BDCs Eligible Portfolio Companies Expanded to Include Certain Listed Securities

July 7, 2008

The Securities and Exchange Commission (“SEC”) has amended Rule 2a-46 of the Investment Company Act of 1940 to expand the definition of “eligible portfolio company.” Effective July 21, 2008, domestic operating companies that list their securities on a national securities exchange, such as NYSE, NASDAQ or AMEX, and have less than $250MM in market capitalization on any day in the 60 day period immediately prior to its acquisition are eligible portfolio companies. The SEC amended the definition of eligible portfolio company to align it more closely with Congress’ original intentions for making capital available to particular types of businesses as well as the current investment activities of business development companies (“BDC”).


Congress established BDCs to create a new category of closed-end investment companies that would make capital more readily available to particular types of companies. To achieve this end, a BDC must invest 70 percent of its total assets (the “70% Basket”) in “eligible portfolio companies” and certain other securities before it can invest in new portfolio companies.

Congress previously defined “eligible portfolio company” to include any domestic operating company that did not have a class of securities that a member of a national securities exchange, broker, or dealer may extend margin credit to under rules promulgated by the Federal Reserve Board. At the time Section 2(a)(46) was adopted, Congress generally accepted the Federal Reserve Board’s definition of “margin security” to be determinant of whether an issuer has access to securities markets. The Federal Reserve Board has periodically modified the definition of “margin security” to increase the types of securities that fall under its rules. However, these modifications have had the practical business consequence of significantly reducing the number of companies that qualify as “eligible portfolio companies” under Section 2(a)(46).

On October 25, 2006, the SEC adopted Rule 2a-46 and Rule 55a-1 to mitigate the impact of the Federal Reserve Boards’ amendments. That same day the SEC re-proposed Rule 2a-46(b) to expand the number of companies a BDC may invest and use in calculating its 70% Basket.

NYSE, NASDAQ and AMEX Companies

The definition change of eligible portfolio companies positively affects both BDCs and national securities exchange listed companies. Based on January 31, 2008 data, 6,602 companies, or 61.3% of the 9,883 public domestic operating companies, qualify as eligible portfolio companies under Rule 2a-46(a). In addition, the January 31, 2008 data also suggest that Rule 2a-46(b) qualifies an additional 1,649 Exchange-listed companies. This brings the total number of companies a BDC can invest in and use in calculating its 70% Basket to 7,711, representing just over 78% of all public domestic operating companies which qualify as eligible portfolio companies and an increase of approximately 20%.

The Private Equity Practice at McGuireWoods LLP is dedicated to keeping our clients advised of new legislative and business developments as they occur. If you have any questions regarding these issues, please feel free to contact your primary attorney at McGuireWoods LLP or you may contact: