    [House Hearing, 114 Congress]
    [From the U.S. Government Publishing Office]

                       LEGISLATIVE PROPOSALS TO MODERNIZE
                         BUSINESS DEVELOPMENT COMPANIES
                      AND EXPAND INVESTMENT OPPORTUNITIES

    =======================================================================

                                    HEARING

                                   BEFORE THE

                      SUBCOMMITTEE ON CAPITAL MARKETS AND
                        GOVERNMENT SPONSORED ENTERPRISES

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                        ONE HUNDRED FOURTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                 JUNE 16, 2015

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 114-33

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                          U.S. GOVERNMENT PUBLISHING OFFICE
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                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                        JEB HENSARLING, Texas, Chairman

    PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking
        Vice Chairman                        Member
    PETER T. KING, New York              CAROLYN B. MALONEY, New York
    EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
    FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
    SCOTT GARRETT, New Jersey            GREGORY W. MEEKS, New York
    RANDY NEUGEBAUER, Texas              MICHAEL E. CAPUANO, Massachusetts
    STEVAN PEARCE, New Mexico            RUBEN HINOJOSA, Texas
    BILL POSEY, Florida                  WM. LACY CLAY, Missouri
    MICHAEL G. FITZPATRICK,              STEPHEN F. LYNCH, Massachusetts
        Pennsylvania                     DAVID SCOTT, Georgia
    LYNN A. WESTMORELAND, Georgia        AL GREEN, Texas
    BLAINE LUETKEMEYER, Missouri         EMANUEL CLEAVER, Missouri
    BILL HUIZENGA, Michigan              GWEN MOORE, Wisconsin
    SEAN P. DUFFY, Wisconsin             KEITH ELLISON, Minnesota
    ROBERT HURT, Virginia                ED PERLMUTTER, Colorado
    STEVE STIVERS, Ohio                  JAMES A. HIMES, Connecticut
    STEPHEN LEE FINCHER, Tennessee       JOHN C. CARNEY, Jr., Delaware
    MARLIN A. STUTZMAN, Indiana          TERRI A. SEWELL, Alabama
    MICK MULVANEY, South Carolina        BILL FOSTER, Illinois
    RANDY HULTGREN, Illinois             DANIEL T. KILDEE, Michigan
    DENNIS A. ROSS, Florida              PATRICK MURPHY, Florida
    ROBERT PITTENGER, North Carolina     JOHN K. DELANEY, Maryland
    ANN WAGNER, Missouri                 KYRSTEN SINEMA, Arizona
    ANDY BARR, Kentucky                  JOYCE BEATTY, Ohio
    KEITH J. ROTHFUS, Pennsylvania       DENNY HECK, Washington
    LUKE MESSER, Indiana                 JUAN VARGAS, California
    DAVID SCHWEIKERT, Arizona
    FRANK GUINTA, New Hampshire
    SCOTT TIPTON, Colorado
    ROGER WILLIAMS, Texas
    BRUCE POLIQUIN, Maine
    MIA LOVE, Utah
    FRENCH HILL, Arkansas
    TOM EMMER, Minnesota

                         Shannon McGahn, Staff Director
                        James H. Clinger, Chief Counsel
      Subcommittee on Capital Markets and Government Sponsored Enterprises

                      SCOTT GARRETT, New Jersey, Chairman

    ROBERT HURT, Virginia, Vice          CAROLYN B. MALONEY, New York,
        Chairman                             Ranking Member
    PETER T. KING, New York              BRAD SHERMAN, California
    EDWARD R. ROYCE, California          RUBEN HINOJOSA, Texas
    RANDY NEUGEBAUER, Texas              STEPHEN F. LYNCH, Massachusetts
    PATRICK T. McHENRY, North Carolina   ED PERLMUTTER, Colorado
    BILL HUIZENGA, Michigan              DAVID SCOTT, Georgia
    SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
    STEVE STIVERS, Ohio                  KEITH ELLISON, Minnesota
    STEPHEN LEE FINCHER, Tennessee       BILL FOSTER, Illinois
    RANDY HULTGREN, Illinois             GREGORY W. MEEKS, New York
    DENNIS A. ROSS, Florida              JOHN C. CARNEY, Jr., Delaware
    ANN WAGNER, Missouri                 TERRI A. SEWELL, Alabama
    LUKE MESSER, Indiana                 PATRICK MURPHY, Florida
    DAVID SCHWEIKERT, Arizona
    BRUCE POLIQUIN, Maine
    FRENCH HILL, Arkansas
                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        June 16, 2015................................................     1
    Appendix:
        June 16, 2015................................................    41

                                   WITNESSES
                             Tuesday, June 16, 2015

    Arougheti, Michael J., Co-Chairman of the Board of Directors,
      Ares Capital Corporation.......................................     3
    Brown, J. Robert, Jr., Professor of Law, University of Denver
      Sturm College of Law...........................................    11
    Foster, Vincent D., Chairman of the Board, President, and Chief
      Executive Officer, Main Street Capital Corporation, on behalf
      of the Small Business Investor Alliance (SBIA).................     6
    Gerber, Michael F., Executive Vice President, Franklin Square
      Capital Partners...............................................     8
    Quaadman, Tom, Vice President, Center for Capital Markets
      Competitiveness, U.S. Chamber of Commerce......................     9

                                    APPENDIX

    Prepared statements:
        Arougheti, Michael J.........................................    42
        Brown, J. Robert, Jr.........................................    48
        Foster, Vincent D............................................    62
        Gerber, Michael F............................................    73
        Quaadman, Tom................................................    81

                  Additional Material Submitted for the Record

    Garrett, Hon. Scott:
        Letter to Chairman Hensarling from Raymond James Insurance
          Group, dated June 25, 2015.................................   160
    Maloney, Hon. Carolyn:
        Written statement of the Consumer Federation of America and
          Americans for Financial Reform.............................   161
        Written statement of the North American Securities
          Administrators Association, Inc............................   164
    Mulvaney, Hon. Mick:
        Chart entitled, ``Leverage Across Financial Services
          Industries''...............................................   170
        Written statement of Prospect Capital Corporation............   171
    Arougheti, Michael J.:
        Letter to Chairman Hensarling and Ranking Member Waters from
          OTG Management, LLC........................................   179

                       LEGISLATIVE PROPOSALS TO MODERNIZE
                         BUSINESS DEVELOPMENT COMPANIES
                      AND EXPAND INVESTMENT OPPORTUNITIES

                                  ----------

                             Tuesday, June 16, 2015

                 U.S. House of Representatives,
                    Subcommittee on Capital Markets and
                      Government Sponsored Enterprises,
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to notice, at 2:17 p.m., in
    room 2128, Rayburn House Office Building, Hon. Scott Garrett
    [chairman of the subcommittee] presiding.
        Members present: Representatives Garrett, Neugebauer,
    Huizenga, Duffy, Stivers, Fincher, Hultgren, Ross, Messer,
    Schweikert, Poliquin; Maloney, Sherman, Hinojosa, Lynch, Scott,
    Himes, Carney, and Murphy.
        Ex officio present: Representative Hensarling.
        Also present: Representative Mulvaney.
        Chairman Garrett. Greetings. Good morning. I apologize for
    being late.
        This hearing of the Subcommittee on Capital Markets and
    Government Sponsored Enterprises is hereby called to order.
    Today's hearing is entitled, ``Legislative Proposals to
    Modernize Business Development Companies--also called BDCs--and
    Expand Investment Opportunities.''
        Without objection, the Chair has the authority to recess
    the subcommittee at any time.
        Before we go to our panel, we will have opening statements.
    And I yield myself 2\1/2\ minutes.
        Again, good morning, and I apologize for being a few
    minutes late. Today's hearing will continue our important work
    on considering legislative proposals that would modernize our
    Nation's securities laws in order to do what? To foster greater
    economic activity.
        One of these proposals is a discussion draft that is being
    circulated right now by the gentleman from South Carolina, Mr.
    Mulvaney. And what would it do? It would modernize the
    regulation of BDCs, business development companies.
        And what are BDCs? Well, BDCs are closed-end investment
    funds that have a statutory mandate to invest much of their
    capital in small and medium-sized businesses. As new
    regulations cause banks and other lenders to pull back from the
    small and midsized lending market--and we have heard that in
    other hearings--BDCs have played an increasingly important role
    in our economy and in that space.
        While it has been 35 years since their creation, the
    regulatory regime for BDCs has not been meaningfully updated
    during that time. Mr. Mulvaney's bill, which includes several
    provisions that this committee has previously considered, would
    do a couple of things. It would enhance the ability of BDCs to
    deploy capital, and therefore create jobs and opportunities, as
    well, for literally thousands of businesses, and therefore also
    their employees.
        Now, aside from that bill, we have a second bill. The
    second bill we will consider toady is H.R. 2127, the Fair
    Investment Opportunities for Professional Experts Act. And that
    was introduced by the gentleman from Arizona, Mr. Schweikert.
        What would Mr. Schweikert's bill do? It would amend the
    definition of who qualifies as an accredited investor under the
    securities laws, and is therefore eligible to invest in certain
    private offerings.
        And while the Dodd-Frank Act directed the SEC to review the
    current income and asset-based definition of what an accredited
    investor is, there is still substantial concern that the SEC
    could ultimately take action that would limit the number of
    Americans eligible to invest in private offerings, a market
    that right now has actually grown to over $1 trillion in recent
    years.
        You see, investing in private companies should not be a
    privilege reserved only for the super wealthy. And so, Mr.
    Schweikert's bill would allow more Americans to have the
    opportunities to secure their financial future.
        Taken together, these two commonsense bills would expand
    upon the previous work of the subcommittee in this very
    important area. And so again, I thank the two sponsors of the
    legislation, as well as the witnesses for the hearing today.
        And with that, my time has expired. I yield to the ranking
    member for 5 minutes.
        Mrs. Maloney. Thank you so much, Mr. Chairman. And I thank
    all our panelists for being here today. We are examining two
    bills today: one to modernize the regulations for business
    development companies, or BDCs; and another to revise the
    definition of an accredited investor.
        The BDC bill is very familiar to all of us in this Congress
    because we considered a similar bill in depth in the last
    Congress. Since then, I am pleased to say that we have made
    some very good progress on this bill, and the draft that we are
    considering today reflects input from the Democratic side of
    the aisle, the Republican side of the aisle, the SEC, and the
    BDC community.
        I am hopeful that we all can get to a ``yes'' on this bill,
    which would increase the availability of capital for small
    businesses. It is an important bill for our economy.
        We will also consider a bill by Mr. Schweikert to revise
    the definition of an accredited investor. How to draw the line
    between someone who is an accredited investor and someone who
    is not is one of the most difficult questions in all of
    securities law.
        An accredited investor is someone who, in the words of the
    Supreme Court, can ``fend for themselves and does not need the
    protections of the securities law.'' These sophisticated
    investors are allowed to buy unregistered securities, which are
    often more complex and riskier than public securities.
        Unregistered securities are also less liquid than public
    securities, which makes these investments in unregistered
    securities harder to exit or sell. As a result, these
    investments are supposed to be limited to investors who can
    legitimately bear the economic risk involved in buying them.
    These investors are referred to as accredited investors.
        Current law defines an accredited investor primarily by
    reference to a person's income or overall net worth. Someone
    whose annual income is greater than $200,000 is an accredited
    investor. Or if someone's net worth, excluding the value of his
    house, is greater than $1 million.
        So the question really is, does this strike the right
    balance? Is everyone who meets these tests truly able to fend
    for themselves?
        The SEC's Investor Advisory Committee recommended a new
    definition of an accredited investor last year that seeks to
    more accurately identify investors with enough financial
    sophistication to fend for themselves. And I think this
    proposal is a very good starting point for this discussion.
        I look forward to hearing a discussion of the benefits and
    drawbacks of the Investor Advisory Committee's proposal versus
    Mr. Schweikert's proposal. This is an important debate to have.
        So I thank Mr. Schweikert for putting it forward. And I
    would also like to thank Chairman Garrett for holding this
    hearing, and to thank all of our panelists.
        Chairman Garrett. The gentlelady yields back. And I thank
    the gentlelady for her comments.
        At this point, we will turn to our panel. Again, I thank
    the panel for being with us today. And I see some familiar
    faces. For those other-than-familiar faces, let me just remind
    you that you will be recognized for 5 minutes. I think there is
    a button there in front of you to tell you the time to start,
    and also an indicator in front of you of some sort that will go
    down to 1 minute on the timing for that.
        We are in a new room now, so we will see just how well the
    microphones are working. I used to always have to ask the
    people to pull the microphone close to you when you speak. But
    we will see how that works here now.
        And finally, you will be recognized for 5 minutes, but of
    course you have already submitted your testimony, and that will
    be made a part of the record. So now we just yield to you for 5
    minutes to summarize your testimony.
        Mr. Arougheti, welcome to the panel. And we look forward to
    your testimony. You are recognized for 5 minutes.

