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BDC Censured for Mischaracterizing Distributions as Income Rather than Return of Capital

 The SEC censured a business development company for overstating its income as a payment of dividends rather than a return of capital and thereby violating several reporting rules.   The BDC included all payments received from underlying asset management subsidiaries as dividends even though a significant portion of the distributions should have been deemed returns of capital.  According to the SEC, the firm failed to offset taxable and accumulated net operating losses.  The SEC asserts that the mischaracterization was material because tax-basis distributable income is a significant metric used by analysts and investors to evaluate BDCs.  The BDC restated its financial statements and reported a material weakness in its financial control infrastructure.

The BDC should be thankful it didn’t get fined.  Although the SEC alleged facts suggesting that the firm should have known about the mischaracterization, an allegation that the firm intentionally juiced reported returns would have resulted in much more significant penalties. 

Compliance Failures Cost BDC Manager $4 Million in Penalties and $2.6 Billion in Assets

 A BDC manager’s compliance failures led to nearly $4 Million in fines, disgorgement and penalties and the loss of its advisory business.   The SEC charges the firm with misallocating overhead expenses to the registered Business Development Companies it managed and with overvaluing portfolio companies.  The SEC maintains that the registrant used material nonpublic information about BDC portfolio companies to benefit affiliated hedge funds that it managed.  In 2014, the firm had over $2.6 Billion in assets under management but withdrew its adviser registration in 2017 following the SEC enforcement action.  The SEC asserts violations of the compliance rule (206(4)-7) in addition to a laundry list of other securities laws violations.

Failure to implement an effective compliance program has consequences beyond penalties and fines.  The negative impact to a firm’s and its principals’ reputations could ultimately bring down the entire franchise.