Comment Letters

SBIA Comment Letters to the Securities and Exchange Commission

On June 28, 2016, the SEC released a proposed rule which will require SEC-registered advisers, including those advising private equity funds, to implement written business continuity and transition plans reasonably designed to address operational and other risks related to a significant disruption in the investment adviser's operations.  The proposed rule would also amend rule 204-2 under the Advisers act to require advisers to make and keep all busincess continuity and transition plans that are currently in effect or at any time within the past five years were in effect.  SBIA submitted comments on the proposal on September 6, 2017.

SBIA Comment Letters on Tax

On July 23, 2015, the Treasury Department released a new proposed rule amending the Internal Revenue Code in regard to the characterization of certain partnership arrangements, and may impact private equity partnerships’ utilization of “management fee waivers.” Comments on this proposed rule are due on November 16, 2015. SBIA submitted a comment letter on this issue on November 13, 2015, which is available here. The Proposed Rule sets out factors that may indicate that a partner in a partnership is inappropriately receiving preferential tax treatment from an arrangement that disguises “payment for their services” as an allocation of partnership income. For example, this may occur where a partner takes a share of a private equity fund’s profits (at a lower capital gains tax rate), instead of being compensated immediately through a fee payment (taxed at the individual rate) for services rendered to the partnership. The new rule seeks to limit the ability for these partners to receive distributions from the partnership at the lower capital gains tax rate by evaluating the compensation arrangement through six factors. This may implicate certain structures of private equity or SBIC “management fee waivers” which allow general partners (GPs) in funds to offset their management fee in return for more of the carry income from the partnership during the harvesting period of the fund.  The six factors the Internal Revenue Service (IRS) will use to evaluate whether this allocation of partnership income is a “disguised payment for services” include: 
  1. A lack of entrepreneurial risk;
  2. The transitory nature of the partner’s interest;
  3. The time between the service provider’s rendition of services and distribution;
  4. Evidence of the service provider joining the partnership solely for tax benefits;
  5. The value of the distribution relative to the service provider’s interest in the profits of the partnership; and
  6. The existence of differing values of distributions or levels of risk with respect to different services rendered. 
The Proposed Rule indicates that the entrepreneurial risk factor is the most important factor, and lack of risk will be presumed by a showing of:
  • Capped allocations of partnership income;
  • An allocation for one or more years under which the service provider’s share of income is reasonably certain;
  • An allocation of gross income;
  • An allocation that is predominantly fixed in amount; and
  • An arrangement in which a service provider waives its right to receive payment for the future performance of services in a manner that is non-binding or fails to timely notify the partnership and its partners of the waiver and its terms. 
These factors can be rebutted by a showing of other facts and circumstances that establish the presence of significant entrepreneurial risk by clear and convincing evidence.

