U.S. GOVERNMENT PUBLISHING OFFICE

30–773 PDF WASHINGTON : 2018

LEGISLATIVE PROPOSALS TO IMPROVE 

SMALL BUSINESSES’ AND COMMUNITIES’ 

ACCESS TO CAPITAL 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS, 

SECURITIES, AND INVESTMENT 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED FIFTEENTH CONGRESS 

FIRST SESSION 

NOVEMBER 3, 2017 

Printed for the use of the Committee on Financial Services 

Serial No. 115–54 

( 


nshattuck on FSR297 with DISTILLER
(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 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

SCOTT TIPTON, Colorado 

ROGER WILLIAMS, Texas 

BRUCE POLIQUIN, Maine 

MIA LOVE, Utah 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

LEE M. ZELDIN, New York 

DAVID A. TROTT, Michigan 

BARRY LOUDERMILK, Georgia 

ALEXANDER X. MOONEY, West Virginia 

THOMAS MacARTHUR, New Jersey 

WARREN DAVIDSON, Ohio 

TED BUDD, North Carolina 

DAVID KUSTOFF, Tennessee 

CLAUDIA TENNEY, New York 

TREY HOLLINGSWORTH, Indiana 

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 

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 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

JUAN VARGAS, California 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 

CHARLIE CRIST, Florida 

RUBEN KIHUEN, Nevada 

KIRSTEN SUTTON MORK, Staff Director 


nshattuck on FSR297 with DISTILLER
(III) 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES, AND INVESTMENT

BILL HUIZENGA, Michigan, Chairman 

RANDY HULTGREN, Illinois, Vice Chairman 

PETER T. KING, New York 

PATRICK T. MCHENRY, North Carolina 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

ANN WAGNER, Missouri 

LUKE MESSER, Indiana 

BRUCE POLIQUIN, Maine 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

ALEXANDER X. MOONEY, West Virginia 

THOMAS MacARTHUR, New Jersey 

WARREN DAVIDSON, Ohio 

TED BUDD, North Carolina 

TREY HOLLINGSWORTH, Indiana 

CAROLYN B. MALONEY, New York, 

Ranking Member 

BRAD SHERMAN, California 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

JAMES A. HIMES, Connecticut 

KEITH ELLISON, Minnesota 

BILL FOSTER, Illinois 

GREGORY W. MEEKS, New York 

KYRSTEN SINEMA, Arizona 

JUAN VARGAS, California 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 


nshattuck on FSR297 with DISTILLER

nshattuck on FSR297 with DISTILLER
(V) 

C O N T E N T S 

Page 

Hearing held on: 

November 3, 2017 ............................................................................................. 1 

Appendix: 

November 3, 2017 ............................................................................................. 33 

WITNESSES 

FRIDAY, NOVEMBER 3, 2017 

Bullard, Mercer, Butler Snow Lecturer and Professor of Law, University 

of Mississippi School of Law ............................................................................... 4 

Gerber, Michael F., Executive Vice President, Corporate Affairs, FS Investments ..................................................................................................................... 5 

McCoy, Patrick J., Director of Finance of the Metropolitan Transportation 

Authority of New York, on behalf of the Government Finance Officers 

Association ............................................................................................................ 2 

Quaadman, Thomas, Executive Vice President, Center for Capital Market 

Competitiveness, U.S. Chamber of Commerce .................................................. 8 

Stevens, Paul Schott, Chief Executive Officer, Investment Company Institute 7 

APPENDIX 

Prepared statements: 

Bullard, Mercer ................................................................................................. 34 

Gerber, Michael F. ............................................................................................ 57 

McCoy, Patrick J. ............................................................................................. 65 

Quaadman, Thomas ......................................................................................... 69 

Stevens, Paul Schott ........................................................................................ 79 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Huizenga, Hon. Bill: 

Letter to Jay Clayton, Chairman, U.S. Securities and Exchange Commission ................................................................................................................. 103 

Response letter from Jay Clayton, Chairman, U.S. Securities and Exchange Commission ...................................................................................... 105 

Letter dated October 13, 2017 regarding The Consumer Financial Choice 

and Capital Markets Protection Act ............................................................ 108 

Emmer, Hon. Tom: 

Letter from the Association of Minnesota Counties ...................................... 110 

Hultgren, Hon. Randy: 

Letter from the State Financial Officers Foundation .................................... 111 

Lynch, Hon. Stephen: 

Letter from Thomas Koch, Mayor of Quincy, Massachusetts ....................... 113 

Rothfus, Hon. Keith: 

Letter from the Association for Financial Professionals ............................... 115 

Letter from the Association of School Business Officials International ...... 117 

Morningstar article entitled, ‘‘Money Market Funds on Life Support’’ ........ 119 

Stivers, Hon. Steve: 

White paper from the Coalition for Small Business Growth ........................ 123 

Written statement from the Coalition for Small Business Growth .............. 136 

Clarification from Mr. Jonathan Bock, Wells Fargo ...................................... 140 

Meeks, Hon. Gregory: 

Written responses submitted for the record from Michael Gerber ............... 142 


nshattuck on FSR297 with DISTILLER
Page

VI 

Quaadman, Thomas: 

Presentation from Treasury Strategies .......................................................... 146 


nshattuck on FSR297 with DISTILLER
(1) 

LEGISLATIVE PROPOSALS TO IMPROVE 

SMALL BUSINESSES’ AND COMMUNITIES’ 

ACCESS TO CAPITAL 

Friday, November 3, 2017 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS, 

SECURITIES, AND INVESTMENT, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 9:17 a.m., in room 

2128, Rayburn House Office Building, Hon. Bill Huizenga [chairman of the subcommittee] presiding. 

Present: Representatives Huizenga, Hultgren, Stivers, Poliquin, 

Hill, Emmer, Mooney, MacArthur, Davidson, Budd, Hollingsworth, 

Hensarling, Maloney, Sherman, Lynch, Scott, Himes, Sinema, 

Vargas, and Gottheimer. 

Also present: Representative Rothfus. 

Chairman HUIZENGA. The committee will come to order. And 

without objection, the Chair is authorized to declare a recess of the 

committee at any time. 

This hearing is entitled ‘‘Legislative Proposals to Improve Small 

Businesses’ and Communities’ Access to Capital.’’ 

Just to get everybody on the same page here, they have moved 

up votes a little bit on us this morning. We have an anticipated 

voting time somewhere between 10:15 and 10:45. With agreement 

with the Ranking Member here, we are foregoing our opening 

statements, because it is about you actually. Hard to believe that 

Congress folks wouldn’t want it to be about them. But it is about 

you, to hear from you all, and to make sure that we get to questions. 

Just for the members, depending on our timing, the Chairman 

may exercise our prerogative to shorten your 5-minute question period. We want to get through as many folks as we possibly can in 

a timely fashion. 

And with that, without objection, the gentleman from Pennsylvania, Mr. Rothfus, is permitted to participate in today’s subcommittee hearing. Mr. Rothfus is a member of the Financial Services Committee, and we appreciate his interest in this important 

topic. And we are pleased that our final witness, was stuck in one 

of our famous lines here in getting into the office building, so we 

are glad you are here, Mr. Gerber. 

So with that, today, we welcome the testimony of Mr. Patrick 

McCoy, the Director of Finance for the Metropolitan Transportation 


nshattuck on FSR297 with DISTILLER
2 

Authority of New York, on behalf of the Government Finance Officers Association; Mr. Mercer Bullard, Butler Snow Lecturer and 

Professor of Law, University of Mississippi School of Law; Mr. Michael Gerber, Executive Vice President, Corporate Affairs of FS Investments; Mr. Paul Stevens, who is the Chief Executive Officer of 

the Investment Company Institute, ICI; and Mr. Tom Quaadman, 

Executive Vice President for the Center for Capital Market Competitiveness to the U.S. Chamber of Commerce. 

Each of you will be recognized for 5 minutes to give your oral 

presentation and your testimony. And without objection, each of 

your written statements will also be made part of the permanent 

record. 

With that, Mr. McCoy, you are recognized for 5 minutes. 

STATEMENT OF PATRICK J. MCCOY 

Mr. MCCOY. Thank you. 

Chairman Huizenga, Ranking Member Maloney, and distinguished members of the committee, I am honored to be here today 

on behalf of the Government Finance Officers Association to share 

with you our comments on H.R. 2319, the Consumer Financial 

Choice and Capital Markets Protection Act of 2017, and its importance to public finance. 

My name is Pat McCoy, and I serve as the President of the Government Finance Officers Association. But today, I will be speaking 

in that capacity and not in my other role as Director of Finance for 

the Metropolitan Transportation Authority in New York. 

Founded in 1906, GFOA represents over 19,000 public finance officers from State and local governments, schools, and special districts throughout the United States. This includes about 2,500 

Michigan and 1,500 New York national and State GFOA members. 

GFOA is dedicated to advancing fiscal strategies, policies, and practices for the public benefit, including topics related to issuing tax 

exempt bonds and investing public funds. 

I am here to testify in support of H.R. 2319. Money market funds 

are an important means of financing capital requirements for State 

and local governments. But the SEC’s (Securities and Exchange 

Commission’s) change of net asset value, or NAV, accounting methodology from stable to floating has negatively impacted our ability 

to use them. H.R. 2319 would allow State and local governments 

to return to utilizing suitable investments as defined by State and 

local government officials rather than by the SEC. 

GFOA has identified two key issues that should be weighed as 

Congress considers this legislation to improve access to capital. 

First, money market funds have been utilized effectively to both 

manage liquidity for public sector investments and to provide a reliable source of working capital to fund public services and finance 

infrastructure investment. Legislation such as this would allow 

governments to seamlessly continue accessing the capital markets 

without increasing costs for taxpayers. Money market funds are a 

widely used cash management tool for individuals, corporations, as 

well as for State and local governments. 

According to Federal Reserve data, State and local governments hold over $183 billion of assets in money market funds. Money 

market funds themselves are key purchasers of municipal securiVerDate Sep 11 2014 07:59 Sep 24, 2018 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-03 CM SBA\30

nshattuck on FSR297 with DISTILLER
3 

ties. Historically, they have been the largest purchasers of shortterm tax exempt debt. 

GFOA has supported and will continue to support initiatives that 

both strengthen money market funds and ensure investors have access to high-quality securities that can be bought and sold in an 

efficient market. However, the SEC rule change that requires a 

floating rather than a fixed NAV created unintended consequences 

that impact large governmental entities and small communities 

alike. 

Second, since the SEC rule changed from a fixed to a floating 

NAV, we have seen a negative impact on State and local governments. The original objective of the rule change was to protect investors in money market funds, but we think that those concerns 

were already addressed in the 2010 amendments to rule 2a–7. 

GFOA and other State and local government issuer groups supported those amendments. Despite the positive impact of the 2010 

amendments, the SEC moved forward in adopting additional 

amendments to the rule in July 2014, which became effective just 

last year. 

Throughout that process, GFOA and public finance officers 

throughout the country submitted analysis showing that a floating 

NAV would do little to deter heavy redemptions during a financial 

crisis and would instead impose substantial costs on State and 

local governments. 

Between January 2016 and July 2017, tax exempt money market 

fund assets under management fell by half, from $254 billion to 

$135 billion, a dramatic shrinking of an important market for municipal debt. At the same time, municipalities issuing variable rate 

demand bonds saw their borrowing costs increase, nearly double 

the Federal Reserve’s rate increases over the same period. Many 

State and local governments opted to issue higher fixed rate bonds 

because issuing variable rate debt to money market funds was costly. In both cases, the higher costs were shouldered by taxpayers 

and ratepayers. 

Finally, the SEC rule changes implications for the investments 

State and local governments rely on to protect public funds. Many 

have specific State or local statutes or policies that require them 

to invest in financial products with a stable NAV. This ensures 

that public funds are appropriately safeguarded. Thus, State and 

local governments commonly use money market funds with a stable 

NAV for managing operating costs—operating cash. Requiring a 

floating NAV creates an unnecessary obstacle that has steered 

State and local entities into very low yielding U.S. Government 

backed funds or other alternatives from what was already a safe 

and highly liquid market. 

Chairman Huizenga, Ranking Member Maloney, and distinguished members of the committee, public finance officers are encouraged by and support initiatives like H.R. 2319, the Consumer 

Financial Choice and Capital Markets Protection Act of 2017. I 

thank you for the opportunity to speak with you here today, and 

I will be happy to take your questions. 

[The prepared statement of Mr. McCoy can be found on page 65 

of the Appendix] 

Chairman HUIZENGA. Thank you. We appreciate that. 


nshattuck on FSR297 with DISTILLER
4 

And with that, Professor Bullard, you are recognized for 5 minutes. 

STATEMENT OF MERCER BULLARD 

Mr. BULLARD. Chairman Huizenga, Ranking Member Maloney, 

members of the subcommittee, thank you again for the opportunity 

to speak before you today. 

I will focus my comments this morning on the BD leverage proposal. And I would like to think that we can all agree that before 

permitting BDCs (business development companies) to increase 

their leverage, we need to know how much leverage BDCs actually 

use, and ensure this information is fully and accurately disclosed. 

It appears to me that neither condition is currently satisfied. We 

do not know how much leverage BDCs actually use. And if we do 

not know how much leverage they use, then it follows that BDC 

leverage is not being fully or accurately disclosed. 

Over the last three decades, since the banking crisis of the 

1980’s, banking regulation has evolved to employ diverse measures 

of risk that provide a more accurate view of the threat of bank failure. Traditional diversification, concentration, and leverage limits 

have been supplemented by risk-based capital ratios, value at risk 

measures, liquidity coverage ratios, off balance sheet contingency 

weightings, tiered asset categories, stress tests, and living wills. 

These measures have still not kept pace with the development of 

increasing complex financial instruments and capital structures, 

but they have them within site. 

The BDC leverage limit is a different story. It captures very little 

of the information one would need to evaluate a BDC’s effective leverage. It does not consider the relative quality, priority, or term 

of BDC assets, nor does it capture the term reliability or portfolio 

income sensitivity of BDC loans. It does not reflect interest rate 

risk. Industry analysts agree the leverage limit is inadequate. One 

publication has stated, quote: ‘‘In our view, the raw leverage measure, debt over equity, doesn’t tell the whole story as loans that 

BDCs hold have various degrees of implicit leverage,’’ end quote. 

This is a bit of an understatement as the effective ratio estimates 

by those same analysts bear little resemblance to the one-to-one 

statutory leverage limit. In the fall of 2015, for example, these analysts rated BDC leverage ratios as ranging from a low of .58 to 1 

to a high of 7.57 to 1. The 7.57 ratio is obviously not consistent 

with the one-to-one statutory limit. The high of 7.57 to 1 is more 

than 13 times the low estimate, which shows a degree of variance 

that also does not comport with the statutory leverage eliminate. 

These high-leverage ratios are not disclosed to investors, nor is 

their potentially disastrous effect. The BDC that had the 7.57 to– 

1 ratio showed in a recent filing that a mere 10 percent loss in the 

market value of its holdings would result in a 23.5 percent decline 

in the value of the shareholder stake. This disclosure is still inadequate. It posits that a 10 percent decline is a worst-case scenario. 

The SEC should know better. 

In comparison, the Fed’s worst-case scenario for its 2017 supervisory stress test assumes a 50 percent decline in equity values and 

a 25 percent decline in housing prices and a 35 percent decline in 


nshattuck on FSR297 with DISTILLER
5 

commercial real estate and a 10 percent unemployment rate. I submit that worst-case scenario disclosure must reflect at least a 20 

or a 25 percent drop, if not a 40 or 45 percent drop, in order to 

be useful. 

It is fitting that the picture on the cover of this 2015 BDC scorecard is a photo of a man climbing a sheer rock face in running 

shoes without any ropes. I find that the inadequacies of BDC risk 

disclosure were matched by inadequate disclosure in other respects. 

A retail investor could not reasonably be expected to understand 

the mechanics of performance fees charged by BDC managers 

based on SEC mandated disclosure. I was unable to determine 

whether BDC managers that charge fees on top of fees charged by 

underlying funds or maybe a questionable practice were also double-dipping by being paid themselves by the underlying fund. Nor 

could I practicably determine whether and to what extent a BDC 

was actually investing consistent with its statutory mandate. 

I am also concerned about BDC’s enforcement history. A recent 

article by a former SEC examiner, John Walsh, lists a pattern of 

BDC enforcement actions over just the last 10 years that is extraordinary in the light of the fact that the total number of BDCs 

has never been much over 100. I recommend that members consider this article which appears in Volume 14 of the Dartmouth 

Law Journal before making a final decision on the pending legislation. 

I again thank the subcommittee for the opportunity to appear before you today, and I would be happy to try to answer any questions you might have on this or other matters before the subcommittee. Thank you. 

[The prepared statement of Mr. Bullard can be found on page 34 

of the Appendix] 

Chairman HUIZENGA. Thank you very much. 

And with that, Mr. Gerber, you are recognized for 5 minutes. 

STATEMENT OF MICHAEL F. GERBER 

Mr. GERBER. Thank you. 

Thank you, Chairman. Thank you, Ranking Member Maloney 

and the other members of the subcommittee, for the opportunity to 

participate in today’s hearing. My name is Mike Gerber. I am an 

Executive Vice President at FS Investments, formerly named 

Franklin Square Capital Partners. We were founded in 2007 in 

Philadelphia with the mission of providing mainstream investors 

access to institutional quality alternative asset management. 

We have used the BDC, among other structures, to execute on 

this mission. In 2009, we launched the industry’s first ever nontraded BDC. We listed that on the New York Stock Exchange a few 

years later, in 2014, creating a liquidity event for our investors. 

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

management than any other manager in the industry. 

We have investors from all 50 States. We have portfolio companies in 39 States. And across the industry, there are now more 

than 90 BDCs and more than $90 billion in assets under management in the BDC space. 


nshattuck on FSR297 with DISTILLER
6 

Importantly, no BDC failed during the Great Recession. We all 

know those were the worst economic times we have experienced as 

a country since the Depression. And I think it is a very important 

point to make because it is a very durable structure that has been 

protective of investors. 

As you all know, in 1980, BDCs were created through bipartisan 

efforts with an eye toward matching mainstream investor dollars 

with Main Street businesses. Because BDCs were designed with an 

eye toward retail investors, they are appropriately very heavily regulated. In fact, whether traded or nontraded, BDCs are among the 

most highly regulated investment vehicles in the marketplace. And 

because of our extensive public filings, BDCs are fully transparent 

to regulators, rating agencies, analysts, lenders, and investors 

alike. 

Specifically, BDC’s 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 we must file 10- 

Ks, 10-Qs, 8-Ks, and proxy statements. Contained in every Q and 

K is a schedule of our investments, along with the details around 

those investments, such as the name of the portfolio company, the 

size of the investment, the position within the capital stack of that 

investment, interest rates, and current price marks. 

Other key protections in the BDC include mandatory third-party 

custody of 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 evaluations of the investments in 

a BDC portfolio. 

In addition, our nontraded BDCs are also regulated by FINRA 

and by the Blue Sky 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 is that BDCs must invest at least 70 percent of our assets in U.S. private and small cap 

companies. As a result, BDCs have provided a significant amount 

of capital to the middle market. Middle market businesses employ 

about 48 million people today, or one out of every three workers in 

the private sector. In fact, between 2011 and 2017, middle market 

firms generated 103.3 percent job growth compared to small business at 7.4 percent and large firms at 52.3 percent. And now, 42 

percent of middle market firm companies say they expect to grow 

in 2018. So we believe it is important that middle market lenders 

like BDCs are well positioned to provide the capital necessary to 

fuel that growth. 

There are two key aspects to this legislation, one that would 

streamline offering reforms making our offering of our securities 

more efficient for investors. Also, as the professor mentioned, would 

enable—there is a provision that would enable BDCs to increase leverage. We believe the increase in leverage is modest. First, 

BDCs—and important. First, BDCs would have more capital to deploy in the middle market, while keeping all investor protections 

that I mentioned in place. 


nshattuck on FSR297 with DISTILLER
7 

Second, this would enable BDCs to build safer portfolios, delivering the same or higher returns, while investing higher up in the 

capital stack of portfolio companies. 

Third, even with the proposed increase, two-to-one leverage 

would still be quite low when compared to other lenders in the 

marketplace. For example, banks are leveraged anywhere from 8 to 

1 to 15 to 1. Hedge funds may even be over 20 to 1. And neither 

of those lending structures offer the same transparency as— 

Chairman HUIZENGA. The gentlemen’s time has expired. 

Mr. GERBER. Yes, sir. Thank you, sir. 

[The prepared statement of Mr. Gerber can be found on page 57 

of the Appendix] 

Chairman HUIZENGA. Thank you. 

And we are going to need to move to Mr. Stevens. You are recognized for 5 minutes. 

STATEMENT OF PAUL SCHOTT STEVENS 

Mr. STEVENS. Chairman Huizenga, Ranking Member Maloney, 

and members of the subcommittee, I appreciate the opportunity to 

testify today on proposals to improve access to capital for small 

businesses and communities. 

ICI is the leading association representing regulated funds globally, and our member funds are the vehicles through which more 

than 100 million Americans pursue important financial goals, including saving for retirement, college, or a first home. Registered 

funds also play a vital role in the U.S. economy. They channel capital from fund investors to the markets and users of capital. Funds 

help fuel innovation, growth, and job creation. 

One measure that could enhance this process is Mr. Hollingsworth’s bill, the Expanding Investment Opportunities Act. ICI fully 

supports the discussion draft, because we feel its provisions to modernize offering rules for closed-end funds will provide significant 

benefits to these funds, to their shareholders, and to the enterprises that they can help finance. 

Like other registered funds, closed-end funds are comprehensively regulated under the Federal securities laws and Securities 

and Exchange Commission regulations. They differ from mutual 

funds, also known as open-end funds, because closed-end funds 

have flexibility to invest in a broader array of assets, such as 

stocks and bonds issued by small private companies. 

For investors, closed-end funds provide enhanced income and 

cash-flow, increased after-tax efficiency, and broader diversification. We estimate that more than 3 million American households 

held $271 billion in assets in 533 closed-end funds as of June of 

this year. 

Now, despite their numerous benefits, the number of closed-end 

funds has declined sharply, by more than 19 percent over the past 

decade. In 2016, only 8 new closed-end funds issued shares, and 

that is a decline of 81 percent from 2007. Clearly, this well-established, well-regulated investment vehicle has untapped potential to 

help fund our economy. 

Mr. Hollingsworth’s bill would help reverse these trends. It 

would reduce the burdens of certain SEC registration and commuVerDate Sep 11 2014 07:59 Sep 24, 2018 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-03 CM SBA\30

nshattuck on FSR297 with DISTILLER
8 

nications requirements that impose heavy costs on funds and their 

investors without commensurate investor protection benefits. The 

resulting cost savings would be passed on to fund shareholders, 

making these funds more attractive. 

Now, while the discussion draft provisions are quite technical, 

they actually follow well-established rules governing securities 

issued by operating companies. If closed-end funds could avail 

themselves of these rules, they would be subject to all of the same 

conditions as operating companies, plus the extensive investor protections of the Investment Company Act. 

When former SEC Chair Mary Jo White evaluated nearly identical legislative provisions in 2013, in that case with respect to 

BDCs, she concluded that, quote, ‘‘In my view, these provisions do 

not raise significant investor protection concerns.’’ We agree, and 

we believe that now is the time for Congress to act. 

Some will argue that these changes should be left to the SEC. 

In fact, the Commission suggested the need to modernize registration and communications requirements for closed-end funds in 

2005. Unfortunately, it has not followed through, and the Commission has no fewer competing priorities today than it has had 

throughout the past dozen years. We believe that the discussion 

draft approach, giving the SEC 1 year to enact new regulations before the bill’s provisions would take effect, is necessary and appropriate. 

We have also heard concerns that automatic shelf registration 

would allow closed-end funds, including some funds that are not 

traded on exchanges, to register new offerings without a full SEC 

review. This is true, but similar treatment for operating companies 

appears to have worked quite well for more than a decade. Moreover, closed-end funds that utilize these provisions already will 

have filed a registration statement, reviewed and declared effective 

by the SEC staff. 

For all these reasons, we wholeheartedly support Mr. Hollingsworth’s discussion draft as a valuable set of reforms that will enhance financing for the economy, while maintaining stringent investor protections. 

Mr. Chairman, if I may briefly comment on one other measure. 

ICI also supports the proposed offering and communications reforms for business development companies. We do not object to the 

bill’s provisions to grant BDCs more flexibility to use leverage. 

Mr. Chairman, Mrs. Maloney, members of the committee, thank 

you again for the opportunity to testify. I will be happy to take any 

questions. 

[The prepared statement of Mr. Stevens can be found on page 79 

of the Appendix] 

Chairman HUIZENGA. Thank you, Mr. Stevens. 

Mr. Quaadman, you are recognized for 5 minutes. 

STATEMENT OF THOMAS QUAADMAN 

Mr. QUAADMAN. Thank you, Chairman Huizenga, Ranking Member Maloney, members of the committee. Thank you for holding 

this hearing today. We appreciate the continued bipartisan leaderVerDate Sep 11 2014 07:59 Sep 24, 2018 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-03 CM SBA\30

nshattuck on FSR297 with DISTILLER
9 

ship of this subcommittee on issues related to capital formation 

and job creation. 

Indeed, the passage of the JOBS Act and the recent introduction 

of reg S-K reforms by the SEC would not have happened without 

the efforts of this subcommittee. And the passage this week of bills 

by the House on testing the waters and accredited investor reforms 

show the continued dedication of this subcommittee on those 

issues. However, the situations of capital formation are still in dire 

straits, and much needs to be done to reverse the trends. To sum 

it up, the diminution of financial resources is calcifying entrepreneurship. 

During this past recession and for the first part of the recovery, 

for the first time ever, business destruction outpaced business creation. This occurred for a contracted period of time, and business 

creation rates have not come back to prerecession norms. Bank 

lending to small business is down and small business capital needs 

are not being met. Firms that are less than 5 years old are being 

particularly hard hit, as are business loans of under a million dollars. This data comes from the FDIC Community Reinvestment Act 

reports, the Federal Reserve, and the U.S. Census Bureau. Our 

2016 corporate treasurer survey and 2017 small business survey 

back this government data up. But the situation is even worse. 

A 2016 study by the Economic Innovation Group found that between 2010 and 2014, 3 of 5 counties in the United States had 

more business exit than entries. And to make it even worse, 50 percent of all business startups occurred in 20 counties in only 7 

States, representing 17 percent of the American population. 

If we are to return to historic rates of economic growth and job 

creation, we need to fix these problems in a comprehensive and 

lasting way. The Chamber in a few weeks is going to issue an IPO 

report, and we look forward to working with this subcommittee on 

some of the comprehensive proposals we are going to make. 

But the bills before us today are a step in the right direction. The 

Small Business Credit Availability Act drafted by Mr. Stivers deals 

with business development corporations. BDCs have slowly been 

filling the void, since the recession, of financial firms that have left 

for regulatory reasons, both to middle market and small market 

capital areas. And BDCs need to be doing more. 

This bill would allow for a modest increase in leverage and would 

allow BDCs to deploy capital more efficiently. The SEC would continue to have oversight and regulations, and this bill would also 

allow for increased investor protections so that if there is an increase in leverage, investors have an opportunity, over a course of 

a year, to remove themselves from the BDC. 

The Expanding Investment Opportunities Act by Mr. Hollingsworth deals with expanding the well-known seasoned issuer status 

to closed-end funds. This will disseminate information more quickly, end duplication, reduce costs, and have capital be deployed—deployed more quickly. If we allow high school students to use a common app to apply for a college, we should do no less for America’s 

job creators. The quick passage of these bills will help middle market and small businesses meet their capital needs. 

I also want to address a bill introduced by Mr. Rothfus, the Consumer Financial Choice and Capital Markets Protection Act. This 


nshattuck on FSR297 with DISTILLER
10 

bill shines a light on a capital formation problem that must be reviewed. The money market fund reforms implemented by the SEC 

have made corporate cash management more difficult and inefficient and has reduced the pool of productive working capital. A recent study by the Treasury Strategies, which we would like to submit for the record, shows that there is a $371 billion shortfall in 

business capital. More troubling, this has led to a crowding-out situation so that where big businesses are removing themselves from 

commercial paper and going into the bank lending space to meet 

their short-term needs, they are crowding out middle market companies and small businesses. 

In conclusion, we believe that we can work together to solve 

these issues and put America back to work. We look forward to 

working with the subcommittee to find comprehensive solutions to 

these problems and addressing America’s capital formation crisis. 

Thank you, and I am happy to take whatever questions you may 

have. 

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

69 of the Appendix] 

Chairman HUIZENGA. Thank you, Mr. Quaadman. I appreciate 

this. 

I am going to attempt to hold the standard and not use my full 

5 minutes, but I will recognize myself for 5 minutes. 

The SEC’s final rule provided money market funds with 2 years 

to comply with these new requirements, which ultimately became 

effective October 14 of 2016, the final rule also permits government 

and retail MMFs to use the method to seek and maintain a fixed 

NAV. Some market participants have expressed the concern that 

the SEC’s 2014 rule would result in the loss of short-term liquidity 

in the capital markets, particularly in the municipal securities 

market. 

Along with Ranking Member Maloney, we wrote to the Securities 

and Exchange Commission to review, and asked them to review the 

current landscape for MMFs (money market funds) and the impact 

of the 2014 rule on both short-term corporate and municipal financing. And without objection, I would like to enter into the record our 

letter to Chairman Clayton as well as his response letter. 

Mr. Quaadman, Mr. Stevens, how, really very quickly, has the 

industry changed, or have we seen significant shifts in the money 

market since the October 2016 implementation date? And then I 

am also curious how the industry has adapted to the new rules. 

Mr. QUAADMAN. We have seen—I will turn it over to Mr. Stevens 

in a second. We have seen a dramatic shift into government prime 

funds, and this is why you have also seen a dramatic retrenchment 

of businesses from using money market funds as a means of cash 

management. So it has actually changed the way that a corporate 

treasurer has to go out and manage their day-to-day activities in 

a negative way. 

What I would also say too, if you look at this rule in conjunction 

with the Volcker rule, Basel III, and a number of others, what it 

does is it places a premium on government funds or shifting money 

into U.S. treasuries, which is also a concentration of risk, which I 

think the regulators have ignored and really should look at as well. 

Chairman HUIZENGA. OK. Mr. Stevens. 


nshattuck on FSR297 with DISTILLER
11 

Mr. STEVENS. I think that is a good summary. But what I would 

say is many of these effects were ones that were predicted at the 

time that these rules were in development. The ICI said many, 

many times that the proposals would have exactly the kinds of adverse effects that my colleague here has said in connection with 

municipal finance. And the way the rules are structured, prime assets have declined very precipitously and in their place rising just 

about as much have been government securities. 

Chairman HUIZENGA. OK. Mr. McCoy, how are municipalities 

currently meeting their short-term financing needs? And how has 

the 2014 reforms impacted how municipalities handle their cash 

management needs? 

Mr. MCCOY. Sure. Thank you. 

I think in terms of short-term products available, there is really 

only one other meaningful product that municipalities use. It is an 

index-based note. So, for example, we take the SIFMA index or a 

percent of LIBOR and put a spread on that. And that can go out 

for 2, 3, 4, 5 years, whatever. That is really the only good alternative other than issuing short-term notes, which are not what I 

would characterize as a long-term financing vehicle. So I think 

from the issuance perspective, we have seen a dramatic reduction 

of State and local governmental issuers accessing this market. 

And then from an investment perspective, as I noted in my testimony, treasurers across the country that invest public funds typically are held to a fixed NAV construct for those investments. And 

with this rule, we have seen them leave this market. 

Chairman HUIZENGA. Chairman Clayton, in his letter, says that, 

basically, we should just take some more time and collect some 

data. I mean, do you have an opinion on this? 

Mr. MCCOY. I think we are always looking at the data and what 

the data tells us. You know, we can’t argue— 

Chairman HUIZENGA. It is more of a time element here, right? 

Mr. MCCOY. Certainly time, yes. We have seen assets in this 

complex drop by half, anticipating the rule change and then after 

the rule change. So I would argue that we have had enough time, 

and we have seen the impacts of the rule change. I don’t think they 

are necessary. 

Chairman HUIZENGA. OK. With that, I will yield back. 

The Ranking Member is recognized for up to 5 minutes. 

Mrs. MALONEY. Thank you so much. And I want to welcome all 

of the panelists here, particularly Mr. McCoy from the great State 

of New York and the MTA, and thank him for his work on completing the Second Avenue Subway, the best subway in the Nation, 

which happens to be in my district. Thank you so much. 

I would like to continue on the Chairman’s questioning and ask 

you about H.R. 2319. SEC Chairman Clayton, in his response to 

myself and Chairman Huizenga, stated that even if we repealed 

the NAV requirement from municipal and corporate funds, some 

investors might not come back to these funds. He stated, and I 

quote: ‘‘While some investors might choose to leave government 

money market funds and return to prime and municipal funds, 

such a shift also might not occur if investors newly appreciate 

prime and municipal money market funds’ inherent liquidity and 


nshattuck on FSR297 with DISTILLER
12 

principal stability risk and, therefore, choose to remain in government money market funds.’’ 

So what do you think of his comments? Do you think that investors who have left municipal funds would come back if the floating 

NAV requirement was repealed? 

Mr. MCCOY. I do believe that that is the case. I believe that investors would take more comfort in this product if they knew that 

a dollar was worth a dollar at all times. And, quite frankly, I think 

that is what we believe to be a core reason why investors fled this 

particular product in substantial ways that they did. 

Mrs. MALONEY. OK. Then, Mr. Stevens, the Expanding Investment Opportunities Act is intended to modernize the offering rule 

for closed-end funds so that these funds are treated the same as 

normal operating companies like Google and GE. Of course, we 

know the SEC could make these changes on their own and decided 

not to extend the fast-track offering rules to closed-end funds back 

in 2005. 

So my question is why did the SEC not include closed-end funds 

in the 2005 offering reform rule? Was it just an oversight or are 

there differences between closed-end funds and operating companies that make it difficult to apply the fast-track offering rules to 

closed-end funds? 

Mr. STEVENS. Thank you for your question, Mrs. Maloney. I don’t 

think it is the second of those. I think it is a fairly straightforward 

proposition. The SEC at the time said, oh, we will get back to that. 

I am speculating now. But sometimes it is very difficult when you 

have two different divisions at the SEC with responsibility that 

overlaps. In the case of operating companies, that is the Division 

of Corporation Finance. In the case of the closed-end funds, it 

would be the Division of Investment Management to come together 

and converge on a set of changes that will affect regulated entities 

in both spaces. 

What we do know is that they said they would get back to it. 

And 12 years later, they haven’t. And, unfortunately, I don’t think 

there is any prospect that they will. I am very sympathetic to the 

limited regulatory rulemaking resources that they have and the 

many, many competing priorities. So with all the goodwill in the 

world, I just don’t think, after a dozen years, we should think that 

they will return to the issue, absent some prompting. 

Mrs. MALONEY. Thank you. 

And, Mr. Gerber, as you know, the Small Business Credit Availability Act would allow BDCs to double their leverage. This could, 

in theory, allow BDCs to lend more to small- and medium-sized 

businesses or it could allow BDCs to simply increase their risks. 

So my question is what would you use the additional leverage 

for? Would you lend to riskier companies or would you lend more 

to creditworthy small businesses? What would the impact be? 

Mr. GERBER. Well, I certainly can answer for FS Investments, 

and it would be the latter. It would enable us to invest in more 

companies higher in the capital stack reducing risk, but still maintaining the returns that our investors have come to expect from 

BDCs. And I think it is fair to assume that the rest of the industry 

would follow suit. And I say that because capital availability to 

poorer performing BDCs will not be the same as it would be for 


nshattuck on FSR297 with DISTILLER
13 

higher performing BDCs. In other words, those poor performers 

would not be able to do 501 offerings, issuing new equity. They 

would not be able to draw down more debt from lenders, from the 

banks. So I think it is fair to assume that that would be an industrywide approach. Investing higher in the capital stack, taking on 

less risk. 

Mrs. MALONEY. Well, I am sympathetic to the testimony of Mr. 

Quaadman where he said this would move more credit availability 

and investment to smaller-sized companies that often do not get 

the attention they deserve. 

Thank you very much. My time is up. 

Chairman HUIZENGA. The gentlelady’s time has expired. 

With that, the Chair recognizes the Vice Chairman, Mr. 

Hultgren, from Illinois for 5 minutes. 

Mr. HULTGREN. Thank you, Chairman. Thank you all for being 

here. 

Mr. Stevens, if I could address my first couple questions to you 

regarding the Expanding Investment Opportunities Act, the draft 

legislation that is being sponsored by Mr. Hollingsworth. From 

what I understand, this is a fairly simple piece of legislation that 

should have strong positive impact for investors and for our capital 

markets. 

Three questions here, if I could. In general, why do you believe 

the number of closed-end funds has declined in recent years? And 

then how will expanding investment opportunities in closed-end 

funds benefit investors? And then final part of that, can you speak 

to the significance of closed-end funds flexibility to invest in less 

liquid securities? I know on page 2 of your testimony you talk 

about this. And what are some of the examples that come to mind 

and how will this contribute to capital formation? A lot there. 

Mr. STEVENS. I hope I remember all three of those questions. 

Mr. HULTGREN. First one, why closed-end funds have declined in 

recent years. 

Mr. STEVENS. They compete in the ecosystem of financing with 

lots and lots of other alternatives, and including some innovations, 

like exchange-traded funds, which are extraordinarily popular now. 

They exceed $3 trillion in assets, in ETFs (exchange-traded funds), 

in the United States. There is a straightforward quality about 

ETFs. Closed-end funds are a slightly more complex vehicle. But I 

think the bill that Mr. Hollingsworth has in view, at the margin 

at least, provides a modernization for closed-end funds with respect 

to the way they can respond to market developments, bring their 

new issuances to market, inform their investors, and will make 

them at least marginally more competitive. 

Now, why is that important? I think it is important because they 

occupy, again, a unique space within the framework of regulated 

investment companies. They have opportunities to invest in small 

enterprises, in stocks and bonds that would not necessarily be ones 

that an open-end or a mutual fund company would. They have opportunities to leverage their portfolios in ways that mutual funds 

would not, and enhance the yield that they offer to investors. And 

they have opportunities to provide additional tax efficiencies. 

So in the broad array of investment opportunities, they occupy 

a specific place, and I think it is a good one. They have been part 


nshattuck on FSR297 with DISTILLER
14 

of our industry since 1940. And I think these modest reforms that 

are in view here will continue to make them an attractive option 

for investors without sacrificing any protections. 

Mr. HULTGREN. Thank you. 

I want to move on to the money market fund legislation. And 

first, Mr. Chairman, I would like to enter a letter into the record 

dated December 1, 2016, which is addressed to Speaker Ryan from 

the State Finance Officers Association, requesting consideration of 

the Consumer Financial Choice and Capital Markets Protection 

Act, one of the three bills we are reviewing today. 

Chairman HUIZENGA. Without objection. 

Mr. HULTGREN. Next, Mr. McCoy, if I can address this to you. I 

was wondering if you could speak to the merits of this legislation. 

What have the SEC’s money market fund rules meant for your cost 

of financing? 

Mr. MCCOY. Thank you for that question, Congressman. As a 

large issuer, we need access to all parts of the yield curve to finance long-term infrastructure. And what we have observed over 

many years of issuing bonds and notes and products into the 

money market complex is that our lowest cost of funding has always been achieved using variable rate products at the short end 

of the yield curve, which go right into the money market complex. 

Mr. HULTGREN. Thank you. 

Mr. Stevens, going back to you. Does the SEC have the legal authority to amend these money market fund rules? And should Congress let the SEC review the data and decide how to move forward 

with this rule? 

Mr. STEVENS. It would have the authority, Congressman. You 

know, I have spent many more than 5 years of my life since 2007 

on money market fund issues, through two sets of really extensive 

reforms of money market funds. I don’t think, at least from the 

perspective of our membership, that there is a lot of conviction 

around going through yet another extended process at the SEC. 

And I am absolutely convinced that at the SEC they have other 

priorities that they would like to be addressing. 

Mr. HULTGREN. Thank you. 

I will yield back a few extra seconds here as well. So thanks, 

Chairman. 

