your membership on what 

you are hearing as far as access to capital, and specifically this tool 

that really is potentially beneficial on both ends, certainly from the 

investor side but also from the recipient of access to capital? 

Mr. QUAADMAN. Yes. We are seeing very severe problems in 

terms of access to capital, primarily with small businesses and 

larger businesses. Part of it is the slow implementation of Basel 

III, which is slowly drying up bank loans. But we are also going 

to see if total loss absorbency coverage goes through in 2019. 

That is actually going to siphon hundreds of billions of dollars of 

capital out of the global markets. So what we are seeing is we are 

seeing this slow combination of events happening where logically, 

each of these different regulatory initiatives would make sense by 

themselves. 

When you put them together, they have very dramatic impacts. 

And what we have seen, and this is a Census Department report 

I had mentioned, I think in April, that we are seeing a net destruction of firms in the United States over the last 6 years. 

So we are not seeing the smaller firms being created at the same 

rate that we used to. So the BDC legislation is good that we are 

helping the middle-market companies and the like. So, but we need 

to help the smaller guys as well. 

Mr. HULTGREN. Yes. And it is something that is really part of my 

heartbeat is I just believe so strongly that really the foundation of 

this country is the ability for someone to have an idea, be passionate about it, have some gifts and talents that they want to put 

into this, but also to have partners that could come alongside 

36 

where they can get access to capital to turn that into truly the 

American dream. We talk about that, but this is the reality. 

But so, Mr. Foster and Mr. Arougheti, any other thoughts on this 

as far as job creation with this— 

Mr. AROUGHETI. I think one additional comment which I don’t 

think we have mentioned before is that by regulations, BDCs are 

actually required to provide managerial assistance to their portfolio 

companies, which is often overlooked, but also contributes to the 

strategic value that we add to middle-market companies. 

So to put that in perspective, within Ares Capital Corporation we 

sit in on, or sit on the boards of directors of over half of our portfolio companies. So our portfolio companies look at us as their bank 

or their lender of choice. But I think they also look at us as a strategic adviser as they grow their business. 

Mr. HULTGREN. That is great I don’t think that was something 

that I understood fully: the value that could come from that, and 

learning from other companies that are succeeding. Quite honestly, 

learning from successes and failures can be certainly beneficial to 

these small and medium-sized companies, as well. 

Mr. Foster, any last thoughts? 

Mr. FOSTER. Sure. And a good example is we specialize in change 

control transaction with retired business owners. The kids aren’t in 

the business, they are too small for a public company to buy, too 

small for private equity. 

We will come in there and arrange a change control transaction. 

And then in the last 10 years prior to retirement, the last thing 

they want to do is open up a new plant. So very frequently we are 

able to come in and regain a growth trajectory. And if it wasn’t for 

us, not only are you creating jobs you might not even retain those 

jobs. 

Mr. HULTGREN. My time has expired. Thank you all very much. 

Thank you, Mr. Chairman. I yield back. 

Chairman GARRETT. Thank you. And to have the last word, Mr. 

Mulvaney, the sponsor of the underlying legislation. 

Mr. MULVANEY. Thanks, Mr. Chairman. Thanks as well to Mrs. 

Maloney for the work she has done on this bill with me, along with 

a couple other Members. 

And thank you, Mr. Carney, for sticking around because I want 

to address a couple of housekeeping things. 

First, Mr. Chairman, I have a statement from Prospect Capital 

Corporation, which is a BDC that has done business in my district. 

And they would like to enter a statement into the record. So I 

would like to do that without objection if I may, please. 

Chairman GARRETT. Without objection, it is so ordered. 

Mr. MULVANEY. Thank you. 

Mr. Carney, we talked before and I think we addressed some of 

that stuff about specifically excluding it. But we will continue to 

talk. But one of the things I will point out when we have these discussion is that while everybody gets a little bit nervous every time 

we talk about levering up or increasing anybody’s leverage, I direct 

your attention to the screen. Even with the proposed changes, this 

is still going to be the least levered of any of the major investment 

facilities that we sort of have oversight on this committee. 

37 

So it is still a very, very small thing. And all of the rest of the 

financial matters that you see on the board have the same issues 

that Mr. Himes may have raised. So if we want to start worrying 

about layering on leverage, maybe the place to start is on the left 

side of that graph and not the right side of that graph. Thank you. 

You can take that down. 

Regarding the buckets, it strikes me—and Mr. Himes raised this 

as well. While I understand his point about perhaps his suggestion 

of not allowing it in the financial services area, part of the reason 

we are doing this is because small and medium-sized financial institutions are having difficulty getting the capital. 

So that is actually one of the expected uses in my district. I am 

a very rural area. We are heavily community-banked. And we are 

trying to figure out a way to provide them with additional sources 

of capital. 

Plus, it strikes me that a well-run community bank or small financial institution would probably carry less leverage than some of 

the operating companies that Mr. Himes mentioned. So I don’t 

think it is a connection between leverage and the bill. 

I think it comes down to, can we make smart, safe, sound capital 

available to as many people as possible? That is the purpose of the 

bill. And I see no reason to arbitrarily limit it to having financial 

institutions getting one level of leverage into operating companies, 

for lack of a better word, getting another. 

Mr. Lynch mentioned go-around on Volcker. I will throw this to 

the panel because it strikes me, gentlemen, that if I was—you mentioned Goldman Sachs. I can’t remember the European bank you 

mentioned that was thinking about doing this. If I wanted to get 

around Volcker, there are a lot better ways to do it than invest in 

BDCs aren’t there, Mr. Gerber? 

Mr. GERBER. As Mr. Arougheti said, Volcker doesn’t apply to us. 

But I do think that when we see banks investing in BDCs, it is actually a positive consequence to some degree to the Volcker Rule 

in that those assets are no longer on the bank’s balance sheet. And 

they are now being invested in a far more transparent environment 

than in a merchant banking private operation. 

So, from our perspective, we don’t—Volcker doesn’t apply to us. 

But in looking at it, it doesn’t seem to us to be an end-run around 

Volcker. 

Mr. MULVANEY. Right. And that is a good point that I don’t think 

that lots of folks are familiar with; when you say Volcker doesn’t 

apply to you, that is not by accident. The Rule actually specifically 

excludes you folks under the rationale that these industries are already so heavily regulated and so transparent that there was no 

reason to apply Volcker to you folks. 

And again, I would suggest that if I am Deutsche Bank or Goldman Sachs and I want to go around Volcker, I can put my money 

in a hedge fund and do it right away. I don’t have to go through 

the hassle of going through the BDC application. 

Dr. Brown, you mentioned something at the very outset of your 

testimony about operating companies versus financial institutions. 

And again, I don’t want to change your words. But I thought you 

said something to the tune of the operating companies need it more 

than the financial institutions. Or— 

38 

Mr. BROWN. No, I don’t think I quite said that, although who 

knows, I could have misspoken. What I really said was I haven’t 

seen the empirical data that says the financial companies need it. 

What we know is the operating companies do need it. And I am 

afraid of the bleed of funds away from operating companies to financial companies and hurting those companies. 

And I would just add, Congressman, that the comment that was 

made earlier about these operating companies getting not only the 

funds, but getting the managerial assistance, I don’t know whether 

the financial companies need the managerial assistance in the 

same way I think a lot of these operating companies do. 

So I think if that these operating companies can’t access as easily 

these BDCs, I think that is a problem for the operating company. 

Mr. MULVANEY. Two things to consider, Mr. Brown, and to my 

colleagues of both parties. 

Number one, it seems that the need for the product would be dictated by the market and not by some empirical research. Either it 

is there or it is not there. But perhaps more importantly to your 

point, if these gentlemen want to take an equity position or a debt 

position in a community bank in my district, I know where the 

money is going, which is to the local businesses. 

So it is just another way to get the money to the operating companies. That is what the community banks and the small financial 

institutions and small investment operations in my district do. So 

if the demand is there within the operating business community, 

I think it probably—capital should be able to find a way there. 

Lastly, Mr. Brown, I will close with this. I have 14 seconds. 

You mentioned some concern about the different levels of stock, 

the different classes of stock, the preferred stock. And I guess I can 

only ask it this way. 

Wouldn’t those concerns that you raised here today apply to any 

company that offers preferred stock? Because a lot of publicly traded companies that I could buy this afternoon offer preferred stock. 

Aren’t your concerns equally applied to them as they would be to 

BDCs? 

Mr. BROWN. Well, of course, not investment companies, but operating companies, yes. 

Mr. MULVANEY. Right. But if I am an investor, I am either going 

to invest in BDCs or I am going to invest in Norfolk Southern Railway and they might have a preferred stock and the BDCs might 

have a preferred stock. And the concerns that you raise would 

apply equally to me as investor as between BDC and Norfolk 

Southern. 

