Investment Company Act of 1940 –Section 12(d)(3)
New Mountain Finance Corporation

November 4, 2013

RESPONSE OF THE CHIEF COUNSEL’S OFFICE DIVISION OF INVESTMENT MANAGEMENT

IM Ref. No. 201310101615 File No. 814-00832

Your letter, dated November 1, 2013, requests assurance that the staff of the Division of Investment Management (the “Division”) would not recommend enforcement action to the Securities and Exchange Commission (“Commission”) against New Mountain Finance Corporation (“NMF Corp”) or New Mountain AIV Finance Holdings Corporation. (“AIV Holdings”), each of which has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940 (“1940 Act”), under section 12(d)(3) of the 1940 Act, as made applicable to BDCs by section 60 of the 1940 Act, if New Mountain Finance Holdings, LLC (“NMF LLC”), which is a BDC wholly owned by NMF Corp and AIV Holdings, registers as an investment adviser under the Investment Advisers Act of 1940 (“Advisers Act”), or if NMF Corp acquires additional common membership units of NMF LLC subsequent to its registering under the Advisers Act.

Background

You state the following:

• The Division previously provided assurances that it would not recommend enforcement action to the Commission against NMF Corp or AIV Holdings under various provisions of the 1940 Act in connection with a structure in which, at the time of NMF Corp’s initial public offering, NMF Corp and AIV Holdings would be feeder funds investing solely in NMF LLC, the master fund, and AIV Holdings eventually would exchange its interests in NMF LLC for shares of NMF Corp. (“NMF Structure”).¹  As detailed in the Prior Letter, the NMF Structure was designed to have beneficial U.S. federal income tax consequences for the public shareholders of NMF Corp and for certain investors in AIV Holdings, and upon NMF LLC being wholly owned by NMF Corp, the two-tiered NMF Structure will no longer be required.
  
  
• The three BDCs that comprise the NMF Structure currently have the same directors, and the shareholders of NMF Corp and the members of AIV Holdings vote on a “pass through” basis with respect to matters requiring a vote of the common membership units in NMF LLC.
  
  
• NMF LLC is contemplating forming one or more private funds (“Funds”) for which it will serve as investment adviser.  NMF LLC expects to receive fees similar to those received by similar private fund investment advisers, and that the formation of the Funds and the related management fees to be paid to NMF LLC would benefit NMF Corp and AIV Holdings and each of their respective shareholders or members.
  
  
• If NMF LLC were to serve as an investment adviser to the Funds, NMF LLC would be required to register under the Advisers Act due to the expected asset size of the Funds.   Registration of NMF LCC under the Advisers Act, in turn, would trigger the prohibition in section 12(d)(3) of the 1940 Act, made applicable to BDCs by section 60 of the 1940 Act, on NMF Corp and AIV Holdings purchasing or otherwise acquiring any security issued by an investment adviser registered under the Advisers Act. 

Legal Analysis

Section 60 of the 1940 Act makes section 12(d)(3) of the 1940 Act applicable to a BDC as if it were a registered closed-end investment company.  Section 12(d)(3) of the 1940 Act provides, in relevant part, that it is unlawful for any registered investment company to purchase or otherwise acquire any security issued by any person who is a broker, dealer, underwriter, or investment adviser to an investment company or investment adviser registered under the Advisers Act.  Sections 12(d)(3)(A) and (B) contain certain exceptions to this prohibition, none of which applies to NMF LLC’s situation.  Rule 12d3-1 under the 1940 Act provides a conditional exemption from section 12(d)(3) for certain purchases or acquisitions, but NMF LLC’s situation does not satisfy certain of the conditions of the rule.²   In addition, the Commission has indicated that the prohibited acquisitions under section 12(d)(3) are not limited to the original acquisitions of stock, but may occur as a result of subsequent events.³ 