Chairman HUIZENGA. Much appreciated by everybody. 

So with that, the Chair recognizes the gentleman from Georgia, 

Mr. Scott, for 5 minutes. 

Mr. SCOTT. Yes. Thank you, Mr. Chairman. 

Mr. Gerber, let me start with you. But first let me, as one University of Pennsylvania graduate to another, welcome you to the 

Financial Services. 

MR. GERBER. Thank you, Congressman. 

Mr. SCOTT. Get back to Philadelphia, give my regards to the 

Wharton School of Finance. 

Mr. GERBER. We will. 

Mr. SCOTT. Let me ask you, I have worked on this bill with my 

good Republican friend Mick Mulvaney when he was here, he is 

now the budget director, that will help the small business development corporations that your bill will. And I understand that you, 

from my staff, that you and Mr. Stivers have made some changes 


nshattuck on FSR297 with DISTILLER
15 

to the bill, improvements to the bill, that address some of the concerns of the consumer advocates. Would you take a moment and 

share those with us? 

Mr. GERBER. Sure. Sure. Thank you, Congressman. 

You are right, when the bill was introduced in the previous Congress, and we had a hearing similar to this one a couple of years 

ago on that bill, there were five key provisions in that bill. And 

three of those five provisions are no longer in the bill—or are not 

reflected in the current discussion draft that Congressman Stivers 

has authored. 

One of those three that is no longer in there was the subject of 

an amendment addressed by Congressman Himes. And that provision would have expanded the definition of eligible portfolio companies. So as you know, we have to invest 70 percent of our assets 

in private or small cap U.S. companies. And in that 30 percent 

bucket, we can invest in non-U.S., large cap, mid cap, and financial 

companies. And I think there was bipartisan concern over expanding the definition, particularly with the focus on not wanting BDCs 

to invest more in financial companies. That provision is no longer 

in the legislation. That has come out. And that was one that caused 

concern by consumer groups, investor protection groups, as well as 

both Republican and Democratic Members here in the House and 

in the Senate. 

Mr. SCOTT. Very good. 

Let me go to you for a moment, Mr. McCoy, on another bill that 

I have worked on prior to that, and that is Congressman Rothfus’ 

bill, which is the Consumer Financial Choice and Capital Markets 

Protection Act, along with my Democratic colleague, Ms. Moore. 

And I wanted to make sure that you would share with the committee some of the issues. There has been an incredible disruption 

that I have seen in the marketplace for money market funds, specifically for the tax-exempt funds. And would you comment on that 

in particular and see how this legislation improves that? 

Mr. MCCOY. Sure. Thank you. You know, as I noted in my testimony, the significant retreat from this product by retail investors 

who have typically invested in money market funds, tax-exempt 

money market funds, has had an effect to cause State and local 

governmental issuers who have historically been very active in that 

market to retrench and, as I noted, to go into other products, most 

predominantly fixed rate bonds which, of course, carry a higher 

cost of interest than a money market product than a variable rate 

demand bond. So that has had an effect on our ability to access, 

again, what we believe to be is the most efficient part of the yield 

curve, again, for building infrastructure. 

Mr. SCOTT. OK. Well, thank you very much. 

And, Mr. Chairman, may I make just a brief inquiry to you? And 

I want to ask if you would be kind enough, you and Chairman 

Hensarling, to—would it be possible for us to move these bills? 

They are both bipartisan bills. And I know we are getting to crunch 

time at the end of the year. Do you think, working with Chairman 

Hensarling and you, that we could get these bills on the floor for 

a vote and over to the Senate before Christmas? 

Chairman HUIZENGA. The gentleman’s time has expired. No. We 

will certainly be giving this full consideration. As you can see, we 


nshattuck on FSR297 with DISTILLER
16 

have the hearing today for the purposes of gathering that information and working toward that. The fact that there is broad bipartisan support helps any and all issues coming out of this committee, and certainly helps over on the other side of the Capitol as 

well. 

Mr. SCOTT. Yes, sir. Thank you, Mr. Chairman. I appreciate it. 

Chairman HUIZENGA. Now the gentleman’s time has expired. 

All right. With that, the Chair recognizes the gentleman from Arkansas, Mr. Hill, for 5 minutes. 

Mr. HILL. Mr. Chairman, I wanted to talk to Mr. Stevens a little 

bit more about the closed-end funds issue. Thank you for the discussion you had with my colleague about their competitive position 

and compared to ETFs. And one of the strong, I think, issues is 

that they can pursue strategies that involve some leverage and disclose that. 

Would you say that that is really one of the principal advantages 

in this ecosystem you are talking about? I mean, from an investor 

point of view, the transparency of the data, and reflect a little bit 

more on that, both on fixed income and equities. 

Mr. STEVENS. Well, the current closed-end fund business is about 

maybe 60 percent fixed income investment and about 40 percent 

equity. And, yes, I think, Congressman, their ability to use a bit 

of leverage in their portfolio is something that is characteristic of 

closed-end funds and provides them an opportunity to enhance 

their return to their investors. And that, I think, in part, is what 

makes them attractive; in a sense, that gives them advantages in 

terms of tax management and things of that nature. So, again, it 

is a unique characteristic that they have. And we are talking about 

a range of different investment options. 

But as I said in my testimony, I think there is untapped potential there. I don’t know how large it is, but untapped to be a source 

of financing to small enterprises and for other purposes in the 

economy. And that is a good thing, in my view. 

Mr. HILL. And do you think they have an advantage over attracting, as you say, smaller market cap stocks into that—as a collective 

format rather than some of their competitors? 

Mr. STEVENS. Well, if you think about mutual funds and ETFs, 

the nature of their investments, ETFs are largely index products, 

so they are looking at, in many instances, large cap issuers and the 

like. Mutual funds tend to be larger in terms of their size. And so 

just their ability to invest in much smaller businesses, the stocks 

and bonds, is going to be constrained in a way that, with a smaller 

closed-end fund, would not necessarily be the case. 

Mr. HILL. Yes. Because I think that has, over of the years, really 

become a real challenge both in—we have talked in this committee 

many times about the cost of being public. But even if you move 

that down from very, very high market cap levels to smaller, you 

still have the coverage issues and the institutional investor interest 

area, even if it is a worthy company. And so we don’t have many 

collective places for people to experiment with different market cap 

sizes. 

And, again, I agree with you on indexing that it, for the most 

part, drives the larger more liquid names, as it should be, by definition of being an index or a near index-type process. 


nshattuck on FSR297 with DISTILLER
17 

Do you know of a closed-end fund trend where they really do 

seek out smaller market cap names? Have you seen that among 

some of your members that have really been a source of looking for 

that emerging company that doesn’t fit with a Morningstar style 

box that doesn’t have the market cap required by a larger ETF requirement? 

Mr. STEVENS. I think those are exactly the investment opportunities that many of them are seeking out. 

Mr. HILL. So you would say that that business is changing before 

our eyes, and you think that these proposals today would make 

that a more compelling and easier for them to pursue that strategy? 

Mr. STEVENS. It is going to make them be able to get to market 

more quickly with respect to new issuance. It is going to facilitate 

their communications with the investing public. Now, I don’t think 

this is going to be some revolution overnight. But at the margins, 

it is modernizing the ways in which they engage in a marketplace. 

Mr. HILL. But I just think this is a really interesting capital formation question. 

Mr. STEVENS. I agree. 

Mr. HILL. Because you can’t say that a closed-end strategy per 

se can compete with large cap growth international per se, although we have closed-end funds that do that. And so this to me 

is an opportunity maybe for the industry to transform itself and 

change and adapt, while so many of what we would think is a traditional collective investment have moved to lower cost different 

formats. 

Mr. STEVENS. And that is why we support the changes. 

Mr. HILL. Yes. I appreciate the time. 

I yield back, Mr. Chairman. 

Chairman HUIZENGA. We are on a roll. The gentleman yields 

back. 

With that, the Chair recognizes the gentleman from California, 

Mr. Sherman, up to 5 minutes. 

Mr. SHERMAN. I want to add my voice to Mr. Scott’s, that I hope 

we move forward on a markup. I would like to thank the Chair for 

holding these hearings and hope that it actually leads to a markup, 

as the gentleman said, well before Christmas. 

I want to first talk about small business development companies, 

because if you look at the capital structure of the United States, 

we have a lot of systems that move money to large corporations, 

to government bonds, to real estate. And yet the national interest, 

I think, requires that we are able to have vehicles that move 

money to small businesses, and that is where the technological 

changes that will give us high GDP growth are going to come from. 

I would point out that the discussion draft, Small Business Credit Availability Act, is patterned after a bill that passed through this 

committee 53 to 4. And it is my understanding that it is now a 

skinnier bill which incorporates, I believe, Mr. Himes’ amendment. 

So you have a chance to start with a 54 to 3, depending upon what 

Mr. Himes says later. I am not speaking for him. That is a pretty 

good starting point. 

Mr. Gerber, in his testimony, Professor Bullard states that markets and regulators lack adequate method for estimating BDC leVerDate Sep 11 2014 07:59 Sep 24, 2018 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 G:\GPO PRINTING\DOCS\115TH HEARINGS - 1ST SESSION 2017\2017-11-03 CM SBA\30

nshattuck on FSR297 with DISTILLER
18 

verage and its effect. The professor sites one industry measure that 

suggests that effective BDC leverage is actually several multiples 

of the current one-to-one limit. Can you tell us more your understanding of this concept of effective leverage? 

It seems like we are using a ruler with inches on it to measure 

the leverage of banks and other institutions in our society. And the 

professor is suggesting that we use millimeters to measure the leverage of BDCs. I am all for the metric system, but then we would, 

in order to put things in context, also have to use millimeters for 

measuring the leverage of all the other financial entities. 

So tell me what you—explain this effective leverage, as you understand it, and how it would allow—how your leverage compares, 

whether we are using millimeters or inches, to leverage off other 

financial institutions. 

Mr. GERBER. Thank you, Congressman. As I stated in my testimony and in one of my answers to an earlier question, BDCs are 

required, under the law, to provide a very significant amount of 

transparency into our portfolios; far more transparency than the 

banks are required to provide with respect to their lending practices or the portfolio companies to which they lend money; far more 

than other capital providers in the capital markets like hedge 

funds. So we are already starting off with a very transparent 

model. 

One of the disclosures that is required of BDCs is that of how 

much leverage is being used by the BDC. Financial leverage. I 

mean, how much money has been borrowed by the BDC so that the 

BDC manager can deploy that borrowed capital alongside the equity capital. That is fully transparent. That is financial leverage. 

I think the effective leverage, and I am using air quotes on that, 

the effective leverage factor or formula is one that was designed by 

an analyst. And I think it speaks to the transparency of the BDC 

model. That analyst was able to take the information that is provided in our disclosures every quarter to come up with this formula. And I think if you were to talk to that analyst, and I can’t 

speak for him, but I think if you were to talk to that analyst what 

he would tell you is his formula is not measuring the financial leverage in a BDC. It is trying to put a score on the portfolio construction of the BDC by looking at where in the capital stack the 

BDC is deploying its assets. And so the lower in the capital stack 

any one investment is, the higher the score would be. And then he 

makes a bunch of assumptions. 

So he just puts a number on mezzanine debt. He puts a number 

on CLO debt. He puts a number on equity. But he doesn’t actually 

look at the underlying portfolio company to determine how much 

debt is on that underlying portfolio company to come up with this 

score. So it is a shorthand way to enable BDC investors to compare 

BDCs. It is not a measurement of financial leverage. And I think 

that is a very important distinction. I would also add— 

Chairman HUIZENGA. The gentleman’s time has expired. I’m 

sorry. We have got to get to other questions. 

Mr. GERBER. Yes. 

Chairman HUIZENGA. The gentleman from Maine, Mr. Poliquin, 

is recognized for 5 minutes. 


nshattuck on FSR297 with DISTILLER
19 

Mr. POLIQUIN. Thank you, Mr. Chairman. I appreciate it. Thank 

you all very much for being here, gentlemen. 

I represent rural Maine, and I am very concerned about small 

businesses. We don’t have very many large businesses in the State 

of Maine. We have got a lot of mom-and-pops and a lot of mid-sized 

companies, small companies. And access to capital is absolutely 

critical. This is always something that is on my mind. Second of 

all is we have a lot of small savers, a lot of small investors who 

are looking to save for their kid’s college or technical education or 

their own retirement. So cost and transparency is also very important when you are looking at various investment vehicles. 

Mr. Gerber, if I could ask you a question, and just give you a— 

just a couple—just a bit of information here, and you probably already know this, is that the State of Maine has benefited from 

BDC investment to the tune of about $76 million, including investments in Auto Europe, CashStar, Fiber Materials, Native Maine 

operations, tools and technology and what have you. So we are very 

grateful for the structure, the investment vehicle that you folks 

represent, you represent here on this panel today. 

One of my questions is what about valuing the underlying portfolios? Tell me how this works. If you are a publicly traded BDC, 

do you have to mark to market any specific time? And what if you 

are not publicly traded? And what if I am an investor? I am worried about the little guy, the little investor, and I want to participate in a vehicle that you offer, how often do you folks mark to 

market as required by law, and should that change? 

Mr. GERBER. Yes, sir. So whether a BDC is nontraded or traded, 

it is required under the law every quarter to post the schedule of 

all investments in the portfolio. The law also requires a BDC to 

mark at least 25 percent of that portfolio every quarter, so 100 percent on the year. Now, at FS, we happen to do 100 percent of the 

portfolio every quarter. 

Mr. POLIQUIN. So if I am an investor and a small investor, I am 

trying to get access to the information that you are providing such 

that I can determine if your investment vehicle is right for me, 

then the best I can do is—especially for a BDC that is not traded, 

is every quarter get a valuation of my investment? 

Mr. GERBER. That is right. And I think it is important to note 

that those valuations are handled by third-party valuation firms, 

and then have to be approved by a majority of the independent directors on the board of the BDC. So not only do you have the transparency, but you have a couple of layers of independent protections. 

Mr. POLIQUIN. Where does an investment in a BDC fit for a middle class family in Maine or any other place around the country? 

And how would that compare to someone investing in a venture 

capital fund, for example? 

Mr. GERBER. Sure. So the investment strategies used by BDC 

managers are quite different than venture capital strategies. Venture capital, you are usually taking a position—an equity position 

in a startup company. 

Mr. POLIQUIN. Qualified investors. 

Mr. GERBER. Qualified investors or credit investors in some case, 

but usually qualified investors. And usually, that venture capital 

firm strategy is to make a bunch of bets knowing that most of them 


nshattuck on FSR297 with DISTILLER
20 

will fail and hoping that a couple of them will really hit it. And 

so it is a much riskier venture. 

With BDCs, we are investing primarily in senior secured debt of 

established companies. So you don’t have the risk of a startup and 

you don’t have the risk of taking an equity position. Now, that is 

not to say that BDC portfolios won’t at times have exposure to equity and have a percentage of the portfolio in equity investments. 

But most BDCs are predominantly investing in senior secured 

loans or debt of a private company. 

Going back to the beginning of the question about the investor, 

why would an investor consider a BDC? It is an opportunity to diversify a portfolio. So the way we manage assets and the types of 

investments we make tend to be less correlated with the markets 

than a publicly traded stock or a publicly traded bond, because we 

are investing in private companies. 

Mr. POLIQUIN. Thank you, Mr. Gerber. Thank you very much. 

Mr. Stevens, if you could comment a little bit on the fit of a 

closed-in fund when it comes to a working class family in our society that is looking to save for the future for their nest egg or they 

are putting the kids through school or what have you. Where would 

a closed-end fund fit, in your opinion, as compared to a BDC? 

Mr. STEVENS. Well, we have an investor base of 3 million households. 

Mr. POLIQUIN. Right. 

Mr. STEVENS. Our understanding is that closed-end fund shares 

are not uncommonly held, for example, in an individual retirement 

account. That may be a vehicle that can be held longer term for 

retirement purposes, again, as a way of diversifying your exposure 

to different kinds of assets. And we think that is commonplace 

among the investors in these vehicles. 

Mr. POLIQUIN. Thank you, gentlemen, very much for being here. 

I appreciate it very much. 

Chairman HUIZENGA. The gentleman’s time has expired. 

With that, the gentleman from Massachusetts, Mr. Lynch, for 5 

minutes. 

Mr. LYNCH. Thank you, Mr. Chairman. I want to thank the witnesses for helping the committee with its work this morning. 

Mr. Chairman, I ask unanimous consent to submit a letter from 

the Office of the Mayor of the city of Quincy, Massachusetts, Tom 

Koch, a dear friend of mine, in support of the Consumer Financial 

Choice and Capital Markets Protection Act of 2017. That is H.R. 

2319. 

Chairman HUIZENGA. Without objection. 

Mr. LYNCH. Thank you. 

Tom Koch is a great pal of mine. We are not necessarily in harmony on our thoughts on this bill, but that is because every city 

is not run as well as Quincy, Massachusetts. Let me just put that 

out there. 

And I want to turn to the other—the BDC bill there for a minute. 

I was one of the four Members who voted against the BDC last 

time. I think the bill has been enormously improved by Mr. Himes’ 

amendment, the gentleman from Connecticut, but I am still not 

there yet. 


nshattuck on FSR297 with DISTILLER
21 

Let me just ask Professor Bullard, in your testimony, you cite the 

fact that—at least in the earlier iteration of this bill, BDCs were 

allowed to invest, I think, 30 percent of the corpus of their funds 

in financial institutions. A lot of investment was going into financial institutions and structured products, collateral loan obligations 

and things like that, that weren’t necessarily helping small- and 

medium-size operating businesses. 

Look, if we were just talking about that, I would be with this bill, 

because I do believe that we need access to capital for those 

smaller- and medium-size businesses. My problem is that we have 

allowed this significant part of this bill to be directed toward, previously, financial institutions and structured products that allow, I 

think, an amplification of the leverage and risk that is involved 

here. And, also, it does not help. It does not help those small businesses and mid-size businesses that we are supposed to be assisting in this bill. 

Is there a rebalancing? Is there a rebalancing that could be possible here, in addition to what Mr. Himes is doing—and I applaud 

his good work—to make sure that the lion’s share, or almost the 

lion’s share, of good here is really directed to those companies that 

need the help? 

Mr. BULLARD. Well, I guess I would like to first say that in the 

last week of reading through registration statements, I have been 

very impressed by the number and diversity of investments in 

BDCs. I hadn’t done that reading before, and with the weekend 

coming up, I recommend that highly to the members of the subcommittee. 

Mr. LYNCH. Not likely, but thank you. 

Mr. BULLARD. But the answer to your question is that it is hard 

to know exactly what the right percentage is for a leverage limit. 

But one direct response would be simply to require that additional 

leverage go 100 percent to the companies for which it is intended 

so to not allow doubling of leverage to be used to double the 

amount invested in that 30 percent window. 

Also in my testimony, I have asked why, given that there may 

have been reasons in the 1980s you needed a 30 percent basket, 

why not reduce that and also directly provide for more assets to 

those economies? And then, third, in looking through the structure 

of these BDCs, many, if not most, have significant buffer between 

the limit they are allowed, meaning that they have made .5 to .6 

ratios as opposed to a 1 to 1. And if a prudential rule of this nature 

is structured correctly, that should not be the case. 

The way the rule like this should work and works in other context, insurance, banking, similarly in money market funds, is that 

you go up to the limit. There is a mechanism that if you are pushed 

across it by changing asset values, which Mr. Gerber mentioned in 

his testimony, then there should be a grace period. It should be 

that you can’t take on additional debt, but that that shouldn’t 

cause you, by something outside of your control, to be in violation 

of the limit. And I believe there should be a way in order to make 

adjustments. It may be the dividend requirement. It may be that 

banks are just not very flexible on renegotiating the one-to-one covenant, I guess. 

Mr. LYNCH. Right. 


nshattuck on FSR297 with DISTILLER
22 

Mr. BULLARD. But if this bill goes through, I think they are going 

to have to renegotiate the covenant anyway. So I think there is a 

way that would let them get the full benefit of the current one-toone. And what that would do is, firms like Mr. Gerber’s and I have 

looked at their structure, and the concern is not his type of BDC, 

it is the one that is at the far end of the spectrum and is going 

to make life a nightmare for his BDC if there is a severe liquidity 

event and it fails. 

So I would look into that as a way of allowing BDCs to get the 

benefit of the leverage limit we intend, and I— 

Chairman HUIZENGA. The gentleman’s time has expired. 

Mr. LYNCH. I am out of time. Thank you, Mr. Chairman. Thank 

you, Professor Bullard. 

Chairman HUIZENGA. With that, the gentleman from Minnesota, 

Mr. Emmer, is recognized for 5 minutes. 

Mr. EMMER. Thank you, Mr. Chair. I would like to request unanimous consent to enter into the record a letter from the Association 

of Minnesota Counties, which expresses their support for the Consumer Financial Choice and Capital Markets Protection Act. And 

I share their support for the legislation, and thank Mr. Rothfus for 

his work on the issue. 

Chairman HUIZENGA. Without objection. 

Mr. EMMER. Mr. Quaadman, in your written testimony, you mentioned that Congress should, quote, ‘‘look at creating the legal 

framework to allow for venture exchanges in an effort to improve 

secondary market trading for small public companies.’’ 

Can you just comment on some of the issues that you see these 

small public companies currently face in today’s market structure 

and how you think venture exchanges could help? 

Mr. QUAADMAN. Yes. Thank you for that question, Mr. Emmer. 

I think the two underlying issues that are at the heart of the capital formation problem here are: One, our liquidity; and two, is research and information. I think one of the things that the venture 

exchange could do is to help drive liquidity to those small cap companies. And I think if you look at it in conjunction with the bills 

that we are talking about here today, you would take a multifaceted approach to try and drive liquidity into those markets. 

I think some of the WKSI issues that we are talking about as 

well are going to activate other participants. And I think that helps 

to get at the liquidity issue. I think we are going to have to do 

some other things in terms of trying to drive out research and information as well. 

Mr. EMMER. Thank you very much. And because of our time and 

the votes pending, I am going to yield the balance of my time to 

my colleague from Ohio, Mr. Stivers. 

Mr. STIVERS. I would like to thank the gentleman for yielding. 

And I have a yes or no question for Professor Bullard. Professor 

Bullard, in preparation for this testimony, did you by any chance 

have a chance to talk to Jonathan Bock from Wells Fargo, who is 

the analyst who came up with the effective leverage ratio method 

that you quoted so extensively in your testimony? 

Mr. BULLARD. No, I haven’t, and I am not endorsing that leverage ratio. 


nshattuck on FSR297 with DISTILLER
23 

Mr. STIVERS. Thank you. And I did have a chance to talk to him. 

And I got an email through Wells Fargo from him this morning at 

7:21. 

Mr. Chairman, without objection, I would like to enter it into the 

record. 

Chairman HUIZENGA. Without objection. 

Mr. STIVERS. Thank you. 

So I would like to quote from the email that Mr. Bock sent me, 

the statement, and I will just quote some excerpts, but the whole 

statement will be entered into the record. 

He said he wanted to offer some additional color on the effective 

leverage statistic in his BDC scorecard, because he is concerned 

many of the items are being taken grossly out of context. Those are 

his words. He says that, first, effective leverage should not be confused with financial leverage, which is what the bill changes. Effective leverage is a chance to look at BDCs’ risk profile between each 

other based on their asset composition. Then he goes on to say: 

This isn’t exact, and in no way is the gauge of financial leverage 

taken on by a BDC. 

Then he goes on later to say: Also taking a step back, if folks 

would like to talk about imbedded leverage risks with BDCs and 

pass it off as financial leverage, then those same individuals might 

want to reexamine all bank and REIT balance sheets whose leverage would skyrocket. 

And, in fact, Mr. Chairman, I would like to enter into the record 

an analysis of some banks using the effective leverage ratio, the 

lowest of which would be 49, the highest of which would be 93. 

Chairman HUIZENGA. Without objection. 

Mr. STIVERS. Thank you. 

It then, Mr. Bock goes on to say: The major point missed is that 

investors, through this analysis and BDC transparency, have actual ability to understand the overall risk composition of each BDC. 

Banks don’t offer that same kind of transparency. Then he says, 

last, folks arguing that effective leverage is too high, then in 

quotes, thus, this isn’t a reason to look at the bill, missed the fact— 

and closed quotes. Missed the fact that increasing leverage—the leverage constraint will actually make effective leverage ratios fall, 

not rise. At the current leverage constraints, several BDC managers are actually reaching for risk owning low-quality subordinated securities, CLO, or sub-debt, to try to hit yield bogeys for investors. 

So I will stop there on that and yield back the balance of my 

time. I look forward to my time later to talk more. 

Chairman HUIZENGA. The gentleman from Minnesota? 

Mr. EMMER. I yield back. 

Chairman HUIZENGA. The gentleman from Minnesota yields 

back. 

With that, the Chair recognizes the gentleman from Connecticut, 

Mr. Himes, for up to 5 minutes. 

Mr. HIMES. Thank you, Mr. Chairman. And thank you to all of 

you for being with us. 

And I would like to say a special thank you to Mr. Stivers. I was 

one of the lonely opposition votes to the Mulvaney bill in the last 

Congress, really exclusively because of the leverage that one might 


nshattuck on FSR297 with DISTILLER
24 

imagine in that 30 percent bucket where investments in financial 

companies, in particular, are permitted. Not inconceivable that a financial company could have 10X, 15X leverage itself, you double 

that, you get into some pretty heady numbers. And I opposed it on 

that basis. 

And I really thank Mr. Stivers for making the change, including 

the one I proposed in the amendment, which I offered and withdrew. So I guess my neighbor in Massachusetts is not quite there, 

but I am supportive of the bill in its revised form. 

Professor, you, in your testimony, write something, though, that 

is interesting to me because of my concern about that leverage and 

the 30 percent bucket. In your written testimony, you say it is not 

clear that that 30 percent basket serves any purpose in modern financial markets. This of course, was established when BDCs were 

created initially. 

What I would love to do with my remaining time, I am going to 

go to you and Mr. Gerber. I think that is an interesting question, 

and it certainly catalyzed my leverage concerns in the last Congress. So I wonder if I could give each of you a minute to reflect 

on the public good associated with that 30 percent basket. And, actually, Professor, let me, since Mr. Gerber is in the business, let me 

ask him to start, and then you can respond to what Mr. Gerber 

has—anyway, Mr. Gerber. 

Mr. GERBER. Thank you, Congressman. I think as a threshold 

matter it is important to note that that 30 percent basket doesn’t 

just cover financial companies; it covers large cap, mid cap U.S. 

companies, it covers non-U.S. private, small cap, mid cap, large cap 

companies, as well as financial companies. 

How an individual BDC manager chooses to use that 30 percent 

bucket is a different issue, but I just think it is important to recognize that, in that basket, you could have a very diverse set of assets, not just financial companies. I think that is an important 

point, number one. 

Number two, that basket is often used for the benefit of investors 

because there is an opportunity to use that basket to help generate 

yield. And part of our mission is to deliver strong returns to our 

investors. And so while very limited, because only in that 30 percent bucket there is an opportunity to use that effectively to generate returns for investors. 

I would say, number three, that just because a company is a financial company doesn’t mean it doesn’t have value in the broader 

capital markets. We have financial company assets in our portfolios. We believe they are good companies. They are operating 

companies. They run lending businesses. They are lending to smaller businesses than we lend to, whether it is through equipment 

leasing programs, factoring programs, or just doing smaller deal 

sizes than we can do because of our scale. And those underlying 

portfolio companies play a very important role in the capital market. 

So I would say there are benefits to investors and there are benefits for the capital markets in giving us the ability to deploy assets 

in that 30 percent bucket which, again, are not all necessarily financial companies. 

Mr. HIMES. Great. Thank you. 


nshattuck on FSR297 with DISTILLER
25 

Professor, let me give you my remaining 90 seconds to reflect on 

that. 

Mr. BULLARD. I guess the short finance answer would be if investors want the additional yield from the 30 percent, they should get 

it from a vehicle that is designed to provide that. If BDCs want to 

compete effectively with each other, they should compete on the 

basis of their BDC investments, not depending on whether the 

BDC invests a lot or a little of the 30 percent in small- and midsize companies. 

So from an efficiency point of view, it is much more efficient, unless there is some reason that they needed this release valve, which 

is probably what in 1980 this was intended to provide. And given 

the liquidity of current markets and the ability of very, very large 

BDCs to find the investments they need, it seems to me highly unlikely that there would be any serious impediment to their ability 

to do that, and it would enhance their status, essentially, as what 

has become a unique asset to reduce that percentage. 

Mr. HIMES. Great. Thank you. That was more to satisfy my own 

curiosity. So I appreciate the reflections, and yield back the balance 

of my time. 

Chairman HUIZENGA. The gentleman yields back. 

The Chair recognizes the gentleman from New Jersey, Mr. MacArthur, for 5 minutes. 

Mr. MACARTHUR. Well, thank you, Mr. Chair. 

Let me talk for one moment before I ask a question. Let me talk 

as a businessman, which I was for 30 years, instead of a Congressman, which I have only been for 3. I have lived in the world of depending on both BDCs and closed-end mutual funds. I bought my 

company with the help of a closed-end mutual fund that was trying 

to transform itself into an operating company. It would have been 

a lot easier had I been able to invest without what we had to go 

through. And at one point, the use of a BDC was really essential 

for me in growing the company. And that company, with one office 

and a hundred people, grew over 15 years to 6,000 people and 100 

offices. You can’t do that without capital. Can’t do it. 

And so I want to mention three things that I think are useful. 

One is just a reminder that business people rely on tranches of capital, both debt and equity capital, not one source. And so I think 

it is incumbent on us, with good public policy, to try to facilitate 

as many of those available tranches as possible. 

Second, companies evolve. And what I needed in an early stage 

small company was quite different than what I needed as a midmarket company. 

And, last, is there is simply no way for public policymakers and 

regulators to anticipate all of the things that business people can 

imagine. And so we should create the most flexibility, the most 

openness, and try to facilitate a good match-making environment 

where investors can make investments in all different kinds of opportunities, and business people can find all different kinds of credit—or capital, both through the credit markets and the equity market. So I support these reforms because I think they all tend toward that. 

My question is on one that is a little different, and Mr. 

Quaadman, it is for you. You mentioned in your written testimony 


nshattuck on FSR297 with DISTILLER
26 

that you supported an increase in Tier 2 reg A-plus offering limits. 

You supported something over the current $50 million. And the 

Treasury Department recently published the report also recommending that we increase those limits. There was a provision of 

choice, which bumped it up to $75 million. And I think that is 

going to be coming back as a standalone. 

I just wanted to ask you how you thought that increase from $50 

million to $75 million would help small businesses access capital 

and what the results might be, from your perspective? 

Mr. QUAADMAN. Thank you, Mr. MacArthur. And, also, I would 

also just add, in your preamble, I would also add in international 

operations as well also have a different capital structure that businesses would need. 

In terms of bumping up the reg A-plus, we were very supportive 

of the JOBS Act provision. We thought this is a way to help make 

it easier for small business to access capital to get deals done. To 

do that, I know, even with the bump up to $50 million, it has 

been—I think people are still finding their sea legs there. But, 

again, in terms of driving liquidity, we thought that the $75 million 

number was important. 

We did also participate with the Treasury Department on a specific roundtable on capital formation in the runup to that report. 

And this was a matter of discussion that we had as well. So this 

is an important way to help inject more liquidity and deal-making 

for small businesses to acquire the capital that they need to grow. 

Mr. MACARTHUR. I appreciate that. In the interest of giving another member a chance to weigh in, I will yield back my remaining 

time. 

Chairman HUIZENGA. The gentleman yields back. 

With that, the gentleman from Illinois, Mr. Foster, is recognized 

for 3 minutes. 

Mr. FOSTER. Yes. Thank you, Mr. Chairman. And I will try to be 

brief. 

Professor Bullard, would you be more inclined to support a bill 

that allowed closed-end funds to be treated as well-known seasoned 

issuers if they were also restricted to be reporting companies under 

the 1934 act? 

Mr. BULLARD. Well, that is a great question because it really hits 

on my differences, I think, with Mr. Stevens. He noted properly 

that closed-end funds are heavily regulated under the Investment 

Company Act regulatory regime. It is not clear why, with respect 

to offering rules, he wants to take them out of that regime and to 

put them in a regime where they don’t belong. 

For example, he made a comparison to closed-end funds filing 

quarterly reports as if they were similar to the 10-Qs filed by operating companies. Well, I would say if I—maybe if I sent a Christmas card to the SEC chairman every year, I might be considered 

to be filing annual reports, but I think that is about as close to filing a 10-K as a closed-end fund’s quarterly report is to a real 10- 

Q. 

So I think the place to do closed-end fund reform, and I would 

agree with many of the reforms that Mr. Stevens probably wants 

to accomplish, would be within that Investment Company Act regulation. 


nshattuck on FSR297 with DISTILLER
27 

Mr. FOSTER. Thank you. 

Now, Mr. Stevens, I am uncertain that the Investment Company 

Act disclosures adequately inform and update the markets to the 

point that they really justify a well-known seasoned issuer’s status. 

Could you explain how current specific disclosures provide a continuous understanding of closed-end funds so that shelf-offering would 

be fully and adequately disclosed? 

Mr. STEVENS. Well, I am astonished at Professor Bullard’s comparison here. The SEC has developed reporting obligations based 

upon the nature of the activities of the reporter. Closed-end funds 

are investment pools. They are not operating companies. They don’t 

have the kinds of activities, the range of activities, that an operating company would. So subjecting them to the same standards of 

an operating company is nonsensical. If there is a need for further 

reporting by closed-end funds or other registered investment companies, I am not aware of it, but the SEC can always enhance 

those reports. 

I think, frankly, there is no absence of information about closedend funds or other registered investment companies in the United 

States that is desired by the market. And the only reason then to 

use the well-known seasoned issuer and the kind of streamlining 

that has been provided to public operating companies is that these 

closed-end funds are also subject to the Securities Act of 1933. So 

they are within that regime. In fact, we always say in my space, 

we are subject to every one of the Federal securities laws. Public 

operating companies are not subject to the 1940 Act. 

So I just think that the Chairman of the SEC, Mary Joe White, 

when she looked at this kind of treatment—in this case it was for 

the kind of closed-end fund that my colleague here, Mr. Gerber, is 

talking about, business development companies, but it could apply 

more broadly. She said making these changes, in her view, does not 

involve any compromise of investor protections. That is where we 

are. 

Mr. FOSTER. Thank you. My time is up, and I yield back. 

Chairman HUIZENGA. The gentleman’s time has expired. 

The gentleman from Ohio, Mr. Davidson, is recognized for 3 minutes. 

Mr. DAVIDSON. Thank you, Chairman. Thank you all for your testimony. 

And, Mr. Quaadman, thank you for your advocacy across the 

country for small and medium businesses, and thanks for the focus 

on business development corporations. 

Mr. MacArthur addressed some of the same things I would say 

as a businessman, and the importance of options. One option is no 

option, when it comes to capital and lots of other things. But with 

limited time, I want to say, could you address the impact the 

Volcker Rule has had on venture capital investment in the middle 

of the country? And, in addition, do you see a significant public policy reason for prohibiting financial institution investment into venture capital? 

Mr. QUAADMAN. Yes. The Volcker Rule has caused a retrenchment of many different forms of capital formation that we would 

normally have expected to see financial institutions engaged in. It 

has made it much harder and more difficult for CFOs to access the 


nshattuck on FSR297 with DISTILLER
28 

debt and equity markets. So our hope is, as has been called for by 

the Treasury Department, that the regulatory agencies are going to 

take another look at the Volcker Rule. 

Venture capital has been under some stress from Volcker and 

from other areas as well. We believe that the capital formation report from the Treasury Department is actually putting forth some 

interesting recommendations for how to deal with this. We also 

have some concerns with some legislation that has been proposed 

in the past with beneficial ownership disclosure, that that is going 

to place another inhibitor on venture capital as well, which is one 

of the reasons why we have also opposed that. 

Mr. DAVIDSON. Thank you. And I yield. 

Chairman HUIZENGA. I am sorry. I was managing the members. 

OK. I am sorry, did the gentleman yield back? The gentleman 

yielded back. 

All right. With that, the gentleman from Indiana, Mr. Hollingsworth, is recognized for up to 3 minutes. 

Mr. HOLLINGSWORTH. Well, good morning. I appreciate everybody 

being here, and I appreciate all the comments that were made 

early on, especially the compliments on the discussion draft that I 

am working on. I certainly won’t take my full 3 minutes. I know 

much of this waterfront has been covered, especially by my partner 

in working in this, Mr. Foster, a few minutes ago. 

But I just wanted to hit, again, Mr. Stevens, if you wouldn’t 

mind commenting on, is there anything about this particular piece 

of legislation that you feel greatly endangers investors or otherwise 

dramatically reduces the amount of disclosure burden that we are 

putting on closed-end funds currently as I have proposed it so far? 

Mr. STEVENS. To your first question, does it pose risks for investors? We would not be supporting it at the ICI if we believed that 

it was posing additional risk for investors, so no. 

Mr. HOLLINGSWORTH. I was operating under the—I am asking 

the question I know the answer to philosophy. 

Mr. STEVENS. I am sorry? 

Mr. HOLLINGSWORTH. I said I am operating under the old lawyer—I am asking a question I know the answer to philosophy. 

Mr. STEVENS. All right. And your second question is what benefits does it provide? 

Mr. HOLLINGSWORTH. Yes. 

Mr. STEVENS. It streamlines the issuance process. It allows 

closed-end funds to get to market more promptly in response to 

market conditions. 

Mr. HOLLINGSWORTH. Right. 

Mr. STEVENS. It facilitates their ability to communicate with the 

marketplace and with the investing public. 

Mr. HOLLINGSWORTH. Right. 

Mr. STEVENS. And hopefully, find a greater interest in the investment opportunities it is bringing to the market. 

Mr. HOLLINGSWORTH. Right. 

Mr. STEVENS. And I think those are all very favorable from the 

point of view of investors. 

Mr. HOLLINGSWORTH. Yes. 

Mr. STEVENS. And from the point of view, ultimately, of getting 

capital to work in our economy, creating jobs and economic growth. 


nshattuck on FSR297 with DISTILLER
29 

Mr. HOLLINGSWORTH. Absolutely. And I think that is exactly the 

push that I have been making, right. The world is certainly not 

slowing down, opportunities come up and go away very, very quickly. I want these closed-end funds to be able to capture those opportunities. 

And as for what was said before about whether closed-end funds 

are an appropriate vehicle or not for individual investors, I leave 

it up to those investors to make those decisions versus bureaucrats 

in D.C., or even legislators in D.C., deciding for people all the way 

across this country that might use these vehicles for specific purposes in fulfilling their financial needs. 

And with that, I will yield back, Mr. Chairman. 

Chairman HUIZENGA. The gentleman yields back. 

With that, the gentleman from Ohio, Mr. Stivers, is recognized 

for 3 minutes. 

Mr. STIVERS. Thank you, Mr. Chairman. And I will be fairly brief 

too, because I know Mr. Rothfus wants to go. 

My question is for Mr. Gerber. Mr. Gerber, can you explain why 

leverage is important and how you will use that to get more capital 

to businesses that want to expand, as well as to make better returns for your investors? And if you want to also talk about why— 

reenforce, again, how financial service firms allow you to help businesses that are below—help BDCs, help firms that are below their 

threshold for lending to get capital to smaller business, that would 

be great. 

Mr. GERBER. Sure. So I will take those in order. And thank you, 

Congressman, not only for the question, but for your work on this 

bill. 

In terms of the role that BDCs play in the capital markets, I 

mentioned in my testimony that most BDCs are deploying capital 

in the middle market, and that is a fast growing sector, very important from a job creation perspective. As I mentioned, from 2011 to 

2017, more than 100 percent growth in job creation. So that is a 

very important role that BDCs play. And as my colleague, Mr. 

Quaadman, mentioned in his testimony, we are doing it at a time 

where other capital providers are not. So I think from a capital 

markets perspective, BDCs play an increasingly important role. 

In terms of what we can do for our investors, again, as I mentioned earlier, it is an opportunity for us to deploy capital in ways 

that other investment vehicles do not, thereby giving investors an 

opportunity to invest differently and to build a more diversified 

portfolio with exposure to assets that aren’t as correlated to the 

market as, say, a mutual fund would be. 

To your question around how we can help smaller financial companies. I mentioned, in response to a question from the gentleman 

from Connecticut, there are portfolio companies within BDC portfolios that are able to lend to smaller businesses. We have them in 

our portfolio. And so as you scale as a BDC, it is harder to do 

smaller deals. It is just an issue of resources. And so larger BDCs 

tend to do larger deals. But if we can invest in portfolio companies 

that have the ability to do smaller deals or lend in ways that we 

don’t lend, it is an opportunity for us to fund companies that are, 

in and of themselves, performing an important role in the capital 

markets. 


nshattuck on FSR297 with DISTILLER
30 

Mr. STIVERS. Thank you very much. 

And with my remaining 14 seconds, I will just say that Mr. 

Rothfus, who is about to ask questions, has done great work on 

H.R. 2319 that will help get—help allow a stable net asset value 

for a lot of folks who need that in their investment requirements. 

I yield back the balance. 

Chairman HUIZENGA. The gentleman’s time has expired. 

With that, our guest today, Mr. Rothfus, is recognized for 3 minutes. 

Mr. ROTHFUS. Thank you, Mr. Chairman. And thank you for allowing me to participate in today’s hearing. 

I would like to just take a couple of minutes here and talk about 

my bill, H.R. 2319, the Consumer Financial Choice and Capital 

Markets Protection Act of 2017. And I would note the broad-based 

support we have gotten from across the country with over 200 

groups and community leaders in support of this legislation. 

I would like to offer for the record two letters, November 2, 2017, 

one from the Association for Financial Professionals, the other from 

the Association of School Business Officials International, to the 

committee. 

Chairman HUIZENGA. Without objection. 

Mr. ROTHFUS. Also, an October 3, 2012 article by Mr. Bullard on 

money market funds and life on support. I would like to offer that 

to the record as well. 

Chairman HUIZENGA. Without objection. 

Mr. ROTHFUS. Real quick, Mr. McCoy, to your earlier point 

whether we need to study this issue and the impact of this rule any 

further. We know what happened, right? $1.2 trillion has moved 

out of the private and mutual fund sector into the treasuries? 

Mr. MCCOY. That is correct. Yes. We have seen investors vote 

with their money and leave, yes. 

Mr. ROTHFUS. There are cost benefits to any regulatory change, 

Mr. McCoy. Have the costs of this rule been justified? 

Mr. MCCOY. I certainly believe so. It is an interesting question. 

I haven’t totally focused on that, but I believe so. 

Mr. ROTHFUS. In what sense? You are seeing an increase in borrowing rates for municipalities. 

Mr. MCCOY. We absolutely are. We are seeing an increase—increased costs to issue variable rate debt into the money market 

funds, and that is filtered through our ability, State and local government’s ability, to finance infrastructure at the lowest possible 

costs. 

Mr. ROTHFUS. And, again, where has this money gone, out of the 

muni funds and out of the corp funds, where has it gone to? 

Mr. MCCOY. Typically, it has gone into fixed rate bonds or, as I 

noted, there is an alternative product out there, a floating rate 

note, that is not eligible to be invested by 2a–7 funds, but that particular product does allow municipalities to participate at the short 

end of the yield curve where we get the best cost of funds. 

Mr. ROTHFUS. Do you know whether money market funds that 

hold treasuries are immune to fluctuations and principal value? 

Mr. MCCOY. I do not. 

Mr. ROTHFUS. Mr. Quaadman, would they be—if you have a 

money market mutual fund holding just treasuries—let’s say there 


nshattuck on FSR297 with DISTILLER
31 

is a fund out there that has a million dollars in treasuries and 

somebody goes out, buys a million treasuries, starts to do this fund. 

Interest rate today is 1.43 percent, and the interest rate goes up 

tomorrow, what happens to the principal value in that money fund? 

Mr. QUAADMAN. I would have to consult with some of our members and get back to you. I had not thought through that question. 

But let me do that and let me get back to you, if you want to— 

Mr. ROTHFUS. Well, it makes sense that the principal value is 

going to fluctuate and it is going to go down. And while that Treasury bill a year from now, if it is a 1-year bill, is going to be worth 

a thousand bucks a bill, it is going to be stable in that sense, but 

it is going to change in principal value— 

Mr. QUAADMAN. Yes. 

Mr. ROTHFUS. —because of the fluctuation. 

Mr. Chairman— 

Chairman HUIZENGA. The gentleman’s time has expired. And we 

are going to miss a vote here if we don’t move quick. 

So I would like to thank our witnesses for their testimony today. 

Without objection, I would like to submit the following letter 

from Government Finance Officers Association and a number of 

others in support of Mr. Rothfus’ bill. 

Chairman HUIZENGA. Without objection, all members will have 5 

legislative days within which to submit additional written questions for the witnesses to the Chair, which will be forwarded to the 

witness for their responses. I ask you all to please respond as 

quickly as you are able. 

And, without objection, all members will have 5 legislative days 

within which to submit extraneous materials for the Chair for inclusion in the record. 

This hearing is adjourned. 

[Whereupon, at 10:53 a.m., the subcommittee was adjourned.] 


nshattuck on FSR297 with DISTILLER

nshattuck on FSR297 with DISTILLER
(33) 

A P P E N D I X 

November 3, 2017 


nshattuck on FSR297 with DISTILLER
34 


nshattuck on FSR297 with DISTILLERInsert offset folio 1 here 30773.001

Testimony ofMerecr E. Bullard 

President and Founder, Fund Democracy, Inc. 

and 

Butler Snow Lecturer and Professor of Law 

University of Mississippi School of Law 

before the 

Subcommittee on 

Capital Markets, Securities and Investment 

Committee on Financial Services 

United States House of Representatives 

Legislative Proposals to Improve Small Businesses' 

and Communities' Access to Capital 

November 3, 2017 
35 


nshattuck on FSR297 with DISTILLERInsert offset folio 2 here 30773.002

Chairman Huizenga, Ranking Member Maloney, members of the Subcommittee, 

it is an honor and a privilege to appear before the Subcommittee today. Thank you for 

this opportunity. I am the Founder and President of Fund Democracy, a nonprofit 

advocacy group for investors, and a Professor of Law at the University of Mississippi 

School of Law. 

This testimony discusses aspects of three bills before the Subcommittee: the 

Consumer Financial Choice and Capital Markets Protection Act of2017; the Expanding 

Investment Opportunities Act; and the Small Business Credit Availability Act. In 

summary, the third bill recognizes that business development companies ("BDCs") are a 

form of special purpose investment company, both in terms of their unique status as 

reporting companies under the Exchange Act and their important role in providing credit 

to small- and mid-sized U.S. companies. The U.S. Securities and Exchange Commission 

has also recognized that BDCs are a different kind of investment company and, 

accordingly, has granted carefully crafted no-action relief from certain offering 

requirements and restrictions. 

I agree that the SEC's positions should be codified to allow BDCs to incorporate 

filings by reference, clarifY their ability to conduct shelf registrations and grant automatic 

effectiveness to registration statements that reflect only nonmaterial changes. However, 

Congress should reconsider amending the legislation by simply requiring the SEC to 

adopt and/or amend its rules. Otherwise, there is a risk that the effect of the bill will be to 

create conflicts and ambiguity in what is currently a delicately balanced set of complex, 

interlocking rules. 

The foregoing reforms identifY actual problems that have been appropriately 

raised by the industry and refined and vetted in Congressional hearings, notwithstanding 

that the problems would be more efficiently and effectively resolved by requiring guided 

SEC rulemaking. In my opinion, the remaining BDC offering reforms in the bill, and 

especially the closed-end fund ("CEF") offering refonns in the Expanding Investment 

Opportunities Act, do not reflect a considered solution to identified problems in offering 

regulation. These offering refonns generally cut and paste rules adopted under the 

Securities Act that were specifically designed for operating companies and apply them 

wholesale to two type of investment companies for which they are a poor fit. Under the 

2 
36 


nshattuck on FSR297 with DISTILLERInsert offset folio 3 here 30773.003

bills, the set of rules under which BDC and CEF offerings are conducted, and that are the 

actual source of any problems that the industry may have with securities offerings, would 

remain unchanged. This approach would create parallel regulatory regimes for BDC and 

CEF offerings that would create needless complexity and confusion. 

This is especially true for closed-end funds. Closed-end funds are registered 

investment companies; BDCS, in contrast, are reporting companies, a kind of hybrid 

issuer. Reporting companies such as BDCs are subject to the full set of annual reports, 

quarterly reports and other filing requirements that apply to other operating companies. 

Closed-end funds are not subject to these rules. They are not hybrid issuers, but pure 

bred registered investment companies. Nor do CEFs serve a particular purpose in making 

capital available to what Congress views as an underserved capital market. There is no 

understanding that CEFs should receive special breaks, or a parallel offering regime, as a 

kind of quid pro quo. Unlike operating companies, which directly increase net social 

wealth, CEFs serve no ultimate end other than as facilitators of capital formation. Any 

perceived parallel between CEFs and BDCs does not reflect reality. There are good 

reasons that CEFs are less popular investment vehicles than mutual funds and exchangetraded funds, and those reasons are not regulatory. And if there are regulatory concerns, 

they should be addressed by dealing with their source, which lies in the rules under which 

they currently operate. 

The bills would increase the amount ofleverage that BDCs may use, which would 

make more capital available to the capital market they serve, but if this, alone, were a 

sutTtcient reason to increase the current I: 1 leverage limit, then there would no reason to 

have a leverage limit at all. Raising the limit- indeed, lowering the limit or setting any 

limit- can only be assessed if the costs and benefits of different levels of leverage are 

understood and should be implemented only if the benefits of any change exceeds the 

costs. I have previously testified before this Subcommittee on the importance of 

assessing the costs and benefits of regulatory reforms, and if incorporation by reference 

may be allowed for prior testimony as proposed for BDC filings, then I ask for such 

treatment of that testimony. 

I have not mastered the literature on BDC leverage or conducted an empirical 

analysis ofBDC portfolios, but my limited preparation for this hearing has revealed 

3 
37 


nshattuck on FSR297 with DISTILLERInsert offset folio 4 here 30773.004

significant potential problems with the proposal to double the BDC leverage limit. And 

the paucity ofliterature and empirical analysis on BDC leverage is the first problem that 

the Subcommittee should consider. We have recently experienced the effects of 

inadequately regulated risk-taking and the systemic threat that it may pose. Over the last 

15 years, market declines have substantially undcnnined Americans' confidence in the 

markets. Allowing BDCs to double their leverage will necessarily significantly increase 

the risk that one or more BDCs will fail in the wake of significant market decline. 

Putting more BDCs in a position to become worthless as a result of a significant market 

drop may throw fuel on that fire. 

As discussed further below, BDCs present a number of problems that Congress 

should consider before permitting BDCs to double their leverage. One problem is that 

we lack an adequate method of estimating BDC leverage and its effect. One industry 

measure suggests that effective BDC leverage is actually many multiples of the ostensible 

1: I limit. Needless to say, this means that BCDs' current risk disclosure may be grossly 

inadequate, and their estimates of their portfolio values' sensitive to market declines 

grossly understated. Additionally, it is not clear that current law allows BDCs to use the 

full leverage that the 1:1 ratio appears to permit. Congress should consider the reasons 

that BDCs typically keep a substantial buffer in place that keeps their regulatory leverage 

well below what is supposedly allowed. Other concerns are that many BDCs invest 

substantial assets in investments that arc not consistent with their mandate and they 

charge extremely high fees. Finally, if Congress wishes to increase BDC investments in 

small- to mid-sized firms, it should consider substantially reducing the 30 percent of 

assets that BDCs may invest in other companies. It is not clear that the 30 percent basket 

serves any purpose in modem financial markets. 

As for a prior proposal to allow BDCs to invest half of their assets in financial 

services firms that are not eligible portfolio companies, I note the irony that while 

Congress seeks to make more capital available to small- and mid-sized companies, this 

proposal would make less capital available to such companies. The financial services 

firm proposal contradicts the very raison d'etre for BDCs, and it does so by diverting 

capital to firms that often provide services very similar or identical to the services 

provided by BDCs. If Congress believes that a social benefit that would be served by a 

4 
38 


nshattuck on FSR297 with DISTILLERInsert offset folio 5 here 30773.005

special purpose entity that invests half of its assets in financial services fim1s and half of 

its assets in small- and mid-sized companies, then it should create such an entity rather 

than destroy the already diluted identity that BDCs have spent almost 4 decades 

cultivating. It should also keep in mind that financial services firms do not create wealth 

by allocating capital, they only secondarily facilitate capital formation as intermediaries. 

I. Doubling the BDC Leverage Limit 

The bills would allow BDCs to increase their leverage ratio from 1: I to 2: 1. This 

would, as intended, make more capital available for BDCs to invest in the short-tenn. 

However, I am not aware of any reasoned basis for changing a decades-old standard, and 

there are many reasons why allowing increased leverage would be imprudent. Increased 

leverage is likely to have adverse long-term effects on the industry as a result of 

increased incidence of BDCs' incurring outsized losses or failing. It will pose significant 

risks for shareholders and abrogate the terms under which they made their investments. 

Current risk levels are poorly disclosed, and the leverage ratio itself is a crude measure 

that fails to reflect the reality of BDC leverage and the complexity of modem finance. 

As discussed below, I have significant concerns regarding the proposal to allow 

BDCs to double their leverage. My concerns, due to the limited time available to prepare 

this testimony, are not, in all cases, fully formed, but they reflect genuine problems in the 

BDC industry that should be a much higher priority for Congress than granting BDCs 

more freedom to take greater risk. 

(a) High BDC Fees 

One concern is that BDCs are characterized by extremely high fees. The BDC 

registration statements that I reviewed show expense ratios consistently above 5.00 

percent and, in some instances, significantly higher. For example, the manager of the 

largest BDC charges a management fee, income incentive fee, capital appreciation fee, 

and administrative fec. 1 The BDC's fee table that appears below2 shows that total 

1 Sample BDC Prospectus at 19 ("We [BDC A) may invest, to the extent permitted by 

law, in the equity securities of investment funds that are operating pursuant to 

5 
39 


nshattuck on FSR297 with DISTILLERInsert offset folio 6 here 30773.006

expenses, excluding interest on borrowings, are almost 6.5 percent of net assets: 

Dividend reinvestment plan expenses 

Total stockholder tmnsaction expenses paid 

percentage of consolidated net assets attributable to 

Total annual expenses 

This table does not show certain expenses. For example, it does not include 

certain exceptions to the Investment Company Act and in advisers to similar 

investment funds and, to the extent we so invest, will bear our ratable share of any 

such company's expenses, including management and performance fees. We will 

also remain obligated to pay the base management fee, income based fee and capital 

gains incentive fee to our investment adviser with respect to the assets invested in 

the securities and instruments of such companies. With respect to each of these 

investments, each of our common stockholders will bear his or her share of the base 

management fee, income based fee and capital gains incentive fee due to our 

investment adviser as well as indirectly bearing the management and performance 

fees and other expenses of any such investment funds or advisers"). I would be 

happy to provide specific citations for this and other filings cited below to interested 

members. 

2 /d.at16. 

3 These data assume that underwriters do not purchase any of their overallotment. 

4 The 0.61 percent ascribed to acquired funds represents those fees spread across 

the BDC's total net assets, i.e., over assets that are not invested in the acquired funds. 

The actual fees charged on the part of the BDC's net assets invested in the acquired 

funds would be up to 2.5 percent of assets and 25 percent of profits. !d. at 19 

("Certain of these Acquired Funds are subject to management fees, which generally 

range from 1 o/o to 2.5% of total net assets, or incentive fees, which generally range 

~1Ww«eiii15% and 25% of net profits."). At the end of 2016, the BDC had $2.236 

billion invested in "Investment Funds and Vehicles," which represented 43.05 

percent of its net assets at that time. This category comprised 21.2 and 25.2 percent 

6 
40 


nshattuck on FSR297 with DISTILLERInsert offset folio 7 here 30773.007

underwriters fee that was paid in the offering made via this prospectus (0.70 percent of 

the $750 million offering, or about 0.07 percent of net assets). Nor does it show the 

commission that would be paid on a purchase of common shares or the associated 

offering expenses (4.43 percent and 0.21 percent, respectively, in the BDC's 2014$235 

million common stock offering, or about 0.16 percent of current net assets).3 

The table also shows that the manager collects management fees on assets that 

someone else is managing. For this BDC, this double dipping amounts to 0.61 percent of 

the BDC's total net assets4 - this fee would alone match the entire expense ratio for a 

reasonably priced mutual fund. The funds in which the manager invests the BDC's assets 

charge management fees ranging from I .00 to 2.50 percent and performance fees ranging 

from 15 to 25 percent of net profits.5 After those fees are paid, the BDC's manager 

collects those fees again.6 Adding insult to injury, the manager may even collect fees on 

3 These data assume that underwriters do not purchase any of their overallotment. 

4 The 0.61 percent ascribed to acquired funds represents those fees spread across 

the BDC's total net assets, i.e., over assets that are not invested in the acquired funds. 

The actual fees charged on the part of the BDC's net assets invested in the acquired 

funds would be up to 2.5 percent of assets and 25 percent of profits. !d. at 19 

("Certain of these Acquired Funds are subject to management fees, which generally 

range from 1 o/o to 2.5% of total net assets, or incentive fees, which generally range 

between 15% and 25% of net profits."). At the end of 2016, the BDC had $2.236 

billion invested in "Investment Funds and Vehicles," which represented 43.05 

percent of its net assets at that time. This category comprised 21.2 and 25.2 percent 

of BDC A's total assets at the end of 2015 and 2016, respectively. It appears that a 

large part of these investments were in two affiliated investment vehicles. The 

prospectus does not indicate whether the adviser itself collected any fees in 

connection with those investments. 

5 /d. 

6 !d. ("We [the BDC] may invest, to the extent permitted by law, in the equity 

securities of investment funds ... and, to the extent we so invest, will bear our 

ratable share of any such company's expenses, including management and 

performance fees. We will also remain obligated to pay the base management 

fee, income based fee and capital gains incentive fee to our investment adviser 

with respect to the assets invested in the securities and instruments of such 

companies." (emphasis added)). 

7 
41 


nshattuck on FSR297 with DISTILLERInsert offset folio 8 here 30773.008

income that the BDC never receives.7 

While it may be more expensive to manage a BDC portfolio than other portfolios, 

this does not explain BDC expense ratios. There are bank loan funds and mutual funds 

that invest in very small companies that have expense ratios that are a fraction of BDC 

expense ratios. There are CEFs that have portfolios that appear to be quite similar to a 

typical BDC portfolio that have much smaller expense ratios. In some cases, BDC 

sponsors offer a similar CEF but charge substantially less to their CEF than they charge 

to their BDC. 

In some cases, BDC expenses are significantly increased by fees paid to other 

investment vehicles. It is not clear how allowing BDCs to invest in other investment 

vehicles fulfills their purpose. For example, as noted above, the BDC that incurs 0.61 

percent of net assets in fees on funds in which it invests appears to have approximately 

one-quarter of its assets invested in underlying investment vehicles. Some of these 

underlying investment vehicles are affiliated with the BDC manager. It appears that the 

BDC manager may itself be collecting fees in connection with the management of the 

underlying fund, thereby exacerbating what already constitutes substantial double 

dipping. 

When a BDC makes a public offering, the fees can easily exceed 10% of the 

amount invested. For example, a BDC recently conducted an initial public offering that 

included a 4.00 percent commission, a 1.00 percent maximum contingent defen·ed sales 

charge, 1.00 percent in offering expenses, an annual 1.33 percent trailing commission,8 a 

7 /d. at 36 ("The income based fees payable by us [the BDC] to our investment 

adviser that relate to our pre-incentive fee net investment income is computed and 

paid on income that may include interest that is accrued but not yet received in 

cash. If a portfolio company defaults on a loan that is structured to provide accrued 

interest, it is possible that accrued interest previously used in the calculation of such 

fee will become uncollectible. Our investment adviser is not under any obligation 

to reimburse us for any part of the income based fees it received that were based 

on accrued interest that we never actually receive." (emphasis added)). 

8 The BDC represented that the distribution fee would comply with Rule 12b-1 

under the Investment Company Act, but such compliance is not required (and for 

8 
42 


nshattuck on FSR297 with DISTILLERInsert offset folio 9 here 30773.009

2.75 percent management fee, a 0.37 percent incentive fee, and a 0.85 percent fee 

representing other expenses. The estimated shareholder expenses for a one year 

investment were $109 of every $1,000 invested (10.9%) and, if the shares were sold after 

one year, $115 of every $1,000 invested (11.5%). And this fund was not investing in 

equities, where it is conceivable (albeit highly unlikely) that investment returns could 

make up for such large first-year expenses, but in debt, where making up for expenses, if 

ever, would take many years. 

(b) Outdated Leverage Measure and Undisclosed Leverage Ratio 

A second concern is that the I: 1 leverage ratio is woefully outdated and 

potentially misleading. When Congress adopted the CEF 1:1 leverage for BDCs, it did so 

at a time when understanding the capital stmcture of a company did not require a finance 

PhD. Almost 40 years later, complex capital structures may have rendered the I: I 

leverage limit meaningless for both BDCs and their portfolio companies. While BDCs 

purport to adhere to this limit, their actual leverage ratios not only may be substantially 

higher, but many multiples higher that 1:1. 

Industry professionals have recognized the misleading nature of the BDC l: 1 

leverage limit. In the words of banking analysts: 

In our view, the raw leverage measure (debt/equity) doesn't tell the whole 

story as the loans that BDCs hold have various degrees of implicit 

leverage 9 

mutual funds, a 12b-1 fee cannot exceed 1.00 percent). See generally LPL to Limit 

Fees on Non-Traded RE/Ts and BDCs, thediwire.com (June 7, 2017) (limiting annual 

trailing commissions to 1 percent) available at https:/ /thediwire.com/lpl-to-limitfees-o n-non-traded-reits-and -bdcs /. 

9 Wells Fargo 4Q17 BDC Scorecard at 14. The "implicit leverage" includes, for 

example, the leverage embedded in the capital structure of the BDC's portfolio 

companies. To illustrate, a $100 million 1st lien senior secured loan to a portfolio 

company presents far less risk than a $100 million subordinated unsecured loan, all 

other factors being equal. A BDC that routinely invests in the latter rather than the 

former will have a higher effective leverage ratio and be a riskier investment. 

9 
43 


nshattuck on FSR297 with DISTILLERInsert offset folio 10 here 30773.010

For example, a widely used industry publication found that some BDCs currently have 

effective leverage .in excess of 5: l -more than 9 times that of the least leveraged BDC 

considered.10 As recently as 2015, the publication found BDCs with leverage in 

excessive of 7.5: 1, with 12 of 25 BDCs evaluated boasting leverage in excessive of 4:1. 11 

Effective leverage ratios ranging from 4:1 to 7.5:1 (if not higher) suggest that the I: 1 

leverage limit is misleading and SEC disclosure requirements are grossly inadequate. It 

also means that BDC illustrative disclosure of the effect of a market decline on share 

value grossly understates the amount of potential losses. Before Congress considers 

allowing BDCs to increase their leverage, it should ensure that the BDCs' current level of 

risk is accurately estimated and adequately disclosed. Neither is currently the ease. 

(c) Effect of Doubling BDC Leverage 

A third concern is that doubling the leverage allowed to BDCs will significantly 

increase the incidence of large losses and BDC failures. To illustrate, the table below 

shows how portfolio losses in a leveraged BDC would translate into much higher investor 

losses. This is the ineluctable effect of leverage, and the losses in the table would be 

substantially higher, of course, if the BDC were allowed to double its leverage. 

w Wells Fargo 4Q17 BDC Scorecard at 16 (showing, as ofSep. 11,2017, effective 

leverage for 25 BDCs ranging from 0.56 to 5.20). 

11 Wells Fargo 4Q1 5 BDC Scorecard at 12. Two days ago, an equity research firm 

released a statement on the BDC that had the 7.5+:1 effective leverage ratio in 2015 

that stated: 

Stock likely headed lower on severe credit weakness, NAV 

degradation, and dividend cut. Announced dividend reduction from 

$0.45 to $0.30 /share appears warranted given credit induced 

earnings stress. The Board has begun to explore strategic 

alternatives including the sale of certain assets as well as the potential 

benefit of partnering with another organization. 

Baird Equity Research (Nov. 2, 2017) (emphasis added}. 

10 
44 


nshattuck on FSR297 with DISTILLERInsert offset folio 11 here 30773.011

Assumed Remm 

on Portfolio 

Return to 

Common 

Stockholdcrs(2) -28.93% -20.20% -11.48% -2.75% 5.97% 14.69% 23.42% 

As noted, this table probably understates the losses that would be incurred if all sources 

of effective leverage were considered, such as the relative priority of loans to portfolio 

companies, and it does not include a truly significant market decline (e.g., -30 percent). 

In addition, the SEC should require that this table be presented in a bar chart, as is 

required for mutual funds, in order to make it intuitively understandable. The same table 

appearing above is shown as a bar chart below. 

30% 

20% 

10% 

0% 

-10% 

-20% 

-30% 

-40% 

0% 

-3% 

-29% 

23% 

15% 

Market Value 

Portfolio Value 

In fact, it is likely that raising the leverage ratio will more than double BDCs' risk 

level. The interest rate that a BDC pays on borrowing (or dividend preference on 

preferred shares) is based, in part, on the degree of risk presented by the BDC. When a 

BDC increases its riskiness by increasing its leverage, it will necessarily incur a higher 

cost of capital in the form of higher interest rates and/or dividend preference terms. For 

II 
45 


nshattuck on FSR297 with DISTILLERInsert offset folio 12 here 30773.012

example, banks, which typically make loans to BDCs subject to a !:!leverage limit,12 

will charge a higher interest rate to BDCs that may exceed the 1:1 limit. When a BDC 

pays more in interest, it must make riskier (subordinated) loans and/or loans to higher 

risk borrowers in order to maintain the same level of income and distributions to 

shareholders. While in good economic times shareholder returns will be even more 

inflated, in a downturn, BDCs are far more likely to fail. A decline in the value of a 

BDC's portfolio of only one-third may be sufficient to wipe out the fund. 

(d) Investing in Non-Eligible Companies 

A fourth concern is that some BDCs arc not investing consistent with their 

statutory purpose. I have not had time to do an empirical analysis of BDC portfolios, but 

it appears that some BDCs have invested heavily in collateralized debt obligations 

("CLOs"). 13 These securities are not typically sold in the narrower capital markets in 

which small- and mid-size company debt is bought and sold. Rather, CLOs are funded 

by a large variety of investors and exhibit no lack of liquidity. The CLO market is not 

the market that BDCs were intended to serve. It also appears that the larger BDCs may 

be buying small pieces of debt tranches in which a wide variety of investors participate. 

Again, this is not the market that BDCs were intended to serve. 

While the 30-percent basket that BDCs may fill with ineligible investments may 

have provided flexibility needed many decades ago, it is not clear why it is needed today. 

The most direct way to increase BDC lending to small- and mid-sized companies would 

be to reduce the 30-percent basket to 20 or 10 percent. The market for BDC shares is 

well-established, including the market perception that BDCs are a particular type of asset 

and that BDCs compete against other BDCs. I am not aware of any compelling evidence 

that BDCs still need the 30 percent basket, but this question needs study. Reducing this 

percentage may make the BDCs that arc truly committed to this market more competitive 

12 Wells Fargo Equity Research at 3 (Nov. 2, 2015) ("many bank credit facilities to 

BDCs have 1:1 debt/equity covenants"). 13 Wells Fargo 4Q15 BDC Scorecard at 14 (BDC with a 2015 effective leverage ratio 

of "has a large portion of CLO equity, which in itself has higher amounts of 

leverage."). 

12 
46 


nshattuck on FSR297 with DISTILLERInsert offset folio 13 here 30773.013

with those BDCs that are not. 

(e) Reasonable Shareholder Expectations 

A fifth concern is that raising the leverage limit abrogates the deal that 

shareholders struck when they invested in a BDC. Investors bought their shares on the 

basis of a statutory leverage limit that the BDC could not alter. Now they will be 

confronted with having to sell their shares, possibly at a discount to net asset value that 

has grown larger in response to the BDC's increase in risk, thereby incurring an 

immediate tax, or stay in a fund that does not match their investment needs and 

experiences a significant decline in dividends. Non-traded BDC shareholder will not 

even have the opportunity to sell their shares. 

The bills' leverage provision does not adequately protect shareholders' rights. 

For publicly-traded BDCs, no shareholder approval is required, so shareholders will 

have no say in whether a fundamental term of their investment is changed. Even with 

shareholder approval, as would be available for non-traded BDCs, dissenting 

shareholders will not even have the rights afforded to shareholders under corporate law. 

Although the BDC is required to offer to repurchase 25 percent of its shares for four 

quarters, there appears to be no requirement that shareholders be paid net asset value. 

Shareholders of BDCs that change such a fundamental investment policy should be 

allowed to vote on the change, and dissenting shareholders should have the immediate 

option of redeeming their shares at net asset value. 

(b) Alternative Options 

A sixth concern is that there may be a more appropriate way to allow BDCs to 

increase their leverage. It appears to be common practice for BDCs to keep a significant 

buffer between their regulatory leverage ratio and the 1: l limit. This does not appear to 

reflect the fear that the BDC will violate the limit not by over-borrowing, but by 

experiencing a decline in asset values that causes its ratio to exceed 1:1. The leverage 

limit appears to require only that the BDC refrain from additional borrowing until is it 

back under the limit. It appears that BDCs are not permitted to pay dividends when 

13 
47 


nshattuck on FSR297 with DISTILLERInsert offset folio 14 here 30773.014

above the 1:1 limit, which might explain the buffer. If this is the case, then it may be 

appropriate, in my view, to permit them to pay dividends when over the limit as long as 

the dividends are paid out of income. If a BDC is over the limit, the receipt and 

immediate distribution of income would not adversely affect the BDC's starting leverage 

position. It may also be that the term structure of BDC borrowing results in a need to 

rollover short-term debt, and the leverage limit would be temporarily violated pending 

the liquidation of the expiring loan. If so, that problem could be fixed by allowing a 

grace period, up to a higher leverage limit perhaps (e.g., 1.2: I) during which debt could 

be rolled over as long as the BDC's leverage was no higher after the rollover than it was 

before. If the problem is bank loan covenants, the Subcommittee should inquire as to 

why these covenants are not structured along the lines above. 

In short, the nature of a leverage limit in many contexts- banking, insurance, 

money market funds, etc. is such that compliance generally should be able to be 

achieved without having to maintain a large buffer. Otherwise, the leverage limit is not 

actually the limit. A I :!leverage limit becomes a de facto 0.7:1 limit. I recognize that 

this discussion may be missing the reason for the buffers, but my sense is that there 

should be a way to allow BDCs to use the full limit prescribed by Congress. This alone 

would free up additional capital for investment. 

II. Offering Rules 

In 2005, the SEC adopted rules that were generally designed to liberalize 

securities offerings by operating companies and not designed for investment companies. 

Investment companies arc regulated under a separate set of rules that are specifically 

tailored to such entities. For this reason alone, allowing CEFs and BDCs to rely on rules 

designed for operating companies is generally not an appropriate approach to securities 

offering reform. 

The 2005 reforms were generally designed to address the problem of company 

communications being restricted or prohibited when the company is "in registration." A 

company is generally deemed to be "in registration" if it is planning to issue securities. 

Under the Securities Act, a company is generally prohibited from making any offers of 

14 
48 


nshattuck on FSR297 with DISTILLERInsert offset folio 15 here 30773.015

securities, orally or in writing, unless a registration statement has been filed with the 

SEC. The term "offer" is interpreted broadly- so broadly, in fact, that the preregistration period is known as the "quiet period." Oral offers are permitted after a 

registration statement has been filed, but written offers (confusingly called 

"prospectuses") continue to be subject to restrictions. 

The 2005 reforms addressed limits on communications that might be deemed to 

be offers by creating safe harbors for certain communications. The safe harbors are 

designed for operating companies, not investment companies, and they are further 

divided between rules for initial offerings and rules for offerings by reporting (public) 

companies (and further for reporting companies by size). For example, Rule 169 allows 

non-reporting issuers to release factual (i.e., not forward-looking) information prior to 

filing a registration statement if they routinely release the same type of information in the 

same manner. Rule 168 allows reporting companies to release factual and forwardlooking information prior to filing a registration statement if they routinely release the 

same type of information in the same manner. Rule 163 allows well-known seasoned 

issuers ("WKSis") to make offers prior to filing if the offer qualifies as a "free writing 

prospectus" and includes a cautionary legend. Rule 163A allows companies to release 

any type of information more than 30 days prior to filing a registration statement 

provided that the communication does not refer to the securities offering and the 

company takes reasonable steps to prevent dissemination of the communication within 30 

days of the offering. 

Mutual funds, closed-end funds and BDCs (and certain other types of issuers) are 

subject to different offering rules that are designed to reflect the differences between 

operating companies and investment companies. This presents the most significant 

concern regarding the proposed offering reforms. Closed-end funds and BDCs would 

become subject to two separate offering regulatory regimes and, apparently, be allowed 

to pick and choose which would apply. More to the point, they would be able to evade 

requirements that are specifically designed for non-reporting issuers such as registered 

investment companies by opting for a set of rules that were not written with investment 

companies in mind. 

15 
49 


nshattuck on FSR297 with DISTILLERInsert offset folio 16 here 30773.016

As noted above, the proposed offering refom1s are particularly inappropriate for 

CEFs. Unlike BDCs, CEFs are not reporting companies. They do not file the reports that 

operating companies file under the Exchange Act. They file reports and use registration 

statements that are designed to reflect their nature as investment pools. The ICI has 

suggested that quarterly reports filed by CEFs are similar to quarterly reports filed by 

operating companics. 14 I think the ICI protests too much. Let's consider this comparison. 

The quarterly report filed by CEFs, Form N-Q, is nothing more than a certified list of 

portfolio holdings. Operating companies file Form 10-Q, which requires a discussion of 

legal proceedings (Item 1 ), risk factors (Item I A), unregistered sales of equity securities 

and usc of proceeds (Item 2), defaults upon senior securities (Item 3), and any other item 

that would be required to be disclosed on Form 8-K, which in turn requires disclosure of 

Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet 

Arrangement of a Registrant (Item 2.03), Triggering Events That Accelerate or Increase a 

Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement 

(Item 2.04), Costs Associated with Exit or Disposal Activities (Item 2.05), Material 

Impairments (Item 2.06), Notice of Delisting or Failure to Satisfy a Continued Listing 

Rule or Standard; Transfer of Listing (Item 3.01), Unregistered Sales of Equity Securities 

(Item 3.02), Material Modification to Rights of Security Holders (Item 3.03), Changes in 

Registrant's Certifying Accountant (Item 4.01 ), Non-Reliance on Previously Issued 

Financial Statements or a Related Audit Report or Completed Interim Review (Item 

4.02), Changes in Control of Registrant (Item 5.01), Departure of Directors or Certain 

Officers; Election of Directors; Appointment of Certain Officers; Compensatory 

ArTangements of Certain Officers (Item 5.02), Amendments to Articles of Incorporation 

or Bylaws; Change in Fiscal Year (Item 5 .03), Temporary Suspension of Trading Under 

Registrant's Employee Benefit Plans (Item 5.04), Amendments to the Registrant's Code 

of Ethics, or Waiver of a Provision of the Code of Ethics (Item 5.05), Change in Shell 

Company Status. Submission of Matters to a Vote of Security Holders (Item 6.01); 

Shareholder Director Nominations, ABS Informational and Computational Material. 

14 See ICI Testimony at 3 ("Like most publicly traded operating companies, closedend funds file annual and semi-annual reports as well as quarterly reports. Each of 

these reports includes certifications from the principal executive officer."). 

16 
50 


nshattuck on FSR297 with DISTILLERInsert offset folio 17 here 30773.017

Change of Scrvicer or Trustee (Item 6.02), Change in Credit Enhancement or Other 

External Support (Item 6.03), Failure to Make a Required Distribution (Item 6.04), 

Securities Act Updating Disclosure (Item 6.05), Static Pool (Item 6.06), Regulation FD 

Disclosure (Item 7.01). A CEF's Form N-Q and an operating company's Form 10-Q are 

both filed quarterly. Any similarity ends there. 

The comparison is also made to the registration process for mutual funds and 

interval funds on the one hand, and CEFs on the other. 15 Both mutual funds interval offer 

their shares for redemption, and both redeem shares at their net asset value. These entail 

registration and transactional burdens that CEFs do not approach. The idea that the 

registration burdens of mutual funds and interval funds is somehow lighter than it is for 

CEFs is ludicrous. Closed-end funds have been unsuccessful despite the significantly 

lower regulatory costs that they incur relative to other open-end investment vehicles. The 

CEF structure is simply not a structure that shareholders prefer; lipstick-on-a-pig offering 

reforms will do nothing to change that fact. 

Closed-end funds are exempt from certain requirements that apply to reporting 

companies and would continue to be exempt under the proposed reforms. Unlike BDCs, 

CEFs register under the Investment Company, where Congress placed a set of 

requirements regarding the issuance of shares by mutual funds, closed-end funds and unit 

investment trusts that it designed for those types of issuers. The only logical arena within 

which to amend CEF offering rules is within the existing framework under which they 

are regulated. I am not aware of a similar package of proposals to that framework having 

been presented, the preference apparently being for the more lax environment that cherrypicked operating company rules offer. The application of operating company offering 

rules to CEFs seems to reflect a last-minute attempt to piggy back on changes being 

proposed for BDCs, which are fundamentally different in their regulation and purpose. 

15 /d. at note 7 (noting eligibility of mutual funds and interval funds for immediate 

effectiveness). This is not to say that nonmaterial CEF filings should not be made 

immediately effective. Rather, they should be regulated within the set of rules that 

were designed for registered investment companies. 

17 
51 


nshattuck on FSR297 with DISTILLERInsert offset folio 18 here 30773.018

Some appear to believe that CEFs are entitled to offering reform because they have not 

been very popular with investors. This reasoning is hard to follow. Closed-end funds do 

not, in and of themselves, represent a public good that Congress should seek to make 

more popular. The regulation ofBDCs reflects a conscious decision by Congress to 

increase a particular type of investing, in part by loosening certain Investment Company 

Act provisions. Closed-end funds are nothing more than a legal structure used for the 

intermediation of investment dollars. It does not make sense to lower the leverage limit 

that applies to closed-end funds simply to make them more popular when they are less 

popular for good reason. Closed-end funds are poor cousins to mutual funds and, more 

recently, their upstart nephews, exchange-traded funds, because they often trade at large 

discounts to the net asset value, they charge high fees, and their managers are less 

accountable to the marketplace because their shares are not redeemable. Their 

unpopularity has nothing to do with offering restrictions and is not a rational basis for 

creating an artificial advantage for them relative to mutual funds, exchange-traded funds, 

separate accounts, collective investment trusts and hedge funds. 

In contrast, there is merit in some of the concerns that appear to have prompted 

the proposal for wholesale application of operating company offering rules to BDCs. 

This largely reflects the fact that BDCs, unlike CEFs, are reporting companies, and 

Congress made them reporting companies as part of a regulatory structure that it designed 

to facilitate investment in small- and mid-sized companies. Their status as reporting 

companies already creates at least a regulatory congruence with operating company 

regulation that does not exist for registered investment companies such as CEFs. The 

same type of information, at the same time intervals, is made available under Exchange 

Act reporting by BDCs as for operating companies that rely on operating company 

offering rules. Furthermore, the SEC has permitted BDCs to engage in the same 

practices that the key proposals appear to be designed to codify. And BDCs, unlike 

CEFs, are investment vehicles that serve a specific policy goal. 

Along this reasoning, in my view BDCs should be afforded three benefits that 

properly reflect their reporting company status. First, they should be able to incorporate 

documents by reference. As noted. as reporting companies BDCs are subject to the kind 

18 
52 


nshattuck on FSR297 with DISTILLERInsert offset folio 19 here 30773.019

of continuous reporting that applies to operating companies, which are already permitted 

to incorporate by reference. Second, BDC registration statements that contain no 

material changes should become automatically effective upon filing16 (I would reconsider 

this position if the SEC demonstrated that its review during delayed effectiveness has 

uncovered abuses relating to nonmaterial changes). Third, BDCs should be allowed full 

use of Rule 415's shelf registration provisions, although not under the ill-fitting guise of a 

Form N-2 Registration statement.17 As the SEC has previously allowed, they should be 

subject to the same standards that apply, for example, to eligible Form S-3 filers. 

