WILLIAMS & JENSEN, PLLC TELEPHONE SUITE 300 FACSIMILE (202) 659-8201 1155 21ST STREET,N.W. (202) 659-5249 WASHINGTON, D.C. 20036-3308 February 17,2006 Ms. Nancy M. Morris Secretary Securities and Exchange Commission 100 F Street, NE Washington, DC 20549-9303 Re: Definition of Eligible Portfolio Company under the Investment Company Act of 1940; File No. S7-37-04 Dear Ms. Morris: This submission provides updated and additional data to support the Commission's efforts to modernize the definition of "eligible portfolio company" under the Investment Company Act of 1940. We continue to hear from business development companies (BDCs) regarding the absence of a meaningful and relevant standard for the definition of "eligible portfolio company." We hope that the Commission will examine the attached data and adopt a rule that modernizes the definition in a meaningful fashion, or alternatively urges Congress to remedy the problem through corrective legislation. An effective definition must provide sufficient access for the smaller- and middle-tier public companies that otherwise have little or no access to the public capital markets and also investment opportunities fox-the benefit of BDC shareholders. In 2004, Congress began to address the need to modernize the definition of "eligible portfolio company." The BDC industry pursued a legislative solution because the staff of the Division of Investment Management had indicated in earlier discussions with representatives of the BDC industry that a legislative remedy was the best course of action. The Investment Company Act defines "eligible portfolio company" to include those public companies that do not have outstanding securities upon which margin credit can be granted consistent with the Federal Reserve Board's margin rules. However, the Federal Reserve Board's changes in its definition of margmable securities eliminated all exchange- and NASDAQ-traded stocks as eligible portfolio companies. When Congress initially addressed the issue of modernizing the definition by passing corrective legislation in the House of Representatives (H.R. 3 170)on April 28,2004, the understood definition of "eligible portfolio company" within the BDC industry included all companies without publicly traded equity securities, and all public companies traded on the pink sheets and over-the-counter bulletin board. However, at about the time the House passed corrective legislation, H.R. 3 170, the staff of the Division of Investment Management took the position for the first time since the establishment of BDCs that private companies that had issued debt securities no longer qualified for treatment as an eligible portfolio company. This new interpretive position has caused significant concern within the BDC community, and has underscored the importance of completing the effort to modernize the definition of eligible portfolio company either by regulation or amendment to the Investment Company Act. We believe that a continued delay in addressing this issue impedes capital support for small- and mid-tier companies and is contrary to the interests of BDC shareholders. Having an outdated definition of eligible portfolio company compounded by the recent reinterpretation of important definitional issues by the staff of the Division of Investment Management undermines the needs of many stakeholders in this issue. Protection of Shareholders /Competitive Impact The proposed rulemaking fails to include empirical data justifiing that the rule as written wouldfurther capital formation, competition, and shareholder protection as required by the Act. The data that mists indicates that the proposed rule is too restrictive. The misting data also indicates that shareholders can be harmed by a policy that restricts capitalfrom an entig such as a BDC that is subject to full transparency and regulation. In addition, the proposed rubfails to describe the impact on shareholders and capital formation by emphasizing a robfor BDCs in providing capital to companies in or near bankruptcy. The SEC authority to establish a new definition of "eligible portfolio company" is contained in section 2(a)(46)(C)(iv) of the Investment Company ~ct..' The proposed rulemaking Section 2(a)(46)(C)(iv) of the Investment Company Act of 1940: "(46) "Eligible portfolio company" means any issuer which- (A) is organized under the laws of, and has its principal place of business in, any State or States; (B) is neither an investment company as defined in section 3 (other than a small business investment company which is licensed by the Small Business Administration to operate under the SdlBusiness Investment Act of 1958 and which is a wholly-owned subsidiary of the business development company) nor a company which would be an investment company except for the exclusion fiom the defmition of investment company in section 3(c); and (C) satisfies one of the following: (i) it does not have any class of securities with respect to which a member of a national securities exchange, broker, or dealer may extend or maintain credit to or for a customer pursuant to rules or regulations adopted by the Board of Governors of the Federal Reserve System under section 7 of the Securities Exchange Act of 1934; (ii) it is controlled by a business development company, either alone or as part of a group acting together, and such business development company in fact exercises a controlling influence over the management or policies of such eligible portfolio company and, as a result of such control, has an affiliated person who is a director of such eligible portfolio company; (iii) it has total assets of not more than $4,000,000, and capital and surplus (shareholders' equity less retained earnings) of not less than $2,000,000, except that the Commission may adjust such amounts by rule, regulation, or order to reflect changes in 1 or more generally accepted indices or other indicators for small businesses; or (iv) it meets such other criteria as the Commission may, by rule, establish as consistent with the public interest, the protection of investors, and the purposes fairly intended by the policy and provisions of this title," (Emphasis added). accurately states that BDCs do not compete against other types of investment companies.2 However, the proposed rule is devoid of any empirical data assessing the competitive impact of the proposed rule or the impact on shareholders. Significant and relevant market data exists that help describe the demand for capital by public companies provided through trmsactions other than registered new offerings. This data describes the significant demand by public companies based on market capitalizations. In addition, the data and at least one academic study, indicates that shareholders of these public companies can suffer financial harm through some non- registered transactions, and that there is a correlation between the nature of the provider of capital and the resulting impact on shareholders of these companies. The proposed rule actually states that "We generally believe that most issuers that are able to list their securities on an Exchange or on NASDAQ have access to the public capital rnarket~."~This statement is not supported by any data. In fact, the attached data and material indicates that the premise of the proposed rule is inaccurate in making this assertion. BDCs have historically competed against private venture capital and hedge funds in extending capital to private and public companies. A private investment in public equity (PIPE) transaction is an example of one such financing tool used by small- and mid-tier companies. For example, an investment bank that provides PIPE financing indicates in a published article that "a PIPE transaction generally best fits companies with a market capitalization under $400 million that seek an equity infusion of less than $75 milli~n."~It Wher notes that traditional public equity alternatives generally require a minimum transaction of "$65 million to $100 million to achieve optimal execution" due to the need for liquidity.5 This clearly indicates that public companies often require alternative forms of financing, especially if they have securities with limited liquidity. The proposed rulemaking fails to discuss the availability of traditional public equity alternatives for capital and debt infusions below $100 million. Because of the limitations on leverage imposed on BDCs by the Investment Company Act, much of the focus of BDCs is in making investments within this transaction size. Attached is data on private investments in public equity (PIPES)transactions for 2005 which hfher illustrates the lack of access to traditional forms of capital for public companies with a market capitalization of less than $300 million. Also attached is a scholarly research article on PPE transactions that analyzes the impact that such transactions can have on the shareholders of public companies. It concludes that the resulting impact on shareholders of PIPE issuing companies (dilution of ownership, loss of company, etc.) fkequently correlates with the nature of the capital provider and the structure of the transaction. BDCs are subject to the strict disclosure regime of the 1940Act, and they must disclose the terms, rates and other conditions of * See Definition of Eligible Portfolio Company Under the Investment Company Act of 1940, Proposed Rule, File No. S7-37-04 (November 8,2004) [69 Federal Register 648221: "We do not anticipate that these proposed rules would harm competition. The proposed rules are designed