    STATEMENT OF MICHAEL J. AROUGHETI, CO-CHAIRMAN OF THE BOARD OF
                  DIRECTORS, ARES CAPITAL CORPORATION

        Mr. Arougheti. Great. Thank you.
        Chairman Garrett, Ranking Member Maloney, thank you for the
    opportunity to testify today. I am Michael Arougheti, the co-
    chairman of the board of directors of Ares Capital Corporation,
    a BDC that has invested more than $20 billion in hundreds of
    small and medium-sized companies, creating tens of thousands of
    American jobs.
        By way of reminder, Congress created BDCs in 1980 to
    encourage capital flows to small and medium-sized companies at
    a time when these businesses had limited options for securing
    credit. Now uniquely, the BDC model allows ordinary investors
    the ability to participate in capital formation for small
    companies, effectively funding Main Street.
        Today, similar to 1980, commercial banks continue to exit
    the middle-market lending space. Perhaps the most striking
    recent example of this is GE Capital's exit from the lending
    space. As the seventh largest bank in the United States, this
    will surely have a further significant adverse impact on the
    small and medium-sized businesses who have traditionally
    borrowed from GE Capital, and obviously on the jobs that these
    businesses have contributed to the economy.
        I am here today to express support for the draft of the
    Small Business Credit Availability Act, H.R. 3868, being
    offered by Mr. Mulvaney. We believe that the proposed bill will
    enable BDCs to more easily raise capital and to make loans to
    middle-market companies, while ensuring that BDCs continue to
    be appropriately regulated and subject to stringent standards
    regarding transparency, and obviously shareholder protection.
        I think it is important to note that BDCs are not seeking
    any government or taxpayer subsidy or support.
        Many of the challenges that we face as BDCs arise out of
    our peculiar place in the regulatory framework, regulated as
    mutual funds yet operating as operating companies. The draft
    bill builds on H.R. 1800 and other bipartisan efforts in the
    previous Congress to modernize this regulatory framework, and
    to ensure that BDCs can continue to fulfill their original
    congressional mandate.
        The proposed bill contains five provisions, each of which
    we believe will enable BDCs to more effectively fulfill their
    congressional mandate.
        First, the proposed bill contemplates an increase in the
    BDC asset coverage test from 200 percent to 150 percent,
    subject to the satisfaction of shareholder-friendly conditions
    such as extensive public disclosure and transparency, and
    either a shareholder vote or a ``cooling-off period'' following
    approval by the independent members of a BDC's board of
    directors.
        We don't believe that this introduces more risk. Rather, it
    will allow BDCs to invest in lower-yielding, lower-risk assets
    that don't currently fit their economic model. In fact, the
    current asset coverage test may ironically force certain BDCs
    to invest in riskier higher yielding securities in order to
    meet the dividend requirements of their shareholders.
        We also believe that this change will grant borrowers
    greater financing alternatives at a reduced cost, and will
    benefit shareholders with more conservative and more
    diversified portfolios. Further, this change will enable BDCs
    to lend to a broader portion of the already underserved middle-
    market.
        This proposed change would apply to BDCs the same leverage
    ratio as small business investment companies, but unlike SBICs,
    without putting any government capital at risk. Further, given
    that the House Small Business Committee just last week passed
    bipartisan legislation increasing the size of the SBIC program,
    the proposed change certainly seems reasonable.
        It is also extremely modest relative to typical bank
    leverage in our country of 10-to-1 and sometimes greater. Under
    the current asset coverage test, most BDCs operate at leverage
    significantly less than allowed. And any prudent manager would
    likely continue this practice if the asset coverage ratio were
    to change.
        Second, the proposed bill would allow BDCs to issue
    multiple classes of preferred stock, and solely for qualified
    institutional buyers, eliminate the requirement that holders of
    preferred stock have board representation. Had BDCs been able
    to raise capital during the post-2008 period by issuing
    preferred stock, many more loans could have been made to cash-
    starved companies to enable them to retain employees, and in
    some instances to remain in business.
        Third, the proposed bill directs the SEC to make specific
    technical amendments to certain securities offering rules that
    make raising capital cumbersome and inefficient. And these rule
    changes are not controversial and would merely place BDCs on
    equal footing with non-BDCs.
        Fourth, the proposed bill would allow BDCs to own
    registered investment advisers, which is a technical matter
    that is currently prohibited under the 1940 Act. Investments in
    IRAs enable money to be raised from third-party investors,
    which in turn could be deployed to small and medium-sized
    companies.
        And fifth, the proposed bill would offer increased
    flexibility for BDCs to invest in a subset of entities
    currently limited by the 30 percent basket. Importantly, this
    provision would not allow the amount of the incremental
    increase in the 30 percent basket to be invested in private
    equity funds, hedge funds, or CLOs.
        So in closing, I am very encouraged by the bipartisan focus
    on this very important initiative. And I look forward to
    working with Representative Mulvaney and Representatives
    Garrett and Maloney and the rest of the committee in moving
    these bills forward.
        I would also like to applaud the committee's efforts to
    revisit the definition of accredited investor, which, like the
    BDC regulatory framework that we are discussing today, could
    indeed benefit from modernization.
        And lastly, as a procedural matter, Mr. Chairman, if I
    could, I would like to introduce a letter into the record from
    one of our portfolio companies that was referenced in my
    written testimony.
        [The prepared statement of Mr. Arougheti can be found on
    page 42 of the appendix.]
        Chairman Garrett. If it is part of your written testimony,
    it will be a part of the record.
        Mr. Arougheti. Thank you.
        Chairman Garrett. Thank you.
        From Main Street Capital, Mr. Foster?

        STATEMENT OF VINCENT D. FOSTER, CHAIRMAN OF THE BOARD,
      PRESIDENT, AND CHIEF EXECUTIVE OFFICER, MAIN STREET CAPITAL
    CORPORATION, ON BEHALF OF THE SMALL BUSINESS INVESTOR ALLIANCE
                                 (SBIA)