In each case, however, it is not appropriate for Congress to specify the 

administrative law means by which the practical goals described above are achieved. 

Rather, Congress should simply instruct the SEC to adopt and/or amend rules as needed 

to accomplish these goals. Granted, the SEC's rulemaking paralysis may necessitate 

tying this instruction to a deadline after which the new standard becomes self-executing. 

But 1 am confident that allowing the SEC to detem1ine how to navigate the most efficient 

way to accomplish these goals will result in rules that work better than legislated reforms 

for the industry and shareholders alike. 

III. Proposed 50 Percent Limit for BDC Investments in Financial Firms 

Prior versions of the bills would have permitted BDCs to invest up to 50 percent 

(or more) of their assets in financial firms that arc not eligible investments. As this 

16 The SEC has essentially permitted automatic effectiveness under certain no-action 

letters. See Nuveen Virginia Premium Income Municipal Fund (Oct. 6, 2006); 

Pilgrim American Prime Rate Trust (May 1, 1998). 

17 The Offering Rules Provisions create the impression that CEFs and BDCs arc not 

currently allowed to conduct shelf offerings under Rule 415. In fact, CEFs and BDCs 

routinely conduct shelf registrations under Rule 415. For example, as recently as 2014, 

almost every BDC (79 out of 88) conducted at least one shelf offering under the rule. 

There has been no practical impediment to BDCs' conducting shelf offerings. For over 

two decades, CEFs and BDCs have relied on SEC no-action letters that permit them to 

conduct shelf offerings under Rule 415. The actual effect of the proposed shelf offering 

reforms would be to allow CEFs and BDCs to circumvent the long-established, carefully 

considered conditions under which the SEC has already allowed shelf otierings by these 

funds. 

19 
53 


nshattuck on FSR297 with DISTILLERInsert offset folio 20 here 30773.020

proposal may resurface, I am compelled to wonder why Congress would choose to make 

BDC less likely to serve their legislative purpose and more likely to lose the interest of 

shareholders. The reason for reduced regulation of BDCs is to make additional capital 

available to small- and mid-sized operating businesses. Allowing BDCs to increase their 

investments in financial fim1s would do the opposite. Every dollar that a BDC invested 

in a financial fim1 is a dollar that would be denied to the intended beneficiaries ofBDCs' 

regulatory regime. 

One BDC witness has illustrated precisely this point He stated that, due to the 

existing 30% limit on investments in financial firms, "a BDC investing in a growing 

leasing company might have to curtail useful lending because of a limit that in context 

feels quite arbitrary." In other words, the BDC would not be allowed to divert more 

assets to a financial business that was doing what the BDC is supposed to do: make 

capital available to small- and mid-sized busincsscs. 18 

Permitting BDCs to invest 50% of their assets in financial services firms may 

destroy BDCs as a unique asset Imagine a period in which financial firms perfom1 well, 

while small- and mid-sized finns perform poorly. The market will view BDCs that hold 

a large percentage of financial stocks as better-performing "BDCs," while the rest arc 

viewed, unfairly, as poorly-pcrfom1ing "BDCs." In fact, their relative perfom1ance 

would have little to do with their identity as BDCs. That term will have essentially lost 

18 For example, the largest BDC has an $88.4 million investment (representing 1. 7% 

of the fund's assets) in 10th Street LLC. See Sample BDC Prospectus at F-25. The 

webpage for lOth Street LLC describes it as having been founded "with the goal of 

providing capital to companies in the lower middle market." At 

http:/ /www.tenthstreet.com/ (last visited Oct. 29, 2017). See also id. ("For over a 

decade, Tenth Street has been giving transaction support to equity sponsors by 

providing mezzanine debt and equity co-investments. Now investing out of a 

seventh fund, Tenth Street has raised almost $400 million in committed capital and 

provided it to growing companies in the lower middle market."). The website for 

another of the BDC's investments-- Imperial Capital Private Opportunities --

describes itself as "a Toronto-based private equity fund manager that focuses on 

investment opportunities in healthcare, business services, and consumer products 

in the Canadian and American mid-market." At httpjjimQ_erialcaJ:J.C!Jm/ (last 

visited Oct. 29, 2017). 

20 
54 


nshattuck on FSR297 with DISTILLERInsert offset folio 21 here 30773.021

any real significance. The effect will be to strip all meaning from the concept of the BDC 

election- a concept that is likely already being substantially eroded under the current 30 

percent limit. IfBDCs arc not held to their purpose, there is no reason to have BDCs. 

IV. Money Market Fund Reforms 

I testified before this Subcommittee on money market fund reforms before they 

were adopted by the SEC. My views have not changed, but circumstances have. Dozens 

of money market funds have closed, hundreds of billions of dollars of credit that had been 

extended to businesses have been diverted to the U.S. government, and institutional 

investors looking to find a short-term home for their cash have been forced to reevaluate 

their longstanding preference for money market funds. 

Notwithstanding such adverse effects, I cannot support the current proposal 

absent an empirical analysis of the after-effects of the money market fund rulemaking. 

Just as the original rules were adopted with an inadequate understanding of their effect, 

Congress should not rush tum back the clock without know the effect of doing so. The 

SEC intends to analyze the effect of the reforms, and I believe, in light of what I viewed 

as an errant perspective the first time around, that the agency might benefit from direct 

instructions from Congress as to the relevant questions that it should answer. 19 In short, 

my position is similar to Chairman Clayton's, who has opined that "it's too early to say 

we're wrong." I recognize that it's too early to say 1 was right. 

19 This should include an analysis of the current status of the SEC's longstanding, 

extra-judicial practice of granting ad hoc, last minute, oral no-action relief to MMFs 

that were at risk of imminent failure. I refer the Subcommittee to the comment 

letter I submitted to the SEC eight months prior to the collapse of the Reserve Fund 

that warned that the developing credit crisis warranted immediate action to protect 

MMFs, including specifically a re-evaluation of the staffs ill-advised no-action 

practices. Indeed, the SEC's excessive reliance on no-action positions, and 

concomitant failure to codify their positions, is one reason that the pending bills 

have been proposed. SEC rulemaking paralysis continues to be a significant 

problem at the agency, as I have also discussed in prior testimony before the 

Subcommittee. 

21 
55 


nshattuck on FSR297 with DISTILLERInsert offset folio 22 here 30773.022

I am also concerned about the bill's restrictions on banking regulators' ability to 

take emergency action in the event of another severe liquidity event. While we might 

believe today that such action is inappropriate, we might take a different view upon the 

onset of another financial crisis. By analogy, the Delaware courts have held that it is not 

consistent with a corporate director's fiduciary duty to adopt a poison pill to frustrate a 

hostile takeover that no future board member can change. Such poison pills, 

appropriately named ''dead hand" provisions, arc impennissiblc because they prevent 

future board members from taking steps that they deem to be in the best interests of 

shareholders. It is a dangerous practice to remove emergency powers from the set of 

tools we have to mitigate financial crises. 

I understand that tying banking regulators' to the mast, so to speak, may signal to 

investors that MMFs will not be bailed out in the future. However, I doubt very much 

that this will influence investors' behavior or attitudes. And this approach may backfire 

in the event that banking regulators are unable to prevent a full-blown run on MMFs, 

which may lead to the systemic meltdown we recently so narrowly avoided. Treasury 

bailouts are not all bad, or even "bailouts." It is worth recalling that the U.S. Treasury 

pocketed more than $1 billion insurance premiums paid by MMF shareholders without 

paying a single penny in claims. 

There are structural checks that Congress could use to ensure proper oversight of 

banking regulators' exercise of emergency powers without making those powers 

practicably unavailable. A common approach is to make the exercise of power 

contingent on certain findings being made, which could be required of the heads of 

multiple agencies (this is the approach that Congress used after the 1980s banking crisis 

to impose tighter discipline on FDIC decisions on whether to allow weak banks to remain 

in business). Banking regulators could be required to submit proposed actions to a 

process that allowed Congress-- perhaps initially through a designated committee, which 

then could pass a recommendation for further action by the full body -to intercede 

without preventing the prompt action that is sometimes needed to right the ship before it 

sinks. It is almost always more workable to authorize emergency action in advance while 

22 
56 


nshattuck on FSR297 with DISTILLERInsert offset folio 23 here 30773.023

providing for a shut-offvalve, than to prohibit emergency action that must be 

legislatively restored to be used in an emergency. 

23 
57 


nshattuck on FSR297 with DISTILLERInsert offset folio 24 here 30773.024

SUBCOMMITTEE ON CAPITAL MARKETS, 

SECURITIES, AND INVESTMENTS 

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

HEARING ON: "LEGISLATIVE PROPOSALS TO IMPROVE SMALL BUSINESSES' AND 

COMMUNITIES' ACCESS TO CAPITAL" 

NOVEMBER 3, 2017 

TESTIMONY OF 

MICHAEL F. GERBER 

EXECUTIVE VICE PRESIDENT 

FS INVESTMENTS 
58 


nshattuck on FSR297 with DISTILLERInsert offset folio 25 here 30773.025

Introduction to FS Investments 

Chairman Huizenga, Ranking Member Maloney and members of the Subcommittee, thank you lor giving 

me the opportunity to testify today. My name is Mike Gerber and I am an Executive Vice President with 

Franklin Square Holdings, L.P., d/b/a FS Investments ("FS"). and also serve on the Board of Directors of 

the Small Business Investor Alliance, the premier membership organization representing Business 

Development Companies ("BDCs"). 

FS, founded in 2007 in Philadelphia, Pennsylvania, manages alternative investment funds. Our mission is 

to enhance mainstream investors' portfolios by providing access to asset classes, strategies and asset 

managers typically available only to wealthy individuals and large institutional investors. In serving our 

primarily retail (individual) shareholder base, we also strive to set the industry standard for best practices. 

with a focus on transparency, investor protection and education for investment professionals and their 

clients. We manage five BDCs, one closed-end fund, two interval funds and one mutual fund. Jn all, we 

manage more BDC assets, in both traded and non-traded BDCs, than any other manager in the industry. 1 

A Brief Historv of BDCs 

A BDC is a type of closed-end investment fund that was created by Congress through the enactment of 

the strongly bi-partisan Small Business Investment Incentive Act of 19802 Congress' stated objective in 

creating BDCs was to encourage the establishment of new capital vehicles that would invest in, and 

increase the flow of capital to, small and mid-sized companies in the United Stales.' As such, the 

Investment Company Act of 1940, as amended (the "1940 Act"), generally requires BDCs to invest at 

least 70% of their total assets in the securities of "eligible porttolio companies," which the 1940 Act 

generally defines as private U.S. operating companies and public U.S. operating companies with market 

capitalizations of less than $250 million.4 Consistent with Congress's goal of providing support to small 

and mid-sized U.S. companies, the 1940 Act also requires BDCs to make available significant managerial 

assistance to such portfolio companies. 5 In complying with these regulatory requirements, BDCs provide 

a significant level of capital and assistance to small and middle market U.S. companies. Jn fact, today. 93 

BDCs from across the industry have more than $90 billion invested! 

In addition to helping fill a void in the capital markets for small and middle market companies, BDCs are 

highly regulated, transparent investment vehicles that provide individual investors access to an asset class 

which historically had been available only to wealthy individuals and institutional investors such as 

university endowments, foundations and pension funds. This access provides an important opportunity to 

aH investors as a generator of current income within a portfolio. 

BDCs Are Highlv Regulated and Transparent Investment Vehicles 

BDCs are among the most highly regulated investment vehicles in the marketplace and, because of the 

robust public disclosures required of BDCs under the Securities Act of 1933, as amended (the "Securities 

Act"), the Securities Exchange Acl of 1934, as amended (the "Exchange Act"), the 1940 Act and the rules 

1 FS currently manages five BDCs with aggregate assets under management of approximately $18.2 billion as of June 30, 2017. 

FSIC. our first fund which launched in January 2009, listed its shares of common stock on the NYSE in April 2014. 2 Small Business Investment Incentive Act of 1980. Pub. L. No. 96-477, 94 Stat. 2275 (1980): see also S. REP. No. 96-958 

( 1980): H.R. REP. No. 96-1341 ( 1980). The Act was approved by the US. House by a vote of 395-l and by unanimous consent in 

the U.S. Senate. 1 See S. REP. No. 96-958, at !. 3 ( !980). 

'See 15 U.S.C. § 80a-2(a)(46), -54. 

'/d. §80a-2(a)(48)(B). 6 SBIA BDC Council. \\\·\W.bdc~\lQffi.fommcrica,or~. 
59 


nshattuck on FSR297 with DISTILLERInsert offset folio 26 here 30773.026

and regulations promulgated by the U.S. Securities and Exchange Commission (the "Commission") 

thereunder, the activities of BDCs are fully transparent to regulators. investors, portfolio companies and 

the general public. Specifically, BDCs register their securities under the Securities Act on Form N-2, 

which requires extensive disclosures regarding, among other things. the issuer. the securities being 

offered, the issuer's investment objectives and strategies, risk 1actors relating to tbe issuer's securities and 

business and the issuer's financial condition. Additionally, BDCs are required to register a class of 

securities under the Exchange Act and, as such, are required to file periodic and other reports with the 

Commission thereunder, including proxy statements and Forms 1 0-K, 1 0-Q and 8-K. Contained in every 

I 0-Q and I 0-K is a schedule of all of our investments, along with details regarding the investments such 

as the name of the portf(Jlio company, the size of the loan or equity position, interest rates, and current fair 

value for each investment. As a result, BDC investment portfolios are marked-to-market in the financial 

statements and disclosed to investors quarterly. The Exchange Act also imposes reporting requirements 

on BDC directors, officers and principal stockholders with respect to their ownership of and transactions 

in the BDC' s securities. 

These extensive and comprehensive disclosure requirements provide regulators, investors and portfolio 

companies with an exceptionally high level of transparency into BDCs and, in our opinion, serve to assist 

investors in making informed investment decisions, minimize conflicts of interest and ensure that BDCs 

act in the best interests of their investors. 

In addition to the robust disclosure requirements imposed on BDCs by the federal securities laws, BDCs 

are subject to significant substantive regulation under the 1940 Act and the rules and regulations of the 

Commission thereunder. Key elements of these 1940 Act protections include extensive regulations 

governing, among many other things, portfolio composition, determination ofthe fair value of 

investments (which must be completed by the BDC's board of directors at least quarterly), share pricing, 

director qualifications and independence, transactions with affiliates, bonding, capital structure, the 

approval of underwriting agreements and advisory agreements, the payment of distributions to investors, 

custody of assets and codes of ethics. Finally, investment advisers to BDCs must register with the 

Commission under the Investment Advisers Act of 1940, which imposes a fiduciary obligation on the 

adviser to act in the best interest of the BDC. 

In addition to regulatory oversight by the Commission through the application of these federal laws, nontraded BDCs are also subject to regulatory oversight by the securities commissions or similar governing 

bodies of each of the 50 states and the U.S. Territories through the review of their public securities 

otJering documents and the imposition of suitability standards for investor participation in those 

offerings. Finally, broker-dealers involved in the distribution of BDC securities are subject to regulation 

by the Financial Industry Regulatory Authority, Inc., which provides an additional level of protection for 

investors. 

Taken together, these and various other regulations applicable to BDCs make BDCs one of the most 

transparent and highly regulated investment vehicles available to investors today. 

BDCs Are Critical Middle Market Lenders 

While BDCs are an important source of capital for small businesses, they have become a critical source of 

capital for middle market businesses as well. 7 Nearly 200,000 U.S. businesses comprise the middle 

market, which is responsible for one-third of America's private sector gross domestic product. 8 Middle 

7 3Q 2017 Middle Market Indicator. National Center for the Middle Market. 

'!d. 

2 
60 


nshattuck on FSR297 with DISTILLERInsert offset folio 27 here 30773.027

market businesses, defined as those with annual revenue between $10 million and $1 billion, employ 

nearly 48 million people, 9 or one out of every three workers in the private sector. 10 

Middle market firms are the engines of the U.S. economy. American Express and Dun & Bradstreet 

report that, despite accounting for just I% of commercially active companies in America, the middle 

market created over half of all new jobs since 2011. 11 In fact, the middle market generated l 03.3% job 

gro"'ih between 2011 and 2017 compared to 52.3% for large firms and just 7.4% for small businesses 

over the same period." Similarly, over the last year, middle market firms increased hiring by 6.4%, while 

large Jirms grew hcadcount by 2.8% and small firms grew by only 1.2%. 13 Importantly, middle market 

growth is increasingly bcne1iting underrepresented populations and geographies. Since 2011, the numbers 

of women-owned and minority-owned middle market companies have grown by 119.6% and 85.8%. 

respectively. 14 Middle market growih has also been particularly robust in legacy industrial states such as 

Ohio and Michigan, which were hit hard during the Great Recession but have seen triple-digit growih in 

their middle markets due to a resurgence in manufacturing and wholesaling over the last six years. 15 

Capitalizing on this small manufacturing renaissance, the number of middle market firms exporting their 

goods and services has quadrupled over the last six years. 16 Behind the scenes, the recovery of the middle 

market in Ohio and Michigan was made possible by BDC investments in these states totaling over $1.6 

billion and $1 billion, respectively. 17 

The success of this middle market growth story is fueled by investment, and the demand for capital 

among middle market companies is still increasing. In its most recent middle market indicator survey, the 

National Center for the Middle Market reported that 42% of middle market companies expect to add more 

jobs in 20 J 8. 18 The National Center for the Middle Market estimates this will translate into another 6.0% 

revenue expansion across U.S. middle market firms over the next year. 19 A record 70% of middle market 

Jirms surveyed by the National Center for the Middle Market reported that they would immediately invest 

extra cash rather than save it, with capital expenditures and employee training and development topping 

the list for investment?" Despite this obvious need and the importance of a healthy and growing middle 

market to the overall U.S. economy, bank lending to small and mid-sized businesses dropped 38% 

between 2006 and 2015. 21 Middle market lenders. like BDCs. must be positioned to fill the void left by 

banks and provide the capital necessary to fuel the middle market's continued growih. 

With the mandate of investing at least 70% of their total assets in U.S. small-cap and private companies, 

BDCs are uniquely positioned to provide the capital middle market firms need to continue to grow 

revenue and create new U.S. jobs. 

The "Small Business Credit Availahilitv Act" 

FS believes the discussion draft of the "Small Business Credit Availability Act" includes modest, 

common-sense amendments that would enable BDCs to enhance their ability to provide capital to small 

9 Id. 

lOfJ. 

11 Middle Market Power Index, Aue,JUst 2017, American Express Global Corporate Payments and Dun & Bradstreet. 12 /d. 13 3Q 2017 Middle Market Indicator, National Center for the Middle Markd. 14 Middle Market Power Index, August 2017. 15 Jd. 

!6 /d. 

17 SBIA BDC CounciL W\\ wJ~cs-wQrk.fun!illffi£fhQ[g. 18 3Q 2017 Middle Market Indicator, National Center for the Middle Market. ]') ld. 

00 !d. 

21 "'Big Banks Cut Back on Loans to Small Business." Ruth Simon. 111e Wall Street Journal. November 26, 2015. 

3 
61 


nshattuck on FSR297 with DISTILLERInsert offset folio 28 here 30773.028

and mid-sized U.S. companies while maintaining the strong regulatory oversight and transparency that 

separate BDCs from other non-bank lenders in the marketplace. FS believes the '·Small Business Credit 

Availability Act," if enacted into law, would allow BDCs to more effectively fill the funding gap created 

as banks back away from the middle market, and thereby continue to support a key driver of economic 

growth. 

Asset Coverage Requirement Changes 

First the Act would amend Section 61 of the 1940 Act to decrease the asset coverage requirement 

applicable to BDCs from 200% to 150%. This change would modestly raise the leverage limit for BDCs 

from the current 1: I debt-to-equity ratio to just a 2: I debt-to-equity ratio. FS strongly supports this 

proposed amendment because we believe it is a modest change that would allow BDCs to provide more 

capital to small and mid-sized U.S. companies in a responsible manner, while maintaining the 

transparency and investor protections that have made BDCs appealing investment options. 

FS also believes that, relative to other lenders in the marketplace, a 2:1 debt-to-equity ratio remains 

conservative. Banks are currently levered in the high single digits to the mid-teens22 and non-bank assetbased commercial lenders, private debt funds and hedge funds can employ as much leverage as the 

market will bear, far exceeding bank leverage ratios in many cases. Jn addition to these elevated levels of 

leverage, traditional banks, hedge funds and other non-bank lenders do not regularly disclose any specific 

details of their loan portfolios, providing far less transparency to investors than BDCs. We also note that 

Small Business Investment Companies, or ''SB!Cs," which are functionally and regulatorily close cousins 

of BDCs, have been operating safely and profitably at 2:1 leverage since 1958 and SBIC loans are backed 

by a federal government guarantee. Moreover, the U.S. Small Business Administration reported in 

January that, on average, the SBIC Program creates approximately one job for every $16,000 invested. 23 

Similar data is not available for BDCs, but assuming BDCs' investment-to-job-creation ratio is similar to 

that ofSBlCs, the potential for job creation from this legislation is immense. BDCs are seeking to follow 

the proven leverage model ofSBICs, with its proven job creation results, and with zero cost to taxpayers. 

It is with this backdrop that we see the proposal to allow BDCs to go to a 2:1 debt-to-equity ratio as a 

responsible, modest update to BDC regulation. 

Importantly, BDCs could use the additional leverage to construct portfolios that are safer for investors. In 

the current low interest rate environment and under the current 1: I leverage limitation, BDCs typically 

choose between two general investment strategies. The first strategy is to seek yield by investing deeper 

in the capital structure of a portfolio company. Such an approach creates more risk in the event the 

portfolio company experiences difficulty as there is less capital behind a BDC's investment to absorb 

potential losses. The second strategy is to accept lower yields by investing higher in the capital structure 

of a portfolio company. This approach actually lessens inherent risk given the position of a BDC's 

investment in the portfolio company's capital structure, but also reduces returns to the BDC's investors. 

An increase to the permissible debt-to-equity ratio would open up a third option. With slightly more 

leverage, BDCs could invest in assets higher in the capital structure that generate less yield, but apply the 

additional leverage to this strategy to compensate investors for the lower inherent risk and generate 

comparable returns. For all three of these reasons, FS supports this key element of the discussion draft 

currently before the subcommittee. 

22 Based on the Federal Deposit Insurance Corporation ('"FDIC') Definition of Tier 1 leverage: Tier 1 (core) capital as a percent 

of average total assets minus ineligible intangibles. S'ee http://\n\w.bankreildata.com/, based on data from the Federal Reserve 

Board (""Fed"), the FDIC and the Office of the Comptroller of the Currency (""OCC"). See also, the FDIC Quarterly Banking 

Profile at https:/1\\ \':}~.fdic.go\/b.;m.Js!gna!\ 1.\_~l:iJ~~QJ)jun!qhp,nQf. 21 '·Measuring the Role of the SBIC Program in Small Business Job Creation, .. U.S. Small Business Administration, January 

2017. available at: https:i'\\\\w.sbaeovrsitesldcJ~mlt/fileslarticks/SBA SBJC .h)bs Report. pdf. 

4 
62 


nshattuck on FSR297 with DISTILLERInsert offset folio 29 here 30773.029

FS also supports the provisions in the discussion draft requiring any BDC that plans to adopt the reduced 

asset coverage requirement to obtain board approval and then either obtain shareholder approval or 

undergo a one-year waiting period following notice of board approval before making a practical change to 

the application of leverage limits. Additionally, we support the requirement that non-traded BDCs offer 

quarterly liquidity to all security holders as of the notice date of such board approval. We believe this 

one-year "cooling off' period to allow investors in traded and non-traded BDCs to exit their investments 

before the BDC exceeds the existing I: I threshold addresses input we received through feedback from 

congressional members and the Commission. 

FS believes certain elements about the application of the leverage provisions of the proposed legislation 

should be highlighted. First, we do not believe that every BDC would choose to, or be able to, take 

advantage of the reduced asset coverage requirement. For those BDCs that wish to take advantage of the 

reduced requirement. there are several natural governors in place that may limit the amount of additional 

leverage they may employ and, in some cases, prevent them from employing any additional leverage at 

all. We also believe that BDCs will not move to the maximum allowable leverage of2:1 because of a 

number of existing regulatory and market-driven constraints. 

The first natural governor on leverage is the cushion BDCs maintain between actual leverage and the 

leverage limit because of their floating net asset values ("NAY"). BDCs' NAYs fluctuate as a result of 

market and other conditions. including the requirement to fair value investment assets on a quarterly basis 

and, as such, so do their leverage ratios. For this reason, most BDCs currently employ leverage in the 

0.55:1 to 0.80:1 range. well below the regulatory maximum of 1:1. 24 FS agrees with the industry analysts 

and rating agencies when they assert that BDC managers will maintain a similar buffer, around 1.65:1, if 

the statutory limit is increased to 2: 1

25 

The second natural governor on leverage is the compliance regimes established by bank regulators. In 

order to access leverage, BDCs typically have bank partners that are willing and able to lend to them and 

agreements in place that permit the additional use of leverage. On that latter point, according to Fitch 

Ratings Inc .. most credit facilities currently in place for BDCs include a financial covenant requiring the 

maintenance of a 200% minimum asset coverage ratio, 26 Therefore, in order to employ leverage above 

I: I. BDCs currently subject to these covenants would be required to amend their credit facilities to reduce 

the asset coverage requirement to 150%. This amendment process for existing leverage facilities, and the 

establishment of any new facilities, would require banks to analyze BDC portfolios, BDC management 

teams and all of the other considerations that go into a bank's decision to extend credit to a BDC. 27 

Yet another natural governor on the use of leverage by BDCs is the rating agencies. Rating agencies 

review the underlying portfolios ofBDCs when assigning credit ratings. BDCs that invest in highly 

leveraged assets, most notably assets that are deeper into a portfolio company's capital structure, while 

increasing their overall leverage ratios, will have a more difficult time maintaining an investment grade 

rating." Needless to say. BDCs with poor (or no) credit ratings will struggle to secure additional leverage. 

Finally, institutional and retail investors, and the analysts that provide investors with research, serve as 

natural governors on leverage, Analysts and investors. particularly institutional investors. pay close 

"The BDC Almanac- Episode Ill. Wells Fargo Equity Research, January 22, 2014. 25 Jd; see also, Fitch Wire: "Leverage Limit Increase Could Differentiate BDC Ratings," Fitch Ratings. Jmmary 7, 2014. 

"/d. 

27 ln particular, the asset quality and market risk provisions of the "CAMElS" ratings used by the Fed, the FDIC and the OCC to 

rate banks based on the performance of their loan portfolios. T11c acronym "CAMEI.S" refers to the six components of a bank's 

condition that are a<>sessed: Capital adequacy, A'>set quality, Management, Earnings, Liquidity and Sensitivity to market risk See 

FDIC Quarterly Banking Profile. ht1n::.::'r\\'\\'\Lfdic.onv;1);mk!g_mal\ticill~20 17iun "qbp.pdf. 28 /d. 

5 
63 


nshattuck on FSR297 with DISTILLERInsert offset folio 30 here 30773.030

attention to the performance ofBDCs. Beyond looking at returns, the transparent nature ofBDCs allows 

investors to frequently review a BDC's leverage ratio and portfolio composition. If analysts and investors 

consider a BDC's leverage levels to be inappropriate, and the demand for shares in that BDC declines, the 

BDC will likely have to de-lever to maintain a leverage ratio that is both compliant and more palatable to 

investors. 

For all of these reasons, FS supports the proposal to reduce the asset coverage requirement trom 200% to 

150%. We believe this is a conservative and rcspomible change that would allow BDCs to provide more 

capital to small and middle market U.S. companies, maintain low leverage ratios relative to other lenders 

in the marketplace, and provide the opportunity to continue to generate returns to individual investors 

while lowering the inherent risk of a portfolio. 

Offering and Proxv Rule Re1orms 

Second, the proposal would direct the Commission to amend certain rules and forms promulgated under 

the Securities Act and Exchange Act to allow BDCs to use the more streamlined securities offering and 

proxy provisions that are already available to many other public companies. Specifically, these changes 

would make BDCs eligible for ''Well-Known Seasoned Issuer" status and, therefore, eligible to file 

automatic shelf registration statements, and permit BDCs to incorporate by reference reports and 

documents previously filed with the Commission into their registration statements and other public 

filings. These changes would help BDCs reduce administrative, legal and printing costs, and in tum, save 

money for investors. Moreover, these changes would streamline and reduce duplicative filings that must 

be reviewed by SEC staff, thereby increasing regulatory efficiency and freeing up regulatory resources for 

more productive purposes. Importantly, this change would not make BDCs any less transparent than they 

are today. This provision of the bill has broad support and FS is in favor of including it in the legislation. 

Rellncments to H.R. 3868 (114'•) 

The current discussion draft of the "Small Business Credit Availability Act" is notably shorter than its 

predecessor, H.R. 3868, introduced in the 114'• Congress. In addition to the leverage and offering reform 

provisions discussed above, H.R. 3868 contained three other provisions that have been excised from the 

discussion draft. The excised provisions would have: (I) allowed BDCs to issue preferred stock; (2) 

allowed BDCs, under certain circumstances, to own securities issued by, and other interests in the 

business of, registered investment advisers; and, (3) expanded the dellnition of "eligible portfolio 

company" to permit 13DCs to signillcantly increase exposure to investments in certain financial 

companies. 29 The BDC industry expressed concerns about a number of these provisions. Despite the 

inclusion of these provisions in H.R. 3868, FS and the BDC industry broadly were supportive of the 

leverage increase and offering reform provisions included in that bill, which was approved by the House 

Financial Services Committee in the previous Congress by a vote of 53-4, and are even more supportive 

of those two provisions standing alone as in the discussion draft. 

Conclusion 

BDCs offer a critical source of capital to small and middle market U.S. companies. The proposed "Small 

Business Credit Availability Act" would position BDCs to play an even more substantial role in 

supporting these job-creating businesses. FS believes that middle market companies in particular will 

29 Specifically, those financial companies exempted from the 1940 Act under paragraphs 3(c)(2) through 3(c)(6) and 3(c)(9). 

Under current BDC law. such investments (along with those in paragraphs 3(c)(l) and 3(c)(7)) are considered non-qualified, 

tncaning they do not qualify under the mandate that requires BDCs to invest at lea'>t 70% of their assets in private or small-cap 

operating companies. The proposal would treat these fmancial company investments as qualified a')sets. but limit them to no 

more than 50% of the BDCs total asseK 

6 
64 


nshattuck on FSR297 with DISTILLERInsert offset folio 31 here 30773.031

continue to grow and drive the U.S. economy and that the time is right to modernize the regulation of the 

BDC sector to help support that growth. Key aspects of this draft legislation would allow BDCs to further 

increase capital flows to America's small and medium-size companies, spurring economic grov.1h and job 

creation while maintaining the BDC's position in the marketplace as a highly regulated, transparent 

investment vehicle. 

We thank Representative Stivers for his efforts in crafting this legislation and Representative Moore for 

her efforts to improve on previous drafts, as well as Chairman Huizenga and Ranking Member Maloney 

for their efforts to help modernize the BDC industry. FS and the SBIA and its members stand ready to 

work with all the members of this subcommittee to advance this modernization effort. Again, we 

appreciate the opportunity to testify today and would be pleased to answer any questions. 

7 
65 


nshattuck on FSR297 with DISTILLERInsert offset folio 32 here 30773.032

® 

STATEMENT OF 

PATRICK J. McCOY 

PRESIDENT, GOVERNMENT FINANCE OFFICERS ASSOCIATION 

ON BEHALF OF THE GOVERNMENT FINANCE OFFICERS ASSOCIATION 

LEGISLATIVE PROPOSALS TO IMPROVE SMALL BUSINESSES' AND COMMUNITIES' 

ACCESS TO CAPITAL 

BEFORE THE 

HOUSE FINANCIAL SERVICES COMMITTEE 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES AND INVESTMENTS 

UNITED STATES HOUSE OF REPRESENTATIVES 

NOVEMBER 3, 2017 
66 


nshattuck on FSR297 with DISTILLERInsert offset folio 33 here 30773.033

Chairman Huizenga, Ranking Member Maloney and distinguished members of the Capital 

Markets, Securities and Investment Subcommittee, thank you for holding today's hearing on 

legislative proposals to improve small businesses' and communities' access to capital. My name 

is Pat McCoy and I serve as the President of the Government Finance Officers Association 

(GFOA). My remarks here today are in my capacity as President of GFOA and not of the 

Metropolitan Transportation Authority in New York where I serve as the Director of Finance. 

GFOA represents over 19,000 public finance officers from State and local governments, schools 

and special districts throughout the United States. This includes about 2,500 Michigan and 

1,500 New York national GFOA and state GFOA members. 

GFOA is dedicated to the professional management of governmental financial resources by 

advancing fiscal strategies, policies and practices for the public benefit, including issues related 

to issuing tax exempt bonds and investing public funds. On behalf of the GFOA and its 

members, I appreciate the opportunity to provide comments at this hearing on H.R. 2319, the 

Consumer Financial Choice and Capital Markets Protection Act of 2017. 

Specifically, I will describe how money market funds have been utilized effectively to both 

manage liquidity for public sector investments and provide a reliable source of working capital 

to fund public services and finance infrastructure investment and economic development. I will 

also describe the impact of the U.S. Security and Exchange Commission's (SEC) change of netasset-value (NAV) accounting methodology for money market mutual funds (MMMF) from 

stable to floating. 

State and local governments access the capital markets and issue short term debt for a variety 

of reasons. This important legislation would allow governments to continue this access without 

increasing costs for taxpayers. I am particularly interested in these issues as a finance officer 

with a large and diverse portfolio of over $38 billion of tax exempt bonds outstanding. Variable 

rate debt structured with hard puts has historically been a reliable low risk investment choice 

for money market funds and it has also been a very low cost method of financing as compared 

to issuing fixed-rate bonds. GFOA has published best practice guidance on the use of variable 

rate debt to ensure that it is used appropriately. 

Overall, money market funds are a widely-used cash management tool for individuals as well as 

for state and local governments. According to Federal Reserve data1, state and local 

governments hold over $183 billion of assets in money market funds. In addition, money 

market funds themselves are key purchasers of municipal securities- historically, they have 

1 See https://www.federalreserve.gov/releases/zl/currentlzl.pdf, page 84. 
67 


nshattuck on FSR297 with DISTILLERInsert offset folio 34 here 30773.034

been the largest purchasers of short-term tax exempt debt. Therefore, the impact of the SEC 

rule on governments is real and it affects not only large governmental entities like mine, but 

also small communities throughout the country. 

While we have supported and continue to support initiatives that both strengthen money 

market funds and ensure that investors are investing in high-quality securities, we applaud 

Representatives Rothfus, Stivers and Moore for introducing legislation which focuses on 

addressing the unintended consequences of the SEC's 2014 amendments to Rule 2a-7 that 

require institutional, non-government MMFs to price their shares at a floating net asset value 

(NAV), and to allow those funds to return to a fixed NAV. 

The original objectives of the floating NAV rule were to protect investors in money market 

funds by preventing runs that hamper access to short-term capital, shield taxpayers from future 

financial bailouts, and promote general market stability. Those objectives were effectively 

addressed in the 2010 Amendments to Rule 2a-7. GFOA supported the amendments which 

dramatically increased the credit quality of the assets held in MMFs, required money market 

funds to have a minimum percentage of their assets in highly liquid securities so that those 

assets can be readily converted to cash to pay redeeming shareholders, and increased 

transparency by requiring funds to regularly calculate their "shadow prices" (i.e., their 

portfolios' per-share values at market prices). 

Despite the success of the 2010 reforms, the SEC adopted additional amendments to Rule 2a-7 

in July 2014. Among other things, those amendments require institutional prime and taxexempt funds to use a floating NAV. 

The SEC's reasoning was that a floating NAV would provide investors with a more frequent and 

accurate assessment of the value of a fund's assets. Under previous rules, institutional prime 

and tax-exempt MMFs were allowed to round their share price to $1.00, so long as the actual 

value of a share does not fall below $0.9950 ("break the buck"). The SEC's change from fixed to 

floating was predicated on the belief that investor awareness of the actual value of the fund's 

assets will make investors less likely to redeem shares in times of economic distress. 

Throughout the rulemaking process, GFOA and public finance officers throughout the country 

submitted analysis showing that a floating NAV would do little to deter heavy redemptions 

during a financial crisis but would, instead, impose substantial costs on state and local 

governments. That is exactly what has come to fruition. 
68 


nshattuck on FSR297 with DISTILLERInsert offset folio 35 here 30773.035

Between January 2016 and July 2017, tax exempt MMFs assets under management fell by 50 

percent, from $254 billion to $135 billion2

, dramatically shrinking an important market for 

municipal debt. At the same time, municipalities issuing variable rate demand bonds saw their 

borrowing costs nearly double the Federal Reserve's rate increases over the same period. Many 

state and local governments determined that issuing variable rate debt to MMFs was 

excessively costly, and opted to issue higher cost fixed-rate bonds. These increased costs are 

shouldered by taxpayers and ratepayers. 

In addition to the impact that the SEC's 2014 actions had on governments accessing the capital 

markets, there are also implications for the investments that state and local governments use 

to protect public funds. Many governments have specific state or local statutes and policies 

that require them to invest in financial products with a stable NAV. The policy reason for this is 

to ensure that public funds are appropriately safeguarded. MMFs with a stable NAV are a 

commonly used vehicle by state and local governments for managing operating cash. This 

important legislation would lift an unnecessary obstacle that has steered state and local entities 

into very low yielding U.S. government backed funds or other alternatives from what was 

already a safe and highly liquid market. 

By allowing all MMFs- prime, tax-exempt and government funds accessible to both retail and 

institutional investors- to offer a stable NAV, H.R. 2319 would allow state and local 

governments to once again utilize suitable investments defined by state and local elected 

officials, rather than by the SEC. 

GFOA is working with a coalition of stakeholders to advance H.R. 2319 and we have submitted 

our most recent letter of support for the record. Thank you again for considering this 

important legislation. We look forward to working with you and supporting your efforts to help 

state and local governments on this and other regulatory and financial matters of mutual 

interest. 

2 See: https://www.federalreserve.gov/releases/efa/exempt-monq-market-funds-invr~ment-holdivzsl!!l!! Money 

Market Mutual Funds: Investment Holdings Detail, Figure 4 
69 


nshattuck on FSR297 with DISTILLERInsert offset folio 36 here 30773.036

Statement of the U.S. Chamber of Commerce 

ON: Legislative Proposals to Improve Small Businesses' 

and Communities' Access to Capital 

TO: House Committee on Financial Services, 

Subcommittee on Capital Markets, Securities and 

Investment 

BY: Thomas Quaadman, Executive Vice President, Center 

for Capital Markets Competitiveness, U.S. Chamber of 

Commerce 

DATE: November 3, 2017 

1615 H Street NW I Washington, DC I 20062 

The Chamber's mission is to advance human progress through an economic, political and social system 

based on individual freedom, incentive, 1nitiative, opportunity and responsibility. 
70 


nshattuck on FSR297 with DISTILLERInsert offset folio 37 here 30773.037

The U.S. Chamber of Commerce is the world's largest business federation, 

representing the interests of more than 3 million businesses of all sizes, sectors, and 

regions, as well as state and local chambers and industry associations. The Chamber is 

dedicated to promoting, protecting, and defending America's free enterprise system. 

:\fore than 96% of Chamber member companies have fewer than 100 employees, and 

many of the nation's largest companies are also activ-e members. \Ve are therefore 

cognizant not only of the challenges facing smaller businesses, but also those facing 

the business community at large. 

Besides representing a cross-section of the American business conmmnity ''~th 

respect to the number of employees, major classifications of ,\merican business--cg., 

manufacturing, retailing, services, construction, wholesalers, and finance-arc 

represented. The Chamber has membership in all 50 states. 

The Chamber's international reach is substantial as welL We believe that global 

interdependence provides opportunities, not threats. [n addition to the American 

Chambers of Commerce abroad, an increasing number of our members engage in the 

export and import of both goods and services and hav-e ongoing iln·estmcnt activities. 

