Closed End Funds vs. Business Development Companies
With Financial Times coverage of closed end interval funds, and the recent growth in credit focused closed end funds, its a good time to compare the business development company structure to the closed end fund structure. Both provide investors with protections under the 1940 Act, and BDCs are technically a subtype of closed end fund, the two fund structures have several key differences in terms of, fees, regulatory and filing requirements, and investment restrictions. These differences are important for investors, asset managers, and those involved in fund distribution.
Here are interactive tables comparing BDCs and CEFs:
Fees and compensation
| BDCs | Closed End Funds | |
|---|---|---|
| Incentive Fees on Capital Gains | Permitted if based on realized gains calculated net of realized and unrealized losses. | Only permitted if all investors are qualified clients, or as a fulcrum fee. |
| Offering Expenses | FINRA Rule 2310 limits to no more than 15% of gross offering proceeds (including commissions). | NASD Rule 2380 does not place a limit on overall offering expenses. |
| Brokerage Commissions | FINRA Rule 2310 limits to no more than 10% of gross offering proceeds. | NASD Rule 2380 allows only with a range of 6.5% to 8.5%, based on whether the CEF has rights of accumulation and volume discounts. |
| Asset-Based Sales Charge | Not addressed by FINRA Rule 2310. | NASD Rule 2380 limits to 0.75% of assets, but subject to the overall sales charge cap. |
| Shareholder Service Fees | Not addressed by FINRA Rule 2310. | NASD Rule 2380 limits to 0.25% of assets, but not subject to commission cap and can be paid in perpetuity. |
| Contingent Deferred Sales Load (CDSL) | Not addressed by FINRA Rule 2310. | Subject to overall commission limit of NASD Rule 2380. |
Regulatory/filing requirements, and investment restrictions
| BDCs | Closed End Funds | |
|---|---|---|
| Fundamental Policies | Not required by BDC’s. | CEF is required to establish and disclose fundamental policies regarding investment of assets. |
| Eligible Investments | At least 70% of assets must be Eligible Portfolio Companies, as defined in Section 2(46) under the 1940 Act | Subject to fundamental policy adopted by board. |
| Management Assistance | Required to provide assistance to at least one investment, and offer it to all Eligible Portfolio Companies. | Not required |
| Custody Rule | Subject to Section 17(f) of 1940 Act and rules thereunder. | Subject to Section 17(f) of 1940 Act and rules thereunder. |
| Fidelity Bond Requirement | Subject to Section 17(g) of 1940 Act and rules thereunder | Subject to Section 17(g) of 1940 Act and rules thereunder. |
| Annual Meetings | Required by State Blue Sky laws. | Not required by State Blue Sky laws. |
| Board of Directors | At least a majority must be independent. | At least 40% of directors must be independent. |
| Periodic Filings | Files periodic reports required by Sections 13 or 15 of 1934 Act. | Files periodic reports required by Section 30 of 1940 Act. |
| Shareholder Meeting to Elect Directors | Elected at each annual meeting. | At any time that less than half of directors were elected by shareholders. |
| Conflict of Interest Rules | Governed by Section 56 of 1940 Act. | Governed by Section 17 of 1940 Act. |
| State Blue Sky Requirements | Offering must be approved in each state on state-by-state basis as a coordinated offering, and subject to review and special state requirements in each state; states are entitled to review and impose special requirements for sales to state residents. | Shares are covered securities, and thus offering of shares are not subject to state regulation (other than notice and fee requirements). States are barred from reviewing closed end fund offerings. |
| Board of Directors (one class offered) | At least a majority must be independent. | At least 40% of directors must be independent. |
| Leverage | Asset coverage of 200% (i.e., 50% leverage). | Asset coverage of 300% (i.e., 33 1/3% leverage) |