        Mr. Foster. Good afternoon, Chairman Garrett, Ranking
    Member Maloney, and members of the Subcommittee on Capital
    Markets and Government Sponsored Enterprises. I appreciate the
    opportunity to testify today on behalf of the Small Business
    Investor Alliance or SBIA. SBIA's members provide vital capital
    to small and medium-sized businesses nationwide, resulting in
    job creation and economic growth.
        My name is Vince Foster, and I am chairman, president, and
    CEO of Main Street Capital Corporation, an SEC-registered BDC
    based in Houston, Texas. We are named Main Street for a reason.
    Main Street is who we are and where we invest.
        As our name makes clear, we have invested in over 400 small
    and midsized companies. That amounts to more than $4 billion
    invested into growing businesses that were not able to
    adequately access capital through traditional financing
    sources. Like many BDCs, we focus on smaller businesses.
        We partner with entrepreneurs, business owners, and
    management teams that generally provide one-stop financing
    alternatives. Currently, we are backing over 70 lower-middle-
    market companies headquartered in 24 States. More than half of
    these businesses have revenues of less than $25 million.
        To illustrate this diversity, we have funded two of the
    fastest growing technology companies in Eugene, Oregon; the
    largest privately owned jewelry store chain in the Rocky
    Mountains headquartered in Twin Falls, Idaho; one of the
    largest Goodyear Tire retailers in the United States
    headquartered in Austin, Texas; the leading micro-irrigation
    design and installation company in the San Joaquin Valley
    headquartered in Delano, California; the leading FBO at the
    Indianapolis Airport; one of the largest fully-integrated
    precast concrete companies headquartered in San Antonio, Texas;
    and one of the only two independent producers of styrene
    butadiene rubber in the United States headquartered in Baton
    Rouge, Louisiana, just to name a few.
        We have also invested in GRT Rubber Technologies
    headquartered in Paragould, Arkansas, which was founded in the
    1880s and manufactures rubber products including conveyor
    belts. And Bridge Capital Solutions, headquartered in
    Hauppauge, New York, which operates Long Island's only licensed
    commercial check-cashing service, serving small businesses in
    New York.
        Today, Main Street has small business investments in at
    least 15 of the 24 States represented by this committee. And we
    are just one of the over 34 BDCs that are a part of SBIA.
        Small and medium-sized businesses need growth capital. BDCs
    are growing to fill that need. BDC loan balances have tripled
    since 2008, and are not slowing. Growing businesses are going
    to continue to need more capital. BDCs will benefit from
    modernization that small businesses will be the ultimate
    beneficiaries of reform.
        BDCs are highly regulated and highly transparent. The
    public can look up and review every one of our investments.
        The BDC industry is not seeking deregulation or any changes
    to the Dodd-Frank Act. We have earned investor trust and grown
    stronger in the face of economic calamity. We earned our good
    name, and we will work to keep it.
        What BDCs do need is commonsense modernization. I might
    need Mike to help me lift this up. Look at this stack of paper.
    This is our SEC filing to issue stock. Hundreds of pages
    represent wasted money and manpower.
        Here is what CIT, $50 billion versus our $1.5 billion, has
    to file to get the same result because they can incorporate
    their other SEC filings by reference, but BDCs cannot. Do 4
    more inches of paper protect better than half an inch? No one
    is protected by the failure to modernize the rules for BDCs.
        This discussion draft would fix this absurdity and make a
    host of other clearly needed reforms. These reforms are overdue
    and worthy of bipartisan support. We encourage the committee to
    act promptly.
        This committee has clearly worked on a bipartisan basis to
    make other reforms and improvements. For example, almost every
    BDC in the industry wants the freedom to access the markets by
    increasing the regulatory cap on leverage from 1-to-1 to 2-to-
    1. Not everyone will make the change, but they want the freedom
    to adjust to changes in the market.
        The proposal does this in a very smart fashion that adds
    meaningful investor protections while adding capacity for
    investing. The draft bill makes other smart reforms that can
    add investor protections with transparency.
        Currently, BDCs can earn registered investment advisers.
    But it requires SEC exemptive relief. This means BDCs are
    playing by different rules, and the investors are in the dark.
        Standardizing the relief makes a level playing field, and
    provides clarity for investors. This, too, is a smart reform
    that is worthy of bipartisan support.
        The bill includes a number of other reforms. Many are
    technical, but they matter, particularly for smaller and
    growing BDCs.
        Every section of this bill shows thoughtful collaboration
    and improvements from previous bills. As the committee works
    through any fine-tuning on the bill, SBIA would encourage the
    committee to continue to keep the process moving and work to
    get real reform signed into law this Congress.
        I would welcome any questions that you may have for me.
    Thank you.
        [The prepared statement of Mr. Foster can be found on page
    62 of the appendix.]
        Chairman Garrett. Thank you.
        And later on we will hear from the gentleman from Maine
    about whether he has any comments about the less use of paper
    products being produced. But we will wait for his comments
    later.
        Next, from Franklin Square Capital Partners, Mr. Gerber is
    recognized for 5 minutes.

       STATEMENT OF MICHAEL F. GERBER, EXECUTIVE VICE PRESIDENT,
                    FRANKLIN SQUARE CAPITAL PARTNERS

        Mr. Gerber. Thank you, Chairman Garrett, Ranking Member
    Maloney, and members of the subcommittee. Thank you for the
    opportunity to testify today. My name is Mike Gerber and I am
    an executive vice president with Franklin Square Capital
    Partners.
        Franklin Square was founded in Philadelphia in 2007 with
    the mission of offering institutional quality alternative
    investments to mainstream American investors, while leading the
    industry in best practices, transparency, investor protection,
    and education. To that end, we launched the industry's first-
    ever non-traded BDC in 2009. We successfully listed that fund
    on the New York Stock Exchange in April of last year to create
    liquidity for our investors.
        Today, we manage four BDCs and have more BDC assets under
    management than any other manager in the industry. Franklin
    Square has investors in all 50 States, and we have portfolio
    companies in 39 States. Importantly, we have delivered strong
    risk-adjusted returns for our investors.
        As you all know, the 1980 law that created BDCs was passed
    with strong bipartisan support, and was designed to stimulate
    investment in U.S. companies by matching mainstream investors'
    capital with mainstream businesses. Because BDCs are designed
    for retail investors, they are appropriately heavily regulated.
        In fact, whether traded or non-traded, BDCs are among the
    most highly regulated investment vehicles in the marketplace.
    And because of the extensive public filings, some of which you
    have seen right here, BDCs are fully transparent to regulators
    and investors alike.
        Our culture at Franklin Square is to embrace this
    regulation. In fact, it is part of how we market ourselves to
    financial advisers and investors. Specifically, BDCs register
    shares under the 1933 Act, and elect treatment as a BDC under
    the 1940 Act. In addition, a BDC is subject to the 1934 Act as
    a public company, meaning it must file 10-Qs, 10-Ks, 8-Ks and
    proxy statements.
        Contained in every Form Q and Form K is a schedule of all
    of our investments, along with details such as the name of the
    portfolio company, the size of the loan, the rate of the loan,
    and the current mark of the investment.
        Other key protections include mandatory third-party custody
    of all BDC assets; a board of directors, the majority of whom
    must be independent; and board approval of key matters such as
    management fees and quarterly valuations. In addition, our non-
    traded BDCs are also regulated by FINRA and by the blue sky
    securities regulators in all 50 States.
        Taken together, these laws and regulations ensure that BDCs
    are extremely transparent, minimize conflicts of interest, and
    provide investors with a high level of protection.
        One of the key mandates under the law requires BDCs to
    invest at least 70 percent of their assets in U.S. private and
    small cap companies. As a result, our BDCs at Franklin Square
    provided a significant amount of capital to middle-market job-
    creating companies.
        Middle-market businesses employ more than 47 million
    people, or one out of every three workers in the private
    sector. In fact, between 2008 and 2014, middle-market firms
    grew jobs by 4.4 percent versus 1.6 percent for big businesses,
    and unfortunately a 0.9 percent decline with small businesses.
        And now 39 percent of middle-market companies say they
    expect to grow and add more jobs in 2015. Middle market lenders
    like BDCs, therefore, must be poised to provide the capital
    necessary to help fuel this anticipated growth.
        Currently, there are 84 BDCs representing approximately $70
    billion in investments. At Franklin Square we have deployed $27
    billion since inception, including $10 billion in directly
    originated loans.
        The primary tool offered by Mr. Mulvaney's legislation that
    would help BDCs support more job-creating middle-market
    companies is the increase in the debt-to-equity ratio from 1-
    to-1 to 2-to-1. We believe this increase in leverage is modest
    and makes sense for three reasons.
        First, BDCs would have more capital available to meet the
    demand of middle-market firms, while keeping all of our
    investor protections in place. Second, this would permit BDCs,
    as Mr. Arougheti explained, to build safer portfolios,
    delivering the same or higher returns, while taking on less
    risk. And third, even with the proposed increase, 2-to-1
    leverage would still be quite low when compared to other
    lenders in the capital markets.
        For example, banks today are levered anywhere from 8-to-1
    to 15-to-1, and hedge funds are levered in the mid-teens to low
    20s. We believe it would be good public policy to increase the
    lending capacity of BDCs, and promote the more heavily
    regulated, more transparent BDC model.
        The discussion draft contains several additional provisions
    which I address in my written testimony, and I would be happy
    to cover in Q&A. I would like to close by thanking
    Representative Mulvaney for his work on this legislation. And I
    look forward to answering questions from the committee.
        [The prepared statement of Mr. Gerber can be found on page
    73 of the appendix.]
        Chairman Garrett. Thank you.
        Now from the Center for Capital Markets Competitiveness,
    Mr. Quaadman, welcome back to the panel. You are recognized for
    5 minutes.

     STATEMENT OF TOM QUAADMAN, VICE PRESIDENT, CENTER FOR CAPITAL
           MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE

        Mr. Quaadman. Thank you, Chairman Garrett, Ranking Member
    Maloney, and members of the subcommittee.
        Markets provide investors with the opportunity for return,
    and businesses with the potential to grow. Markets must have an
    even playing field and certainty in order to achieve these
    purposes. But we also live in a global economy.
        So this past February, the Chamber released a report
    entitled, ``International Markets: A Diverse System is the Key
    to Commerce,'' which was written by Professor Anjan Thakor of
    Washington University.
        And what the report found was two things: first, for
    businesses to operate in this global economy, they need to have
    diverse forms of financing; and second, capital will go to
    those markets that are most efficient, and businesses will go
    to where the capital is.
        Therefore, in this global competitive environment, we have
    to keep in mind that the United States is not the only
    destination for capital. Indeed others, including the European
    Union today, are currently considering proposals to make their
    market-based financing more efficient in order to spur their
    capital formation. So these bills and the hearings that the
    subcommittee has been holding this year are very timely.
        The business development corporations are filling a void
    for the midsized businesses and provide an alternative means to
    raise capital as other options have dried up over the years. We
    want to thank Mr. Mulvaney for introducing the Small Business
    Credit Availability Act, and we support it.
        While BDCs have only been in operation since 1980, it is
    only in the last few years that they have become an attractive
    means of capital formation for businesses. Indeed, the Chamber
    has supported past bipartisan efforts to increase BDC activity.
    And we believe that this bill addresses the concerns that were
    raised in prior legislative debates, as well as by the SEC.
        This bill will provide greater capital and flexibility
    investments while still having BDCs as a regulated entity. BDCs
    will increase, but still on a limited basis.
        The Chamber also supports robust disclosures and investor
    protections of BDCs so that retail investors have both the
    opportunity to understand the upside, as well as the risk of
    investing in BDCs. We believe that the Mulvaney draft bill
    achieves that purpose.
        I would also like to address the H.R. 2187, the Fair
    Investment Opportunities for Professional Experts Act. We need
    to have limits to allow sophisticated investors to invest in
    private companies and to access complex investment vehicles. We
    need to do this to ensure that unsophisticated investors are
    not harmed.
        The Chamber supports objective tests such as asset and
    income thresholds to determine accredited investors. Mr.
    Schweikert has thoughtfully pointed out that there may be some
    on the periphery who should be allowed in. And we have some
    suggestions on how to improve the bill.
        First, those who are licensed and certified to sell
    securities should be considered to be a sophisticated investor,
    but with caps to ensure that their investments match their
    financial wherewithal. Secondly, we understand the intent
    behind the FINRA test and think it is an innovative way to get
    at the solution. However, the test is also subjective.
        We would prefer that the SEC be authorized to study the
    issue. What are the characteristics of a sophisticated
    investor? What are some of the innovative ways to bring those
    in, in a safe manner? And then to have the SEC report back to
    this committee as to what those innovations should be. And that
    those should be brought in under limited circumstances.
        Additionally, we have concerns on the language regarding
    the use of financial intermediaries conveying an accredited
    investor status to retail investors. While we understand the
    intent behind that provision, we are concerned that the
    exception will subsume the rule, that it will also place some
    unsophisticated investors at harm, as well as increase
    liability for financial intermediaries. But we think this is a
    good step forward, and we are happy to work with Mr. Schweikert
    to make the bill a reality.
        The Chamber feels that these bills will enhance the
    competitiveness and increase opportunities for return, growth,
    and job creation. We look forward to working with the sponsors
    of this legislation, both bills, with the subcommittee, and to
    improve them as well as to include these vehicles into a JOBS
    Act 2.0 that we hope can become law in this Congress. Thank
    you.
        [The prepared statement of Mr. Quaadman can be found on
    page 81 of the appendix.]
        Chairman Garrett. Thank you.
        Finally, last but not least, Professor Brown. You are
    recognized for--
        Mr. Brown. ``Jay'' is fine.
        Chairman Garrett. There you go.