The Chamber favors strengthened international competitiveness and opposes arrificial 

U.S. and foreign barriers to international business. 

2 
71 


nshattuck on FSR297 with DISTILLERInsert offset folio 38 here 30773.038

Chairman Huizenga, Ranking Member 1\!aloney and members of the 

Subcommittee on Capital Markets, Securities, and Investment: My name is Tom 

Quaadman, executive vice president of the Center for Capital J\hrkets 

Competitiveness ("C:Cl\1C") at the U.S. Chamber of Commerce ("Chamber"). 

The Chamber commends the continued work of both this subcommittee and 

the full Financial Services Committee to modernize our nation's securities laws and 

create opportunities for American households, businesses and investors. Over the 

last seven years, the Financial Services Committee has advanced dozens of pieces of 

bipartisan legislation, many of which have been enacted into law. Most notably, the 

Jumps tart our Business Startups ("JOBS") Act, si1,>ned by President Obama in April 

2012, has successfully helped a number of business go public in addition to creating 

more ways for businesses to raise capital through private channels. 

The 2008 financial crisis and the ad-hoc legislative and regulatory response that 

followed the crisis made clear that the financial regulatory system in the United States 

is badly out of date and in need of serious reform. Elements of our regulatory 

framework date as far back as the Civil War, and many agencies that were created in 

response to a particular historical event have struggled to meet the modem needs of 

an economy as dynamic as the United States. lt is little wonder that instead of a 

strong rebound to the 2008~2009 financial crisis-which typically occurs after a severe 

financial downturn-our economy has meandered along between one and two percent 

growth over the last decade. 

The time to pursue pro~growth policies is now. The historically weak recovery 

has left millions behind in our economy, exacerbated our national deficits and debt, 

and resulted in an alanningly low number of business startups as compared to 

previous recoveries. \Vhile fundamental tax reform remains the Chamber's top 

priority to spur c,>rowth and opportunity, we believe that Conc,>ress and regulatory 

agencies should pull every lever possible to modernize our regulatory systems for the 

21" Century. 

To put our economic potential into perspective, if the economy moved from 

2% to 3% annual growth, that would mean doubling gross domestic product (GDP) 

per capita 12 years faster (23 years vs. 35 years); it would also reduce our annual deficit 

by over $3 trillion over the next decade. If our economy went from 2.5% growth to 

3% growth, average annual incomes would rise by $4,200 and 1.2 million jobs would 

be created over the next decade. That is tl1e top-level perspective, but underlying 

these macro statistics is the opportunity for millions of Americans to create a better 

life for themselves and their families. 

3 
72 


nshattuck on FSR297 with DISTILLERInsert offset folio 39 here 30773.039

It is also worth noting that not only has the post-crisis recovery been 

historically weak, it also been remarkably uneven from a geographic standpoint. An 

illuminating 2016 report from the Economic Innovation Group showed that while 

certain pockets of the country have rebounded economically, others continue to 

struggle. For example, 50'Yo of the net national businesses created from 2010-2014 arc 

located across only twenty counties in the United States, despite these counties only 

representing 17% of the U.S. population. Moreover, nearly three in five counties saw 

more businesses close than open from 2010 to 2014. The overall level of business 

creation is well below pre,·ious recovery levels: while the rebound from the recession 

of 2001-2002 saw 400,500 businesses created, the post-crisis number has only been 

166,5001 

The Chamber believes that it is by no means a coincidence that these anemic 

economic numbers have coincided with a massive expansion of the regulatory state, 

particularly in the wake of the 2008 crisis. Modernization of our financial regulatory 

structure is sorely needed, and we appreciate this opportunity to have the voice of the 

Chamber's members heard in this important debate. 

1. Modernizing our Financial Regulatory Structure 

In September 2016, the Chamber released a reform plan entitled D£J.J!6~~"" 

""-'=O!.!...!~<;U.C"-"-L"--""'-"'-"-'""'-'="-"5.L""""'-""""~'-'-'~~ (Re.rtarti1(g the Growth 

which has over 100 recommendations for creating a regulatory system that 

stability and growth. The Chamber was pleased to sec that the Financial 

Cl IOICE Act approved by the Financial Services Committee during tl1e 114'h 

Congress included a number of the recommendations in the Restarting the Growth 

Engine Plan, including but not limited to: 

• Structural and managerial reforms to the Securities and Exchange Commission 

(SEC), as well as streamlining SEC enforcement authorities to ensure fair 

treatJncnt and due process during the course of investigations. 

• Congressional oversight of the regulatory policy functions for all financial 

regulators through the appropriations process. 

• Reco~omition that several pro,·isions of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act, including addressing arbitrary thresholds for 

regional and mid-size banks, capiml, liquidity, and other requirements, are 

l "The New ~lap of Economic Growth and Rcco-w~ry" Economic Innovation Group, !\fay 2016 

4 
73 


nshattuck on FSR297 with DISTILLERInsert offset folio 40 here 30773.040

creating a severe drag on the economy and damaging the health of the capital 

markets. 

• Structural and authority modifications to the Financial Stability Oversight 

Council (FSOC), as well as greater transparency requirements for U.S. 

participants in Financial Stability Board (FSB) decisions and actions, as well as 

the actions of other international standard setters and regulators that report to 

the FSB. 

• Repeal of the V olcker Rule, as it has created impediments for non-financial 

businesses to enter the debt and equity markets. The Volcker Rule has placed 

market participants operating in the U.S. at a global competitive disadvantage. 

• Incorpo•·ation of several bills that passed this Conunittee or the full House of 

Representatives during the 114'" Congress. These bills would help foster 

capital formation by expanding opportunities for investors and ensuring that 

regulators focus on the need of small and growing businesses. 

The Chamber has been especially supportive of Title X of the CI IC)ICE Act, 

which would modernize securities regulation in a manner similar to the JOBS Act. 

We would also note that there were several recommendations in the Restarting the 

Growth Engine Plan that were not included in the previous version of the CHOICE 

Act. 1\s the Financial Services Committee continues its important work during the 

115'" Congress, we look forward to collaborating with you on many of these 

important issues. 

2. Legislative Proposals 

a. Small Business Credit Availability Act (Discussion Draft) 

One of the unfortunate developments in the wake of the financial crisis has 

been the difficulty for small and medium-sized businesses to obtain the capital and 

liquidity they need to grow and serve Main Street I\merica. While large corporations 

often times face their own fiuaucing challenges, the obstacles that smaller firms face 

arc particularly acute. Gi,·cn the slow rate of business creation in the wake of tl1e 

crisis, it is no exaggeration to say that the very survival of thousands of businesses 

depends on the ability of our capital market to serve them. 

In 2016, the Chamber released a report, Finandnr Growth: The lmpatt o[Filtlllhial 

Regulation ("Financing Growth Report") which highlighted the ftnancing ch~llenges 

5 
74 


nshattuck on FSR297 with DISTILLERInsert offset folio 41 here 30773.041

faced by the middle market, and the need for businesses to have access to a variety of 

financing mechanisms. For example, 79°'o of the 300 professionals surveyed in the 

report have seen their business affected by changes in the financial services markets, 

and as a result nearly one~ fifth of respondents had delayed or cancelled planned 

investments. ,\nd 20% of all small and midsize companies said they use four or more 

financial institutions to issuer commercial paper, raise debt, or access trade fmancing. 

Business development companies ("BDCs") arc a critical source of financing 

for small and middle market companies. BDCs offer a unique form of financing with 

certain attributes similar to private equity, venture capital, or hedge funds, but in a 

registered, highly~ regulated and transparent investment vehicle. BDC lending has 

become increasingly popular as the credit cycle and regulatory reaction to the financial 

crisis have made accessing debt financing more challenging. Importantly, BDC:s are 

actually mandated to invest 70% of their assets in small and mcdium~sizcd U.S. 

operating businesses. 

Since their creation in the 1980's BDCs have been highly regulated entities, 

where oversight can occur either at the regnlatory level, or indirectly through the types 

of financing that BDC:s are able to access in order to finance their investments. BDCs 

also tend to provide investors witl1 a higher yield and, because they arc publicly 

registered, are open to non~accredited investors. In fact, there are now 93 BDCs total 

with over SO publicly traded in tl1e United States, affording ample opportunities for 

investors to participate in the growth of middle market companies. 

Investment vehicles such as BDCs are all the more important given the above~ 

referenced geographic unevenness of the economic recovery. \V'hile credit has 

tightened and bnsincss creation has languished in some parts of tl1c country, BDCs 

have made sizeable investments tlmmghout the Rust Belt and other areas that have 

not enjoyed a strong recovery from the 2008 crisis. For example, BDCs have made 

investments of $1.6 billion in Ohio, $1.06 billion in Michigan, and $1.8 billion in 

Tennessee. 2 

The Small Business Credit Availability Act would increase the capital available 

to BDCs and increase their ability to provide small and medium~si%ed businesses with 

the funding they need to grow. For example, the legislation would allow for a modest 

increase in the use of leverage available to BDCs which would ultimately permit them 

to deploy more capital to portfolio companies. Additionally, the legislation would 

allow some BDC:s to be treated as "well~ known seasoned issuers" under the securities 

laws which wonld allow them to issue securities more efficiently, and reduce some of 

1 Small Business lnvesror Alliance BDC ~[oderntzatton _ \genda for the 115'h Congress 

6 
75 


nshattuck on FSR297 with DISTILLERInsert offset folio 42 here 30773.042

the unnecessary cost burdens that are ultimately passed on to portfolio companies or 

investors. 

"\dditionally, we believe that the Small Business Credit 1\vailability Act also 

strikes an appropriate balance by allow~ng BDCs to expand \Vithout compromising 

investor protection. The SEC wonld maintain full o,·ersight of BDCs to ensure that 

transparency, efficiency, and competition remain hallmarks of the market. 

The Chamber strongly supports the Small Business Credit Availability Act and 

urges the Committee to take up the legislation as soon as possible. 

b. Expanding Investment Opportunities Act (Discussion Draft) 

The Chamber also supports the Expanding Investment Opportunities Act, 

which would allow certain qualifying closed-end funds to be eligible for status as a 

well-known seasoned issuer (\'VKS1) and therefore subject to a host of filing and 

proxy requirements that would allow them to operate more efficiently. For example, 

by allowing certain funds to achieve WKSI status, they would be eligible to usc 'short 

form' registxation statements, as well as communications mechanisms with their 

shareholders that they are currently prohibited from using. 

i\t mid-year, closed end funds held over $270 billion in assets,3 providing an 

attractive investment option for investors and serving as an important liquidity 

provider for issuers of secut~ties. But the SEC's rules regarding closed end funds have 

not kept pace \v~th rules gove1;ning securities offerings by other public companies. 

Closed end funds were largely excluded from the SEC's 2005 securities offering 

reform initiati\'e. This asymmetry has created an unnecessary and expensive 

rcgulatoty burden for closed end funds, which must regularly petition the SEC and its 

staff for exemptive relief to permit such funds to engage in capital-raising activities 

that otllCr public companies can do automatically without the need for special relief. 

We believe these additional regulatory hurdles also stifle capital formation in the 

closed end fund indusny. CCMC supports the Expanding Investment Opportunities 

:\ct as a sensible response to this situation. We believe if enacted the bill would place 

closed end funds on even footing with other public companies and stimulate capital 

formation in that sector without harming investors. 

c. Consumer Financial Choice and Capital Markets Protection Act of 

2017 

J https: I /w\V\V.ici.ori~ I research I srars I closedend Ice f q2 17 

7 
76 


nshattuck on FSR297 with DISTILLERInsert offset folio 43 here 30773.043

Main Street businesses rely on a variety of instruments to meet their short tcnn 

financing and liquidity needs, including lines of credit from financial institutions as 

well as the lJ .S. commercial paper market. The nature of many businesses places a 

significant importance on obtaining short term financing-without it, orders may have 

t:o be cancelled, production could ground to a halt, and inventories could mn low or 

become depleted. The importance of vibrant, competitive, and liquid short term 

financing markets for Main Street bu;;inesses cannot be overstated. 

Regrettably, the post-crisis onslaught of dozens of new rules designed to 

strengthen the health of the financial system have in many cases made it more difficult 

for businesses of all sizes to obtain the short-term liquidity and financing that is so 

vital to their long-te11n health. These rules have included the V olckcr Rule, the 

liquidity coverage ratio (LCR), net stable funding ratio (NSFR), as well as a host of 

other Basel capital rules that have made it more difficult for banks and other financial 

service pto\'iders to serve business. Indeed, 76% of respondents to the Chamber's 

Pinancing Growth Report believe that "the regulations on the financial services sector 

will not help their companies' outlook over the next two to three years." 

This is why the Chamber has long called for the financial regulators to conduct 

a study of all major post-crisis regulatory initiatives in order to determine the full 

impact of these rules not just on the health of the banking system, but on the ability 

of nonfinancial companies to obtain credit. Fortunately, we are beginning to see 

recognition on behalf of regulators that tl1cse rules have come at a significant cost. 

The President's executive order earlier this year regarding core principles for 

regulating the U.S. financial system was a welcome start, as was the Office of the 

Comptroller of the Currency (OCC) announcement in J\ugust that it was beginning to 

conduct a review regarding the impact of the Volcker Rule. 

One significant post-crisis regulatory development was adoption by the SEC of 

new rules for money market funds that went into effect on October 14, 2016. 1\long 

w~th corporate treasurers and many other market participants, the Chamber expressed 

significant concerns during the rulemaking process that the new rules would 

significantly impact the ability of corporate treasurers to manage litjuidity and to raise 

cash in the commercial paper market. Specifically, we bclic\'cd that the requirement 

for prime money market funds to float their net asset value ("N, \ V") and have it 

reported to the nearest hundredth of a cent would significantly hamper investments in 

such funds and also make recordkccping much more complicated. Additionally, the 

imposition of liquidity fcc and redemption "gate" provisions in the rules have also 

created significant deterrents for institutional investors to participate in institutional 

prime funds, as these proYisions could limit liquidity during times of market stress and 

create the potential for loss of principaL 

8 
77 


nshattuck on FSR297 with DISTILLERInsert offset folio 44 here 30773.044

;\s the Chamber testified at a hearing of this subcommittee last year, during the 

12 months prior to the October 2016 implementation date, prime fund purchases of 

corporate commercial paper declined sit,mificantly, while a number of institutional 

prime funds have also closed during the same time period. This has created further 

pressure upon corporate treasurers and businesses that have historically relied upon 

the liquidity provided prime institutional money market funds. A recent Treasury 

Strategies report stated that prime money market funding for businesses dropped 

from $460 billion to $88 billion from 2015 to 2017. This has caused a shift to bank 

funding which leads to smaller businesses getting crowded out of bank lending. 

As with any major regulation, the Chamber strongly believes that agencies 

should first identify the problem, limit unintended consequences and address a 

specific issue in a targeted manner. We have advocated for regulators to review 

regulations after a certain period of time to determine if the problem is being 

addressed and to identify and correct unintended consequences. 

We also appreciate legislative efforts such as H.R. 2319, the Consumer 

Financial Choice and Capital Markets Protection Act of 2017, which highlights an 

issue of importance to the funding of businesses. We look forward to working with 

this subcommittee to address these issues. 

Additional Efforts to Spur Capital Formation 

The Chamber believes that the Committee should look at additional ways to 

build upon the success of the JOBS Act and help more companies access the capital 

markets. While the JOBS Act was a positive step forward, in some ways it is not 

reaching its full potential. For example, as the Chamber pointed out in testimony 

earlier this year, the "Regulation;\+" market (created by Title IV of the JOBS Act) 

has not taken off in the manner that Congress envisioned, and many deals still lack 

underwriters. Reg A+ offering compliance has proven to be costly relative to the 

amount of securities allowed under the current exemption. Congress should consider 

increasing the current SSO million threshold in order to inccntivizc more market 

participants to use this valuable exemption. 

Additionally, while the JOBS "\ct did a great deal to case the burdens related to 

the offering of securities, it did relatively little to address secondaty market trading 

issues for small public companies. In order to create a competitive and liquid trading 

environment for these companies, Congress should look at creating the legal 

framework to allow for "venture exchanges," based on legislation from H.R. 4868 in 

the 114'" Congress, the "Main Street Growth Act." We believe that creating venture 

9 
78 


nshattuck on FSR297 with DISTILLERInsert offset folio 45 here 30773.045

exchanges and allowing issuers to choose where they want to list would provide a 

positive alternative to today's market structure that often times fayors large, liguidly 

traded companies over smaller ones. 

Looking Forward 

We appreciate the work of the Capital ,\1arkets, Securities and Investment 

subcormnittee on these important bills and issues. The Chamber is prepared to work 

with the subcommittee on a bi-partisan basis to achie,·c the reforms necessary to help 

American businesses and their customers. 

10 
79 


nshattuck on FSR297 with DISTILLERInsert offset folio 46 here 30773.046

I

,.... IINVESTMFNT f , COMPANY 

~ 1//;rcJI/# INSTITUTL" 

STATEMENT 

OF 

PAUL SCHOTT STEVENS 

PRESIDENT & CEO 

INVESTMENT COMPANY INSTITUTE 

BEFORE THE 

US HOUSE OF REPRESENTATIVES 

COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES AND INVESTMENT 

ON 

LEGISLATIVE l'ROl'OSALS TO IMPROVE SMALL BUSINESSES' AND COMMUNITIES' 

ACCESS TO CAPITAL 

NOVEMBER 3, 2017 
80 


nshattuck on FSR297 with DISTILLERInsert offset folio 47 here 30773.047

EXECUTIVE SUMMARY 

Closed-End Fund Legislation 

• I Cl fully supports Representative Hollingsworth's discussion draft of the "Expanding 

Investment Opportunities Act," The legislation would m?dernize the offering and 

proxy rules for closed-end funds, enabling them to utilize already existing offering and 

communications rules that traditional operating companies have relied on since 2005. 

• By simplifying the closed-end fund offering process and liberalizing existing restrictions 

on communications, the legislation would reduce unnecessary regulatory burdens that 

raise costs for investors. In turn, this would enhance the ability of closed-end funds to 

act as a source of financing in the economy. 

• Specifically, the legislation would require the Securities and Exchange Commission 

("SEC") to amend its rules within one calendar year to provide several technical. but 

tangible, benefits to closed-end funds and their shareholders: 

o Closed-end funds that meet the criteria of a "well-known seasoned issuer" 

(having at least $700 million common equity outstanding and having timely 

made required filings for the preceding 12 calendar months) could register and 

offer additional shares more quickly through the "automatic shelf registration" 

process to take advantage of current market conditions, 

o Closed-end funds that meet the criteria of a "seasoned issuer" (having at least 

$75 million in common equity outstanding and having timely made required 

filings for the preceding 12 calendar months) could incorporate information 

from subsequent filings into their registration statements automatically. 

o Closed-end funds that meet the conditions of several existing safe harbors could 

rely on those safe harbors to communicate with investors and potential 

investors more freely during a registered offering. 

o Closed-end funds and, ultimately, their shareholders could save on the costs of 

prospectus delivery under certain conditions. 
81 


nshattuck on FSR297 with DISTILLERInsert offset folio 48 here 30773.048

Business Development Company Legislation 

Congress created business development companies ("BDCs") as a specialized type of 

closed-end fund whose principal activities consist of investing in, and offering to 

provide "significant managerial assistance" to, small, growing, or financially troubled 

operating companies. BDCs are regulated under the Investment Company Act of 1940, 

but Congress provided BDCs with greater operating flexibility than other closed-end 

funds or mutua! funds. 

• Congress already has granted BDCs more flexibility to utilize leverage than other 

registered investment companies. Consistent with that approach, the BDC legislative 

proposal would lower the asset coverage requirement for senior securities, i.e., debt and 

preferred stock, to 150 percent from 200 percent. We do not object to this change. 

• I C I supports the proposed offering and communications reforms for BDCs for the 

same ,·easons ICI supports the proposed offering and communications reforms for 

closed-end funds. 

Money Market Fund Legislation 

• The Securities and Exchange Commission has modernized and strengthened tile 

regulatory requirements for money market funds from time to time as circumstances 

have warranted-most recently in 2010 and 2014 in response to the 2008 financial 

crisis. 

• The 2010 and 2014 SEC reforms add layers of transparency and redundant safeguards 

that more than adequately address any risks that may have existed in 2008. 

The Consumer Financial Choice and Capital Markets Protection Act of 2017 ("H.R. 

2319") would rescind many of the 2014 reforms including the requirement that prime 

institutional and tax-exempt institutional money market funds float t~1eir NAVs. 

Although some I Cl members have expressed strong interest and support for the bill, 

ott1er members believe that a third round of regulatory crlilnges to money market funds 

is neither appropriate nor desirable. 

As a result of these strongly cJiffering member views regarding H.R 2319, ICI takes no 

position on the proposed legislation. 
82 


nshattuck on FSR297 with DISTILLERInsert offset folio 49 here 30773.049

Statement of Paul Schott Stevens 

I. Introduction 

My name is Paul Schott Stevens. I am President and CEO of the Investment Company Institute 

("ICI"), the leading association representing regulated funds globally, including mutual funds, 

exchange-traded funds, closed-end funds, and nnit investment trusts in rlle United States ("registered 

limds"), and similar funds offered ro investors in jurisdictions worldwide. ICI seeks to encourage 

adherence to high ethical standards, promote public understanding, and otherwise advance the interests 

of funds, their shareholders, directors, and advisers. ICI' s members manage total assets ofUS$20.9 

trillion in the United States, serving more than 100 million US shareholders, and US$6.6 trillion in 

assets in other_Jurisdictions. Thank you, Chairman Huizenga, Ranking Member Maloney, and 

members of rhe Subcommittee for inviting me to testifY on "Legislative Proposals to Improve Small 

Businesses' and Communities' Access ro Capital." 

In addition to serving as the vehicles through which more than 100 million Americans save for 

retirement or pursue other important financial goals, registered funds play an important role in the US 

economy. They cllannel capital from fund investors to the markets which, in turn, stimulates economic 

growth and JOb creation. The in.Jection of capital through fund investments benefits underlying 

businesses that rely on the markets as an important source of financing. The underlying businesses 

utiliLe the capital to hire employees. fund their enterprises, and develop new technologies, sparking 

continued innovation and growth. 

My testimony focuses on Mr. Hollingsworth's discussion drafi: of the "Expanding Investment 

Opportunities Act," legislation that would modernize rlle offering and proxy rules for one type of 

registereci fund-closed-end funds ("Discussion Draft"). Notwithstanding tbe benefits these funds 

provide to investors and the capital markets, the last several years have seen a steady decline in the 

number of closed-end funds and new closed-end fund offerings. By simplifying the closed-end fund 

offering process and liberali?ing existing restrictions on communications with investors before and 

during an offering, the legislation would reduce unnecessary regulatory burdens that raise costs for 

investors. These changes, which would conform closed-end fund offering rules to those for traditional 

operating companies, could encourage new closed-end fund offerings and lead to a concomitant 

increase in the long-term capital these funds supply to companies in which they invest. For these 

reasons, I C I strongly supports this lcgislatron. 

In the sections that follow, I first provide background information on closed-end funds and their 

comprehensive regulatory framework (Section II). I then describe how the Discussion Draft would 

change the current requirements for closed-end fund offerings and communications, and explain the 

benefits of these changes for closed-end funds and their shareholders and, by extension, capital 

formation (Section Ill). I conclude with brief comments on pending legislative proposals concerning 

business development companies and money market funds (Section IV). 

-1 
83 


nshattuck on FSR297 with DISTILLERInsert offset folio 50 here 30773.050

II. Background on Registered Closed-End Funds 

To provide context for ICI's views, it is important to understand what closed-end funds are and how 

they are regulated. 

A closed-end fund, like ot11er types of investment companies, is a pooled investment vehicle that is 

professionally managed in accordance with the fund's investment objectives and policies. Generally, a 

closed-end fund is created by issuing a fixed number of common shares to investors during an initial 

pub I ic offering. Subsequent issuances of common shares can occur through secondary or follow-on 

offerings. A closed-end fund may raise additional capital by issuing debt securities and one class of 

preferred stock in addition to common shares. The holders of the common stock experience a gain or 

loss depending on whether the fund earns a rate of return on its assets that is higher or lower than the 

amounts that it pays to the holders of its debt securities and preferred stock. 

After a fund's initial public offering, investors generally buy and sell shares of a closed-end fund in the 

open market (typically on a securities exchange such as the New York Stock Exchange), rather than 

directly from or to the fund. Some closed-end funds, however, may adopt share repurchase programs or 

periodically make tender offers for shares. The market price of a closed-end fund share fluctuates like 

that of other pul11 icly traded securities and is determined by supply and demand in the marketplace. In 

contrast to a mutual fund, which must stand ready to meet shareholder redemptions on a daily basis 

and therefore must invest mostly in liquid assets, a closed-end fund has the flexibility to invest a 

significant percentage of its assets in less liquid securities. For example, a closed-end fund may invest in 

securities issued by small private companies and long-term tax-free investments. 

The flexibility that closed-end funds have to invest in these types of assets and to issue debt securities 

and preferred stock allows closed-end funds to: 

• provide enhanced income and cas~1 flow (through investments in longer term or less 

liquid higher yielding assets); 

• maximize after~ tax efficiency (through investments in certain tax··free investn1ents); 

and 

• broaden diversification (through investments in specialized asset classes). 

Registered closed-end funds are comprehensively regulated under the federal securities laws and related 

Securities and Exd1ange Commission ("SEC") regulations, which serve to protect the interests of fund 

investors. Closed-end funds, like publicly traded operating companies, are subject to the Securities Act 

of 1933 ("1933 Act"), whicl1 governs the way public offerings are conducted. Closed-end funds file 

registration statements with the SEC on Form N-2 to register the offering of their securities under the 

1933 Act and to register as investment companies under the Investment Company Act of 1940 

2 
84 


nshattuck on FSR297 with DISTILLERInsert offset folio 51 here 30773.051

("Investment Company Acr"). The Form N-2 contains three parts, including a prospectus, which 

includes required disclosures about the fund. 

In addition, closed-end funds are subject to regulation under the Securities Exchange Act of 1934 

("Exchange Act"). Like most publicly traded operating companies, closed-end funds file annual and 

semi-annual reports as well as quarterly reports. 1 Each of these periodic reports includes certifications 

from the principal executive officer and the principal financial officer. Like operating companies, 

closed-end funds also are subject to the proxy and tender offer provisions of the Exchange Act. 

In contrast to publicly traded operating companies, closed-end funds are subject to further substantive 

regulation under the Investment Company Act. The Investment Company Act restricts, among other 

things, a closed-end fund's abiliry to use leverage, offer new shares below net asset value, engage in 

affiliated transactions, and imposes strict requirements on the custody, diversification (for a diversified 

closed-end fund) and transparency of fund assets. The Investment Company Act also requires a 

registered closed-end fund to have a board of directors with a specified proportion of directors that are 

independent of the fund's manager.2 1n addition, it requires registered closed-end funds to have a chief 

compliance officer who oversees the day-to-day operations of the fund under a board-approved fund 

compliance program and policies. 

With their ability to provide enhanced income and cash flow, closed-end funds serve as an important 

retirement savings and investment vehicle for retail investors. As of June 2017, there were 533 closed· 

end funds with total assets of $271 billion. We estimate that approximately 3 million retail investors 

rely on closed-end funds to help meet their investment needs. 

Ill. Importance of the Closed-End Fund Discussion Draft 

Despite their numerous benefits, the number of closed-end funds has declined steadily over the last 

several years. Since 2007, the number of closed-end funds has dropped 19 percent (from 662 funds at 

year-end 2007 to 533 funds in June 2017). In addition, the number of new closed-end fund offerings 

has dropped. In 2007, there were 42 new closed-end fund issuances; in 2016, tt1ere were only eight3 

That is an 81 percent decline. 

The Discussion Draft would help reverse these trends by reducing tile burdens of certain requirements 

under current SEC registration and communications regulations that apply to closed-end funds. 

Existing requirements impose substantial costs on closed-end funds and their shareholders without 

commensurate investor protection benefits. Closed-end funds offer and sell their shares in the same 

1 Closed~end funds fl!e annual and semi-annual shareholder reports on Form N-CSR and f1lc quarterly reports on Form 

N-Q. Operating companies make periodic fllmgs on Form 10-K and Form 10-Q. 

21n practice, most boards have 75 percent or more independent members. 

3 ThiS >S based on the last full year of data. 5eeAntoniewicz, Rochelle. andJulicth Saenz. 2016. "The Closed-End Fund 

Marker, 2016" ICI Research Perspective 2:\, no. 2 (April) at Figure 7. 

3 
85 


nshattuck on FSR297 with DISTILLERInsert offset folio 52 here 30773.052

manner as securities issued by traditional operating companies, yet their offer and sale arc subject to 

additional requirements. The Discussion Draft would cure this unjustified regulatory disparity by 

applying the same rules to closed-end funds and operating companies. To take advantage of the 

additional flexibility provided by the rules, a closed-end fund would have to meet the same conditions 

of the rule that operating companies must meet. Those requirements would apply in addition to the 

extensive investor protection provisions of the Investment Company Act and other federal securities 

laws. 

In 2013, when former SEC Chair Mary Jo White evaluated legislative proposals nearly identical to the 

Discussion Draft that would put business development companies, one form of closed-end fund, on par 

with other operating companies for bod1 offerings and communications, she noted that "[i]n my view, 

these provisions do not raise significant investor protection concerns."' We wholeheartedly agree that 

these offering and communications reforms do not raise significant investor protection concerns. We 

therefore believe that now is the time for Congress to act to modernize the regulatory framework for 

closed-end fund offerings and communications. 

The Discussion Draft addresses the current, unsatisfactory situation. It directs the SEC, within one year 

of the legislation's enactmem, ro amend certain ruJes and registration forms to permit dosed-end funds 

to operate under the streamlined registration process-and additional flexibility around public 

communications-that operating companies have been able to take advantage of for more than a 

decade. The cost savings associated with these changes would be passed on to fund shareholders, making 

these important investment vehicles more attractive than they are today. 

The section of my testimony below begins with a description of the closed-end fund registration process 

and how the Discussion Draft would simplify it. It then describes how closed-end funds currently 

communicate with the public about their offerings and how the Discussion Draft would encourage 

them to provide even more information. Finally, it concludes with a brief discussion responding to 

potential concerns that. the Discussion Draft raises. 

A. Current Registration Process for Closed-End Funds 

As mentioned above, a closed-end fund generally is created by issuing a fixed number of common shares 

to investors during an initial public offering. Depending on market conditions, a registered closed-end 

rund after its initial public offering might determine that it is an opportune lime to invest more assets 

into the market. In these circumstances, certain closed~end funds can utilize a streamlined process 

known as "shelf registration," which involves filing a" shelf registration statement" wirh the SEC to 

register and publicly offer additional securities to raise additional capital for investment5 

4 See Letter from Mary Jo White, Chair, Securities and Exchange Commission, to The Honorable Jeb l·lensarling, 

Chairman, financial Services Committee, US House of Representatives, dated October 21, 2013 (providing the Chair's 

v1ews on substantially !dentJca! busmcss development company !cgJslatJon). 

5 Ru!e 41 b under the 1933 Act permits issuers to utilize shelf regJstratJon stah~ments. Although Rule 415 docs not expressly 

extend to closed-end funds because the Rule only applies to rorm S-3 and not Form N~2, two SEC staff no-action letters 

-4 
86 


nshattuck on FSR297 with DISTILLERInsert offset folio 53 here 30773.053

To use a shelf registration statement, the closcd-cncj fund must meet the criteria of a "seasoned issuer," 

which essentially requires that the closed-end fund have at least $75 million in common equity 

outstanding and have made timely periodic filings with the SEC for the preceding 12 calendar months. 

Assuming the fund meets such criteria, the closed-end fund can offer additional shares to the public by 

filing a new shelf registration statement on Form N-2 to register the shares. Once the SEC staff declares 

the registration statement effective, the closed-end fund then can sell shares from the shelf registration 

statement as market conditions dictate for a period of up to three years. During this three-year period, 

the closed-end fund must make additional post-effective amendment filings to the shelf registration 

statement to include updated financial statements, to the extent necessary so that the incorporated 

financial statements are never more than 16 months old 6 

This offering process has its drawbacks. First, the closed-end fund must wait for the SEC staff to declare 

the shelf registration statement effective before the fund can sell any additional shares. It can take 

several months for H1e SEC staff to provide comments, if any, on the registration statement, for the 

closed-end fund to r-espond to them, and for theSE C staff to declare the registration statement 

effective. The time this entire process takes can affect the timing and success of an offering. 

Second, the process of filing a post-effective amendment to the shelf registration statement to 

incorporate a fund's updated financial statements into the registration statement could cause issues if 

the SEC staff review is not completed and the post-effective amendment is not declared effective by the 

time the financial statements become "stale" (i.e., are more than 16 months old) 7 

Many traditional operating companies do not face these issues. In 2005, the SEC adopted rules that 

significantly modernized the registration, communications and offering processes for them. 8 These 

reforms have been extremely successful as evidenced by the many operating companies that rely on 

them. The 2005 SEC Rule permits traditional operating companies that qualify as "well-known 

seasoned issuers," or "WKS!s," to uti lite an automatic shelf registration process. As their name suggests, 

automatic shelf registrations become effective automatically without SEC staff review and comment. 

perm1t closed-end funds meeting required conditions to rely on the rule using Form N-2. See Nuveen Virginia Premium 

Income Municipal Fund (pub. avail. Oct. 6, 2006); P11gnm Amenca Prime Rate Trust (pub. nvail. May 1, 1998). 

6 "'Incorporation by reference" is the act ofincluding an additional document within anorhn document by rdCrcndng the 

additional document. Issuers utilize incorporatiOn by reference to include the substance of prcv1ous and future fll1ngs in a 

registration statement Without attaching those f1l1ngs as part of tt·1e reg1strntion statement 

7 T111S stands in sharp contrast to the treatment afforded to open-end funds and closed-end interval funds. Open-end funds 

may rely on Rule 485 under the 1933 Act. whrch prov1dcs that a post-effective amendment f1ling shall become effeCtive 

immediately if the amendment IS filed solely to update financial statements, among other things. Closed-end Interval funds 

may rely on Rule 486 under the 1933 Act, which provides similar eligibi!Jty for immediate effectiveness. A closed-end 

mtcrval fund is a closed-end fund that. pursuant to Rule 23c-3 under the Investment Company Act, penod1cally offers to 

repurchase shares from its shareholders. 

8 See Securities Offering Reform, SFC Release No. 33-8591 (July 19, 2005), 70 Fed. Reg. 44722 (Aug.:'>, 2005) ("2005 SEC 

Rule"), available 

-5 
87 


nshattuck on FSR297 with DISTILLERInsert offset folio 54 here 30773.054

To qualify as a WKSI, generally an issuer must have at least $700 million in common equity 

outstanding and have timely filed required reports for the preceding 12 calendar months. In addition, 

the issuer within the past three years must not have engaged in conduct, or be subject to a conviction, 

decree, or order, that would make it ineligible9 

The 2005 SEC Rule also permits operating companies that qnalifY as "seasoned issners" (generally, 

issuers that have at least $75 million in common equity outstanding and have timely filed required 

r·eports for the preceding 12 calendar months) to utilize a technique known as "forward incorporation 

by reference." This means that such issuers can incorporate information from future filings into a 

registration statement without having to amend the registration statement to reference the specific 

filing from which the information will be derived. 

The 2005 SEC Rule, however, excluded registered closed-end funds from the reforms. Instead, the SEC 

indicated that the parallel regulatory framework for registered investment companies also should be 

updated. A dozen years later, no similar reforms ever l1ave been proposed. Nor is there any prospect that 

they will be proposed in the future, considering the SEC's crowded rule making agenda. 

Although the frameworks governing operating company filings and closed-end fund filings may be 

separate, as described earlier, in substance they are substantially the same. We strongly support the 

Discussion Draft, because it would allow closed-end funds and their shareholders to benefit from the 

same cost saving reforms that operating companies have enjoyed for more than 12 years, and potentially 

spark additional closed-end fund offerings that would contribute to capital formation. 

8. Reforms to the Registration Process 

The Discussion Draft would address the drawbacks of the current registration process by reforming 

closed-end fund offerings in two respects. First, closed-end funds would be able to utilize "antomatic 

shelf registrations" to offer additional shares if they qualifY as "well-known seasoned issuers," or 

"WKSis." As of December 2016, we estimate that there were 93 closed-end funds that could qualify as 

WKSis. This is approximately 18 percent of all closed-end funds (93/530 total closed-end funds). 

Giving qualifying closed-end funds the ability to use this process would help those funds better evaluate 

and assess the market for their offerings. It would enable them more readily to access the capital markets 

without facing the r·isk of a delay tl1at could suspend or terminate the offering. 

Second, closed-end funds that qnalifY as "seasoned issuers" would be permitted to "forward incorporate 

by reference" information into their registration statements. As of December 2016, we estimate that 

there were 473 closed-end funds that could qualify as seasoned issuers. This is approximately 89 percent 

of all closed-end funds (473/530 total closed-end funds). As a result, closed-end funds would not need 

to file a post-effective amendment simply to amend their existing registration statement to include 

9 An 1ssuer would be ineligible, for example, 1fw1thin the past thre~ years it filed a bankruptcy petition or had an involuntary 

bankruptcy petit1on fried against it, was conv1ctcd of a felony or certC:!Jn rnisclcmcanors, entered mto a judicial or 

governmental decree relatJng to certain violations of law, or was suQject to an SEC stop order . 

. 6-
88 


nshattuck on FSR297 with DISTILLERInsert offset folio 55 here 30773.055

updated financial staternents. Permitting closed-end funds to incorporate by reference in this manner 

would save time and money by eliminating unnecessary filings and associated costs. 

By way of illustration, consider the contrast between the registration pr-ocess for additional shares 

currently applicable to a hypothetical large, seasoned closed-end fund with an active shelf registration 

statement, on the one hand, and that of an operating company of similar size and experience, on the 

other. Assume that bott1 companies have a public equity float of at least $700 million and have made 

timeiy filings witll the SEC for the past year. The fiscal year for both companies ends on December 31. 

Neither company has engaged in conduct within the past three years that would make it ineligible to 

rely on certain rules. 

To use a shelf registration statement for the sale of securities, the audited financial statements therein 

must not be more than 16 months old. Accordingly, for the closed-end fund, the fund's kwyers must 

draft a full registration statement as a post-effective amendment to the shelf registration, file the same, 

await SEC staff comments, and resolve them. This process could entail multiple filings. Then, the SEC 

staff must declare the post-effective amendment effective, and do so before the 16-month period expires 

in order for the fund to be able to sell securities registered on the shelf without interruption. This 

process entai Is not only substantial delays, but also legal and audit fees. The fund's attorneys, for 

example, may charge fees for preparing each post-effective amendment and responding to SEC staff 

comments. Each time the audited financial statements near the end of their 16-month lifespan, the 

closed-end fund repeats the process. 

In contrast, an operating company does not have to file a post-effective amendment to its registration 

statement because it simply files its annual report with the SEC. as the law requires, and the financial 

statements therein are automatically incorporated by reference in the shelf registration statement. 

There are no additional legal or audit fees associated with a filing, and there is no additional time that is 

spent for the review process. 

Set forth in Appendix A is a more detailed, tectmical explanation oftl1e registration process 

amendments the Discussion Draft would require the SEC to make to current rules under the 1933 Act, 

the proxy rules, Regulation FD, and Form N-2 under the Investment Company Act. 

C. Current Communications Process for Closed-End Funds 

The federal securities laws regulate public securities offerings and impose certain requirements upon the 

"offer" of a security. The term "offer" is interpreted broadly and covers several types of communications 

regarding the security. There are very specific requirements as to what information can be 

communicated prior to the filing of a registration statement, during the period between the filing of the 

registration statement and its effective date, and after its effective date. Generally, when a security is 

pub! icly offered, the issuer of the security must provide required disclosures about the security to 

investors in the form of a full or "srarutory" prospectus. Given the broad interpretation of the term 

"offer," the federal securities laws provide several exceptions to the statutory prospectus requirements 

when the issuer or others make public communications about the security. Many of these exceptions 

-7-
89 


nshattuck on FSR297 with DISTILLERInsert offset folio 56 here 30773.056

take the form of" safe harbors" under which a company, upon meeting certain conditions, can provide 

information without having to deliver a statutory prospectus, 

A closed-end fund primarily relies on Rule 482 under the 1933 Act to provide a broad range of 

communications without having to deliver the statutory prospectus. Rule 482 docs not impose any 

limits on the types of information that may be included in the communication but, in certain instances, 

does require specific legends and, when performance advertising is included, does require certain 

disclosures. A closed-end fund may rely on Rule 482 only after it files a registration statement and must 

file all Rule 482 communications with the SEC or F I NRA For purposes of the federal securities laws, a 

Rule 482 communication is a prospectus, but it is deemed to be an "omitting" prospectus because it 

does not include all information a statutory prospectus must contain. 

Absent a safe harbor or similar exception, Section 5(b) (2) of the 1933 Act requires a closed-end fund 

that sells its securities during an offering to provide a purchasing investor with its statutory prospectus. 

D. Reforms to the Communications Process 

The Discussion Draft would provide a closed-end fund with greater flexibility regarding its public 

communications. By making available to closed-end funds these additional safe harbors that operating 

companies have relied on for years, the legislation could reduce the number of Rule 482 filings a closedend fund is required to make (and the attendant costs), reduce liability risk, and facilitate the issuance 

of communications during the period prior to filing a registration statement. The safe harbors aiso 

would provide legal protections to broker-dealers when issuing research reports on the closed-end fund. 

Finally, the safe harbors would allow a closed-end fund and ultimately, its shareholders, to save on the 

costs of prospectus delivery under certain conditions. 

Together these reforms would facilitate greater availability of information to investors and the market 

and eliminate barriers to communications that have been made increasingly outmoded by technological 

advances. Providing investors and the market with rnore information could make closed-end fund 

offerings more attractive and spur additional investments. Eliminating these barriers also could reduce 

expenses for closed-end funds and their shareholders, again spurring additional interest. 

A rnore dctaileti description of the communications safe harbors under the 1933 Act that would 

become available to closed-end funds under the Discussion Draft is included in Appendix B. 

E. Response to Potential Concerns 

As noted above, former SEC Chair White weighed in on earlier legislative proposals nearly identical to 

the Discussion Draft (but pertaining to business development companies). She concluded that the 

provisions" do not raise significant investor protection concerns." Nonetheless, we understand that 

possible concerns have been raised regarding the Discussion Draft. Closer examination indicates that 

none is well placed. 

-8-
90 


nshattuck on FSR297 with DISTILLERInsert offset folio 57 here 30773.057

The first concern is that closed-end funds that utilize automatic st1elf registrations could register new 

offerings without a full SEC staff review. While this is true, similar treatment for operating companies 

appears to have worked well for over a decade. Moreover, all closed-end funds that would utilize these 

provisions already will have filed a registration statement that the SEC staff has reviewed and declared 

effective. Under the Investment Company Act, any change to an investment policy that a fund has 

designated as fundamental would require shareholder approval, so the fund could not unilaterally 

cl1ange such policies. In addition, the Sarbanes-Oxley Act of 2002 requires the SEC staff to review each 

reporting company at least once every three years, though the SEC staff review a significant number of 

companies more frequently. The SEC staff routinely comments on previously made filings and, at 

times, r·equires registrants to amend their filings in response to such reviews. Tt1e SEC staff also can 

issue stop orders to halt any ongoing offering. Finally, closed-end funds--like all other issuerscontinue to be subject to the antifraud provisions of the securities laws. The SEC can bring actions 

against issuers for any false or misleading statements or omissions in the registration statement. 

We understand that the question of SEC staff review may relate more specifically to closed-end funds 

that are not traded on a public exchange and invest in very specialized, less liquid assets (e.g., funds of 

hedge funds). 10 In this regard, the SEC staff already has implemented its own set of restrictions, 

requiring that registered closed-end funds that are funds of hedge funds only sell their shares to 

"accredited investors" and in minimum initial amounts of no less than $25,000. Accredited investors 

are investors who earned income that exceeded $200,000 (or $300,000 with a spouse) in each of the 

prior two years and reasonably expect the same for the current year or have a net worth of over $1 

million either with or without a spouse (excluding the value of the person's primary residence). 

According to the SEC, the category of "accredited investor" is "intended ro encompass those persons 

whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for 

themselves render the protections of the [ 1933 Act's] registration process unnecessary."" Nothing in 

the Discussion Draft would change the SEC staff-imposed accredited investor requirement (or 

minimum initial investment), and we believe that, under these circumstances, those investors do not 

need the protections of a further SEC staff review. Moreover, as discussed above, to be eligible to utilize 

an automatic shelf registration, any non-exchange-traded closed .. end fund would need to meet the 

WKSI qualifications." 

The second concern involves whether the one-year period that the Discussion Draft affords the SEC to 

amend the rules is a sufficient timeframe in which to propose and adopt changes. If new rules are not 

adopted within that period, then a closed-end fund shall be entitled to treat the changes as having been 

completed. We understand that one year is a tight rulemaking timeframe, but believe that such a 

~° Closed-end interval funds typically arc not cxct1ange traded, but they do not appear to be the su!?Ject of concern. These 

funds operate pursuant to Rule 23c-3 under the Investment Company Act. 

11 See Regulation D Revisions; Exemption for Certain Employee Benefit Plans, SEC Release No. 33-6683 (Jan. 16, 1987), ~2 

Fed. Reg. 3015. 

12 With respect to any other type of non·exchange·traded c!osed·cnd fund (other than an mtcrva\ fund or a fund of hedge 

funds), we hove not 1dcntif11;d any such fund that would meet ttle WKSI qualifications 
91 


nshattuck on FSR297 with DISTILLERInsert offset folio 58 here 30773.058

requirement is necessary and appropriate in the circumstances. When it adopted the 2005 SEC Rule, 

the SEC expressed the view that, because closed-end funds and other registered investment companies 

are subject to a separate framework governing communications with investors, "it would be more 

appropriate to consider investment company issues in the context of a broader reconsideration of this 

separate framework." 13 Since the 2005 SEC Rule was adopted, the SEC has had more than 12 years to 

consider a parallel framework for closed-end funds, but has not done so. We appreciate that the SEC 

constantly must determine how to allocate its limited resources among numerous competing (and 

changing) priorities. This unavoidable reality may well explain why the SEC has not yet returned to this 

matter. But it also suggests the odds are that the agency never will do so-absent direction from 

Congress and a time limit such as that prescribed in the Discussion Draft. It is for this reason tl1at we 

support Congressional direction in this ar·ea. 

IV. Proposals on Business Development Companies and Money Market Funds 

A. Business Development Companies 

Congress created BDCs as a specialized type of closed-end fund whose principal activities consist of 

investing in, and providing "significant managerial assistance" to, small, growing, or financially troubled 

domestic businesses. As originally conceived, Congress intended for BDCs to be publicly offered 

venture capital funds and to stimulate small business growth through their capital investments and 

"significant managerial assistance." BDCs l1ave grown in popularity since their creation in 1980 and 

through their growth have provided needed financing and support to small and mid-sized businesses, 

which can use this financing to fund job creation and new capital prqjects that boost economic growth. 

Like other closed-end funds, BDCs are subject to substantial regulation under the federal securities 

laws. The primary regulations, under the Investment Company Act, require BDCs to provide 

"significant managerial assistance," which involves providing guidance and counsel about the 

management, operations, or business objectives and policies of their portfolio companies or exercising a 

controlling influence over the management of policies of portfolio companies-" Congress did not 

intend BDCs to be passive investment vehicles like mutual funds. The Investment Company Act 

accordingly requires a BDC to invest at least 70 percent of its portfolio assets in cash (or high quality, 

short-term debt securities), securities issued by financially troubled businesses, or certain securities 

issued by "eligible portfolio comp;mies" (generally, small private companies). 

Given their specialized investment focus, Congress provided BDCs with greater operating flexibility 

than other closed-end funds or mutual funds. BDCs are subject to portions of the Investment 

Company Act and are not required to register as investment companies. The Investment Company Act 

does, however, impose the same restrictions on their custody of assets as other investment companies 

2005 SEC Rule, supw note 8, 70 Fed, Reg. at 44735. 

14 ln addlt!On, BOCs arc suQjcct to the reporting requirements under the F xchange Act and therefore must fife annua! and 

quarterly reporting requirements. 

-10-
92 


nshattuck on FSR297 with DISTILLERInsert offset folio 59 here 30773.059

and imposes different but significant restrictions on a BDC's transactions with affiliates, among ott1er 

things. The Investment Company Act also requires that a majority of rhe BDCs directors or general 

partners be independent of the BDCs manager. Congress did, however, permit BDCs to incur greater 

leverage than other types of investment companies. 11 

Congress already has granted BDCs more flexibility to utilize lever·age than other registered investment 

companies. Consistent with that approach, the BDC legislative proposal would lower the asset 

coverage requirement for senior securities, i.e., debt and preferred stock, to 150 percent from 200 

percent. We do not ObJect to this change. 

The BDC legislative proposal also includes provisions that would enable business development 

companies to rely on the same offering and communications reforms that we support for closed-end 

funds. Because business development companies are one form of closed-end fund that would be 

required to meet identical criteria or conditions of the reforms before utilizing them, we support the 

proposal for the same reasons we support the proposal for closed-end funds generally. 

B. Money Market Funds 

Since the early 1970s, money market funds have been a steady, predictable mainstay of finance. Today, 

over 54 million retail investors, as we!! as corporations, municipalities, and other institutional investors, 

entrust some $2.7 trillion to money market funds as low-cost, efficient cash management tools that 

provide a high degree of liquidity, stability of principal value, and a market-based yield. Money market 

funds also serve as an important source of direct financing for state and local governments, businesses, 

and financial institutions, and of indirect financing for households. Without these funds, financing for 

all of these institutions and indrviduals would be more expensive and less efficient. 

Money market funds owe their success, in large part, to the stringent regulatory requirements to which 

they are subject under the federal securities laws-including, most notably, Rule 2a-7 under the 

Investment Company Act. The regulatory regime under Rule 2a-7 has proven to be effective in 

protecting investors' interests and in sustaining their confidence in money marker funds as a valuable 

tool for managing cash. The SEC has modernized and strengthened the rule from time to time as 

circumstances l1ave warranted (most recently in 2010 and 2014, as discussed below). 

In light of money market hmds' experience in the tlnancial crisis, and with the industry's strong 

support, the SEC in 2010 approved far-reaching rule amendments that enhanced an already-strict 

regime of money market fund regulation. 16 The amended rules made money market funds more 

h The Investment Company Act requires that BDCs retain ZOO percent asset coverage for senior securities (i.e., debt 

securities and preferred stock). For other closed-end funds, the asset coverage requ1rement IS 300 percent for debt securities 

and 200 percent for preferred stock. 

lG Money market funds 1n fact were the first part of the US financial system to be reformed in the wake of the fmancia! crisis. 

See Money Market Fund Reform, SEC Release No. IC-29132 (February 23, 2010), 75 Fed. Reg. 10060 (March 4, 2010). 

T ak1ng the initiative to respond qu1ckly and aggrcss1vc!y to the events of tall 2008, IC! formed the Money Market Working 

11 
93 


nshattuck on FSR297 with DISTILLERInsert offset folio 60 here 30773.060

resilient by, among other things, imposing new credit quality, maturity, and liquidity standards and 

increasing the transparency of these funds, 

The SEC amended Rule 2a-7 again in 2014. The 2014 SEC rules, which took effect on October 14, 

2016, largely centered around two principal reforms. 17 The first reform requires prime institutional and 

tax·exempt institutional money market funds to price and transact in their shares using "floating" net 

asset values ("NAVs"). The new rules also require these fimds to calculate their NAVs to four decimal 

places. (For a fund with a NAV of $1.00, that means calculating the NAV to one-hundredth of a 

penny-·- i.e .. $1.0000.) Government money market funds'" and retail money market funds 19 may 

continue to seek to maintain a stable NAV using amortized cost valuation and/or penny rounding. 

The second principal reform enables, and in certain cases requires, all non-government money market 

funds (i.e., all prime and tax-exempt funds, whether institutional or retail) to impose barriers on 

redemptions (so-called liquidity fees and gates) during extraordinary circumstances, subject to 

determinations by a money market fund's board of directors. Specifically, the new rules give a money 

market fund's board the flexibility ro impose liquidity fees of up ro 2 percent, redemption gates (a delay 

in processing redemptions for up to 10 business days), or both if the fund's weekly liquid assets have 

dropped below 30 percent of its rota! assets. If a fund's weekly liquid assets fall below !0 percent of irs 

total assets, the SEC rules require the fund to charge redeeming investors a fee of 1 percent of their 

redemption, unless the fund's board determines either that no fee, or a lower or higher fee (not to 

exceed 2 percent), would be in the best interests of the fund. 

The 2014 amendments required funds to make a number of significant operational changes on a very 

aggressive timeframe. Thanks to substantial effort. planning, and execution within the industry, funds 

were prepared to meet the new requirements on time and, as a result. the transition went smoothly. 

When coupled with the 2010 SEC reforms, tllese new rules add layers of transparency and redundant 

safeguards that more than adequately address any risks that may have existed in 2008. Indeed, so farreaching were these last two rounds of reforms thar today' s money market fund industry, as indicated in 

the chart below, is dramatically different from that of 2008. 

Group to study the money market, money market funds, and other participants in the money market, and the fmancial en sis 

of 2007~2008. The March 2009 Report of the Money Market Wc;rking Group addressed these topics and advanced wideranging recommendations for the SEC to strengthen money market fund regulation. See Investment Company Act, Report 

oftl7e Money M-::l!ket Working Group {March 17' 2009), aval I able at J1tt !)'> / /www.ICI.Q.r:..gfuQf I oor 09 ..... ITlCIJ2Y_Q,.P-.d[. The 

SEC's 2010 amendments incorporated many of the report's recommendations. 

17 See Money Market Funcf Reform, Amendments to Form PF. SEC Release No. IC-31166 (July 23, 2014), 79 Fed. Reg. 

47/36 (August 14, 2014). 

18 Government money market funds invest at least 99.5 percent of their total assets 1n cash, government securities, and/or 

repurchase agreements that are collateralized by cash or government securities. 

N Retail money market funds have poltClCS and procedures reasonably designed to 11m it all beneficial owners of the fund to 

natural persons. 

-12-
94 


nshattuck on FSR297 with DISTILLERInsert offset folio 61 here 30773.061

Assets Migrated from Prime Money Market Funds and Tax Exempt Money Market Funds into 

Government Money Market Funds in 2015 and 2016 

Total net assets, billions of dollars; week-ended Wednesday, January 7, 2015- October 25, 2017 

1,800 

1.600 

1,400 

1,200 

1,000 

800 

600 

400 

200 

0 

Source: Investment Company Institute 

, ___ ...,. ____ _ 

As the chart shows, in the two years leading up to the October 2016 effective date for the 2014 reforms, 

large sums shifted from prime money market funds-both institutional and retail-to government 

money market funds. According to weekly data, from January 1, 2015, to October 25, 2017, assets in 

prime institutional money market funds dropped $740 billion. Over the same period, assets in 

government institutional money market funds rose by a very similar amount. $785 billion. 

A similar, though more muted, shift occurred in retail share classes of money market funds. From 

January 7, 2015, to October 25, 2017, assets in prime retail money market funds dropped $266 billion. 

In addition, over the same period, assets in tax exempt money market funds-the vast mC!Jority of 

which are held by retail investors-fell $137 billion. Over the same period, assets of government retail 

money market funds rose by $398 billion. 

HR2379 

The Consumer Financial Choice and Capital Markets Protection Act of 201'/ (H.R. 2319) would 

rescind many of the 2014 reforms including the requirement that prime institutional and tax-exempt 

institutional money market funds float their NAVs. In recognition of tloe importance of money market 

funds to the global economy and to investors, IC I and its members have closely monitored H.R. 2319 

and other efforts to change money market fund regulatory requirements. 

- 13-
95 


nshattuck on FSR297 with DISTILLERInsert offset folio 62 here 30773.062

Some I Cl members have expressecl strong interest and support forthe bill, believing that it will restore 

investor choice and increase low~cost financing in the capital markets for business and municipal issuers 

without amending Rule 2a-7. These members contend that H.R. 2319 would not require any industry 

participant to change its current products. Rather, it would permit a sponsor to elect to continue to use 

a floating NAV under Rule 2a-7 for its non-government institutional money market funds or instead to 

use amortized cost accounting to maintain a stable value for all its funds. 

Other IC I members urge that a third round of regulatory changes to money market funds is neither 

appropriate nor desirable. They contend that their customers are content with the broad set of money 

market fund investing options still available, that further changes run the risk of making the product 

more confusing and less attractive, and that the money markets have adjusted to the reforms. 

As a result of these strongly differing member views regarding H.R. 2319, ICI takes no position on the 

proposed legislation. 

I appreciate the opportunity to share these views with the Subcommittee. IC I looks forward to 

continued engagement with Congress on these important matters. 

-14 
96 


nshattuck on FSR297 with DISTILLERInsert offset folio 63 here 30773.063

Appendix A: Registration Process Rule Amendments 

Representative Hollingsworth's discussion draft of rl1e "Expanding lnvemnent Opportunities Act" 

("Discussion Draft") would amend the following rules under the Securities Act of 1933 ("1933 Act"), 

the proxy rules, Regulation FD, and Form N-2 under the Investment Company Act of 1940 to improve 

the registration process for closed-end funds. 

Rule 405 underthe 1933 Act (Well-Known Seasoned Issuer Status) 

Under current Rule 405, "well-known seasoned issuers" or "WKSis" enjoy a streamlined registration 

process that gives them the flexibility to take advantage of market conditions when offering securities. 

Specifically, WKSis can file "automatic shelf registrations" that become effective immediately upon 

flling without the SEC staffs review and comment. This enables WKS!s to issue additional shares or 

other securities more quickly, allowing them to take advantage of current market conditions. To qualify 

as a WKSI, generally an issuer must have at least $700 million in common equity outstanding and have 

timely filed required reports for the preceding 12 calendar months. In addition, the issuer within the 

past threre years must not have engaged in conduct, or be subject to a conviction, decree, or order, that 

would make it ineligible20 Closed-end funds currently are not eligible for treatment as WKSis. 

The Discussion Draft would amend Rule 405 to allow closed-end funds to take advantage of it The 

amendments would: (1) delete the current exclusion of registered investment companies from the 

definition of WKSI; and (2) add Form N-2 (the form on which closed-end funds register securities 

with the SEC) to the definition of"amomatic shelf registration statement." (That definition specifics 

which SEC registration forms a WKSI is permitted to use.) 

Notably, closed-end funds that would qualify for WKSI status already will have filed registration 

statements that have been through the SEC staff review process. The staff thus would have examined 

these funds' investment objectives, assets, risk disclosures, and other matters that might affect 

shareholder interests. 

Rule 415 under the 1933 Act (Shelf Registration) 

Rule 415 governs so-called "shelf registrations." The Discussion Draft would amend Rule 415 in two 

ways. First, it would require the rule to state explicitly that the shelf registration process is available to 

any closed-end fund. Closed-end funds already utilize this process in reliance on two SEC staff noactron letters," but it is entirely appropriate for the SEC to codify this time-tested regulatory treatment. 

This would be a technical but important change. 

20 An 1ssuer would be inelig1ble, for example, if within the past three years, 1t f!led a bankruptcy pet1t1on or had an 

involuntary bankruptcy petition filed against it, was convicted of a felony or certain misdemeanors, entered mto ajud1cia! or 

governmental decnm relatmg to certain VIOlations of law, or was subject to an SEC stop order. 

21 See Nuveen Virginia Premium Income Munic1pal Fund (pub. avail. Oct. 6, 2006); Pilgrim America Prime Rate Trust 

(pub. avarl. May 1, 1998). 

A-1 
97 


nshattuck on FSR297 with DISTILLERInsert offset folio 64 here 30773.064

Second, it would delete the requirement tl1at a registrant using Forrn N· 2 must furnish the 

undertakings required by Item 34.4 of Form N-2. Those undertakings obligate a closed-end fund, 

among other things, to file a post-effective amendment to its registration statement to (a) update the 

fund's financial statements, (b) reflect mare rial changes occurring snbseqnent to the registration 

statement's effective date, or (c) include material information as ro the fund's plan of distribution not 

previously disclosed in the registration statement. Filing a post-effective amendment (which would be 

subject to SEC staff review and comment) in the context of a shelf registration would eliminate the 

benefits of forward incorporation by reference, discussed below. Moreover, operating companies that 

qualify to use forward incorporation by reference do not need to make these undertakings. 

Form N-2 (Forward Incorporation by Reference) 

Currently, to incorporate information from other filings (such as shareholder reports) into its 

registration statement, a closed-end fund must amend its existing registration statement after the filings 

are made to specifically reference those filings. In other words, the fund must file a post-effective 

amendment to the registration statement, which entails SEC staff review and commenl. 

The Discussion Draft would amend Form N-2 to allow a closed-end fund that meets the criteria to be 

considered a "seasoned issuer" to incorporate by reference into its registration statement annual and 

semi-annual shareholder reports that the fund files subsequent to the ti rne the registration statement is 

declared effective. To qualify as a "seasoned issuer," an issuer must have at least $75 million in common 

equity outstanding and have made timely periodic filings with the SEC for the preceding 12 calendar 

months. 

This amendment would greatly reduce the time and expense involved in preparing and updating closed· 

end fund registration statements. And it would provide these benefits without diminishing investor 

protection. Under the legislation, closed-end funds would be required to indicate in their prospectus if 

they incorporate any material by reference, and to provide a legend indicating where and how such 

materials can be obtained. 

Rule 497 under the 1933 Act (Prospectus Filing Obligations) 

Rule 497 governs the filing of investment company prospectuses and requires funds to file final 

prospectuses. The Discussion Draft would amend Rule 497 to simplify a closed-end fund's prospectus 

filing obligations. Under tile amendments, a fund would be required to file only those prospectuses that 

contain substantive changes from, or additions to, a prospectus previously filed with the SEC as part of 

a registration statement- rather than "every form of prospectus" that differs in any way These changes 

would conform a closed-end fund's prospectus filing obligations to those for operating companies, 

Rule 418 under the 1933 Act (Reports of the Registrant) 

Rule 418 requires issuers to provide to the SEC "promptly upon request" reports or memoranda 

relating to broad aspects of the business, operations or products of the registrant, which have been 

prepared within the past twelve months, but exempts operating companies that meet certain criteria 

A-2 
98 


nshattuck on FSR297 with DISTILLERInsert offset folio 65 here 30773.065

from this requirement?/ The Discussion draft would amend the rule to provide closed-end funds that 

rTJeet the same criteria with an exception from this requirement, treating closed-end funds the same as 

similar operating companies. 

Rule 14a-1 01 allows operating companies that meet certain criteria23 to incorporate by reference into 

proxy statements previously filed documents, such as annual reports. The Discussion Draft amends the 

proxy rules to extend to closed-end funds that qualify the same benefits that operating companies 

already enjoy. 

Rule 103 of Regulation FD (Reporting of Non-Public Information) 

Regulation FD requires issuers (including closed-end funds) disclosing any material non-public 

information to certain persons also to disclose the information to the public. Public disclosure must be 

made simultaneously, in the case of an intentional disclosure, and promptly, in the case of a nonintentional disclosure. Rule 103 provides that any failure to make such disclosures should not affect 

whether an issuer has complied with its reporting obligations under the Securities Exchange Act of 

1934. The Discussion Draft amends Rule 103 of Regulation FD to extend to closed-end funds this 

technical relief, which currently is limited to operating companies. 

22 The cxcept1on extends to a wider range of entfties than JUSt WKSis and seasoned issuers, It applies to any issuer that: (a) 

has equity securities l1sted and registered on a national securities exchange; (b) has not sold securities amounting to more 

than one-thlrd of ftS outstandmg secunt1os m certain offerings over the previous 12 calendar months; and (c) is not a shell 

company and has not been a shelf company for at least 12 calendar months 

Thnsc criter1a arc the same as those described in the preced1ng footnote. 

A-3 
99 


nshattuck on FSR297 with DISTILLERInsert offset folio 66 here 30773.066

Appendix B: Communications Process Rule Amendments 

Representative Hollingsworth's discussion drafi: of the "Expanding Investmem Opportunities Act" 

("Discussion Drafi:") would amend the following rules under the Securities Act of 1933 ("1933 Act") to 

improve the communications process for closed-end funds. 

Rules 164 and 433 ("Free Writing Prospectuses") 

Rules 164 and 433 permit an operating company to ntilize the "free writingprospecms" safe harbors. 1\ 

"free writing prospectus" is any written communication deemed to be an offer of a security that does 

not meet the full requirements of a statutory prospectus set forth under the 1933 Act (including any 

television or radio broadcast), 

Rule 164 permits an issuer to use such a prospectus when it meets the conditions of Rule 433. Rule 433, 

in part, allows a WKSI issuer to use a free writing prospectus at any time during an offering once the 

registration statement has been filed, with no requirement to deliver a statutory prospectus with or in 

advance of the free writing prospectus. Tt1e safe harbor, among other things. requires that the issuer file 

any free writing prospectus with the SEC prior to its date of first use. To qualify as a WKSI, generally 

an issuer must have at least $700 million in common equity outstanding and have timely filed required 

reports for the preceding 12 calendar months. In addition, the issuer within the past three years must 

not have engaged in conduct, or be subject to a conviction, decree, or· order, that would make it 

ineligible. 24 

The Discussion Draft would permit a closed-end fund that meets the WKSI criteria to utilize free 

writing prospectuses. Currently, many closed-end funds rely on Rule 482 under the 1933 Act to 

provide communications to investors and prospective investors, wt1ich permits funds to use a broad 

range of advertisements after a registration statement has been filed. While Rule 482 communications 

could in theory be a satisfactory substitute for free writing prospectuses, Rule 482 includes filing 

requirements (e.g., for certain electronic road show materials) that do not apply under Rule 433. The 

additional filing requirements mean that closcd~end funds must shoulder additional expenses as 

compared to operating companies, with no clear justification. 

Rule 134 ("Tombstone Ads") 

Under Rule 134, an operating company may make certain limited written communications regarding 

an offering after a registration statement has been filed without causing the communications to be 

considered a prospectus or free writing prospectus. These communications, known as "tombstone ads," 

permit issuers to provide specified facts about the legal identity and business of t11e issuer, and 

underwriters of an offering, 

24 An issuer wou!d be 1nel1g1blc, for example, 1fwithin the past three years, 1t filed a bankruptcy petition or hnd an 

involuntary bankruptcy petition Filed against 1t, was convicted of a felony or certain m1sdemcanors, entered into ajudicml or 

governmental decree relating to certain violations of !aw, or was suQjcct to an SEC stop order. 

81 
100 


nshattuck on FSR297 with DISTILLERInsert offset folio 67 here 30773.067

The Discussion Draft would amend Rule 134 to permit any closed-end fund to usc tombstone ads. 

Registered funds currently can provide this same information in Rule 482 communications, but those 

communications are subject to prospectus liability because the Rule 482 communications are deemed 

to be prospectuses. Closed-end funds should have the same ability as operating companies to issue these 

narrowly circumscribed communications that do not entail the added threat of prospectus liability. 

Rules 163 and 163A (Pre-Filing Communications) 

Under Rule 163, WKSI may make oral or written offers prior to the filing of a registration statement. 

In addition, Rule 163A provides a safe ~1arbor to operating companies for any communication that is 

made more than 30 days before the filing of a registration statement, when that communication does 

not reference the offering that is or will be the subJect of that registration statement. Although the 

securities laws typically prohibit many types of communications before t11e filing of a registration 

statement on the theory that they could "condition" the market or draw interest for t11e offering, the 

SEC has deemed it appropriate to adopt safe harbors that permit operating company issuers to 

communicate more freely to the public during these periods. 

The Discussion Draft would permit a closed-end fund that is a WKSI to rely on Rule 163, and any 

closed-end fund to rely on Rule 163A. to make pre-filing communications. Unlike Rule 482, which 

only provides a safe harbor for qualifying communications that follow the filing of a registration 

statement. these safe harbors would provide flexibility to a closed-end fund to communicate with the 

public during the period prior to the filing of a registration statement. 

Rules 168 and 169 (Factual Business Information) 

An operating company may communicate certain information provided in the ordinary course of 

business prior to or during an offering. Specifically, Rule 168 establishes a safe harbor for an issuer that 

already is filing periodic reports with the SEC to continue to disseminate regularly released or factual 

business information and forward-looking information prior to or during a registered offering. Rule 

169 establishes a similar safe harbor for an issuer that does not file perioc.lic reports to disseminate 

regularly released or factual business information (but not forward-looking information) prior to or 

during a registered offering. Bod1 safe harbors define "factual business information" to include 

information about the issuer, its business or financial developments, or other aspects of its business, as 

well as advertisements, and require that the information must have been previously released in the 

ordinary course of business. 

The Discussion Draft would amend Rules 168 and 169 to permit a closed-end fund to communicate 

certain factual business information about the closed-end fund, its business or other developments at 

any time before or during an offering. Permitting a closed-end fund to rely on these safe harbors could 

encourage the fund to issue more useful and timely reports regarding its business without the fear that 

doing so could subject it to liability (on the theory that it is making an offering of its securities without 

first delivering a statutory prospectus). 

B-2 
101 


nshattuck on FSR297 with DISTILLERInsert offset folio 68 here 30773.068

f~ules 138 and 139 (Research Reports) 

Broker-dealers that provide research on an operating company may rely on two safe harbors that 

encourage the publication and distribution of research reports during an offering. Rule 138 permits a 

broker-dealer participating in a registered offering to publish and distribute research reports about 

securities of the issuer that are not the subject of the offering. (For example, it permits a broker-dealer 

that is serving as an underwriter of an issuer's current debt offering ro write research reports about the 

issuer's common stock.) Rule 139 permits a broker-dealer that participates in a registered offering to 

issue research reports specifically abour the issuer and its securities or the issuer's industry or subindustry under specified conditions. Under Rule 139, the issuer must qualify as a "seasoned issuer" and 

the broker-dealer must distribute research reports in the regular course of its business. 

The Discussion Draft would permit a broker-dealer providing reports on a closed-end fund to rely on 

tt1e two research report safe harbors. Similar to the factual business information safe harbors discussed 

above, the research report safe harbors would encourage additional reporting about a closed-end fund 

and its securities. As a closed-end fund often issues l>oth common and preferred stock, permitting 

broker-dealers to rely on the first safe harbor (under Rule 138) would allow for more coverage of a 

closed-end fUnd's issuances. 

Similarly, the second safe harbor (under Rule 139), which would be available only to closed-end funds 

that meet criteria for "seasoned issuers," might encourage broker-dealers to issue and distribute more 

research reports about specific closed·end fund issuances or the closed-end fund's industry or subindustry. To qualify as a "seasoned issuer," an issuer must have at least $75 million in common equity 

outstanding and have made timely periodic filings with the SEC for the preceding 12 calendar months. 

Earlier this fall, Congress passed, and the President enacted, the Fair Access to Investment Research Act 

of 2017. That Act requires U1e SFC to amend Rule 139 to permit broker-dealers providing reports on 

"covered investment fUnds," including exchange-traded funds, to rely on that safe harbor. Although 

closed-end funds technically are within the definition of"covered investment fimd," the law seems to 

l1ave excluded broker-dealer reports about closed-end funds from its scope. T11e Discussion Draft 

would correct this flaw. 

Rule 172 and 173 (Prospectus Delivery) 

Rule 172 permits a traditional operating company to meet its prospectus delivery obligations when it 

makes a good faith and reasonable effort to timely file a final statutory prospectus with the SEC. The 

rule also permits operating company issuers to deliver a written confirmation to shareholders without 

treating tt1e confirmation as a prospectus. Rule 173 permits each underwriter or broker-dealer 

participating in an offering of an operating company's securities to satisfy its prospectus del Ivery 

obligations by furnishing a notice witt1in two business days after a purchase that states that the sale was 

made pursuant to an effective registration statement or in a transaction pursuant to Rule 172. 

B-3 
102 


nshattuck on FSR297 with DISTILLERInsert offset folio 69 here 30773.069

Operating companies, underwriters, and broker-dealers may rely on these rules to satisfy their 

prospectus delivery obligations once the company's registration statement is declared effective. 

The Discussion Draft would enable a closed·end fund to meet its obligation to deliver a final prospectus 

during an initial public offering or follow-on offering without having to (ieliver the prospectus. 

Permitting a closed-end fund and underwriters and broker· dealers participating in an offering to utilize 

these safe harbors will save funds and their shareholders the expense of delivering final prospectuses. 

Although a closed-end fund only is required to provide prospectuses during the offering period, which 

typically lasts 40 days after the offering begins. the expenses of meeting these obligations can be quite 

significant. Moreover, permitting reliance on these safe harbors for closed-end fund offerings would put 

them on an equal footing with traditional operating company offerings, which have availed themselves 

of these two safe harbors si nee 2005 

B-4 
103 


nshattuck on FSR297 with DISTILLERInsert offset folio 70 here 30773.070

,JFB HfNSAflltNG, rx, CIIAH\fvlf\N 

The Honorable Jay Clayton 

Chairman 

1:\nirrd ,5tutrn Honse ontrprrnmtariUC!\ 

Q:ommittrc on j1noncial,5cmiml 

llliJ 'RaQburn tloHsr c'lffirr ,Building 

1:UJshmyton. 1.":'!Q:2o5li 

September 14.2017 

U.S. Secu!'lties and Exchange Commission 

I 00 F S!reet NE 

Washington, DC 20549 

Dear Chairman Clayton, 

As you know. in 2014, the Securities and Exchange Commission (SEC) approved a final mle to 

require institutional prime money market funds (MMFs) to adopt market-based pricing and float the 

fund's net asset value (NA V). The final rule also authorized the boards ofMMFs to impose liquidity fees 

and redemption gates during periods of stress. The SEC's final rule provided MMFs with two years to 

comply with these new reqllirements, which ultimately became effective on October 14,2016. The final 

rule also permits government and retail MMFs to use the method to seek and maintain a fixed NAY. 

Some market patticipants and commentators have expressed the concem that the SEC's 2014 

MMF ndc would result in the loss of short-term liquidity in the capital markets, particularly in the 

municipal securities market. With the experience of the past eleven months, we ask the SEC to review 

the current landscape for MMFs and the impact of the 2014 rule on both short~term corporate and 

municipal financing. Specifically, we would welcome your views to the following questions: 

l. What was the impetus behind the SEC's 2014 money market reforms? How has the 

imp!eme11tation of these reforms addressed those issues? 

2, Has the SEC conrlucted a comprehensive review of short-term lending, especially with regard 

toMMFs, sinc.e the 2014 money market reforms became effective on October 14, 2016? If not, 

does the SEC plan to conduct such a review? 

3. How has the landscape for money markets funds changed since the approval of the SEC's2014 

money market fund mles? Have there been significant shifts in these markets since the October 

2016 effective date? 

4. What concerns, if any, has the SEC heard in response to the implementation of the 2014 MMF 

reforms? 

5. What impacts have the2014 money market reforms had on short-tenn financing and liquidity? 

6. What other market conditions or regulatmy initiatives, if any, have impacted the market for 

money market funds? 

7. Whar would be the impact on prime and municipal MMFs if the SEC was to reverse its rule and 

revert to a constant $1.00 share price? 
104 


nshattuck on FSR297 with DISTILLERInsert offset folio 71 here 30773.071

Thank you for your attention to this important matter, Please respond in writillg by October 2, 2017, 

Sincct'ely, 

CAROLYN MALONEY 
105 


nshattuck on FSR297 with DISTILLERInsert offset folio 72 here 30773.072

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION 

WASHINGTON. D.C, 20549 

OFFICE Of' ¥HE CHAiRMAN 

The Honorable Bill Huizenga 

Chairman 

October 5. 2017 

Subcommittee on Capital Markets, Securities, and Investment 

Committee on Financial Services 

U.S. House of Representatives 

2129 Rayburn House Office Building 

Washington. DC 20515 

Dear Chairman 1-Iuizcnga: 

Thank you Cor your letter dated September 14. 2017 concerning the market effects to the 

regulation of money market Cunds ( .. MMPs'") that the Commission adopted in 2014 and which 

were fully implemented in October oflasl year. l appreciate your interest in this issue and share 

your goal of preserving liquidity in the shorHcnn funding markels and minimizing disruptions to 

investors, markets, and market patiicipants. 

The Commission. in the 20! 4 release adopting the refonns, indicated that the- impetus 

behind the refonns was a conccm thal MMFs, as they existed then, could pose risks to investors 

and the broader markets, particularly to the extent their tCaturcs may have created a Jirst-movcr 

advantage that inccntivlzcd investor runs during periods of market stress. The Commission's 

adopting release further noted the harm that can result from rapid investor redemptions during 

periods of market stress .. as the Reserve Fund's Primary Fund "broke the buck" and other prime 

institutional funds experienced heavy redemptions- which in turn caused fund managers to 

retain cash, thereby freezing short-term financing markets. Ultimately, as the 2014 release 

describes, the Department of the Treasury intervened with its Temporary Guarantee Programextmordinary measures that helped quit:t the mnrket disruptions. Treasury was subsequcm!y 

prohibited by statute from unde11aking such measures in the future, thereby creating the need tOr 

structural rctt1m1s to the markets to prevent such disruplions going f()rward. 

Accordingly, the 2014 refOrms included certain structural rcfonns designed to mitigate 

run risk in MMFs. These included a Jlonting NAV for a!! institutional prime (e.g .. nongovernment and retail) MMFs designed to address potential firsH11ovcr advantages. The reforms 

also provide non-govcnunent MMF boards new tools- liquidity fees and redemption gates-

\Vhich arc designed to help MMFs better manage any potential investor run should one occur. 

The staff have been closely monitoring the implementation of the 2014 rc!{mns and 

reviewing their impnct on MMFs and the short-term funding markets. Based on their review and 

analysis. the staff have shared the fOllowing observations. 
106 


nshattuck on FSR297 with DISTILLERInsert offset folio 73 here 30773.073

The Honorable Bill Huizenga 

Page2 

• As MMFs were implementing the 2014 reforms. there was a shift in assets of 

approximately $l.l trillion from prime MMFs into government MMFs. Despite this 

reallocation, overall MMF assets remained largely stable (at about $3 trillion) 

throughout this period and to date. 

• During this period, some short-term rates increased, though these rate increases have 

since dissipated. The reallocation of assets from prime to government MMFs and 

potential effects on yields in the short-run were possible consequences of the reforms 

that were anticipated and discussed in the rule's 2014 adopting release. At that time. 

the Commission detetnlined, however, that realizing the goals of the rulemaking 

justified the reforms, despite the potential costs. 

• Since the October 2016 compliance date for the reforms, investor fund reallocations 

have not significantly changed, with assets in both government and prime MMFs 

largely stabilizing. The time period since the compliance date Of the reforms has also 

coincided with a rising interest rate environment, with the Federal Reserve raising 

short-term interest rates several times over the last year. This has resulted in yield 

increases for MMFs. 

The staff have further informed me that, as the reforms went into effect, many fund 

managers chose to realign their fund offerings and close certain funds, many of whose assets had 

been shrinking during the extended (ow interest rate environment. These changes have Jed to 

some reductions in investment in prime and municipal MMFs, particularly when combined with 

the reallocation of assets from prime to government funds that I mentioned above. To the extent 

that MMFs experiencing outflows invested more heavily in certain types of assets than the 

MMFs receiving inflows during this period~ those types of assets could be experiencing 

decreased demand from MMFs. Some market participants and corporate and municipal issuers 

suggest that this decrease in demand for commercial paper and short~term municipal securities 

from MMFs and related increase in demand for government securities from MMFs is one of the 

primary impacts of the 2014 refonns on the short-tcnn funding market. 

I appreciate your question regarding the SEC potentially reversing the floating NAY 

element of the 2014 reforms. It is difficult at this time, however, to predict what the impact on 

prime and municipal funds woutd be if the Commission were to permit them again to use a stable 

$1.00 NAV. While some investors might choose to leave government MMFs and return to prime 

and municipal funds, such a shift also might not occur if investors newly appreciate prime and 

municipal MMFs' inherent liquidity and principal stability risks and therefore choose to remain 

in government MMFs. The MMF reforms were not fully implemented until October 2016, and I 

am concerned that making major changes at this time could be disruptive to the short-term 

funding markets. The Commission and its staff are monitoring the short-tenn funding markets 

and MMFs' activities generally, and will remain focused on the role MMFs play for investors 

and the short-term markets. 

