Finra is expected to issue investor alert on nontraded BDCs
Securities regulators are taking a close and careful look at a fast-growing alternative investment known as a nontraded…
Securities regulators are taking a close and careful look at a fast-growing alternative investment known as a nontraded business development company.
The Financial Industry Regulatory Authority Inc. could issue a nontraded BDC investor alert notice by the end of next month, according to one compliance officer at an independent broker-dealer, who asked not to be identified.
“We are looking at a number of new products being sold to investors, and BDCs are one of them,” said Finra spokeswoman Nancy Condon.
“Firms need to do the necessary due diligence and consider whether they are suitable for a particular investor,” she said. “We conduct account reviews, and as part of those reviews, we review for suitability.”
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Such a notice would highlight concerns about the products similar the ones Finra listed in its September investor alert about nontraded real estate investment trusts, including “know your customer” guidelines and the lack of liquidity in a nontraded investment, the executive said.
In addition, the North American Securities Administrators Association is “gearing up to draft a statement of policy” on nontraded BDCs, said Arkansas securities commissioner A. Heath Abshure.
Such a statement would include review policies and standards governing the drafting an offering document for a new fund, he said.
NASAA GUIDELINES
“The attention is on the marketplace,” Mr. Abshure said.
In the past, one or two filings per year for a new nontraded BDC were typical, he said.
Now there are at least 10 that are either raising money or in line to become offerings, market sources said.
“We've heard the same rumblings for a while,” said Michael Forman, chief executive of Franklin Square Capital Partners, the parent company of FS Investment Corp., the biggest-selling nontraded BDC. “Finra is looking at some kind of release. We've talked to some of the states, and there will be new NASAA guidelines for BDCs. In the past, REIT guidelines have been loosely applied, so [the industry] needs new guidelines.”
Roxanne Pipitone, a spokeswoman for the Investment Program Association, said the organization has not heard of any upcoming Finra investor alert about nontraded BDCs. The IPA is a trade organization for nontraded REITs and “direct-participation programs,” such as private investments in equipment leasing, and oil and gas wells.
Nontraded-REIT sponsors have taken a stake in the nontraded-BDC business.
Corporate Capital Trust Inc. is advised by CNL Fund Advisors Co. and KKR Asset Management LLC. CNL is a leading sponsor of nontraded REITs.
Business Development Corp. of America is in the stable of nontraded investments offered by Realty Capital Securities LLC, a wholesaling broker-dealer owned by nontraded-REIT sponsor AR Capital LLC. That firm announced Wednesday that it had changed its name from American Realty Capital II LLC.
No doubt, nontraded BDCs are hot right now.
Franklin Square Capital Partners raised $1.35 billion from sales of FS Investment Corp. to independent broker-dealers last year. That made Franklin Square the second-largest program sponsor of public nontraded investments, according to Robert A. Stanger & Co., an investment bank that focuses on such programs, including nontraded real estate investment trusts.
In total, nontraded BDCs last year raised almost $1.5 billion, according to Stanger. That's compared with $369 million a year earlier and just $94 million in 2009.
The surge of nontraded BDCs that either are raising money or are in the pipeline reminded one independent-broker-dealer executive of the tremendous growth of nontraded REITs in the part 10 years.
“The money-raising sort of reminds me of the hot days in REITs,” said Eric Schwartz, chief executive of Cambridge Investment Research Inc. “At our big, annual national conference, we have about 65 sponsors. My marketing people once joked they could have 65 REIT sponsors at another different conference. It's a little scary when there are more REIT sponsors than all the others combined. That could happen with BDCs.”
Nontraded BDCs have “a lot of appeal right now,” Mr. Schwartz said. “There's the sex appeal of a private-equity situation, combined with the yield play when people are nervous about almost every other type of investment. Performance will tell the story. Three or four years from now, if the sector is raising $5 billion a year, will there be enough [private-company debt] out there to buy?”
The sales commission on nontraded BDCs typically is 7%, and the product is supposed to be sold only to those investors with a net worth of $250,000 or more, or a net income of at least $70,000 combined with a net worth of at least $70,000. Investors also are supposed to be informed of the product's illiquidity.
Technically, business development companies are closed-end funds regulated under the Investment Company Act of 1940. Congress created them in 1980 in response to what was a perceived crisis in the capital markets in the 1970s, with the intent of providing access to capital for small and growing companies.
BDCs invest in the debt and equity of such companies, with the debt instruments ranging from the senior-secured level to below-investment-grade, or “junk,” an asset class typically not available to retail investors.
There are about 28 publicly traded BDCs, ranging in market capitalization from $10 million to $3 billion, according to a recent presentation by KBR Capital Partners Inc., due-diligence firm Fact Right LLC and law firm Sutherland Asbill & Brennan LLP.
And in an environment where many nontraded REITs are telling investors the estimated value of the holding is declining, some nontraded BDCs are seeing an increase in per-share net asset value.
For example, Corporate Capital Trust last month raised its NAV to $10.65 per share, from $10.45 per share, with an annualized distribution yield of 7%.
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