Therefore, you request our assurance that we would not recommend enforcement action to the Commission against NMF Corp or AIV Holdings if NMF LLC becomes an investment adviser registered under the Advisers Act or if NMF Corp acquires additional common membership units of NMF LLC subsequent to its registering under the Advisers Act.  In support of your request, you argue that NMF Corp’s and AIV Holdings’ ownership of NMF LLC as an investment adviser registered under the Advisers Act raises none of the concerns underlying section 12(d)(3) of the 1940 Act.  You state that these concerns were two-fold.  First, Congress wished to limit the exposure of registered investment companies to the entrepreneurial risks of a securities-related business, including those of a registered investment adviser.⁴   Second, Congress wanted to prevent potential conflicts of interest and reciprocal practices between registered investment companies and securities-related businesses.⁵ 

You state that the first concern stems from the fact that, in 1940, when section 12(d)(3) was adopted, most securities-related businesses were organized as privately held general partnerships.⁶   You argue that shareholders of NMF Corp and members of AIV Holdings will not be exposed to the risks of unlimited liability associated with the NMF LLC’s investment advisory activities because NMF LLC is structured as a limited liability company and not as a partnership.

You also argue that potential conflicts of interest and the risk of reciprocal practices would not be present because the entities in the NMF Structure currently have the same directors, and the shareholders of NMF Corp and the members of AIV Holdings vote on a “pass through” basis with respect to matters requiring a vote of the common membership units in NMF LLC.  You note that the NMF Structure was designed for bona fide tax reasons and that once the NMF Structure has accomplished its desired purpose and is collapsed into a single BDC model, the requested relief will no longer be necessary.  Finally, you state that this concern in the context of section 12(d)(3) was raised by Congress primarily with respect to an investment company’s ownership of a brokerage or underwriting business, rather than the ownership of an advisory business.⁷ 

Conclusion

Based on the facts and representations set forth in your letter, we would not recommend enforcement action to the Commission under section 12(d)(3) of the 1940 Act against NMF Corp or AIV Holdings if NMF LLC registers as an investment adviser under the Advisers Act, or if NMF Corp acquires additional common membership units of NMF LLC subsequent to its registering under the Advisers Act.  This letter expresses our position on enforcement only, and does not express any legal conclusion or interpretive conclusion on the issues presented.  Because our position is based on the facts and representations in your letter, any different facts or representations may require a different conclusion.⁸ 

David Joire
Senior Counsel

Endnotes

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¹New Mountain Finance Corp., SEC No-Action Letter, pub. avail. Apr. 27, 2011 (“Prior Letter”).

⁶Id. See also Securities Trading Practices of Registered Investment Companies, Investment Company Act Release No. 10666 (April 18, 1979) (“the legislative history … suggests that its purpose principally was to prevent investment companies … from exposing their assets to the entrepreneurial risks of an investment banking business, as would be the case where an investment company took a partnership interest in a broker/dealer”).

⁷Compare section 12(c)(2)(B) in H.R. 8935, 76th Cong. (3d Sess. 1940) at 30, S. 3580, 76th Cong. (3d Sess. 1940) at 30, and Investment Trusts and Investment Companies:  Hearings on S. 3580 before the Subcomm. on Securities and Exch. of the Senate Comm. on Banking and Currency, 76th Cong (3d Sess. 1940), pt. 1, at 10 (“Senate Hearings”) with section 12(d)(3)(B) of the 1940 Act.  See also H.R. Rep. No. 76-2639, at 16 (1940); S. Rep. No. 76-1775, at 15-16 (1940); Senate Hearings, pt. 1, at 243.

⁸The Division generally permits third parties to rely on no-action or interpretive letters to the extent that the third party’s facts and circumstances are substantially similar to those described in the underlying request for a no-action or interpretive letter.  See Informal Guidance Program for Small Entities, Investment Company Act Release No. 22587 (Mar. 27, 1997), n. 20.  In light of the very fact-specific nature of the request, however, the position expressed in this letter applies only to NMF Corp and AIV Holdings, and no other entity may rely on this position. 

Incoming Letter

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The Incoming Letter is in Acrobat format.

http://www.sec.gov/divisions/investment/noaction/2013/newmountain110413.htm