SBIA Comment Letters to the Small Business Administration

 On May 31, 2017, SBIA submitted a comment letter on the SBA Passive Business Rule. The rule, which was scheduled to be implemented on January 27, 2017, has been delayed multiple times for additional comment under the new Trump Administration. According to the Federal Register notice, SBA is "considering removing the provision that would allow SBICs to use a blocker entity...if an investor in an SBIC, typically a business development company (BDC), has elected to be taxed as a regulated investment company (RIC) and a direct investment into the operating company would cause the investor to receive income that would jeopardize its RIC status." SBA opened this most recent comment period to receive feedback regarding the removal of this provision.
Regarding the blocker provision, SBIA commented that, rather than removing the provision altogether, entities who choose that investment structure should be allowed a pre-approval mechanism. If BDCs cannot take advantage of this provision, they are severely limited in their ability to take equity positions, and they pass along millions in profits. As the letter states, "Preventing BDCs from having any equity positions in their portfolio limits some of the most important profit upsides while maintaining downside risk - thus removing a core taxpayer protection..."
SBIA urged the SBA to implement it expeditiously and ease burdens on SBICs.
On February 14, 2017, SBIA submitted a comment letter in opposition to the SBA's proposed rule hiking licensing and examination fees for SBICs. SBA issued this proposed rule on December 16, 2016, which almost doubled licensing and examination fees over the next 4 years, and adjusted for inflation after that date. SBA anticipated adding $3-4 million in fee revenue each year by October 2020 under the proposal. SBIA argued in our comment letter that SBA no longer had the authority to issue this regulation due to the recent executive order on regulations issued by President Trump, as well as that the SBA had not adequately made the case for why these dramatic fee increases were necessary, or that resources raised would be dedicated to the SBIC program.
On December 28, 2016, the SBA released as a final rule the Passive Business Rule, which provided a number of important regulatory changes to help SBICs when structuring deals, including permitting the use of blocker corporations to prevent adverse tax consequences for foreign investors, and impacts on RIC status for BDCs with SBICs. The rule was scheduled to be implemented on January 27, 2017.
Due to a memorandum released by the new Trump Administration labeled "Regulatory Freeze Pending Review", implementation of the rule will be delayed until March 21, 2017.
Therefore, the changes in the final rule cannot be relied upon until the rule is implemented.  SBIA submitted a letter to the SBA on February 15, 2017, noting that while the rule still should be improved, it should be finalized expeditiously to provide relief for our SBIC and BDC members.
On December 16, 2016, the SBA released a new administrative fee rule.

On February 14, 2017, SBIA submitted a comment letter in opposition to the SBA’s proposed rule hiking licensing and examination fees for SBICs.  The proposed rule almost doubled licensing and examination fees over the next 4 years, and continually adjusted for inflation upwards after that date.  SBA anticipated adding $3-4 million in fee revenue each year by October 2020 under the proposal.  SBIA argued in our comment letter that SBA no longer had the authority to issue this regulation due to the recent executive order on regulations issued by President Trump, as well as that the SBA had not adequately made the case for why these dramatic fee increases were necessary, or that resources raised would be dedicated to the SBIC program. 
On December 14, 2016, the Small Business Administration held an Examiner’s Workshop to which SBIC accountants, tax professionals, attorneys and other fund administration personnel were invited.  A number of issues were discussed that impact those operating in the SBIC space, including the current priorities for SBIC examinations.  Please see the attached memorandum for more information, as well as this overview on the operations of the Passive Business Rule (which has not yet been finalized).
SBA issued a proposed rule on September 19, 2016, updating the Early-Stage SBIC program and incorporating changes suggested in a 2015 request for comments.  SBIA submitted a Comment Letter on May 18, 2015 in response to that request for comment, presenting a series of recommendations directed at improving the Early Stage SBIC Initiative and the broader SBIC program.

SBIA submitted a further comment letter on the new proposed rule on October 19, 2016, applauding some of the changes adopted from our 2015 letter.  Our comment letter also suggested a number of additional improvements to make the program more attractive, including making it clear what standards are required to receive a license under the program, and permitting early-stage SBICs to impose higher prepayment penalties on convertible debt provided to portfolio companies.

The 2016 comment letter is available here.
SBA  issued a notice for public comment on the MAQ and License Application Forms in June 2016. SBA requested comments on (a) Whether the collection of information is necessary for the agency to properly perform its functions; (b) whether the burden estimates are accurate; (c) whether there are ways to minimize the burden, including through the use of automated techniques or other forms of information technology; and (d) whether there are ways to enhance the quality, utility, and clarity of the information. This provided an opportunity for our members to provide feedback on the information requested in the MAQ and License Application.

On August 15, 2016, SBIA submitted a comment letter in response to the request for comment highlighting a number of changes that should be made to the forms.
On February 3, 2016, the SBA released a new proposed rule defining a new class of SBICs called “Impact SBICs”. This formalizes the Impact Investment SBICs that have been licensed since April 2011 when the SBIC launched its Impact Investing Initiative.  The goal of Impact SBICs is to target capital investments into segments of the economy where capital formation gaps exist, such as in LMI areas, economically distressed areas and rural areas, as well as in certain underserved sectors.  SBIA submitted the following comment letter on the Proposed Rule on March 4, 2016.