    STATEMENT OF J. ROBERT BROWN, JR., PROFESSOR OF LAW, UNIVERSITY
                     OF DENVER STURM COLLEGE OF LAW

        Mr. Brown. Chairman Garrett, Ranking Member Maloney, and
    members of the subcommittee, it is a privilege to be here
    today.
        In addition to my position at the University of Denver
    Sturm College of Law, I also serve as the Secretary to the
    SEC's Investor Advisory Committee (IAC). The remarks I make,
    however, are my own, and do not necessarily reflect the views
    of the other members of the IAC.
        With respect to H.R. 2187, the Fair Investment
    Opportunities for Professional Experts, and the definition of
    accredited investor, let me give a bit of context. The SEC's
    definition of accredited investor for individuals was set out
    in 1982. While the dollar amounts have largely remained
    unchanged, the financial landscape has undergone a tectonic
    shift.
        The markets have of course grown in complexity. But most
    significantly has been the shift from pension plans to defined
    contribution plans. Almost everyone with retirement savings
    today has a 401(k) or an IRA. The result has been what I
    believe is a dramatic increase in individual responsibility for
    managing the retirement nest egg.
        Likewise, the number of retirees is increasing rapidly.
    Every day, 10,000 Baby Boomers reach the age of 65, a trend
    that will continue until 2030. Many of these older investors
    are unsophisticated and lack, as one study put it, ``even a
    rudimentary understanding of stock and bond prices, risk
    diversification, portfolio choice, and investment fees.''
        With the end to the ban on general solicitations, our
    retirees and other investors can now be offered unregistered
    investments through indiscriminate forms of mass marketing,
    including blast emails, ads on the Internet, infomercials, and
    seminars. So imagine our 85-year-old parent or uncle or friend
    who gets the unsolicited phone call or the pitch at a free
    lunch to invest in pre-IPO shares, or--I am from Colorado--the
    marijuana business. If that doesn't work, how about a
    children's television network or a company that is making a
    grandchild-safe alternative to the Internet?
        All of this brings me to the definition of accredited
    investor. The definition needs to include those who are
    sophisticated and exclude those who are not.
        In reforming the definition, I believe there is more
    agreement than disagreement. There is agreement that it should
    be changed to include the people who are, in fact,
    sophisticated. The recommendation of the SEC's Investor
    Advisory Committee has set out standards for when this should
    occur, basing sophistication on education, experience, and
    testing.
        The dollar thresholds also need reexamination. It may mean
    increasing the amounts. It also may mean changing the way the
    amounts are calculated. Maybe some portion of retirement assets
    should be excluded from the calculation.
        Even people who oppose changes to the numerical thresholds,
    I believe, are mostly worried that a sudden increase in the
    dollar amount will significantly reduce the number of
    accredited investors. But if the definition is reformed
    simultaneously to make the income and net worth standards a
    better predictor of sophistication and allow individuals to
    also qualify on the basis of education, experience, and
    testing, I believe that all sides in the debate will benefit.
        With respect to H.R. 2187, my written testimony has a more
    complete critique. But let me just offer these observations.
    First, the draft legislative proposal does not deal with our
    85-year-old parent or uncle or friend who is in fact
    unsophisticated and qualifies as accredited because of the net
    worth test.
        Second, the bill treats as accredited whole categories of
    individuals, such as lawyers. Lawyers are not invariably
    rendered sophisticated as a result of education or practice
    area. Extending the definition to persons who are not
    sophisticated is of particular concern since these individuals
    are not required to meet the numerical thresholds and may not
    be in a position to withstand the loss.
        Finally, a serious risk is that regulators charged with
    implementing this legislation will stop other efforts. The bill
    leaves out other groups that ought to qualify as accredited as
    a result of experience and education.
        The SEC is working on a study in this area that ought to
    include some recommendations. The Commission is in a good
    position to achieve the grand bargain that I think is needed,
    and should be allowed to complete the process without
    legislative intervention.
        Very quickly with respect to business development
    companies, I think that the increase in leverage proposed under
    the legislation will raise the risk profile for at least some
    of these companies. But disclosure is an appropriate method of
    addressing the issue.
        My most significant concern is with the changes that would
    allow BDCs to redeploy a higher percentage of their assets away
    from operating companies to financial firms. In 1980, Congress,
    in adopting the legislation creating BDCs, sought to provide
    additional funding and managerial advice to operating
    companies.
        Why these companies? As the House report said then, the
    committee is well aware of the slowing of the flow of capital
    to American enterprises, particularly to smaller growing
    businesses, that has occurred in recent years.
        The importance of these businesses to the American economic
    system in terms of innovation, productivity, increased
    competition, and the jobs they create is of course critical,
    hence the need to reverse this downward trend is a compelling
    public concern.
        I suspect that this is no less true today than it was in
    1980, and that these companies remain critically important to
    our economy and the creation of jobs. I think that any reform
    in this area should not change the framework in a manner that
    may disadvantage the very kinds of companies that the
    legislation was originally intended to assist.
        Thank you again for providing me with the opportunity to be
    here today.
        [The prepared statement of Professor Brown can be found on
    page 48 of the appendix.]
        Chairman Garrett. I appreciate your comments.
        I thank the panel. And at this point, I will recognize
    myself for 5 minutes for questions, and I will go in reverse
    order.
        And again, I thank the gentleman from Arizona for his work
    on the accredited investors change of definition. I guess our
    one takeaway from Professor Brown is that lawyers are not
    sophisticated. Will we have consensus on that from everybody on
    the panel that lawyers are not sophisticated? Okay.
        So, moving on from that degree of consensus, on the issue
    of accredited investors, isn't it somewhat an issue of fairness
    too, as far as having drawn a distinction in class as to who is
    allowed to have the opportunity to these investors versus which
    class of people in the country don't have the opportunity?
        What I was thinking as I heard the professor talk was that
    those people that you were defining, the retiree or what have
    you, currently probably don't fit into that definition of
    accredited investor. But they have the opportunity to do all
    sorts of other investments with their money.
        Mr. Foster showed the disparity between BDCs and public
    companies. And those public companies are available on all the
    exchanges and what have you.
        And the unsophisticated investor can be making life-
    changing investments in all of those. Of course in most of
    those investments, you don't necessarily see the rate of return
    that you sometimes see in a BDC. I see some nods on that.
        So is this--maybe I will throw it out to Mr. Gerber. Is
    this an issue of degree of fairness as far so this distinction
    that will be allowing those who should be able to have the
    opportunity to get into these investments who currently are
    precluded simply by law?
        Mr. Gerber. Thank you, Mr. Chairman. Just a point of
    clarification--
        Chairman Garrett. I should probably not have thrown that to
    Mr. Gerber.
        Mr. Gerber. No, that is okay. But I just think it may be
    important to mention this on behalf of the BDCs. To invest in a
    publicly traded BDC, a person does not need to be an accredited
    investor, number one.
        Number two, to invest in a non-traded BDC, investors--that
    transaction is regulated by the blue sky laws in each of the
    States. And all of the States have their own suitability
    standards that apply to whether or not an investor is
    appropriate for--
        Chairman Garrett. So let me throw it over to Mr. Quaadman
    as far as the rest of the investment field.
        Mr. Quaadman. Sure. Chairman Garrett, you raise a very good
    question, because we have a robust private company market.
        Most businesses in the United States are private. So what
    we need to do is ensure that we have capital flows into those
    private companies to ensure that they have the liquidity to
    grow and operate.
        What is also important is that with public companies, we
    have a vast amount of disclosure with the notion that investors
    can go in there and make whatever decisions they want because
    they can access the information.
        What we want to do with the private companies is ensure
    that you have people with the knowledge base and the
    wherewithal to go in there and to invest in companies.
        Chairman Garrett. Let me stop you there and go back to Mr.
    Gerber then because he was saying that these are not--which is
    correct. It was with regard to accredited investors in BDCs.
        Satisfy for me then that there is enough transparency,
    information, and the like for that class of non-accredited or
    non-sophisticated in that realm.
        Mr. Gerber. With respect to BDCs, as I mentioned in my
    testimony, Mr. Chairman, we fall under the 1933 Act, the 1934
    Act, and the 1940 Act. So in the BDC context, there is a load
    of transparency and a ton of information that is provided to
    investors, just the same as a publicly traded company.
        Chairman Garrett. So who is it when you are trading in
    these and--where has that information actually gotten to? In
    other words, where the investment is certainly done through
    your broker or what have you, in the securities in the street
    name, is that actually getting back to me as the nominal
    investor in that situation?
        Mr. Gerber. It certainly can be. It is available on the SEC
    Web site EDGAR. It is available on all of our Web sites. So it
    is easily accessible.
        Chairman Garrett. So what about--and I will throw this to
    anybody else to talk about the BDCs. What about what is in Mr.
    Mulvaney's bill as far as changing the leverage ratio--the
    ratio? As far as getting sufficient transparency there back to
    the actual investor who may not actually be in the--may not
    actually be the street name investor? Anyone who wants to chime
    in on that?
        Mr. Arougheti. Yes. I think we talked about this proposed
    legislation relative to prior attempts to increase the asset
    coverage ratio, I think the combination of a form of
    shareholder vote and a ``cooling-off period'' provides the
    adequate shareholder protection.
        So as this bill contemplates, the independent board of
    directors would make a determination that they would like to
    access the increased asset coverage ratio. And then under the
    securities regulations, an 8-K would need to be filed publicly
    to make public notice of the intention.
        And then obviously the shareholders will have 12 months of
    a cooling-off period to effectively vote with their feet. So
    even in the event that there wasn't a shareholder vote--
        Chairman Garrett. Right.
        Mr. Arougheti. --it would give people free time to
    determine whether or not they wanted to stay within that
    investment.
        Chairman Garrett. Okay. Great. Thanks. I appreciate that.
        I have some other questions with regard to the testing
    requirements, but I will throw it to the gentlelady from New
    York.
        Mrs. Maloney. Thank you, Mr. Chairman, for calling the
    hearing. And I thank all the panelists.
        I would like to ask Mr. Arougheti about the additional
    leverage that the BDC bill would allow. Of course, we are still
    talking about very low levels of leverage.
        The bill would only increase the maximum leverage ratio
    from 1-to-1 to 2-to-1. But it is still a higher leverage. What
    would your company do with the higher leverage that this bill
    would permit?
        Mr. Arougheti. I think, as Mr. Gerber said in his
    testimony, it is not abundantly clear that every company will
    actually take advantage of the incremental asset coverage
    ratio.
        I think one of the wonderful things about the BDC industry
    is that it services all types of companies from venture finance
    companies all the way through two larger middle-market
    companies. And even on this panel you have companies who focus
    on the lower middle-market with more equity orientation through
    to folks like ourselves who focus more on larger market senior
    secured loans.
        So what Ares would likely do would be to increase the scope
    of its lending activities, probably become more senior secured
    and therefore less risky in our investment positioning, and use
    the increment to leverage, back to Mr. Gerber's commentary, to
    drive the same, if not higher returns to our investors but
    taking less risk at the asset level.
        Mrs. Maloney. So how much of the additional money would go
    to increase investments in the so-called 70 percent bucket for
    small businesses? It would give you more money to--more
    liquidity to put out to these smaller businesses.
        Mr. Arougheti. Right. So, all of that capital should
    theoretically find its way to small business.
        Maybe addressing at least for Ares the 30 percent basket as
    we use it has two concentrated positions in it today. One is
    called the senior secured loan program, which is a joint
    venture that we had with GE Capital that we used to actually
    make middle-market loans. And the second is in the form of a
    company that we call Ivy Hill Asset Management, which similarly
    is in the business of making middle-market loans.
        So at least from the Ares strategic perspective, we have
    been using our ``30 percent basket'' to in fact make middle-
    market loans to small companies.
        Mrs. Maloney. I would like to ask you and also Mr. Foster
    about the discussion draft of the BDC bill, which would allow
    BDCs to invest more of their assets in finance companies. And
