(Article from Registered Funds Regulatory Update, October 2024)
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On September 23, 2024, the SEC announced that it settled charges against a publicly-traded business development company, for failing to properly custody uncertificated securities (e.g., privately offered securities, loans, and other securities not represented by a physical certificate) it held in violation of Section 17(f) of the Investment Company Act. The SEC’s Order also focused on the BDC’s failure to properly custody its uncertificated securities in violation of its written policies and procedures regarding custody of assets.
Section 17(f) of the Investment Company Act requires that registered investment companies and, as Section 59 of the Investment Company Act makes Section 17(f) applicable to BDCs to the same extent as to RICs, companies that have elected to be regulated as BDCs maintain their securities and similar investments with a qualified bank, a member of a national securities exchange, or the RIC itself (i.e., self-custody) subject to any rules prescribed by the SEC. While each option is specifically allowed under Section 17(f), a RIC’s policies and procedures must accurately reflect the RIC’s actual custodial arrangements. From around July 2019 through June 2022, the BDC failed to ensure that that its uncertificated securities were kept with a qualified custodian bank, even though its policies and procedures stated that these securities would be custodied as such. Moreover, the BDC’s board-approved custody agreement contemplated the custody of uncertificated securities with the BDC’s custodian. Instead, the BDC variously held these securities with brokers, with transfer agents, and in self-custody.
In accepting the offer and issuing the Order, the SEC recognized the remedial efforts that the BDC had promptly taken, such as updating its own written policies and procedures and custody agreement as to the handling of uncertificated securities. In particular, the SEC noted that the new policies and procedures required that the BDC (i) send all executed documentation regarding an investment to its custodian bank within two business days of investing in a portfolio company; (ii) reconcile on a weekly basis the securities and other assets held in the custody of a board-approved custodian; and (iii) confirm that any transfers or withdrawals of such securities or other assets are only made in accordance with the applicable custody agreement. Further, the custody agreement was updated to explicitly define uncertificated securities to ensure that loans are captured under the term given that the agreement was previously silent with respect to loans.
Without admitting or denying the SEC’s findings, the BDC consented to the entry of an order requiring it to cease and desist from further violations of the custody- and compliance-related provisions of the Investment Company Act. Notably, there was no civil monetary penalty.
In the Matter of SuRo Capital Corp., SEC Admin. File No. 3-22158 (Sept. 23, 2024), available at: https://www.sec.gov/files/litigation/admin/2024/ic-35331.pdf.