 The proposed rule does the following: 
  • Creates a new definition of Impact Investment (divided between the following)
    • SBA-Identified Impact Investments (SBA designated geographic areas)
    • Fund Identified Impact Investments (SBICs own definition of impact, and that are proposed by the SBIC and approved by SBA during licensing process)
  • Creates a new Impact SBIC designation requiring the following to be licensed as an Impact SBIC:
    • Must be organized as a limited partnership;
    • Impact SBIC designation applies to those licensed under this new proposed rule and those launched since 2011 under the Impact Investing Initiative;
    • Must invest at least 50% of its financing dollars in small business concerns meeting the “impact investment” definition above; (follow-on investments in the same portfolio company would count towards the 50% requirement)
  • Fee Discounts:
    • Licensing Fee Discount (60%)
      • Impact SBICs would receive a 60% licensing fee reduction to incentivize the formation of Impact SBICs.  SBA would devote neither less time nor fewer resources to the licensing process for Impact funds as opposed to traditional SBICs.
      • SBA is able to recoup these discounts if the fund does not end up getting licensed as an Impact SBIC
      • Current SBIC Licensing fees are the following:
        • All Applicants: $10,000
        • Partnership Licensees: $15,000
        • Early-Stage Licensees: $25,000
      • Examination Fee Discount (10%)
        • Impact SBICs would receive a 10% licensing fee reduction in the examination “base fee”.  Current Impact funds would be eligible for this discount on an going forward basis.
        • The Base Fee for all SBICs is determined by the licensee’s total assets (at cost) as of the date of the latest certified financial statement and ranges from a minimum of $3,500 to a maximum of $14,000.
  • Availability to Apply as Dual Early-Stage/Impact SBIC
    • Those applicants who make early stage investments in impact areas would be eligible to apply simultaneously for both licenses and would not be subject to the early-stage call notice periods.  The applicants would still be subject to the regulations applying to both licenses.
  • Licensing Standards:
    • Licensing standards will remain the same as a traditional SBIC, and background in Impact Investing will only be considered in the context of the suitability to be licensed as an Impact SBIC.
    • Applicants will be expected to use SBA Form 2181 to provide definitions of the Fund Identified Impact Investments they intend to make, and will be required to describe in qualitative and quantitative analysis, the expected social, environmental, or economic impact of their Fund Identified Impact Investments.
  • Impact Measurement:
    • Impact SBICs must submit an impact measurement and assessment plan to SBA, which requires the SBIC to obtain an assessment of their impact from:
      • Independent 3rd party assessment provider;
      • Using SBA approved impact measurement standard;
      • Using an transparent and comprehensive assessment process.
    • At the outset the following standards will be approved:
      • Impact Reporting & Investment Standards (IRIS), created by GIIN;
      • G4 Sustainability Reporting Standards, created by Global Reporting Initiative (GRI);
      • Standards produced/maintained by the Sustainability Accounting Standards Board (SASB).
  • Branding:
    • Impact SBIC funds will required to identify themselves as impact investment funds to the public when marketing their funds to investors.
  •  Investment Certification of Investments
    • Impact SBICS would have to certify the basis for which each of their investments qualifies as an Impact Investment.  Fund-Identified Impact Investments only require the certification of the Impact SBIC, while SBA-Identified Impacts Investments require certifications from both the Impact SBIC and its portfolio concern.
  •  Leverage Certification
    • Impact SBICs would be required to certify when drawing leverage or seeking a leverage commitment, that it will invest at least 50% of the aggregate dollar amount of its financings in Impact Investments.  SBA will monitor Impact SBIC performance to ensure they are making investments meeting this requirement.
  •  SBA Default Remedies
    • SBA will create two new sections in the regulations that would apply to only Impact SBICs. 
      • Not Meeting the 50% Investment Requirement: First, an event of default would be considered to have occurred if an Impact SBIC fails to meet the 50% impact investment requirements.  If the Impact SBIC is unable to cure, SBA could invoke remedies including the right to declare outstanding leverage due immediately.
      • Not conducting an Impact Assessment: Second, it would be an event of default  if an Impact SBIC licensed to create Fund Identified Impact Investments fails to obtain an acceptable independent third party assessment to measure its impact.  If the Impact SBIC fails to cure to SBA’s satisfaction, SBA could invoke remedies including the right to declare outstanding leverage due immediately.
  •  Impact SBIC non-compliance with regulations:
    • SBA proposes creating a series of action the SBA can take with respect to Impact SBICs that fail to avoid the events of default covered above, including:
      • SBA will have the authority, upon written notice, to take any or all of the following actions:
        • Convert the Impact SBIC license to a standard SBIC license, with at SBA’s discretion, requiring the GP to notify its private investors of the conversion;
        • Require the licensee to return to SBA the full dollar amount of any licensing/examination fee discounts it received prior to receiving the written notice.
      • SBA would only be authorized to do these things after giving the licensee at least 15 days to resolve its non-compliance, with the licensee failing to resolve the non-compliance.
    • These requirements would not apply to:
      • Leveraged Funds
      • Those SBICS prepaying their leverage in full.

Comment Letters to Banking Regulators

On September 1, 2015, the Financial Crimes Enforcement Network (FinCEN) released a proposed rulemaking prescribing minimum standards for anti-money laundering (AML) to be established by certain registered investment advisers (RIAs), and to require these advisers to report suspicious activity to FinCEN pursuant to the Bank Secrecy Act (BSA). FinCEN has created this new regulatory requirement to regulate RIAs that may be at risk for attempts by money launderers or terrorist financers seeking access to the U.S. financial system. This rule will only apply to registered advisers with the Securities and Exchange Commission.  The Proposed Rule has been in the works since the first attempt to issue a proposed rule in 2003, and FinCEN’s announcement that they would be re-evaluating these requirements in 2007. The Proposed Rule will require RIAs to now be defined as a “financial institution” under the BSA, and require them to file a variety of reports with FinCEN and retain certain records. These requirements include: 
  • Filing Currency Transaction Reports (CTRs) with FinCEN for transactions involving a transfer over $10,000 by, through, or to the RIA;
  • Create and retain records for transmittals of funds over $3,000, and ensure that certain information pertaining to the transmittal of funds travel with the transmittal to the next financial institution in the payment chain;
  • Create and retain records for extensions of credit and cross-border transfers of currency, monetary instruments, checks, investment securities, and credit in amounts over $10,000;
  • Develop internal policies, procedures and controls, designate an AML compliance officer, and create an ongoing employee training program and an independent audit function to test programs; FinCEN believes many policies developed for SEC registration purposes could be adapted to deal with these rules;
    • This includes the development of a written AML program reasonably designed to prevent the RIA from being used to facilitate money laundering or the financing of terrorism activities
  • These requirements would extend to RAI’s providing subadvisory services to a client;
  • Requires reporting suspicious transactions through Suspicious Activity Reports (SARs) of transactions over $5,000 in fund or assets, and encourages voluntary reporting of transactions that are under that amount and are suspicious in nature;
  • Retain copies of filed SARs and underlying related documentation for 5 years;
  • All SARs and information that reveal the existence of a SAR are confidential and shall not be disclosed under certain circumstances. If subpoenaed, or otherwise requested to disclose a SAR, the officers of the RIA must decline to produce the SAR and notify FinCEN; and
  • Supply information under the USA PATRIOT ACT to the government and can be required by FinCEN to search their records to determine whether someone law enforcement has certified is suspected of engaging in terrorist activity or money laundering.
  • The SEC will examine for compliance with FinCEN’s new requirements.
To read the proposed rule, please click here.  On November 2, 2015, SBIA submitted a comment letter on the proposal.  To see the comment letter, please click here.
On September 8, 2014, the Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve (Fed) (collectively “Bank Regulators”) released for comment updated Interagency Questions and Answers regarding Community Reinvestment. The Proposed Q&A Update is available here. SBIA submitted comments on the Proposed Q&As on November 7, 2014.  They are available here. "Community Development”:  These activities are considered under the large institution, intermediate small institution and wholesale and limited purpose institution performance tests.  Additionally, small institutions may use community development activity to receive consideration toward an outstanding rating.  The current CRA regulations (12 CFR _.12(g)(3) define community development as follows: “activities that promote economic development by financing businesses or farms that meet the size eligibility standards of the Small Business Administration’s Development Company or Small Business Investment Company programs (13 CFR 121.301) or have gross annual revenues of $1 million or less.”  The Q&As provide that activities that “promote economic development” must meet 2 tests, (1) a size test (e.g. the recipient of the activity must meet the SBIC or SBDC size standards or have $1 mil in revenues or less) and (2) a purpose test.  The Bank Regulators propose to amend the language in the Q&As covering the “purpose” test.  The current Q&A states that  activities meet the purpose test if they “support permanent job creation, retention and/or improvement for persons who are currently low-or moderate-income or support permanent job creation, retention and/or improvement either in low or moderate income geographies or in areas targeted for redevelopment by federal, state, local, or tribal governments.  The Agencies will presume that any loan to or investment in an SBDC, SBIC, Rural Business Investment Company, New Markets Venture Capital Company or New Markets Tax Credit-eligible Community Development Entity promotes economic development.”  SBIA’s Take:  SBIA commented favorably on the regulators retaining the SBIC investments presumptively qualify under the "investment test" for CRA credit.  SBIA suggested that, along with expanding the community development loan definition and those considered under the "lending test", that banks investing in SBICs engaged in lending activities should also qualify under the "lending test."

SBIA Comment Letters to Agencies Other than the SBA & SEC

On Monday, April 17, 2017, SBIA submitted a comment letter on the Department of Labor Fiduciary Rule. SBIA submitted comments in 2015, and DOL made changes to the final rule that allowed non-traded BDCs to continue to sell their products in retirement accounts. The final rule was published on April 8, 2016, but its applicability date was delayed following a memorandum from President Trump asking the Department to conduct an economic and legal analysis on the rule's impact. The comment letter submitted this week encouraged DOL to further improve the Best Interest Contract (BIC) Exemption to improve investor choice. The letter also discussed the rule's private right of action and the potential for increased litigation, as well as SBIA's desire for DOL and the SEC to work together to craft a larger rule that "would provide clarity for broker dealers, address consumer protection concerns, and eliminate burdensome compliance costs and duplicative regulations.
On April 14, 2015, after 43 months in development, the U.S. Department of Labor (DOL) released its re-proposal to expand the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974, as amended (ERISA), which was published in the Federal Register on April 20, 2015. A summary of the re-proposal can be found here. SBIA intends to submit a comment letter on this important issue to encourage the DOL to include non-traded BDCs as eligible Assets under the BIC exemption. The rule proposal can be found here, and the BIC exemption is available here. A summary of the fiduciary rule is available here. If you have any input on these regulatory proposals, please contact Chris Hayes, SBIA’s Legislative & Regulatory Counsel by email or at (202) 628.5055. Update: On July 21, 2015, SBIA submitted a comment letter to the Department of Labor in response to their request for comment on the Department’s “Fiduciary” rule and associated “Best Interest Contract Exemption,” which was released for public comment on April 15, 2015. SBIA’s non-traded Business Development Company (“BDC”) members were impacted by the proposal, which governs how financial advice is given in connection with employee benefit plans and individual retirement accounts (“IRAs”), and imposed limitations on the types of products that could be sold by financial advisers to their clients. The Best Interest Contract Exemption permits financial advisors to sell a specified list of investment products in connection with retirement plans and IRAs under a commission-based model. Unfortunately, the exemption did not permit the sale of shares of non-traded BDCs, directly impacting the business model of our non-traded members. SBIA’s comment letter highlights that the other elements of the exemption were strong enough to obviate the need for the specified asset list and, if such a list is included in the final rule, it should include non-traded BDCs due to their similarity to other products currently on the list in the proposed rule, and the benefits of the products for investors.