    as Mr. Foster testified, the intent of the first BDC bills was
    to direct these monies towards goods and services that are
    really underfinanced and need this help.
        Are you concerned that this change could change how BDCs
    are viewed by investors and analysts? And what is your feeling
    about being able to invest more in finance companies as opposed
    to goods and services?
        And I would like first to hear from Mr. Foster and Mr.
    Arougheti. But also any comments from anybody else on the panel
    on this question of allowing the finance companies.
        Mr. Foster. Sure.
        The BDCs in the SBIA have generally been polled by the
    staff. And in general there is a consensus with respect to the
    BDCs, the 34 BDCs in the SBIA--not 100 percent, but a general
    consensus is that this additional flexibility would be nice. It
    is not a priority at all.
        And I don't think many of us would take advantage of it. We
    personally would not take advantage of it. I think you would do
    so at your own risk to the degree you alienated some of your
    shareholders or what have you by changing your business plan.
        On the other hand, we are permanent vehicles for capital.
    And there is a constantly changing array of investment
    opportunities out there. And the credit cycle goes up and down.
        So to me, it is kind of like the swimming pool in the
    backyard. I really don't use it, but it is nice to know it is
    there if I ever want to use it. And I think that is the general
    consensus of the SBIA.
        Mrs. Maloney. Mr. Arougheti, do you--
        Mr. Arougheti. Yes. I think about this two ways, one just
    in the context of modernization.
        And as we sit here today talking about legislation that was
    passed 35 years ago, while many things are still similar in
    terms of the capital void for middle-market companies, the
    structure of the financial markets has changed. And things like
    small ticket leasing, things like factoring, things like
    receivables financing, all exist today in a way that they
    didn't exist 30 years ago.
        So as one example in our portfolio, we have a leasing
    company that makes office equipment leases to small business--
        Mrs. Maloney. Okay. My time has almost expired and I would
    like to hear Mr. Foster's reaction to it, too. I only have 7
    minutes left. Excuse me--Mr. Brown's--
        Mr. Brown. My biggest concern is that there will be funds
    redirected away from operating companies and to these financial
    firms.
        I don't know if financial firms need the funds in the same
    way that operating companies do. But there is a defined need
    here for operating companies. And I think before the
    legislation allows for the redirecting of funds away from those
    companies, it should have a stronger empirical basis for
    determining that, which is a more appropriate use of funds.
        Chairman Garrett. Thank you.
        The gentleman from Texas is recognized for 5 minutes.
        Mr. Neugebauer. Thank you, Mr. Chairman. Thanks for holding
    this hearing.
        Mr. Arougheti, Mr. Brown had said that increasing the
    leverage ratio would be harmful to--has the potential to be
    harmful to the investors. But what I heard you saying is that
    you would use that leverage in a way that enhances shareholder
    value, wouldn't you?
        Mr. Arougheti. Yes, I would. I believe, and I think it is
    just common knowledge in the investment business that the
    introduction of leverage could amplify risk the same way it
    could amplify returns.
        So I would be remiss to say that there is not the
    possibility that it could theoretically improve risk. But what
    I believe Mr. Brown also said is that the benefits, provided
    there is adequate disclosure, which this legislation provides
    for, far outweigh those potential risks.
        One thing I think is worth highlighting is that the
    structure of the market already accommodates the leveraging of
    lower risk assets.
        In fact, within the BDC industry, where we borrow from
    banks they give us a schedule of investments identifying how
    much they are willing to leverage our various investments. And
    from that list, starting with common equity all the way up
    through senior secured loans, what you will see is a market's
    unwillingness to leverage equity investments and a market's
    willingness to leverage senior secured loans well in excess of
    the proposed 2-to-1.
        So, outside of the BDC construct, the idea of risk-based
    leverage is pretty well-established. And even within the BDC
    framework, the existing leverage facilities are already in
    place to accommodate that changing leverage requirement if the
    1-to-1 overlay were widened.
        Mr. Neugebauer. So, if this bill passes and becomes law,
    you don't see this big rush out to all these companies to
    leverage up because basically it is going to--you have a
    business model and there is certain amount of opportunity out
    there to determine how you can best fund that.
        Mr. Arougheti. Yes. I think that is exactly right. And
    again, one of the things that we have seen over the last decade
    is that BDCs have grown.
        As I mentioned, there are various business models. There
    are certain BDCs who lend exclusively to venture-backed
    companies who may be pre-revenue or pre-cash flow. And those
    will attract a certain amount of de minimis leverage.
        And then there are people like ourselves who would probably
    be moving into lower risk senior secured leverage and attract a
    different balance sheet profile. So I think that is one of the
    nice things about the bill.
        Mr. Neugebauer. So do you see this, the growing of the BDC
    market increasing as the--as we see the diminished
    participation in the banking community?
        Mr. Arougheti. Yes, I do. I think the growth in the BDC
    market has been significant, but not nearly enough to keep pace
    with the growing capital void. So I would hope that this
    legislation would in fact spur capital formation.
        Mr. Neugebauer. And from the panel--these are some
    thoughtful ideas--are there other things in that space that we
    need to be thinking about that is under-addressed in this
    legislation that would encourage the BDC activity and help--
    more importantly help small businesses access capital?
        Mr. Foster, you look like you--
        Mr. Foster. Thank you. Yes. The first thing that is going
    to happen, all three of us, our investment grade rated by the
    S&P, we are the most creditworthy of the BDCs out there.
        And the first thing we are likely going to do if the
    legislation passes is sit down with the rating agencies and
    talk about their reaction, if any, to it. And they probably
    won't have a reaction--just because we can have more leverage
    doesn't mean they are going to allow us to have more leverage.
    And I don't think any of us are going to take on more leverage
    if it means a ratings downgrade.
        Similarly, like Mr. Arougheti said, we will sit down with
    our banks and say what, if anything, are you willing to provide
    us now that we have the ability to have slightly more leverage?
    And so there is a lot of self-correcting mechanisms, the way we
    all operate, where you are not going to see a huge amount of
    immediate leveraging.
        You are going to sit down with your constituents. You are
    going to figure out what makes sense. But I think the
    shareholders are the winners at the end of the day. And I think
    that there are businesses out there that we can't reach that we
    are going to be able to reach. But I think that it will be
    selective and I think it will take some time.
        Mr. Neugebauer. Mr. Quaadman?
        Mr. Quaadman. Sure, Chairman Neugebauer. Just two points I
    wanted to make with that.
        One is if this bill were to pass, become law, we would see
    the activity move forward. I think this is also a great example
    of something that should be taken up by Mr. Hurt's
    retrospective review bill that was raised in the last hearing,
    that the SEC can come back in 5 years and take a look at the
    activity to see if anything needs to be changed, or how BDC
    activities can be changed more to become a better capital
    formation facilitator in the marketplace.
        The other point I just wanted to raise, too, and this goes
    back to the last question with the 50 percent cap, my
    recollection is with the previous bills that were under
    consideration the last Congress, there was no such cap. So this
    50 percent cap in the Mulvaney bill actually provides a low or
    potentially lower level to financial companies, which I think
    actually helps operational companies in that regard.
        Mr. Neugebauer. Thank you, Mr. Chairman.
        Chairman Garrett. The gentleman's time has expired.
        The gentleman from California?
        Mr. Sherman. Thank you.
        Mr. Brown, one definition that would be added is for
    accredited investors or those who have retained or used the
    services of various advisers. As you understand the
    legislation, would that mean that an investor could just retain
    the advice of an adviser who is affiliated with, selected by,
    or compensated by the issuer?
        Mr. Brown. I don't think there is anything in the
    legislation that prevents that. It defines categories and all
    you have to be is in one those categories of people in order to
    be considered someone who can provide the services that
    transform you into an accredited investor.
        Mr. Sherman. So, if I had a product I wanted to get
    investors in, and let's say I have a perverse interest in
    selling to those who couldn't even afford the risk, I could
    just have a CPA or lawyer on staff and say you could advise
    each investor, and I will pay you to do it. And/or you will
    earn a commission with regard to the investment.
        I don't see any of the other witnesses anxious to
    contradict that. So I hope we would correct that in the
    legislation and say that if you are going to be an accredited
    investor because you have a good adviser, that adviser better
    not be affiliated with, selected by, or compensated by the
    issuer. Nor should his or her compensation depend upon whether
    the investor chooses to make the investment.
        We have--back when I was in the business world, which was a
    long time ago, we established this million-dollar rule; a
    million dollars now isn't even a good house in many parts of my
    district. And this $200,000 income used to be those who were
    really rolling in money.
        I would point out that even Members of Congress would be
    making $200,000 if we hadn't legislated to prevent ourselves
    from getting cost-of-living increases. And I would hope that we
    would take a look at this.
        If we are going to liberalize the rule by saying well, you
    are going to get good advice, you don't have to be a
    millionaire. We would realize in today's world a millionaire is
    somebody who has at least a couple million bucks.
        To say that somebody is a millionaire because they have a
    net worth of a million ignores the inflation over the last 20
    or 30 years. As to leverage for the BDCs, what we have in our
    economy now is all the money is locked in banks and other very
    risk-averse investors.
        If you want to get a prime loan or a prime plus 1 loan, you
    can get 10 banks to bid on it. You get all the money and they
    beg you to take more and you say no. If the U.S.--if the German
    government wants to borrow money, you have to pay them to take
    it.
        So, those that are--the money is locked up. And if we can
    get some of that money lent to BDCs and then through BDCs,
    extend it to the companies that really need it and that are
    growing and that--or might grow. And then have some risk; that
    is moving the money from this little sheltered world where it
    only gets lent to sovereign governments and et cetera and gets
    out.
        Which is why I am a bit reluctant to--I think Mr. Brown
    commented on this--to see the BDC money then go to financial
    institutions. It is the financial institutions that already
    have enough money.
        Does anyone here--I will address this to Mr. Foster, but
    anybody, have any economic analysis that said not as good for
    investors? And you do have to be here just for your investors.
    But that it is good for the economy to create another pipeline
    so that investment money goes to those in the financial sector.
        Mr. Foster. Sure. Well, yes. We have investments. And Mr.
    Arougheti has one too. We have--and probably Mike as well. We
    have investments in leasing companies that might have to occupy
    a small role in our 30 percent bucket. And would it be nice to
    not have to worry about that if another leasing company came in
    because the leasing company's equipment leasing companies, they
    are helping operating businesses, right. So just because--
        Mr. Sherman. And in a lot of ways, they are your business.
        Mr. Foster. Yes. We--
        Mr. Sherman. They are financing the same people you are
    financing.
        Mr. Foster. Yes. But I think our members think that the 30
    percent bucket is adequate to deal with those. We welcome it.
    It would be nice if it were bigger. But I just don't see it as
    a priority to--
        Mr. Sherman. Should all financial--
        Chairman Garrett. The gentleman's time--
        Mr. Sherman. My time has expired.
        Chairman Garrett. Mr. Huizenga is now recognized for 5
    minutes.
        Mr. Huizenga. Thank you, Mr. Chairman.
        And actually I will kind of continue on the line of
    questioning that my friend from California had. And I might
    add, while I might question your judgment on things on
    occasion, politically I would view you as a qualified investor.
    I would hope that reasonably educated people who can go do this
    would be able to go in and make these types of decisions.
        So I am kind of curious about this--sort of this fiduciary
    issue that seemed to be the pursuit, and about compensation.
    And Mr. Gerber, when the little exchange was happening you had
    a very contemplative look on your face. I am curious if you
    were looking to try to respond to that or any of the others.
        And then Mr. Quaadman, you had mentioned that from your
    perspective, quickly, at the end of I think it was Mr.
    Neugebauer's questioning about you believe that this could help
    operational companies. And I wanted to expand on that a little
    bit.
        And then Mr. Arougheti, you had talked a little bit about
    adequate protection. So that is kind of that direction I would
    like to go.
        And Mr. Gerber, I don't know if you care to lead off, if
    you had something to say about that fiduciary element?
        Mr. Gerber. I am not sure exactly which period of the