You said the board of directors could change the voting rights, 

they could change the payouts. They could, think about me as an 

unsophisticated investor, might get caught in that. That applies 

anyway, right, in the market. 

Mr. BROWN. You are absolutely right. The legal authority exists 

irrespective of the company because it is the authority of the board 

of directors. But what I would say right now, is there are protections in the Investment Company Act of 1940 that don’t exist for 

other companies. So we are talking about removing something that 

is there that does not apply to operating companies. 

39 

Mr. MULVANEY. Fair enough. Gentlemen, I appreciate the additional 50 seconds, and for the right to participate in the hearing 

since I am not on the subcommittee. Thank you, Mr. Garrett. 

Chairman GARRETT. Thank you. And welcome to the subcommittee. 

So I said that was going to be the last word, but, no, I am not 

going to say the last word. I am going to give the last word to the 

gentlelady from New York. 

Mrs. MALONEY. A vote has been called. But very briefly, thank 

you to all of the panelists. And I ask unanimous consent to place 

two letters into the record: one from the North American Securities 

Administrators Association; and one from the Consumer Federation 

of America and Americans for Financial Reform. 

And I look forward to continuing to work with you, Mr. 

Mulvaney, to see if we can get a product that has unanimous bipartisan support. Getting capital out is important. Thank you. 

Chairman GARRETT. Without objection, is is so ordered. And 

again, thank you to the witnesses. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

And with that, this hearing is adjourned. And again, thank you 

to the panel. 

[Whereupon, at 4:10 p.m., the hearing was adjourned.] 

(41) 

A P P E N D I X 

June 16, 2015 

42 


96994.001
43 


96994.002
44 


96994.003
45 


96994.004
46 


96994.005
47 


96994.006
48 


96994.007
49 


96994.008
50 


96994.009
51 


96994.010
52 


96994.011
53 


96994.012
54 


96994.013
55 


96994.014
56 


96994.015
57 


96994.016
58 


96994.017
59 


96994.018
60 


96994.019
61 


96994.020
62 


96994.021
63 


96994.022
64 


96994.023
65 


96994.024
66 


96994.025
67 


96994.026
68 


96994.027
69 


96994.028
70 


96994.029
71 


96994.030
72 


96994.031
73 


96994.032
74 


96994.033
75 


96994.034
76 


96994.035
77 


96994.036
78 


96994.037
79 


96994.038
80 


96994.039
81 


96994.040
82 


96994.041
83 


96994.042
84 


96994.043
85 


96994.044
86 


96994.045
87 


96994.046
88 


96994.047
89 


96994.048
90 


96994.049
91 


96994.050
92 


96994.051
93 


96994.052
94 


96994.053
95 


96994.054
96 


96994.055
97 


96994.056
98 


96994.057
99 


96994.058
100 


96994.059
101 


96994.060
102 


96994.061
103 


96994.062
104 


96994.063
105 


96994.064
106 


96994.065
107 


96994.066
108 


96994.067
109 


96994.068
110 


96994.069
111 


96994.070
112 


96994.071
113 


96994.072
114 


96994.073
115 


96994.074
116 


96994.075
117 


96994.076
118 


96994.077
119 


96994.078
120 


96994.079
121 


96994.080
122 


96994.081
123 


96994.082
124 


96994.083
125 


96994.084
126 


96994.085
127 


96994.086
128 


96994.087
129 


96994.088
130 


96994.089
131 


96994.090
132 


96994.091
133 


96994.092
134 


96994.093
135 


96994.094
136 


96994.095
137 


96994.096
138 


96994.097
139 


96994.098
140 


96994.099
141 


96994.100
142 


96994.101
143 


96994.102
144 


96994.103
145 


96994.104
146 


96994.105
147 


96994.106
148 


96994.107
149 


96994.108
150 


96994.109
151 


96994.110
152 


96994.111
153 


96994.112
154 


96994.113
155 


96994.114
156 


96994.115
157 


96994.116
158 


96994.117
159 


96994.118
160 


96994.119
161 


96994.120
162 


96994.121
163 


96994.122
164 


96994.123
165 


96994.124
166 


96994.125
167 


96994.126
168 


96994.127
169 


96994.128
170 


96994.129
171 


96994.130
172 


96994.131
173 


96994.132
174 


96994.133
175 


96994.134
176 


96994.135
177 


96994.136
178 


96994.137
179 


96994.138