Thank you again for your letter and for your attention to this important matter in our 

capital markets. Should you wish to discuss these issues further, please do not hesitate to contact 
107 


nshattuck on FSR297 with DISTILLERInsert offset folio 74 here 30773.074

The Honorable Bill lluizenga 

Page 3 

me at (202) 551 ~21 00 or have your stall' contact Bryan Wood, Director or the Office of 

Legislative and Intcrgo\·crnmental Affairs. at (202) 551-2010. 
108 


nshattuck on FSR297 with DISTILLERInsert offset folio 77 here 30773.077

Government Finance Of!lcers Association 

U.S. Conference of Mayors 

National Association of Counties 

National League of Cities 

International City/County Management Association 

Large Public Power Council 

National Association of Health and Educational Facilities Finance Authorities 

International Municipal Lawyers Association 

National Council of State Housing Agencies 

October 13, 20 l 7 

The Honorable Michael Crapo 

Chairman 

Committee on Banking 

United States Senate 

Washington, DC 20515 

The Honorable Jeb Hensarling 

Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

American Public Power Association 

The Honorable Sherrod Brown 

Ranking Member 

Committee on Banking 

United Stales Senate 

Washington, DC 20510 

The Honorable Maxine Waters 

Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Dear Chairmen Crapo and Hensarling, and Ranking Members Brown and Waters: 

The organizations listed above, representing state and local governments, authorities and other public 

entities, wish to express their support for H.R. 2319/S. 1117, The Consumer Financial Choice and 

Capital Markets Protection Act. 

Our organizations have long opposed the Securities and Exchange Commission (SEC) modifications to 

SEC Rule 2a-7 of the Investment Company Act of 1940 that changed the net-asset-value (NAY) 

accounting methodology for money market mutual funds (MMMF) from stable to floating. Our members 

rely on the hallmark stable NA V feature in a variety of ways. First many governments have spccitic state 

or local statues and policies that require them to invest in financial products with a stable NA V. The 

policy reason for this is to ensure that public funds arc appropriately safeguarded to best serve the 

entity. Second, MMMFs with a stable NA V arc the most commonly used investment by state and local 

governments. Forcing governments to lind alternative investments to MMMFs creates additional risk for 

public funds by driving them to potentially invest in other, less suitable products. Finally, non- MMMF 

options may not meet liquidity standards required by their governments to meet cash management 

policies and statutes. H.R. 2319/S. 1117 would enable state and local government~ to continue to usc 

stable NA V funds for their essential and critical investment needs. 

In addition to the vital usc of MMMFs as state and local government investments, it is important to note 

that MMMFs arc the largest purchasers of short tcnn municipal securities. Due to the new SEC rules, 

these ti.tnds have curbed their appetite for these securities, thus decreasing demand and increasing costs to 

state and local govemmcnts that issue this type of debt. In fact, between January 2016 and July 2017, tax 
109 


nshattuck on FSR297 with DISTILLERInsert offset folio 78 here 30773.078

exempt MMMFs assets fell by 50 percent, from $254 billion to $135 billion, thereby dramatically 

shrinking the funding pool available to municipal borrowers. Over 30 states lost at least $1 billion in 

funding from tax-exempt MMMFs. At the same time, municipalities fortunate enough to continue selling 

their debt to tax-exempt funds saw their borrowing costs increase by nearly double the Federal Reserve's 

rate increases over the same period. Those costs have increased even more for state and local 

governments that can no longer sell their debt to MMMFs, and have to borrow from other investors or 

replace the debt with bank loans. 

Money market funds have been utilized effectively in the past to both manage liquidity and provide a 

reliable source of working capital to fund public services and finance continued infrastructure investment 

and economic development throughout all economic conditions. This is particularly important today as 

states and communities impacted by recent devastating hunicanes and other natural disasters seck to 

finance rebuilding and recovery efforts. We ask that you enact H.R. 2319/S. 1117 so that state and local 

governments can continue to have unrestricted access to tl1ese safe and highly liquid capital markets tools. 

Thank you again for considering this important legislation. We look forward to working with you and 

supporting your efforts to help state and local governments on this and other regulatory and financial 

matters of mutual interest 

Sincerely, 

Emily Swenson Brock, Government Finance Officers Association, 202-393-8467 

Larry Jones, United States Conference of Mayors, 202-861-6709 

Jack Peterson, National Association of Counties, 202-66!-8805 

Brett Bolton, National League of Cities, 202-626-3023 

Elizabeth Kellar, International City/County Management Association, 202-962-361! 

Noreen Roche-Carter, Large Public Power Council, 916-732-6509 

Chuck Samuels, National Assn of Health & Educational Facilities Finance Authorities, 202-434-7311 

Chuck Thompson, International Municipal Lawyers Association, 202-466-5424 

Garth Rieman, National Council of State Housing Agencies, 202-624-7710 

John Godfrey, American Public Power Association, 202-467-2929 
110 


nshattuck on FSR297 with DISTILLERInsert offset folio 79 here 30773.079

.6. Association o( 

:lflft: iVIinnesota Counties 

September 21,2016 

The Honorable Tom Emmer 

United States House of Representatives 

503 Cannon HOB 

Washington, D.C. 20515 

Dear Congressman Emmer: 

The Association of Minnesota Counties (AM C) respectfully brings to your attention the looming impacts of an 

amendment to Securities and Exchange Commission (SEC) rule ZA-7 and the adverse effects this move will 

have on the investmentvahw of municipal bonds for Minnesota counties. 

As you may know, counties use tax-exempt debt to finance various capital and public works projects. In this 

regard, money market funds (nMMFs~) are significant purchasers of tax-exempt obligations, Starting in 

October, we fear that once the net assel value w.,anges from a fixed sum to floating value-pursuant to the 

new SEC rule-MMFs may no longer be interested in purchasing such debt. Without MMFs to purchase 

municipal bonds, the cost of projects will be incrementally more expensive, timlting our future growth and 

adding a new cost to taxpayers. !n addition, obtaining the lowest possible interest costs for tax-exempt 

financing is an especially important tool to fund count}' public works and other infrastructure projects and 

facility upgrades. 

As such, we ask for your support of H.R.4216 to benefit not only Minnesota residents, but local governments, 

business owners, developers, and the construction trades by preservmg stable value money market funds for 

public infrastructure investment, economic development, and growth. As a member of the U.S. House 

Financial Services Committee, we know that you are in a unique position to request a hearing for this bill or to 

relay Minnesota counties' concerns to members of the committee. 

Thank you for your attention to this issue, we greatly appreciate your consideration, Please feel free to 

contact my office should you have any qu<'stions or requests for specific county information. 

Sincerely, 

]R,MH 

125 Ut<lrk·:: Avenl!e, Samt P<~u!, :-.JN 55103-21081 Main Unr/Switrhboard 
111 


nshattuck on FSR297 with DISTILLERInsert offset folio 80 here 30773.080

December l, 2016 

The Honorable Paul Ryan 

Speaker of the House 

United States Capitol 

Washington, D.C. 20515 

Dear Mr. Speaker: 

As you work to complete the legislative activity of the 1141

h Congress, we ask that you include in that 

process the expeditious enactment ofH.R 4216, the Consumer Financial Choice and Capital Markets 

Protection Act. This bipaJtisan legislation, and its counterpart in the Senate (S. 1802, sponsored by Senator 

Pat Toomey) would address the significant unintended consequences of a Securities and Exchange 

Commission (SEC) rule which is undermining business and public infrastructure investment, and crimping 

state and local government finances. 

As members of the State Financial Officers Foundation (SFOF), we are dedicated to developing:, 

implementing and promoting conservative, fiscally responsible ("pro-growth") public policies. Those 

policies include maintaining efficient, low cost financing provided by money market funds, and 

maintaining access to a convenient and safe tool for obtaining market returns on cash in the management of 

public money. 

Unfortunately, both of those objectives have been severely undennined by an SEC rule adopted two years 

ago, which went into effect six weeks ago. It requires institutional prime and tax-exempt money market 

funds to be offered only with a floating net asset value (NAY). Under this rule, only funds investing solely 

in U.S. government securities or offered only to certain retail investors who are '"natura! persons'' may 

continue to use a stable NAV. TI1is rule has led to a run on prime and tax-exempt money market funds, 

causing more than $12 trillion to no longer be available for business and public infrastructure investment. 

As a result, short-tcnn interest rates have risen to their highest levels since the financial crisis, issuers of 

commercial paper have see11 their cosl of borrowing more than double, and issuers of municipal debt and 

their borrowers have all seen their cost of short-tcnn financing rise fi·om, in some cases, below five basis 

points last November to nearly 80 basis points today. 

At the same time that the mle has cat1sed our cost of shorHenn borrowing to rise dramaticaUy, it has also 

driven down our investment income. As a result of the floating NAV rule, yields on prime money market 

funds are double that of government funds, but state and local govemments are unable to benefit from those 

market rates of return on their shmi-tcrm cash investments. This is redueing our projected revenue, making 

it more difficult to fund public servlces. 

Even though the implementation date of the SEC rule has passed, the negative impacts pcrsisr as 

institutions continue to pull their investments out of prime and tax-exempt money market funds, leading to 

more fund liquidations and less private capital fOr our communities and businesses. Enactment of H.R. 

4216 and S. 1802 is urgently needed to address this artificially created financial crisis caused by overregulation and a failure by the SEC to conduct realistic cost-benefit analyses. 

We look forward to working with you, alongside the new Administration, to advance conservative, progrmvth economic policies. Enactment ofiLR. 4216 and S. 1802 would be a welcome step in that direction. 

P.O. B0x 9584 A \1ission. KS 66201 A (866) 816~0873 ... \\lV\-v.statctinancialofficers.com 
112 


nshattuck on FSR297 with DISTILLERInsert offset folio 81 here 30773.081

Derek Kreifels, President 

State Financial Officers Foundation 

Idaho Treasurer Ron Crane, Vice Chair 

State Financial Officers Foundation 

Arizona 

~ Treasurer Jeff DeWit 

Colorado 

~-~ Treasurer Walker Stapleton 

~ ud:IJ..JJ 

Indiana Treasurer Kelly Mitchell 

Kentucky 

~-&J{ Treasurer Allison Ball 

-r~x}t:;_uo~t::r 

Nevada Controller Ronald Knechl 

South 

~~£ Carolina Treasurer Curtis Loftis 

Wyoming Treasurer Mark Gordon 

Mississippi Treasurer Lynn Fitch, National Chair 

State Financial Officers Foundation 

/~~~~~+-

North Dakota Treasurer Kelly Schmidt, Past Chair 

State Financial Officers Foundation 

d~·tk/4~ Arkansas Treasurer Dennis Milligan 

Georgia Treasurer Steve McCoy 

tJ 

1 \.t:rr1/ 

Kansas Treasurer Ron Estes 

-----1 ,.--./ I I .-Mf' 11 at"'J Maine Treasurer Terry Hayes 

(]J/\. /1.c-- Ncvada Treasurer Dan Schwartz 

{2Wj~~J South Dakota Treasurer Richard Sattgast 

P.O. Box 9584 A. i\1ission, KS 66201 ..._ (S66) 816~0873 A \\'W\V.Statefinnncia!officers.com 
113 


nshattuck on FSR297 with DISTILLERInsert offset folio 82 here 30773.082

Thomas P. Koch 

Mayor 

September 21, 2017 

The Honorable Stephen Lynch 

2268 Rayburn HOB 

Washington, DC 20515 

~itp of <!auincp 

City Hall 

Office ofthe Mayor 

Re: Support for the Consumer Financial Choice and Capital Markets Protection Act of2017 (H.R. 

2319) 

Dear Representative Lynch, 

As the Mayor of Quincy, a city that relies on a stable, low-risk municipal bond market, I respectfully urge 

you to support fiR 2319, The Consumer Financial Choice and Capitallifarkets Protection Act of2017, 

which would undo damaging new rules imposed on municipal money market funds (MMMFs) by the 

Securities and Exchange Commission (SEC). I joined Governor Patrick, Treasurer Grossman! the 

Massachusetts Municipal Association and others in opposing this rule in comments to the SEC when they 

considered the rule in 20!3 and 2014, and am extremely disappointed that they moved forward with it. 

These regulatory changes require a floating net asset value (NA V) for MMMFs as opposed to the prior 

fixed NAY of$1 per share. The low risk provided by the fixed NA V was an essential municipal financial 

tool, and l am deeply concerned by the way these changes make municipal bonds less attractive to 

investors. As municipal bonds became substantially less attractive to investors, municipal funds1 a key 

source of funding for state and Iocal governments and their infrastructure projects, experienced a 50 

percent decline since the implementation of the rule. 

In our city of Quincy .. municipal bonds are the financial backbone tOr what is the most ambitious urban 

center redevelopment program in the Northeast, having provided for tens of minions of dollars in 

infrastructure improvemenL<;. 

H.R. 23 J 9, which will allow these MMMFs to regain the essential fixed net asset value, is vital to our city 

of Quincy and cities nationwide. Thus, T again respectfully urge you to support this legislation. 

Thank you in advance for your consideration. 

Regards, ~ 

~~ Mayor 

1305 Hancock Street, Quincy, MA 02169 

617-376-1990 - rnayorkoch@quincyma.gov 
114 


nshattuck on FSR297 with DISTILLERInsert offset folio 83 here 30773.083

<!itp of ~uinrp 

Thomas P. Koch 

Mayor 

September 21, 2017 

The Honorable Elizabeth Warren 

United States Senate 

317 Hart Senate Office Building 

Washington, DC 20510 

City Hall 

Office ofthe Mayor 

The Honorable Edward Markey 

United States Senate 

255 Dirksen Senate Office Building 

Washington, DC 205!0 

Re: Support for the Consumer Financial Choice and Cupital Markets Protection Act of 2017 (S. 1 117) 

Dear Senator Warren and Senator Markey, 

As the Mayor of Quincy, a city that relies on a stable, low-risk municipal bond market, I respectfully urge 

you to support Senate Bill 1117, The Consumer Financial Choice and Capital Markets Protection Act of 

2017, which would undo damaging new rules imposed on municipal money market funds (MMMFs) by 

the Securities and Exchange Commission (SEC). I joined Governor Patrick, Treasurer Grossman, the 

Massachusetts Municipal Association and others in opposing this rule in comments to the SEC when they 

considered the rule in 2013 and 2014, and am extremely disappointed that they moved forward with it. 

These regulatory changes require a floating net asset value (NA V) for MMMFs as opposed to the prior 

fixed NAY of$1 per share. The low risk provided by the fixed NAY was an essential municipal financial 

toot and I am deeply concerned by the way iliese changes make municipal bonds less attractive to 

investors. As municipal bonds became substantially less attractive to investors. municipal funds, a key 

source of funding for state and local governments and their infrastructure projects, experienced a 50 

percent decline since the implementation of the rule. 

In our city of Quincy, municipal bonds are the financial backbone for what is the most ambitious urban 

center redevelopment program in the Northeast, having provided for tens of millions of dollars in 

infrastructure improvements. 

S.lll7, which will allow these MMMFs to regain the essential fixed net asset value, is vital to our city of 

Quincy and cities nationwide. Thus, I again respectfully urge you to support this legislation. 

Thank you in advance for your consideration. 

Regards, 

c~?~ Mayor 

1305 Hancock Street, Quincy, MA 02169 

617-376-1990 - mayorkoch@quincyma.gov 
115 


nshattuck on FSR297 with DISTILLERInsert offset folio 84 here 30773.084

November 2, 2017 

The Honorable Jeb Hensarling 

Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, DC 20515 

The Honorable Maxine Waters 

Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, DC 20515 

The Honorable Billlluizenga 

Chairman 

Subcommittee on Capital Markets and GSEs 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney 

Ranking Member 

Subcommittee on Capital Markets and GSEs 

U.S. House of Representatives 

Washington, D.C. 20515 

Dear Representatives Hensarling, Waters, Huizenga and Maloney: 

On behalf of the Association for Financial Professionals (AFP), I am writing to request your 

support for H.R. 2319, the Consumer Financial Choice and Capital Markets Protection Act, 

which will be the subject of a Capital Markets Subcommittee hearing on November 3. This 

legislation seeks to preserve business access to liquidity for cash management, and capital access 

for business and public infrastructure investment. 

As the global resource and advocate for the finance profession, AFP serves over 16,000 members 

who manage and safeguard the fmancial assets of more than 5,000 U.S. organizations. Many of 

our members are responsible for issuing short- and long-term debt and for managing the 

corporate cash, 401k and pension assets of their organizations. In these fiduciary capacities, our 

members rely on money market funds as both investors and issuers of debt. 

Unfortunately, the flexibility, efficiency and lower cost that money market funds provide was 

undetmincd by a Securities and Exchange Commission (SEC) rule that took effect in October 

2016. The rule in question prohibits prime and tax-exempt money market funds operating on a 

stable net asset value (NA V) basis from being offered to investors other than "natural persons." 

As a result, organizations that require stable value investments have been forced to shift their 

short-term cash management needs out of these money market funds and into other types of 

investments that do not support the capital access needs of businesses and communities. 

As a result of the implementation date of the floating NAY rule, the capital pool that is available 

to business borrowers shrank hy about $160 billion since the beginning of 2016, while many 

businesses are pay higher rates to alternative lenders. At the same time, municipal entities and 

non-government conduit borrowers, such as hospitals and universities, have seen their borrowing 

costs increase from under 10 basis points to about 90 basis points over the same period. 
116 


nshattuck on FSR297 with DISTILLERInsert offset folio 85 here 30773.085

Our members prefer money market funds over other investment vehicle because they provide 

liquidity, principal preservation, diversification, built-in credit analysis, and ease of accounting. 

In addition, these funds are a key source of short-term financing for businesses to purchase 

seasonal inventory, pay suppliers, and fund payroll and other expenses when cash outflows arc 

greater than inflows. Issuing short-tcnn variable rate debt held by money market funds is 

preferable to secured bank loans for businesses because it provides more efficient and affordable 

short-term financing, and allows businesses to invest more in job creating activities. 

It is important that H.R. 2319 be enacted as quickly as possible to reverse the long-term damage 

being done to the indispensable capital markets financing options provided by money market 

funds. The legislation will provide accounting consistency in our global money funds market 

while maintaining other recently adopted regulations regarding asset maturities, credit quality, 

and transparency. 

1 appreciate your leadership in advancing H.R. 2319 as quickly as possible, and am available to 

answer any questions or provide additional information. 

Sincerely, 

Jeff A. Glenzer 

Chief Operating Officer 

Association for Financial Professionals 

4520 East-West Highway, Ste. 800 

Bethesda, MD 20814 

301-961-8872 

cc: Members of the House Financial Services Committee 
117 


nshattuck on FSR297 with DISTILLERInsert offset folio 86 here 30773.086

~!\-··········· 

ASSOCIATION OF 

SCHOOL BUSINESS OFFICIALS 

INTERNATIONAL 

---------------------

November 2, /017 

The Honorable jeb Hensarling 

Chairman 

Committee on Financial Services 

U S. House of Representatives 

Washington, Q_C. 20515 

The Honor able Maxine Waters 

Ranking Member 

Committee on rinancial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Honorable Bill Huizenga 

Chairman 

Subcommittee on Capital Markets and GSEs 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney 

Ranking Member 

Subcommittee on Capital Markets and GSFs 

US House of Representatives 

Washington, D.C. 20.S 15 

Dear Representatives Hensarling, Waters, Huizenga, and Maloney, 

The Association of School Business Officials International (ASBO) is an education association that, through its 

members and affiliates, represents approximately 30,000 school business professionals. ASBO International 

members are trusted stewards of taxpayers' Investment in public K-12 education and represent every aspect 

of school support services, includmg school finance, procurement, taciiities management human resources, 

technology, transportation, and rnore. We are writing to ask for your support of H.R. 2319, the "Consumer 

Financial Choice and Capital Markets Protection Aot," and to urge the Financial Services Committee to act on 

this bipartisan legislation as quickly as possible. 

ll.R 2319 would preserve access to an important source of capital and prornote low-cost financing for school 

facilitieS and other public infrastructure investments. As the financial leaders and facility managers of school 

distncts. ASBO members depend on tax-exempt money market funds (MMFs} for readily available, low-cosr 

capital expenditure financing for school construction projects. Unfortunately, this financing option is no 

longer feasible because of a Securities and Exchange Cornmiss1on {SEC) rule that took effect in October 2016 

The rule prohibits tax-exempt MMFs from operating on stable net asset value (NAV) basis, and now must 

operate on a floating NAV 1nstead. This change has caused investors to flee ta.x-exernpt funds, whtch has 

unnecessarily raised the cost of financing school construction projects 

fax-exempt MMFs are among the largest purchasers ot variable rate notes issued by or on behalf of school 

dtstricts and other educational institutions. They have a nominal long-term marurity, but the interest rate is 

adjusted on a daily or weekly basis As a result. schools districts across the country are able to undertake 

long-term infrastructure projects at very low short-term rates. At the beginning of 2016, the cost of borrowing 

11401 North Shore Drive 1 Reston, VA 20190 I Phone: 866.682.2729 1 Fax: 703.708.7060 1 asbointl.org 
118 


nshattuck on FSR297 with DISTILLERInsert offset folio 87 here 30773.087

at those adJUStable rates was as low as a few basis points (BPS). Those rates have skyrocketed to about 90 

BPS as a result of the SEC's floating NAV rule. By dnving up the cost (and increasing the unpredictability) of 

borrowing, the SEC rule is squeezing school district budgets and undermining d1strict leaders' efforts to 

provide safe educational facilities for our children to grow in and learn. 

Please support H.R. 2319 so that we can preserve stable value MMFs as a viable, efficient, and cost -effective 

source of financing school facilities and other important public infrastructure investments. 

Thank you for your leadership on this issue. If you have any questions or would like to discuss H.R. 2319 in 

further detail, please feel free to contact us at 866.682.7729. 

Sincerely, 

john D. Musso, CAE, RSBA 

Executive Director 

ASGO International 

11401 North Shore Drive I Reston, VA 20190 1 Phone: 866.682.2729 1 Fax: 703.708.7060 1 asbointl.org 
119 


nshattuck on FSR297 with DISTILLERInsert offset folio 88 here 30773.088

Pnnt 

Money Market Funds on Life Support 

By Mercer Bullard ! 10-03-12 1 06:00AM 1 Email Article 

Three years ago, I asked: Will Qbama Kill Money Market Funds? He certainly is trying, 

but the MMF industry is not going down without a fight. It scored a victory in round 

one when SEC chairman Mary Schapiro~ trying to persuade her fellow 

commissioners to support reforms that the industry argues would, in effect, eliminate 

MMFs as we know them. This battle has now moved to round two with Treasury 

secretary Timothy Geithner's reauest to the Financial Stability Oversight Cmill.Ql to 

pick up where the SEC has left off. 

Geithner's request is probably more bark than bite. It would be imprudent for a 

novice regulator such as FSOC to test its new powers in a fight with industry and 

Congress (see Sen. Pat Toomey's comments) that it may lose. And if chairman 

Schapiro leaves the commission, which some have predicted, her replacement may 

take up MMF reform again, in which case FSOC action would not be needed. 

At this point, the best bet might be that the SEC will revisit MMFs late this year or 

early in the next and issue a request for data on the potential effect of additional 

reforms. However, this will provide only a brief respite. Geithner has thrown down a 

gauntlet that promises an epic showdown between the banking and securities models 

of financial regulation that is likely to reach a boiling point in the next couple of 

years. 

Financial Crisis Fallout 

The MMF battle is a residue of the financial crisis. In September 2008, the failure of 

Lehman Brothers caused the Reserve Money Market Fund's per-share net asset value 

to drop below $1. The Reserve Fund's "breaking a dollar," along with the other 

stresses of the financial crisis, precipitated large withdrawals from that fund and 

other MMFs. Before the run on MMFs could metastasize, the Treasury Department 

announced that it would insure investors' MMF accounts, which calmed investors and 

stopped the exodus. 

Banking regulators insist that the MMF run proved that MMFs present systemic risk to 

our financial markets. The Dodd-Frank Act of 2010 purported to address such 

systemic risks in part by creating the banker-dominated FSOC, which has the 

authority to brand non banks as systemically important financial institutions, or SIFis. 

If the FSOC declared MMFs to be SIF!s, then they would become subject to oversight 

by the Federal Reserve. 

Schapiro's SEC responded to systemic-risk concerns by adopting fairly draconian MMF 

reforms in 2010. Banking regulators were not satisfied, however, and demanded that 

the SEC take more extreme measures. 

http·ftnews.morningstar.com/art!denet/Htm!Temp!ate /PrlntArtlde.htm7time=0183597 2 

4/l/14, l2:l0AM 

Page 1 of4 
120 


nshattuck on FSR297 with DISTILLERInsert offset folio 89 here 30773.089

So Schapiro moved to propose further reforms that would require MMFs to choose 

between: 1) allowing their NAVs to float like any other ultra-short-term bond fund, or 

2) keeping up to 1°/o of assets in reserve and holding back 3% of investors' assets for 

30 days when they make withdrawals. When three of the five SEC commissioners 

declined to sign on, she criticized their decision in a public statement, which provoked 

sharp responses from her colleagues (here and here). In a clear invitation to federal 

banking regulators, Schapiro wrote: 

Other policymakers now have clarity that the SEC will not act to issue a 

money market fund reform proposal and can take this into account in 

deciding what steps should be taken to address this issue. 

But Geithner is not letting her off the hook. He has asked the FSOC to make a formal 

recommendation to the SEC to go back to work. He wants the FSOC to tell the SEC to 

propose at least three MMF reforms: Schapiro's two proposals cited above plus a third 

under which MMFs would be subject to "liquidity and enhanced capital standards, 

potentially coupled with liquidity fees or temporary 'gates' on redemptions." 

In the event that the SEC does not get the message, Geithner also asked the FSOC to 

initiate parallel proceedings to declare MMFs to be SIFls, though the FSOC's authority 

to do so is questionable. It may hesitate to court a legal showdown this early in its 

tenure. As a last resort, Geithner threatened to use banking regulators' existing 

powers to beat MMFs into submission, such as by banning them from tri-party repo 

transactions involving banks. 

The same day that Geithner sent his letter, SEC commissioner Daniel Gallagher stated 

in an interview that the floating NAV "is an attractive option that I am likely to 

supoort." This seems a reversal of his August oosition that Schapiro's proposals: 

were not supported by the requisite data and analysis, were unlikely to 

be effective in achieving their primary purpose, and would impose 

significant costs on issuers and investors while potentially introducing 

new risks into the nation's financial system. 

He has not said whether he would now provide the third vote for Schapiro's proposaL 

The Next Step 

Some speculate that the Geithner letter and Gallagher switch will lead to a rule 

proposal, but the next step is more likely to be a request for information. Gallagher 

might not wish to flatly contradict his position that Schapiro's rule amendments "were 

not supported by the requisite data and analysis" and simply proposing them "could 

have harmful consequences." Also, collecting more data might temper increasing 

concerns in Congress, where criticism of SEC cost-benefit analysis has been heated, 

while also improving the SEC's chances of surviving an inevitable legal challenge from 

the MMF industry. The SEC's recent record in such court challenges has been 

abysmal. 

http://news.morning~tar.com/ artlclenet/HtmiTemplate /PI intArticlf'.htm~tlme"'01835<}72 

4/l{14, 12:20 AM 

Page 2 of 4 
121 


nshattuck on FSR297 with DISTILLERInsert offset folio 90 here 30773.090

Pnnt 

Commissioner Luis Aguilar supports issuing a request for information, though he 

might be less cooperative after having been thrown under the bus for opposing 

Schapiro's proposal. After The New York Times excoriated him for opposing 

Schapiro's plan, a popular blog reported that the "industry got to him" and called for 

"replacing turncoat regulators" as a "top priority" for President Obama. 

Ironically, Aguilar has actually been the current SEC's strongest investor advocate. 

Indeed, he was the lone opponent of Schapiro's recent proposal to allow hedge funds 

(including unregulated MMF surrogates) to publicly offer their shares without 

complying with any of the investor protections that apply to MMFs. Even Geithner 

conceded in his letter that the SEC must consider the potential for MMF reforms to 

drive cash to "unregulated cash-management products." 

The risks of MMF money flowing to hedge funds will only increase because the SEC's 

proposal will allow them to engage in public advertising. The SEC has taken the 

position that it is not required to consider the increased retail investor risk created by 

letting hedge funds loose in the mutual fund space. However, it now may find it 

necessary to consider the systemic risk of its hedge fund advertising proposal If it 

expects its MMF reforms to survive. 

The shoe yet to drop is the systemic risk created by driving MMF cash to banks, 

rather than to hedge funds. Placing additional burdens on MMFs will undoubtedly 

drive more cash to banks, over 3,000 of which have failed (compared with one retail 

MMF) since MMFs were first offered. Contrary to popular belief, banks pose risks for 

savers. Just ask retail depositors in the failed--but "insured"--lndyMac Bank who lost 

about 50% of their deposits above $100,000. They would have been far better off 

with a 1 °/o loss in the Reserve Fund--which lost more money than any MMF in history. 

Geithner wants the FSOC to focus on MMFs when it has not even gotten around to 

declaring D American International Group (AIG)--the archetype of too-big-to-fail 

systemic risk--to be a SIFI. He sees a huge threat in virtually risk-free MMFs while 

proposing no steps to deal with the fact that four firms--10> Bank of America (BAC), D 

)Neils Fargo (WFC), II> Citigroup (!:),and II> J.P. Morgan Chase (JPM)--control !I!Jlli'. 

than half of a !I bank holding company assets. 

It is banks, not MMFs, that are the epitome of the moral hazard model we should be 

devising ways to dismantle, not encourage. The Dodd-Frank Act increased moral 

hazard by raising the insured deposit limit from $100,000 to $250,000 (non-interestbearing accounts still have unlimited insurance), while doing nothing to shrink toobig-to-fail banks. The hard question that the SEC should tackle, but that it is likely to 

dodge, is whether driving MMF assets to banks would create more systemic risk, not 

less. 

The Ideological Divide 

The MMF battle reflects the economist's conceit that fixing the last crisis is simply a 

matter of finding the right formula. Basel Ill will correct the deficiencies of Basel II. 

The Volcker rule will prevent speculative trading. The Titanic will never sink. And 

http:/ /news.mormnqstar.comjartic1en€'t/Htm!Template/PrintArticle.htm-:>t1me""Ol835972 

4/l/14, l2:20AM 

Page 3 of 4 
122 


nshattuck on FSR297 with DISTILLERInsert offset folio 91 here 30773.091

PnrH 

Schapiro's 1% capital reserve coupled with a 3% redemption holdback will prevent 

another run on MMFs. No matter that a Fed study found that past bailouts of MMFs 

have exceeded 6% of assets. After the next run, we will simply increase the reserve 

requirement to 7%. 

The ultimate solution to panics such as the MMF run of 2008 has been the same as 

long as governments have coined money. Restoring confidence during financial panics 

requires a reliable source of infinite liquidity. Currently, the markets believe that the 

Fed has infinite liquidity (which depends entirely on the strange loop of our believing 

that it does). 

Yet it appears that the only regulatory model under which banking regulators can 

imagine resorting to the promise of infinite liquidity is their own, where taxpayerguaranteed deposits are invested by banks in illiquid, long-term, risky assets. 

Notwithstanding the extraordinary safety record compiled by MMFs investing in liquid, 

short-term, safe assets--backed by only an implicit government guarantee--banking 

regulators are only able to see the Reserve Fund's failure and the MMF run that it 

triggered. MMFs' short-term asset structure has proved to be a better, safer way to 

manage government-backstopped cash accounts than banks' long-term asset 

structure. 

The MMF battle embodies the central ideological divide in financial-services 

regulation. Banking regulation promotes the socialization of risk and thrives on 

secrecy. Securities regulation promotes the decentralization of risk and thrives on 

disclosure. Banking regulation places the highest value on a communitarian ethic of 

systemic safety and soundness, whereas securities regulation exalts an individualistic 

ethic of risk and reward. Banking regulation fosters the expansion of government 

power while securities regulation inevitably weakens it. These are the battle lines in 

the fight over the future of MMFs. 

t-1ercer Bullard is president and founder of Fund Democracy, a mutual fund shareholder advocacy 

organization, an associate professor of law al the University of Mississippi Schoo! of Law, a semor 

adviser for financial plann1ng f1rm Plancorp Tnc, and a former ass1stant chief counsel at the Secunlies 

and Exchange Comm1ssion. He has testified frequently before Congress on regulatory 1ssues, He can 

be reached at bu!lardm@funddemocracy.com. 

http:/ /news.morningstar.com/artic!enet/Htm!Template/PrintArtide.htm7time""01835972 

4/1!14, 12:20AM 

Pag!' 4of 4 
123 


nshattuck on FSR297 with DISTILLERInsert offset folio 92 here 30773.092

Delivered to the Staff of the 

Securities and Exchange Commission 

September 6, 2017 

Request for Guidance Related to Disclosure of BDC 

Expenses by Acquiring Funds 

The purpose of this paper is to request guidance from the Securities and Exchange 

Commission's Division ofinvestment Management related to disclosure requirements that 

inadvertently cause potentially misleading and inaccurate disclosures of fees by mutual funds 

and other registered funds when those funds invest in publicly traded business development 

companies ("BDCs"). The issue arises in the context of amendments to investment company 

registration forms adopted by the SEC in 2006. 1 The amendments require each fund registered 

under the 1940 Act to include in its prospectus fee table its pro rata share of any expenses of the 

shares it has purchased of another fund. These "acquired fund fees and expenses'' (commonly 

referred to as "AFFE") are included as a separate line item in the acquiring fund's fee table. 

The application of this disclosure requirement to BDCs distorts and overstates the 

expenses of mutual funds and other registered funds when those funds invest in BDCs. We 

request that the SEC staff treat BDCs like similar investment vehicles and issue guidance stating 

that the AFFE requirement does not apply to investments in BDCs. The guidance can be issued 

quickly and efficiently in the form of an FAQ, which we propose at the end of this paper. 

Neither the proposing release nor the adopting release for the AFFE rule made any 

reference to the AFFE disclosure applying to a registered fund's purchase of shares of a BDC. 

We understand that, after the fact, the staff applied the AFFE rule to BDCs, but the staff did so 

See Fund of Funds Investments, Investment Company Act Release No. 27399 (June 20, 

2006), available at: http://www.scc.gov/rules/final/2006/33-8713.pdf. 
124 


nshattuck on FSR297 with DISTILLERInsert offset folio 93 here 30773.093

without providing any robust explanation or justification for their inclusion and despite the fact 

that the staff did not apply AFFE disclosure to very similar investment products. such as real 

estate investment companies ("REITs''). More importantly, the staff applied the AFFE rule 

relating to BDCs without considering the effect of such application on investors or the BDC 

market. 

2 

The application of the AFFE rule to BDCs has resulted in grossly overstated expenses of 

funds that invest in BDCs, and as a result, misleading information is being disseminated to fund 

shareholders. This is because, as we explain in more detail below, the fees and expenses of 

BDCs already are reflected in the share price of the BDC. Adding those fees to fund disclosures 

double-counts those fees. To make matters much worse, the AFFE disclosure has resulted in an 

effective ban on BDCs from most indices. This consequently has restricted the market for 

BDCs, has limited institutional ownership of BDCs and has reduced investor choice for these 

beneficial investment options. 

We urge the staff of the Division of Investment Management to issue guidance, like it has 

done for RETTs and other similar investment products, clarifying that the AFFE rule does not 

apply to investments in BDCs. The guidance will result in more accurate expense information 

being provided to investors. It also will help attract institutional ownership of BDCs. This will 

benefit investors and the capital markets by allowing BDCs to provide greater support for capital 

formation and capital deployment to lower and middle-market companies. It also will promote 

beneficial corporate governance practices. 

Below we explain the benefits BDCs provide to investors and the markets. We then 

summarize the SEC's stated policy goals for adopting the AFFE rule and we explain, in light of 

these goals, the policy rationale for excluding BDCs from the AFFE disclosure. We also explain 
125 


nshattuck on FSR297 with DISTILLERInsert offset folio 94 here 30773.094

3 

the hann that the AFFE rule has caused to constituents in the BDC marketplace. Finally, we 

provide recommended language for staff guidance to remove BDCs from the A.FFE rule 

disclosure requirement. 

t. BDCs Benefit the U.S. Economy and Investors 

Congress established BDCs in 1980 to make capital available to small, developing, and 

financially troubled companies that do not have ready access to the public capital markets or 

other fonns of conventional financing. 2 BDCs must invest a certain amount of their assets in 

eligible portfolio companies. typically US issuers that arc either privately owned or have less 

than $250 million in market capitalization.3 

While not limited to debt investments, BDCs' primary role in the economy to date has 

been to provide debt financing to companies, primarily in the small and middle-markets, that 

may find it difficult to obtain traditional bank financing. These small and medium sized 

businesses are vital to promoting job fonnation and growth of the U.S. economy as a whole. 

This role has only increased in recent years as banks have pulled back from middlemarket lending in the face of stricter post-financial-crisis capital requirements. As their statutory 

mandate contemplated, BDCs have sought to expand their role and fill this void. They have had 

some success. managing over $50 billion as of April 1, 2017, while the number of publiclytraded BDCs has grown to more than 50 as of that same date. A supportive equity market, in the 

fonn of access to retail and institutional investors, is critical to tully realize Congress's goal in 

Small Business Investment Incentive Act of 1980, H.R. 7554, 96th Cong. (J 980), 

amending the Investment Company Act of 1940. 

U.S. Securities and Exchange Commission, "Definition of Eligible Portfolio Company 

under the Investment Company Act of 1940, Amendments to Rule 2a-46" (May 15, 

2008). 
126 


nshattuck on FSR297 with DISTILLERInsert offset folio 95 here 30773.095

4 

creating BDCs, and the staffs application of the AFFE rule has inadvertently limited BDCs' 

potential to do just that. 

To give just one example, Ares Capital Corporation ("Ares''), invested in OTG 

Management, Inc. ("OTG"), a founder-owned operator of full service sit-down and quick service 

restaurants, bars, lounges, gourmet markets, and news and gift shops in U.S. and Canadian 

airports. OTG had been awarded a contract to build and operate the food and beverage 

concessions at the new Terminal 5 at New York's JFK International Airport. As a small 

company with limited operating history, OTG had been unable to obtain financing from 

traditional lenders. Ares stepped in to provide OTG with much-needed capital, as well as 

management expertise and support, to assist OTG in continuing to grow its business. BDCs have 

the potential to create far more success stories, like OTG's, but the AFFE rule is hampering their 

ability to do so. 

In addition to their unique and valuable capital formation role. investments in BDCs 

provide many benefits to investors. Investors frequently find BDCs to be attractive and 

diversified investments, particularly in the current low interest rate environment. BDCs provide 

access to an asset class typically only accessible to institutional and wealthy investors through 

private funds, and they provide access to such investments in a liquid structure through exchange 

traded shares. BDCs pay out strong dividends, making them attractive to income-seeking 

investors, such as retirees. And they accomplish this in an efficient, flow-through tax structure. 

2. The SEC's Policy Rationale for Adopting the AFFE Rule Does not Apply to 

BDCs 

When adopting the AFFE rule, the SEC stated that its primary goal was to provide 

investors with a greater understanding of the actual costs of investing in a fund whose 

investments included shares of other "traditional investment funds.'' as some of those other funds 
127 


nshattuck on FSR297 with DISTILLERInsert offset folio 96 here 30773.096

5 

have their own expenses that may be equal to or higher than the acquiring fund. The SEC further 

stated that the disclosure requirement would allow investors to compare their investment 

opportunities, such as investing in alternative funds of funds or traditional funds. 

The SEC's policy goals do not apply to the operational expenses of a BDC. AFFE 

disclosure regarding investments in BDCs misleads investors-- it does not provide them greater 

understanding about the cost of investing in funds that invest in BDCs. And AFFE rule 

disclosure relating to BDCs does not result in an investor's ability to compare investment 

opportunities. Instead, the AFFE rule requires a double-counting ofBDC operating expenses. 

a. BDC "fees" are just like au operating company's expenses 

At the heart of the issue is a need to avoid confusing the fees of a BDC, which is not a 

traditional investment fund, with the expenses of a mutual fund or other traditional investment 

fund. The fees of a BDC arc a component of its operating costs, like the compensation expense 

of traditional operating companies which is not required to be included under the AFFE rule 

disclosure requirements. 