    discussion you are referencing. But I think what--
        Mr. Huizenga. I think it was like the time of compensation
    for someone who was giving advice, where that compensation
    would come from.
        Mr. Gerber. Yes. The thought that was crossing my mind at
    the time, because there are some related issues between these
    two bills, and the gentleman from California was asking
    questions about conflicts of interest. And that has come up
    with some of the provisions in the BDC legislation as well
    where there could theoretically be an adviser-issuer conflict.
        And that is something that Congressman Mulvaney has tried
    to address in the BDC legislation by ensuring that the SEC
    would have an opportunity to review those types of conflicts.
    And I think that is an improvement over the legislation, the
    BDC legislation.
        And again, it is not a priority for Franklin Square, but it
    is something that we think is important to consider on behalf
    of the industry and on behalf of investors in the BDC industry.
    And we were pleased to see that addressed in Mr. Mulvaney's
    draft legislation.
        Mr. Quaadman. Sure. Chairman Huizenga, the point I was
    trying to make is in the previous BDC legislation that was
    considered in the last Congress, there was no such 50 percent
    cap on financial companies. So, theoretically, a lot more than
    just 50 percent could have gone in.
        The current draft actually provides a ceiling. So
    theoretically, with that ceiling you would have a certain
    amount that would have to go to operational companies.
        Frankly, if you take a look at the BDC model historically,
    they are going to be investing in operational companies anyway.
    But I think this creates a ceiling where there hadn't been one
    before.
        Mr. Huizenga. And the vast majority of your investments,
    right, the gentleman that actually are involved in the BDCs
    here, they do go into operational companies. Correct?
        Mr. Gerber. Absolutely.
        Mr. Quaadman. Okay. Mr. Arougheti, you had the microphone
    there for a second. Why don't you talk a little bit about the
    adequate protections that you thought were in there for those
    investors? And that seems to go back a little bit ago, so I
    don't know if you remember uttering that, but I do--
        Mr. Arougheti. Yes. It is interesting because I think
    people have been focused appropriately on regulation and
    shareholder protection.
        I will just reiterate some of the things that Mr. Gerber
    said in his testimony that as far as financial services models
    go, you can't get more transparent than a BDC.
        We have a quarterly schedule of investments where we
    delineate every investment in the portfolio. If you juxtapose
    that with a bank balance sheet, as an example, it would be very
    difficult for anybody in this room to actually open up a public
    filing for a bank and figure out exactly what they own.
        Now, they are under a completely different regulatory
    regime, so that is not to say that they are bad investments.
    But I think it is important that we always get re-grounded in
    the transparency and the regulatory framework under which we
    operate.
        Vis-a-vis the increase in leverage, a very positive change
    in the new legislation being introduced is this idea of
    shareholder protection through a cooling-off period.
        I personally believe that the investor community will
    welcome this change and it will actually create a significant
    amount of renewed interest in the BDC space from both retail
    and institutional investors.
        But the idea of giving the retail investor the opportunity
    over a prolonged period of time to vote with their feet I think
    is a very innovative way to give them the adequate protection
    that certain people are trying to give them.
        Mr. Huizenga. Okay. Any concerns, anybody, about whether
    there might be leveraged money allowed to be leveraged again in
    this if you were changing that ratio? That had been--someone
    had brought up to me that sometimes these investors into the
    BDCs are using leveraged money.
        So my time has expired. But thank you.
        Chairman Garrett. Thank you.
        Mr. Hinojosa is now recognized for 5 minutes.
        Mr. Hinojosa. Thank you, Chairman Garrett. And thank you,
    Ranking Member Maloney, for holding this hearing.
        It seems to me that when it comes to innovation the United
    States is the envy of the world. And we are the envy not only
    because our economy values and rewards entrepreneurship and
    hard work, but because our markets are transparent, safe, and
    liquid.
        My first question goes to Professor Brown. The discussion
    draft of the Small Business Credit Availability Act creates
    multiple classes of preferred stock, each with different
    shareholder rights. With different characteristics and rights,
    do the new classes of preferred stock pose risk to retail
    investors?
        Mr. Brown. I think that there are advantages to multiple
    classes of preferred stock. And of course operating companies
    today have that authority.
        I think that this draft legislation eliminates some
    investor protections that are associated with preferred shares.
    And I think that is of concern. I think the idea that this
    legislation would limit the purchase of those shares to
    qualified institutional buyers is a helpful way to approach
    that.
        My concern is actually not with the purchase of preferred
    shareholders, but the common shareholders. This bill would
    strip away the obligation to have voting rights on those
    shares. But it would also allow for things like super-voting
    stock, at least as I read the legislation.
        There is no legislation of voting rights anymore if this
    bill passes as is. So in theory, a board of directors could
    transfer voting rights away from the common stockholders and to
    the preferred shareholders.
        I actually have a suggestion in my testimony as a way that
    I think that should be fixed. I don't think that authority
    should be allowed.
        Mr. Hinojosa. Mr. Brown, as you know, H.R. 2187 would
    classify brokers, investment advisers, accountants, and lawyers
    as accredited investors. The legislation assumes that these
    persons or entities by nature of their profession are
    sophisticated enough to understand the private securities
    offerings under Regulation D. Do you have any concerns for
    these classes of persons being deemed sophisticated under the
    law?
        Mr. Brown. Congressman, I sure do. And as I mentioned in my
    testimony, I know lawyers, obviously the best. I teach them. I
    am around them all the time. They are not an inherently
    sophisticated group of people, at least when it comes to
    investments.
        The education--we have plenty of lawyers in this room. In
    your law school education, you are not taught about the
    intricacies of complex investments. We are lucky if students
    take corporations or securities at all. And then those courses
    don't really prepare you.
        So unfortunately, the way this is drafted right now it
    doesn't take into account age. It doesn't take into account
    experience. And really you can't really rely on education as a
    way of saying that they are sophisticated. So I am concerned
    about those categories.
        Mr. Hinojosa. Thank you.
        My next question is to Vincent Foster.
        Pursuant to Section 413 of Dodd-Frank, the SEC is currently
    working on a study of whether it needs to redefine its current
    accredited investor definition. Rather than jumping in with a
    legislative fix, do you think we should wait to see how the SEC
    comes out on any changes to the definition?
        Mr. Foster. I don't think the SBIA really has a position on
    that because we are dealing exclusively with either SBIC funds
    that have as their investors accredited investors, or SEC-
    registered companies that have as their investors retail and
    institutional shareholders, which is accompanies by extensive
    disclosure and generally full liquidity for the shares. And so
    I don't think we really have a position on that.
        Mr. Hinojosa. Okay.
        Next question is for Mr. Arougheti. In your testimony you
    have indicated that commercial banks and other traditional
    financing sources continue to retrench the business of
    providing loans to small and medium-sized companies. Can you
    elaborate on your prepared testimony and provide us some
    insights into why you think this retrenchment is happening? And
    what, if anything should be done to ensure that those small and
    medium-sized businesses have adequate access to capital?
        Mr. Arougheti. Sure. I will try to be brief. It looks like
    we are pressed for time. But I think it is important to put
    this in historical--I'm sorry, Mr. Chairman. Should I--?
        Chairman Garrett. You can finish.
        Mr. Arougheti. To put it in a historical context, because
    the shift from banks to nonbanks, or what we would call
    parallel banks, has actually been occurring for about 25 years.
    And it started in the late 1980s with a big wave of bank
    consolidation in this country.
        So I just think it is important that we clear the
    misperception that this is a post-Great Recession issue. This
    has been happening in this country for 25 or 30 years. I think
    it has accelerated post the Great Recession for a whole host of
    market-based and regulatory reasons. But I don't think there is
    any one issue.
        I think something that has gotten some discussion is also
    just talent. I think a lot of the folks like ourselves who are
    classically trained within bank credit programs have frankly
    fled the banking industry and now reside in firms like BDCs.
    And I think that is part of it.
        Mr. Hinojosa. Thank you. I yield back.
        Chairman Garrett. Thank you.
        Mr. Stivers, you are recognized for 5 minutes.
        Mr. Stivers. Thank you, Mr. Chairman.
        Chairman Garrett. Thank you.
        Mr. Stivers. Thank you, Mr. Chairman. I appreciate you
    holding this hearing on this very important issue of access to
    capital and capital formation in our economy. And as the Chair
    of the Middle Markets Caucus, I know how important middle-
    market companies are, not only in Ohio, but throughout our
    country.
        They represent about 200,000 businesses, about a third of
    our economy. They employ 47 million Americans, and BDC loans in
    that middle-market marketplace have tripled, in fact, over the
    last--since 2008, I believe, so a lot of money. Currently BDCs
    net about, I think, and somebody can correct me if I am wrong
    about this, $70 billion of outstanding middle-market loans.
        So my first question is for Mr. Arougheti. Can you please
    help this committee and everybody understand how this bill
    would help impact capital access to these very important
    middle-market firms by allowing BDCs to have greater access to
    capital and leverage?
        Mr. Arougheti. Sure. I think a real-life example, but just
    to understand why BDCs are so attractive as capital providers.
    We are permanent capital vehicles. So we have many of our
    portfolio companies who view us as their bank, their lender of
    choice. And we try to service them throughout their entire
    lifecycle.
        So we have 250 portfolio companies, a number of whom we
    have been lending to for 10-plus years in a whole variety of
    different ways. It all comes down to scale and product
    capability.
        And the broader our product set, i.e., if we can service
    those same clients and customers with senior secured asset
    based loans that currently don't meet the economic requirements
    of the BDC, that will be a good thing for those underlying
    companies.
        To the extent that the banks can provide some of that
    marginal credit, I think that is a good thing as well, because
    that just promotes more competition and more healthy cost of
    capital to the investors. But I think it is really about the
    increasing mandate that the asset coverage test would provide
    us.
        Mr. Stivers. I appreciate that. And clearly BDCs add value
    to the economy, are adding a lot of value to these middle-
    market companies that are in many cases family-owned, and in a
    lot of cases fast-growing and employing as I said 47 million
    Americans. So I want to thank all of you for your willingness
    to do that.
        I do want to quickly hit on transparency and protections
    because I think that is important. With regard to transparency,
    I think, Mr. Gerber, you said it really well when you talked
    through the quarterly reports you have to do where you do a
    whole review of your portfolio by company, by amount. No bank
    does that. No other financial institution in the capital
    markets has that kind of transparency, do they?
        Mr. Gerber. That is right, Congressman. And I think that is
    one of the reasons why we are all very comfortable making the
    recommendations we are making. It is because of the power of
    the transparency behind the model of the BDC.
        And you are right. When you compare us to other lenders,
    even if we were to go to 2-to-1 leverage, it would still be far
    less leverage.
        And I think Mr. Arougheti addressed this in his comments,
    far less leverage than the other lenders against which we
    compete. And I mentioned it earlier as well. Banks are anywhere
    from 8-to 15-to-1. Hedge funds are in the mid-teens. We are
    just talking about 2-to-1. But it is 2-to-1 in a far more
    transparent model.
        So as Mr. Arougheti said, you cannot go to a bank's balance
    sheet or filing and find a schedule of investments like you can
    in a BDC. And we all know you certainly can't do that in a
    private fund, whether it is a private credit fund or a hedge
    fund that is engaging in lending.
        So it is the most transparent form of lending in the
    marketplace. And we are--even if we go to 2-to-1, it is one of
    the lowest levels of leverage.
        Mr. Stivers. And I would like to just give you a second to
    expand upon that because today you are absolutely the lowest
    leverage at zero. But if you went to 2-to-1 leverage, that
    would be between 4 and 10 times less leverage than your
    competitors in the marketplace employ.
        Mr. Gerber. That is right.
        Mr. Stivers. Thank you.
        And the last thing I do want to hit on is protections with
    regard to accredited investors. We all did laugh at the lawyer
    joke. And I think we should cut all their bills by about 50
    percent because of how unsophisticated they are.
        But I do think that--I was in the investment adviser
    business. If you pass a Series 7, you are pretty sophisticated,
    I would argue. If you pass--my sister is an accountant and