BDCs are registered under the Securities Act of 1933 and the Securities Exchange Act of 

1934, and are subject to all registration and reporting requirements under those two statutes. 

Similar to other operating companies, BDCs must file periodic reports, including Form I 0-Ks 

and, Form l 0-Qs, which include the BDC's statement of operations and other financial 

statements. A BDCs fees arc reported on its statement of operations as expenses. These 

expenses include compensation, real estate and other operating expenses. The statements of 

operations calculates a BDC's net investment income as the difference in revenues minus these 

operating expenses. The BDCs net asset value (NA V) is reported on the statements of assets 
128 


nshattuck on FSR297 with DISTILLERInsert offset folio 97 here 30773.097

6 

and liabilities and is calculated as total assets minus total liabilities. The information reported on 

these financial statements have a direct influence on a BDC's trading price. 

A BDC's fees and expenses, furthermore, are not direct costs paid by the acquiring fund's 

shareholder. They are not used to calculate the acquiring fund's net asset value. They have no 

impact on the costs associated with the operations of the acquiring fund. They also arc not 

included in the acquiring fund's financial statements, which provide a clearer picture of the 

acquiring fund's actual operating costs. 

b. The AFFE rule requires a double-counting of a BDC's expenses and results 

in misleading disclosure 

Long-established, traditional valuation techniques dictate estimating a firm's intrinsic 

value by valuing the assets in its portfolio. The typical approach is to conduct a discounted cash 

flow analysis to value all the assets in the portfolio. As outlined by one of the foremost 

authorities on valuation, Gaughan et al., ''The discounted future cash flows approach to valuing a 

business is based on projecting the magnitude of the future monetary benefits that a business will 

generate."4 The earnings or cash flows for each asset, which are calculated net of expenses, are 

discounted back to present value to dctennine the intrinsic value of the firm. Public share prices 

reflect a firm· s intrinsic value. According to Koller et al., another authority on valuation, 

"Valuation levels for the stock market as a whole clearly reflect the underlying fundamental 

performance of companies in the real economy .... Our studies indicate that, in most cases and 

Patrick A. Gaughan ''Valuation" in Mergers, Acquisitions, and Corporate Rcstructurings 

(Hoboken. NJ: John Wiley & Sons, Inc., 2007) p. 535. 
129 


nshattuck on FSR297 with DISTILLERInsert offset folio 98 here 30773.098

7 

nearly all the time, managers can safely assume that share prices retlect the markets' best 

estimate for intrinsic value.''5 

When an acquiring fund purchases a mutual fund, shares are purchased at the acquired 

fund's NA V. The NA V reflects the portfolio asset values but does not capitalize the present 

value of the future management fees, and these future management fees will represent a 

reduction in the investor's returns. When an acquiring fund purchases a BDC at its market price, 

however, that price effectively capitalizes future expenses. The BDCs trading price will already 

reflect its operating expense structure, which in tum will reduce the total return of the acquiring 

fund's investment in the BDC. Reflecting these expenses again under the AFFE rule results in 

double-counting a BDCs expenses, and hence the AFFE rule disclosure requirements will result 

in significantly overstating acquiring fund expense ratios. 

Disclosure in a recent Vanguard prospectus illuminates the point.6 In providing a 

rationale for an acquiring fund's expense ratio, the prospectus explained, ''Like an automaker. 

retailer. or any other operating company, many BDCs incur expenses such as employee salaries. 

These costs arc not paid directly by a fund that owns shares in a BDC, just as the costs of labor 

and steel are not paid directly by a fund that owns shares in an automaker. "7 The Vanguard 

prospectus went on to say that an acquiring fund is nevertheless required to include BDC 

expenses in an acquiring fund's expense ratio, and to explicitly state that "the expense ratio of a 

Tim Koller, Marc Hoedhart, and David Wessels, "Market Value Tracks Return on 

Invested Capital and Growth" in Valuation (Hoboken, NJ: John Wiley & Sons, Inc., 

2010). p. 326. 

Vanguard Explorer Value Fund Prospectus. "Plain Talk About Business Development 

Companies and Acquired Fund Fees and Expenses" (December 22, 2016). 

!d. 
130 


nshattuck on FSR297 with DISTILLERInsert offset folio 99 here 30773.099

8 

fund that holds a BDC will thus overstate what the fund actually spends on portfolio 

management, administrative services, and other shareholder services by an amount equal to these 

Acquired Fund Fees and Expenses.''8 As demonstrated by the Vanguard disclosure, including 

BDC expenses in an acquiring fund's fee ratio overstates the acquiring fund's expenses and 

provides misleading and inaccurate infonnation to investors. 

The Market Vectors BDC Income ETF (Ticker: BlZD), which tracks an index comprised 

almost entirely of BDCs, provides another example of how the AFFE rule forces an acquiring 

fund to overstate its expense ratio. 9 As reflected in the ETF's fee table in its most recent 

prospectus, the ETF' s management fee is 0.40%, the ETF's other expenses arc 0.18%, while its 

acquired tund fees and expenses arc 8. 79%, resulting in a gross operating expense ratio of 

9.37%. 10 That number massively overstates the fund's actual gross expenses of0.53%, as 

reflected in the ETF's annual report for the fiscal year ended April 30, 2016 (the period reflected 

in the ETF's fee table). The AFFE rule's applications to investments in BDCs required a 

dramatically large overstatement of this fund's expenses in its prospectus, and therefore a 

significant financial disclosure discrcpancy. 11 

This example shows the distortion of an acquiring fund's reported expenses when it is 

required to include BDC expenses in its AFFE rule disclosure, and calls into question the 

usefulness or validity of such disclosure to acquiring fund shareholders. Another example is the 

10 

11 

!d. (emphasis added) 

Market Vectors BDC Income ETF Summary Prospectus (September 1, 2016), available 

at: https://www.vaneck.com/etf/incomc/bizd/overview/ 

I d. 

VanEck Vectors ETF Trust Annual Report (April 30, 2017), available at: 

https://www.vaneek.com/etf/income/bizd/overview/ 
131 


nshattuck on FSR297 with DISTILLERInsert offset folio 100 here 30773.100

9 

impact on the Russel12000 Index. In 2013, before they were removed from that index, BDC's 

represented roughly 1.2% of the Russell 2000 Index. Though they represented only a very small 

portion of the index, inclusion of BDCs increased the expense ratio of the overall index by 25% 

(from 20 to 25 basis points). 12 If operating companies were the subject of AFFE disclosure, they 

would have a similarly distortive effect. 

c. The staff should treat BDCs the same as REITs and certain other nontraditional investment vehicles for purposes ofthe AFFE rule 

BDCs operate almost entirely the same way as RE!Ts. This makes sense because BDCs 

essentially modeled themselves structurally after RE!Ts. Like RETTs, BDCs operate a portfolio 

of financial assets (loans for BDCs, real estate for REITs) that requires sourcing and managerial 

expertise. Both REITs and BDCs are characterized as nontraditional investments that are 

designed to provide yield to investors, they are taxed identically under Subchapter M of the 

Internal Revenue Code, and, due to these similarities, they are often accepted in the same 

distribution channels. 13 

The AFFE rule is not applied to an acquiring fund's investment in securities issued by 

REITs, even though their fee and expense structures are materially identical to BDCs. We know 

of no sound policy rationale for treating RE!Ts and BDCs differently for purposes of the AFFE 

rule- both should be excluded because they function like operating companies, not traditional 

investment vehicles that were at the heart of the SEC's policy rationale for the requirement. 

12 

13 

Wells Fargo Securities Equity Research, ''The 1 Q 17 BDC Scorecard" (January 18, 20 17). 

See Cynthia M. Krus, Esq. and Owen J. Pinkerton, Esq., "How Are RE!Ts and BDCs 

Different?" FYI: Timely Insights by the Real Estate Investment Securities Association 

(REISA) (August 2012 Vol. 7, Issue 3). available at: 

https://www .adisa.org/MediaLibraries/REISA/1 mages/ .. ./FYI-August20 1 2.pdf 
132 


nshattuck on FSR297 with DISTILLERInsert offset folio 101 here 30773.101

10 

Almost immediately after adoption, the AFFE rule caused some confusion as to whether 

it applied to certain investments other than mutual funds and other traditional investment 

vehicles. Like our request for BDCs, other non-traditional investment vehicles have sought and 

obtained guidance that the AFFE rule does not apply to investments in them. The Investment 

Management Division issued FAQs discussing the disclosure of fund of fund expenses by mutual 

funds. 14 In response to "Question 1" of the F AQs, for example, the staff stated that requirements 

of the AFFE rule were not applicable to ·'collateralized debt obligations ["CLOs"], or other 

entities not traditionally considered pooled investment vehicles." The structure of CLOs are 

similar to that of BDCs in many ways. Like BDCs, CLOs are comprised of loan assets and 

distribute substantially all of their interest income from the such loans to investors. Despite the 

similar business models of CLOs and BDCs, BDCs were not included in the exception provided 

to CLOs in Question l of the AFFE FAQ. 

d. There is no evidence that the SEC intended to apply the AFFE rule to 

investments in BDCs 

We believe that BDCs never were the intended target of the SEC's AFFE rule. At the 

time the AFFE rule was proposed, the BDC market was exceptionally small-there were only 

five significantly sized BDCs in 2003, when the SEC proposed the AFFE rule. In 2003, BDC 

assets under management were less than $5 billion, but they have grown to over $50 billion in 

2017. This likely explains why the SEC did not analyze the impact on BDCs and why the 

limited number ofBDCs in existence at the time failed to provide any comments on the rule 

14 SEC Staff Responses to Questions Regarding Disclosure of Fund of Funds Expenses (last 

modified May 23, 2007), available at: 

https://www.sec.gov/divisions/investment/guidance/fundfundfaq.htm. 
133 


nshattuck on FSR297 with DISTILLERInsert offset folio 102 here 30773.102

II 

proposal. 15 There appears to have been little understanding of the implications of the AFFE rule 

on BDCs because the BDC marketplace was new and the impact of the rule on BDCs was not yet 

clear. BDCs might have commented if they had understood that the rule would be an effective 

ban on BDCs from most indices. 

Regulatory agencies have been directed by executive order to revisit and revise 

regulations that are unnecessary or ineffective, that eliminate jobs or inhibit job creation, or that 

impose costs that exceed benefits. 16 The application of the AFFE rule to BDC investments meets 

all these criteria. 

3. The AFFE Rule Has Reduced BDC Access to Capital aud Liquidity 

The AFFE rule's application to BDCs has created significant problems for BDCs in the 

capital markets and specifically has resulted in a substantial decline in institutional ownership. 

First, the inclusion ofBDC expenses in an acquiring fund's AFFE rule disclosure has 

negatively affected traditional institutional investment in BDCs (primarily mutual fund 

investments) due to the unnecessary consolidation of all the expenses of a BDC investment into 

the acquiring fund's expense ratio. This makes it very chalienging in a competitive mutual fund 

environment for portfolio managers to consider investments in BDCs because a large emphasis is 

placed on reported mutual fund expenses. 17 

15 

16 

17 

Comments on Proposed Rule: Fund of Funds Investments available at: 

http://www.sec.gov/rules/proposed/s71803.shtml. 

Presidential Executive Order on Enforcing the Regulatory Reform Agenda, Executive 

Order 13777 (February 24, 20 17). 

Wall Street Journal, "Fees on Mutual Funds and ETFs Tumble Toward Zero'' (January 

26, 2016). 
134 


nshattuck on FSR297 with DISTILLERInsert offset folio 103 here 30773.103

12 

Second, in 2014 the MSCI, Russell and S&P indices all removed BDCs from their 

respective indices primarily because of the AFFE rule disclosure requirement. 18 In all, the 

decisions by these index providers affected more than 30 BDCs, and BDC index performance in 

2014 showed a negative result. 19 The removal ofBDCs from these prominent indices has further 

reduced institutional share ownership in BDCs which has resulted in reduced BDC share 

liquidity and increased capital raising costs. Access to the capital markets is of particular 

importance for BDCs, because they are limited in their ability to retain capital. This is because 

BDCs are required to distribute a minimum of 90% of their taxable earnings annually and, as a 

practice, they typically pay out dividends at a relatively stable level. 

The impact on the total number of public BDCs and their assets under management 

(''AUM") as a result of their removal from the MSCI, Russell and S&P indices in 2014 is 

palpable, as the chart included as Attachment A shows. The steady growth in the number of 

public BDCs for more than a decade prior to 2014 has flattened since that time. In addition, the 

chart also shows that while AUM grew rapidly starting in 2010, it has declined during the last 

two years. 

After the exclusion ofBDCs from the MSCI, Russell and S&P indices, institutional 

ownership of BDCs also declined significantly. Earlier this year, one ofthc most respected 

research analysts on the BDC sector examined voting participation rates in BDCs and concluded 

that retail shareholders get better governance from the BDCs they're invested in when the BDCs 

18 

19 

See Removal of BDCs from Indices May Reduce Equity Access, Fitch Ratings (March 

13, 2014) available at: 

https://www.fitchratings.com/gws/en/fitchwire/fitchwirearticle/Removal-of. 

BDCs?pr _ id=823651. 

CEFA's Closed-End Fund Universe (December 31, 2014). 
135 


nshattuck on FSR297 with DISTILLERInsert offset folio 104 here 30773.104

13 

have strong/significant institutional ownership.2° Conversely, governance suffers when 

institutional ownership is lower. Institutional investment is imperative for providing access to 

capital for BDCs. which in tum supports the liquidity ofBDC shares, leads to improved 

corporate governance, and provides greater protection for all BDC shareholders. both retail and 

institutional. 

4. The Staff Should Amend the AFFEs Rule FAQ to Exclude BDCs 

The most efficient and direct way to remedy the disparate treatment of BDCs is simply to 

amend the AFFEs Rule FAQs to exclude BDCs. Our proposed AFFEs Rule FAQ is as follows: 

Question 9 

20 

Q: Although REITs are not excluded from the definition of"investment company" under 

sections 3(c)(l) and 3(c)(7) of the Investment Company Act, and are instead excluded 

under section 3(c)(5). AFFE disclosure requirements do not apply to REITs. Like RE!Ts, 

BDCs operate a portfolio of financial assets (loans for BDCs, real estate for REITs) that 

requires sourcing and managerial expertise, and their fees and expenses are materially 

identical to those ofRETTs. Does instruction 3(t)(i) to Item 3 of Form NI-A require an 

Acquiring Fund to disclose fees and expenses associated with investments in BDCs? 

A: No. Like REITs, BDCs are not considered to be traditional pooled investment 

vehicles of the type targeted by the AFFE disclosure requirements. 

Wells Fargo Securities Equity Research, "The IQ17 BDC Scorecard" (January 18, 2017) 

("lower institutional ownership led to a much less engaged shareholder base, which, in 

turn, led to much less corporate governance on behalf of retail investors .... Large 

institutional investors are often much better about actively vetting corporate/board 

proposals).'' 
136 


nshattuck on FSR297 with DISTILLERInsert offset folio 105 here 30773.105

WRITTEN STATEMENT FOR THE RECORD 

FOR THE HEARING ENTITLED 

"LEGISLATIVE PROPOSALS TO IMPROVE SMALL BUSINESSES' 

AND COMMUNITIES' ACCESS TO CAPITAL" 

UNITED STATES HOUSE COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES, AND INVESTMENT 

3 NOVEMBER 2017 

SUBMITTED BY THE COALITION FOR SMALL BUSINESS GROWTH 

Chainnan Huizenga, Ranking Member Maloney, Members of the Subcommittee, 

The Coalition for Small Business Growth (CSBG) thanks you for the opportunity to submit this 

written statement for the record for the 3 November 2017 hearing before the House Financial 

Services Committee entitled, ·'Legislative Proposals to Improve Small Businesses' and 

Communities' Access to Capital." CSBG is a national advocacy group composed of small 

business, financial institutions and law firms from around the country focused on protecting and 

expanding access to capital for small and mid-sized businesses in the U.S. 

Today's hearing comes at a critical time for America's Main Street businesses. In the aftermath 

of the financial crisis of 2008, large banks have retrenched from lending to small businesses. 

Stunningly, according to the Wall Street Journal, small business lending from the 10 largest 

banks collectively decreased 38% from 2006 to 2014, 1 while those institutions continued to grow 

in asset size. Fortunately, America's small businesses have had other options to keep them afloat 

and grow: business development companies (BDCs). 

BDCs are closed-end funds that provide capital to small- and middle-market companies, while 

allowing ordinary investors to finance startups- effectively ·'Main Street funding Main Street." 

Congress created BDCs in 1980 following a period of economic turmoil similar to the Great 

Recession. BDCs make direct investments in smaller, developing American businesses, 

providing access to capital for companies that may not be able to access capital from traditional 

1 https ://www. wsj .com/articleslbi g-banks-cut -back -on-small-busi nes~-144858663 7 
137 


nshattuck on FSR297 with DISTILLERInsert offset folio 106 here 30773.106

sources, such as banks. Importantly, a BDC is required by law to offer '"significant managerial 

assistance'' to any portfolio company invested in eligible assets. 2 They are also regulated by the 

Securities and Exchange Commission under the Investment Company Act of 1940, and publiclytraded BDCs are subject to the disclosure requirements under the Securities Act of 1933 and the 

Securities Exchange Act of 1934. Despite an outdated regulatory regime that is now more than 

36 years old, BDCs have managed to provide over $87 billion in investment capital to America's 

entrepreneurs and have evolved into a primary source of Main Street financing. This growth 

accelerated following the economic downturn after the recent financial crisis, where BDCs 

addressed the needs of companies starved for capital. Currently, there arc over 80 BDCs in the 

United States and, at a time when bank lending has scaled back significantly, BDC loan halances 

have more than tripled since 2008. 

While BDCs have attempted to fill the financing gap, there are nearly 200,000 middle market 

businesses that represent one-third of private sector GDP, employing approximately 47.9 million 

pcople3 eager for capital to grow. hire, and expand the economy. With the appropriate 

modernization of the outdated regulatory regime with common sense changes, Congress can help 

BDCs continue to fund America's entrepreneurs. 

Reform of Asset Coverage Test 

The first modest change Congress can make to help unleash lending to small businesses is to 

update the asset coverage test. Today, while BDCs often take the place of banks in filling the 

void in lending to small businesses, they are subject to much more restrictive asset coverage 

rules than banks. Specifically, BDCs are not pennitted to borrow more than $1 for every dollar 

of assets they own, while banks are permitted to borrow up to $10 (or more), and small business 

investment companies (SB!Cs)--which function similarly to BDCs-are allowed to borrow $2. 

While being allowed to maintain a l :1 debt to equity ratio, currently most BDCs maintain an 

average leverage ratio of0.5x-0.75x, reflecting a desire and a practical need to maintain an 

adequate cushion in the unprecedented, unlikely event of a sudden and steep drop in asset values. 

This practice is driven in part by the requirement that BDCs ''mark-to market" the value of their 

portfolio companies, which can erode the fair market value of a BDC's holdings due to negative 

changes in the broader loan market, irrespective of the actual financial performance of such 

portfolio companies. The maintenance of this cushion has the unintended effect of reducing the 

ability of BDCs to raise and invest capital, thereby frustrating the original intent of Congress to 

increase capital to small- and medium-sized businesses. 

To solve these problems we encourage Congress to enact a modest increase in the BDC asset 

coverage test from a 1: I to a 2: l debt to equity ratio, thereby allowing BDCs to increase their 

lending to small businesses while allowing them to simultaneously decrease their risk-profiles by 

allowing BDCs to invest in lower-yielding, lower-risk assets that don't currently fit their 

economic model. We believe that this proposed change will benefit borrowers through greater 

'See Investment Company Act, 15 U.S.C. §2(a) 47 -· 48. 3 http://www. mi<ic!kmai!<etcentcr.org/M_e<!iJlffi.osc~m_c_nts/MiddleMarketlndicators/20 16-

04/FuJIReooJ:(;j\JCMM MMI 04 2016 web.pdf 
138 


nshattuck on FSR297 with DISTILLERInsert offset folio 107 here 30773.107

financing alternatives and a reduced cost of capital, and will also benefit shareholders by 

enabling BDCs to construct more conservative, diversified portfolios. 

Because BDCs are already required to file quarterly valuations of their portfolios, and are subject 

to very strict Securities and Exchange Commission (SEC) reporting and disclosure rules, if 

BDCs were provided additional leverage, shareholders would be fully informed and safeguarded 

from any additional risk. 

As an additional investor protection, we would propose significant safeguards for accessing 

additional leverage, including (i) a shareholder vote or (ii) an independent board of director vote 

with a 12 month "cooling off' period. These protections will ensure that a BDC's shareholders 

will be able to decide whether they want to continue to hold shares of a BDC that plans to access 

additional leverage. 

Offering Reform 

Second, while Congress has streamlined burdensome reporting and disclosure requirements for 

small operating companies, it has not extended this regulatory relief to their BDC business 

partners. Despite having developed into a mature and trusted lending sector, BDCs are required 

to file lengthy, duplicative SEC statements and wait for the SEC to review them. Many 

companies, including BDCs, often have a very narrow window in which to access the capital 

markets. Access to this streamlined reporting and registration process under the federal 

securities laws, where the information included in a company's periodic reports is integrated 

seamlessly into a registration statement, would enable BDCs to more efficiently access the 

capital markets, thereby enabling BDCs to bring this capital more quickly to small and mediumsized businesses. 

BDCs and other operating companies are subject to generally the same disclosure regimes. To 

the extent that other types of operating companies are eligible to be well known seasoned issuers 

(WKSl), we urge Congress to create parity among all operating companies, including BDCs, to 

be WKSI-eligible. We would further request Congress direct the Commission to amend a series 

of rules so that BDCs have access to safe harbors available to other operating companies under 

Rules 168 and 169, Rules 163A and 163, Rules 134. 164,433, 138, and 139. We would further 

request Congress direct the Commission to amend Rule 415(a)(l )(x) to clarify that BDCs can be 

.. qualified" to register on Fonn S-3 even if they are required to register on Form N-2. We would 

also request similar clarifying amendments to Rule 497 effecting BDC usage of shelf registration 

and changes to Rule 172 so that BDCs may rely on this "access equals delivery" rule. Finally, we 

urge Congress to direct the Commission to allow BDCs to use incorporation by reference on 

Form N- 2. 

Conclusion 

Thank you for your consideration ofrefonns to help spur small businesses lending. Commonsense reforms to modernize BDC regulations would permit BDCs to continue to fill the capital 

void for many promising small businesses and expand the amount of critical financing they can 
139 


nshattuck on FSR297 with DISTILLERInsert offset folio 108 here 30773.108

make accessible to America's entrepreneurs and communities that are the engines ofU,S, 

economic growth. 
140 


nshattuck on FSR297 with DISTILLERInsert offset folio 109 here 30773.109

Gilbride, Mark 

From: 

Sent: 

To: 

Subject: RE: Stivers 

Mark- below is some clarification from Jonathan. 

t wanted to offer some additional color on our "effective leverage" stat in our BDC scorecard as I'm concerned items are 

being taken grossly out of context. 

First, effective leverage should not be confused with financial leverage (which is what the bill discusses). Effective 

leverage is a look at a global risk profile for a BDC as derived by its asset composition-and not simply the amount of 

debt on the balance sheet and it's a mistake to assume the two are the same. 

For example, my research shows that a BDC who chooses to invest in CLO equity and mezzanine loans today carry a 

much higher risk level than those BDCs who choose to invest in 1st lien debt. That said, it is much harder for investors to 

grasp/quantify this point. So, to make this asset composition point more palatable for investors, I simply apply a set of 

broad assumptions to BDC portfolio composition to assume a !eve! of debt ahead of that investment. This isn't exact and 

it in no way is a gage of financial leverage being taken on by the BDC. It just shows that BDCs who hold more risky 

securities are in fact riskier. I could have easily have called this factor asset composition {which I did when I first started) 

and simply weighted all BDCs by their ownership of 1st lien debt. You might ask why I went the effective leverage route? 

The reason I altered the factor early on was that asset composition risks went well beyond who had the most senior 

debt For example a BDC with a 70% senior debt and 30% sub debt is much less risky than a BDC with 70% senior debt 

and 30% CLO equity-~-so I needed a way to help investors distinguish between the two (hence the current scorecard 

factor). 

Also taking a step back, if folks would like to talk about embedded leverage risks with BDCs and pass it off as financial 

leverage-then those same individuals might want to re-examine a !I bank I REIT balance sheets-whose leverage levels 

would skyrocket. 

The major point missed here is that investors through this analysis and the BDCs transparency have the actual ability to 

understand overall asset composition risks ln a SOC portfolio. Banks don't offer that transparency. I'll argue RE!Ts do not 

either. Interestingly enough, because of this factor investors have been rightfully avoiding BDCs with high concentrations 

of subordinated securities-not because they believe these securities to be highly levered, but because they believe the 

assets within these funds to be of higher risk. lnteresting!y, if folks just use this one scorecard factor in a vacuum they 

miss the fact that the higher effective leverage {i.e. asset composition) goes to lower the BDCs overall scorecard rank 

(identifying to investors it is more risky)! 

lastly, folks arguing that effective leverage is too high {thus this isn't a reason to look at the bill) miss the fact that 

increasing the leverage constraint will actually make effective leverage levels FALL, not rise. At current leverage 

constraints, several BDC managers are actually reaching for risk owning low quality subordinated securities {CLOs/sub 

debt) to try and hit a yield bogey for investors. With additional financial leverage, BDCs will be able to earn the same net 

return for investors but do so in a much safer asset class {lst!ien debt)-thus effective leverage overall falls. More 

Importantly, to the folks who believe that BDCs will simply lever AND buy risky securities, they are completely missing 

the point that both the banks and the capital markets several restrict ownership of higher risk securities. Banks don't 

lend to CLO equity as well as subordinate debt Moreover, it is very difficult for BDCs that own high amounts of risky 

securities to issue equity or term debt~ .. -just look at TICC! 
141 


nshattuck on FSR297 with DISTILLERInsert offset folio 110 here 30773.110

Page 1 of 1 

fi le:/1/C:/Users/mgi !bride/ A ppData/Local/Microsoft!Windows/Temporary%20lnternet%20 .. 11/3/20 17 
142 


nshattuck on FSR297 with DISTILLERInsert offset folio 120 here 30773.120

NVESTMENTS" 

Michael F. Gerber 

Executive Vice President, Corporate Affairs 

FS Investments 

Philadelphia, PA 19112 

Honorable Gregory W. Meeks 

Committee on Financial Services 

U.S. House of Representatives 

Washington, DC 20515 

Responses to November 3, 2017 Questions for the Record 

Dear Congressman Meeks, 

Thank you for your additional questions the November 3, 2017 Hearing on Legislative Proposals to 

Improve Small Business' and Communities' Access to Capital. My responses to your questions are 

set forth below. 

1. Mr. Gerber, one of the reasons I have been examining regulatory changes to the BDC asset 

coverage test is that small businesses, who are the engines of economic growth in my district, have 

been struggling to access capital ever since the financial crisis in 2008. Opponents of altering the 

asset coverage test claim this will harm financial stability, even if debt to equity simply increases to 

2 to 1, which is significantly lower than leverage at other lenders like banks, who are 10 to 1 -

and the same as SBICS (2 to 1). Can you please explain if and how BDCs can continue to lend safely 

if they increase their ability to borrow $2 for every $1 of equity? 

Increasing BDCs' debt to equity ratio limit from 1:1 to 2:1 is a very moderate increase. 

Relative to other lenders, such as banks (debt to equity ratio of 8:1 to low·teens) 1 and hedge funds 

(high-teens to low 20's),2 BDCs, even at 2:1, would remain the most conservative users of leverage, 

1 United States Federal Deposit Insurance Commission, Global Capita/Index, (June 2017). 2 UK Financial Conduct Authority, 2017 Hedge Fund Survey, (2017). 
143 


nshattuck on FSR297 with DISTILLERInsert offset folio 121 here 30773.121

by far, while maintaining the most transparent lending model. BDCs can use this moderate 

additional leverage to construct safer portfolios for investors. In the current low interest rate 

environment and under the current l:lleverage limitation, BDCs typically choose between two 

general investment strategies. The first strategy is to seek yield by investing deeper in the capital 

structure of a portfolio company. Such an approach creates more risk in the event the portfolio 

company experiences difficulty as there is less capital behind a BDC's investment to absorb 

potential losses. The second strategy is to accept lower yields by investing higher in the capital 

structure of a portfolio company. This approach lessens inherent risk given the position of a BDC's 

investment in the portfolio company's capital structure, but also reduces returns to the BDC's 

investors. An increase to the permissible debt-to-equity ratio would open up a third option. With 

slightly more leverage, BDCs could invest in assets higher in the capital structure that generate less 

yield and apply the additional leverage to this strategy to compensate investors for the lower 

inherent risk and generate comparable returns. For these reasons, FS strongly supports increasing 

the BDC debt to equity ratio to 2:1. 

2. Another reason I have been supportive of BDCs is the connection to Main Street. Congress 

created these entities so that non-accredited investors could help finance lending to small and 

medium-sized businesses. But I understand that some regulatory decisions have mislead investors 

about BDCs, which may impede interest in investing in BDCs, ultimately depriving these small 

business lenders of the capacity to fund entrepreneurs. Specifically, the Coalition for Small Business 

Growth put out a white paper recently on "acquired fund fees and expenses" (AFFE) as it relates to 

BDCs, noting that "the application of the AFFE rule to BDCs has resulted in grossly overstating 

expenses of funds that invest in BDCs, and as a result, misleading information is being disseminated 

to fund shareholders." Further, the white paper notes that the SEC incorrectly applies this to B·Dcs 

despite not applying similar requirements to very similar investment products. Mr. Gerber, can you 

please explain (1) what impact this has on investors seeking to fund BDCs, and (2) whether and how 

this can be addressed to minimize the ultimate impact on America's small businesses who are 

seeking investment capital? 

When adopting the AFFE rule, the SEC stated that its primary goal was to provide investors 

with a greater understanding of the actual costs of investing in a fund whose investments included 

shares of other "traditional investment funds," as some of those other funds have their own 

expenses that may be equal to or higher than the acquiring fund. However, the application of the 

AFFE rule to BDCs has actually distorted investor's understanding of BDC fees, harming investors, 

the industry, and the small businesses that rely upon BDC's for capital. 

Given the capital-intensive nature of sourcing and managing a bespoke portfolio of 

investments, BDC expense ratios can be high. However, BDCs quarterly report their net asset value 
144 


nshattuck on FSR297 with DISTILLERInsert offset folio 122 here 30773.122

(NAV), which accounts for the fees and expenses associated with managing such a portfolio. This 

information has a direct impact on a BDC's trading price. When an acquiring fund purchases a BDC 

at its trading price, that price already reflects the BDC's expense structure. Requiring funds to 

report BDC expenses again under the AFFE rule is actually misleading to investors because these 

expenses are already accounted for in the share price. Thus, the AFFE rule results in a double 

counting of BDC expenses, artificially inflating acquiring fund expense ratios. 

The gross overstatement of BDC "fees" as a result of AFFE has reduced institutional 

investment (primarily by mutual funds) in the industry, as the inflated expense ratios make it 

difficult for funds to justify BDC holdings. The rule also resulted in the MSCI, Russell and S&P indices 

removing BDCs from their respective indices, further decreasing institutional investment- reducing 

BDC share liquidity and increasing the cost of raising capital. The industry's removal from indices 

has also resulted in less analyst coverage, further decreasing institutional investment and leaving 

retail investors without high-quality information upon which investment decisions can be made. 

This reduction of institutional investment has also resulted in a less engaged shareholder base, 

leading to less corporate governance on behalf of retail investors. Therefore, although the rule was 

enacted with the best of intentions, which FS supports, in practice AFFE has generally mislead 

investors regarding BDC "fees" and left investors without the information and mechanisms to make 

and protect their investment decisions. 

If the SEC were to exempt BDCs from AFFE, institutional investment in the industry would no 

longer be hampered by the misleading effects of the Rule. Mutual funds and ETFs could reasonably 

justify investing in BDCs to their shareholders, and the return of institutional investment would 

likely result in a positive feedback loop, resulting in even more institutional investment in the 

industry. This increased institutional investment and associated analyst coverage would likely result 

in BDCs being added back to the MSCI, Russell, and S&P indexes. The potential capital infusion to 

BDCs resulting from this change is significant. In the first two months following the S&P's decision to 

de-list BDCs, industry shares fell an average of 8.4% relative to a 3.7% decline in the S&P 500.3 This 

decrease in share liquidity increased BDC's cost of raising capital, ultimately hampering the ability of 

BDCs to make investments. Therefore, resolving the AFFE issue for BDCs will increase share liquidity 

and reduce the cost of raising capital for the industry, allowing the industry to invest more capital 

into portfolio companies. 

Despite the structural and regulatory similarities of REITs and BDCs, AFFE has not been 

applied to REITs. Thus, there is a logical regulatory precedent for staff at the SEC to follow in 

providing BDCs with an exemption from AFFE. Through conversations with the SEC Commissioners 

and Investment Management Division staff, FS believes a formal rulemaking process is unnecessary 

to provide the necessary relief. Rather, FS believes a series of regulatory options, short of formal 

rulemaking would be sufficient to remedy this issue. Doing so would not only improve market· 

3 Fitch Ratings, Removal of BDC's from Indices May Reduce Equity Access, 

https://www.fitchratings.com/gws/en/fitchwire/fitchwirearticle/Removal-of-BDCs?pr_id=823651 (March 13, 2014). 
145 


nshattuck on FSR297 with DISTILLERInsert offset folio 123 here 30773.123
146 


nshattuck on FSR297 with DISTILLERInsert offset folio 111 here 30773.111

nshattuck on FSR297 with DISTILLER

Massive flight from Prime and Tax Exempt money 

funds 

Prime funds, a key funding source for corporations and banks, 

feU from $1.73 tri!!ion to $0.62 trillion 

Tax exempt funds, a key funding source for municipalities, 

universities and hospitals, fell from $254 b!f!ion to $135 billion 

In total, $1.22 trillion has exited Prime and Tax Exempt funds 

between July 2015 and July 2017 

Source: SEC, Treasury Strategies 

Municipal borrowers hit with higher rates Main street businesses see credit contraction 

Investors see sub par returns 

www. T reasuryStrategies.com 

nshattuck on FSR297 with DISTILLER

Investors forced to abandon Prime and Tax Exempt funds 

Sweep Accounts rendered inoperable by the fluctuating NAV 

Fees, gates and FNAVs not permitted under many corporate investment policies 

Fees, gates and FNAVs not permitted by many loan covenants and bond indentures 

Fees, gates and FNAVs not permitted by most state and local government investment p

Tax and recordkeeping requirements raise operational costs to investors in Prime and T

Exempt funds. 

These structural barriers will prevent much money from ever returning - no matt

wide Prime vs. Government fund spreads, nor how attractive Prime and Tax Exe

rates. 

Current Prime vs. Government spreads recently hit 30 bps - double the historic 

average (cranedata.com)- yet only a few billion of the $1.2 trillion exodus has t

back. 

TE MMFs exceeded $500 billion prior to interest rates falling to zero after the fin

crisis. Absent the regulations, assets in TE MMFs today would likely be much g

than before rates started to rise. 

nshattuck on FSR297 with DISTILLER

Biggest Winners 

US Government and Agencies - $1.2 Trillion 

GSEs such as the Federal Home Loan Bank and 

Freddie Mac - $263 Billion 

US Treasury and Repo - $567 Billion 

Winners are rewarded with lower borrowing 

costs and significantly increased access to 

credit Source~ SEC, Cranedata, Treasury Strategies 

Biggest Losers 

Business and Municipal borrowers - $1.2 Trillio

Business borrowers - $371 Billion 

Municipal borrowers - $145 Billion 

Financial institutions- $700+ Billion 

Investors - $1.2 Trillion 

Main Street business borrowers get crowded out by 

borrowers; pay higher borrowing costs and see more 

limits. 

Municipalities maintain credit access but at higher pr

market rates 

Investors get 20bps- 30 bps lower rates on Gov't fu

$2.5- $4 billion in lost income 

Note: Large, highly rated corporate borrowers seek 

elsewhere; find it at competitive rates 

www. TreasuryStrategies.com 

nshattuck on FSR297 with DISTILLER

Tax Exempt MMFs assets fell from $254 Billion to $135 Billion between July 2015 and July 

shrinking the funding pool available to municipal borrowers 

Primary instruments for municipal borrowing are variable rate demand notes (VRDNs), mai

by Tax Exempt MMFs. Rates reset weekly or monthly based on the SIFMA index, even tho

are long-term instruments. 

In a radical shift of the supply and demand dynamics, the supply of funds to buy VRDNs fell m

half, yet demand remained constant, which caused rates to rise 

Some municipalities still have Tax Exempt MMFs owning their VRDNs but now pay substantially highe

The remaining municipalities must resell their notes to other investors at even higher rates 

Municipalities unable to find buyers must put their notes back to a commercial bank, at still higher rate

The lowest municipal borrowing costs are up far more than Fed rate increases 

From January 2016 (nine month prior to the implementation of the SEC regulations) thru Sept. 27 201

SIFMA index increased 93bps, from 1 to 94 bps 

Over the same period, Fed Funds rose from 50 to 125 bps- an after-tax increase equal of 45 bps* 

*Assumes a 40% tax rate; 60% of 75 bps (125 bps- 50 bps)= 45 bps 

nshattuck on FSR297 with DISTILLER

Municipalities fortunate enough to continue selling VRNDs to Tax Exempt MMFs saw 

borrowing costs skyrocket at double the Fed rate increase- 94 bps vs. 45 bps after 

others, the they would have to borrow from other investors or replace the VRDN with bank 

much higher rates. 

Prior to the market adjustments to the new MMF regulations, municipal short term borrowi

were consistently sell under the after tax Fed Funds rate. Since then, however, municipal 

have been well above the after tax Fed Funds rate. 

nshattuck on FSR297 with DISTILLER

Primary pools of short term capital for U.S. businesses are bank commercial and industria

loans and Prime MMFs 

Large firms with top credit ratings borrow from Prime funds 

Small and medium businesses borrow from commercial banks 

In July 2015, capital available from these sources was $2.35 trillion 

Bank C & I loans totaled $1.89 trillion 

Prime MMFs provided $460 billion 

By July 2017, that capital pool shrank by $161 billion to $2.19 trillion, the direct result of in

leaving Prime MMFs. 

Banks C & I loans grew $210 billion, to $2.1 trillion 

Prime MMFs funding for businesses shrank by $371 billion, to $88 billion 

Main street businesses were much more severely impacted by this shift 

" Large, highly rated borrowers could replace their Prime MMF debt with bank borrowings 

The $161 billion shortfall burden fell on the shoulders of main street businesses. They have been c

of bank lending sources by the larger companies. Some now pay higher rates to alternative lenders

be simply unable to borrow at any competitive rate. 

For each $1 billon of Prime MMF debt that a large company replaces with bank borr

10,000 main street businesses lose access to $100,000 in funding. 
153 


nshattuck on FSR297 with DISTILLERInsert offset folio 118 here 30773.118
Æ 


nshattuck on FSR297 with DISTILLER

Treasury Strategies, a division of Novantas, Inc., is the leading treasury consulting firm. Armed with decades of 

experience, we've developed solutions and delivered insights on leading practices, treasury operations, technolog

risk management for hundreds of companres around the globe. 

We serve corporate treasurers, their financial services providers and technology providers for the complete 360' v

treasury. 

Novantas is the industry leader in analytic advisory services and technology solutions for retail and commercial ba

We create superior value for our clients through deep and insightful analysis of the information that dnves the fina

services industry- across pricrng, product development, treasury and risk management, distnbution, marketing, 

sales management. 

With more than 200 professionals, Novantas and Treasury Strategies make a formidable team in both bank and 

corporate treasury markets. 

Email us at info@treasurystrategies.com 

Connect With Us 

+1 312A43-084

www.youtube.com/c/treasurystrategieslncconsult