    their exams are really hard. You are pretty sophisticated if
    you are an accountant.
        We can all debate the attorneys, I will give you that. But
    clearly most people in those professional educations are way
    more sophisticated than just being worth a million dollars--
    would you say that makes somebody more sophisticated than just
    being worth $1 million, regardless of how they got it, Mr.
    Gerber?
        Mr. Gerber. I don't consider myself an expert on this one--
        Mr. Stivers. Okay.
        Mr. Gerber. --Congressman.
        But what I would like to say to you is that when you just
    look at arbitrary numbers, I don't think you are getting into a
    substantive consideration. And I think the proposal before us
    is driving at the notion that we ought to be considering
    something other than just arbitrary numbers.
        And I don't know that anybody on this panel would disagree
    that sometimes the substance of someone's background may be
    more meaningful in terms of their level of sophistication than
    just the assets that they have in their possession.
        Mr. Stivers. Thank you.
        Thank you all. I am out of time. I yield back the balance
    of my time. But thanks for being here.
        Chairman Garrett. Thank you. The gentleman yields back.
        The gentleman from Massachusetts, Mr. Lynch, is recognized
    for 5 minutes.
        Mr. Lynch. Thank you, Mr. Chairman. And I want to thank the
    members of the panel. You have been helpful.
        Let's drill down on that a little bit, though. Under the
    terms of the bill right now, H.R. 2187, a personal injury
    attorney with no other requirements would be able to self-
    certify as an accredited investor. Isn't that right, Mr.
    Quaadman?
        Mr. Quaadman. I believe you are correct, and that is one of
    the reasons why we said there should be an SEC study to see
    exactly what those characteristics are.
        Mr. Lynch. Right.
        Mr. Quaadman. So we think Mr. Schweikert is going down the
    right path. But maybe it is also good to have the SEC look at
    it and then report back as to what some of those substantive
    different changes should be.
        Mr. Lynch. Right. I totally agree.
        And I think for the CPA side of this, someone who does your
    taxes once a year doesn't necessarily know what we are talking
    about in many cases--27 of these BDCs are private, they are
    non-traded. So they are rather opaque investments.
        And I don't think the average tax attorney or personal
    injury attorney, excuse me, would necessarily be able to drill
    down and make a good determination whether or not that
    investment is right for themselves or for others.
        The bill also says that as long as you hire a registered
    broker-dealer, that allows you to make that investment as well
    in a BDC that might not have the information public. Mr. Brown,
    does that create a problem?
        Mr. Brown. I certainly believe that it does.
        If we go back to my 85-year-old parent or uncle or friend,
    and we were to say if they happen to have a lawyer who maybe
    was their estate planner or a CPA, as you say, who was doing
    their tax returns, and those two people gave them some
    investment advice, is that person really suddenly transformed
    into someone who is sophisticated just by virtue of the
    relationship? Not necessarily.
        Mr. Lynch. Okay. I want to ask you something else.
        Professor Brown, as you are aware, Congress passed and the
    regulators have finalized the Volcker Rule to prohibit banks
    from using their taxpayer-backed deposits to make proprietary
    trades. The final rule accomplished this by requiring banks to
    divest from certain assets.
        However, BDC funds were excluded from that definition. And
    for purposes of defining affiliation as well, BDCs were not
    considered to be affiliated with a bank so long as the bank's
    ownership of the fund was under 25 percent.
        Recently, Goldman Sachs took a BDC public. They retained a
    20 percent share in the company. Credit Suisse has also formed
    a BDC. I am not sure what their retention is. Should we be
    concerned now that even before the Volcker Rule is effective we
    are already tinkering with an asset class that may enable banks
    to reengage in proprietary trading?
        Mr. Brown. I can say that it concerns me. And my concern
    is--there are a couple of them. But one of the ones is that
    banks, when they form these other entities, especially when it
    is the big commercial banks, the market just judges them
    differently.
        Sometimes the market thinks that the big bank is making an
    implicit guarantee of backing that company even if they only
    own less than 25 percent.
        Mr. Lynch. Right.
        Mr. Brown. That other company gets a break on--the company
    can borrow at a cheaper rate. I might be able to do things that
    other BDCs can't do. So I worry very much when banks get into
    space like this that it may dramatically change the nature of
    that market. And it frankly may give them a competitive edge
    that other BDCs don't have.
        Mr. Lynch. Okay. Thank you very much.
        Mr. Chairman, I yield back.
        Chairman Garrett. Thank you. The gentleman yields back.
        The gentleman from Arizona, Mr. Schweikert, the author of
    the legislation before us today, is now recognized.
        Mr. Schweikert. Thank you, Mr. Chairman. And we will walk
    through a couple of the things, and maybe if one or two of the
    misunderstandings and then work through--work a little
    backwards from there.
        First of all, I think for all of us here there is an
    understanding that we have both the societal problem and some
    other mechanical problems. My understanding is that of our 318
    million population right now we have only about 600,000
    Americans who have gone through the process who are qualified
    investors.
        We know that half of our Baby Boom population is moving
    into retirement with very, very little savings. So part of our
    goal here is how do we move more of our population into the
    investment class, and do it in a safe and rational fashion? And
    so I actually have been working on this bill for a while, but
    quite open to any brilliant suggestion.
        I do want to go over a couple of things, just because one I
    think was sort of a misunderstanding, a misstatement. Under
    current legislation right now, under a current law 506, if you
    are the lawyer, if you are the CPA, if you are the registered
    broker-dealer, you get to certify someone as being a qualified
    investor. It doesn't make you a qualified investor.
        The second part of that is the way the bill is drafted
    right now, if you were to hire one of those people for
    guidance, it would allow you to invest in some of these
    products. Maybe that is where it needs to be tightened up.
        And my first question, Mr. Chairman, and it was actually to
    Mr. Brown, just one quick one. You are actually on the SEC's
    committee that has been somewhat looking at the definitions of
    qualified investor?
        Mr. Brown. Yes, sir, I am.
        Mr. Schweikert. Would I be pushing the limit of getting too
    complicated and too, I will use the word ``sophisticated,'' to
    also look at it as saying a 30-year-old who just happened to do
    really well that year who has $50,000 of risk capital is a lot
    different than your 80-year-old mother example?
        Would you be also willing to support an idea that also
    would put some time as part of one of the kind of
    counterbalancing--or age as one of the counterbalancing
    factors?
        Mr. Brown. Absolutely. And when I read your draft, there is
    no question in my mind that was a good-faith effort to try to
    address a problem that the Investor Advisory Committee agrees
    is there, which is how to let people who are sophisticated in
    fact, actually sophisticated, irrespective of the dollar
    amounts, to invest. The definition should allow for that.
        We are in complete agreement. I should say I am, but the
    committee's recommendation.
        I do think, for example in the testing area, in your
    language in the bill I think there should be a provision in
    that says the test only lasts for so long. I think if somebody
    is 30 and then they--I don't want them to have taken it once
    and then at 80, that is fine. There should be some--
        Mr. Schweikert. But for those of us who do really well on
    multiple guess tests, we like that.
        Mr. Quaadman, what would you suggest in the world of--is it
    a--would you be comfortable with a world where a broker-dealer
    could provide advice to someone to invest in what today is
    limited to only qualified investors? And if not, how would you
    tighten it up? What would make you comfortable?
        Mr. Quaadman. My concern there is you could take an
    unsophisticated investor and effectively use the accredited
    investor patina of the broker-dealer and then transfer it over
    to that unsophisticated investor. And that is why I think there
    are some issues where, even though there is advice that has
    been given, the unsophisticated investor, just by definition,
    may not necessarily understand the risks that are involved.
        Mr. Schweikert. If we created sort of an A-B test in the
    legislation, something that also demonstrates some risk capital
    or something of that nature, would that create a--
        Mr. Quaadman. Yes, and that is where I think we need to get
    to is that you need to ensure that the investor has a level of
    knowledge where they can understand what the risks are that
    they are undertaking. And then you also want to have something
    else underneath to make sure that the risks that they are
    taking are commensurate with their financial experience.
        And you can take the flipside too, because if you take a
    look at the bright line test, right, what is interesting
    there--because I talked to somebody who was at the SEC in 1982.
    They picked those tests because they couldn't really figure
    anything else out at the time.
        Mr. Schweikert. Mr. Chairman, in the last 30 seconds, and I
    think all of us have come across this experience, I have a very
    good friend, P.H. Dean Electrical Engineering had some friends
    that had started a business. He is an absolute international
    expert in this subject, except he wasn't allowed to invest in
    it.
        How do we reward people, both from their risk tolerance,
    where they are in their lifecycle of investing, but also their
    knowledge base, and get rid of the sort of arbitrary that you
    have made it in like--you get to continue to make it in life.
    Because you are on this side of the ledger, you don't get to
    participate. We are quite open to any brilliant ideas that will
    come our way.
        With that, I yield back, Mr. Chairman.
        Chairman Garrett. The gentleman yields back. I am looking
    forward to more brilliance from Arizona on the legislation
    then.
        We now go to Connecticut. And Mr. Himes is recognized for 5
    minutes.
        Mr. Himes. Thank you, Mr. Chairman.
        And I thank you all for being here for the duration. I am
    encouraged by what is a robust and substantive bipartisan
    conversation.
        I do have, though, a couple of--and by the way I appreciate
    Mr. Mulvaney's offer. I have a couple of concerns that I would
    like to have addressed here. The first and most important
    pertains to the levels of leverage that would be permitted
    under the Mulvaney proposal.
        Specifically if you start to do the math on the 30 percent
    bucket where, as you know, there are plenty of firms out there
    that are holding equity tranches in CLOs which themselves are
    seven, eight, nine, 10 times levered.
        When you start to do the math on going to 2-to-1 leverage
    in these instruments, on investments in financial companies
    which may themselves have 3 or 4 times leverage, investing in
    instruments which themselves may have 7, 8, 9 times leverage,
    you pretty quickly get to some pretty stratospheric leverage
    numbers. It is not hard to get up into the sort of 70x leverage
    numbers if you just work through that math.
        And of course if you then expand the 30 percent bucket into
    50 percent, you have conceivably, and I understand that there
    will be some prudence exercised by some players in the
    industry, but you potentially have a very highly leveraged
    vehicle here.
        So I wonder--and let me just start with Mr. Gerber since he
    is in the business. And then I would welcome comments. But am I
    right to be concerned that if we permit this degree of
    leverage, you have essentially a very, very volatile
    instrument?
        I don't need to tell you that at 50x leverage, a tiny
    fluctuation in the value of underlying asset puts this
    instrument completely underwater and eliminates the investment
    of a lot of retail investors for whom this product is created.
    So, Mr. Gerber, make me feel more comfortable on that issue.
        Mr. Gerber. I will make my best effort. I think in the
    question you are raising, there are really two issues that are
    distinct, but at the same time, when brought together you have
    to consider it as a whole. So on one hand, it is increasing
    leverage going from 1-to-1 to 2-to-1 in our debt-to-equity
    ratio.
        On the other hand, it is the redefinition of an eligible
    portfolio company, moving something out of the 30 percent
    basket that we talk about into the 70 percent basket. And I
    think what you are getting at is if you combine the two, what
    is happening to a term that we all are familiar with, effective
    leverage.
        You are looking at three of the BDCs in the space that have
    lowest levels of effective leverage. And you can--different
    people have different ways of defining effective leverage and
    doing different calculations. And I think when you look at any
    lender, whether you are looking at a hedge fund or you are
    looking at a bank, you have to ask the same questions.
        And so what you are essentially looking at is the
    multiplier effect, if you will. And in our--
        Mr. Himes. Well, that is the math I was doing. And again, I
    get that you guys are prudent, but--
        Mr. Gerber. Yes. But if I may just finish--
        Mr. Himes. On the less prudent side--I want to check my
    math first.
        Mr. Gerber. Yes.
        Mr. Himes. Again, you could very quickly see very high
    degrees of leverage in this instrument.
        Mr. Gerber. Yes. I think so. And that is why you hear some
    expressions of concern up here at the panel. And I think that
    is one of the areas of legislation where we still have some
    more work to do as an industry. And the members of the
    committee, and I think we are all committed to doing that work
    together.
        But what I wanted to mention is earlier when Mr. Arougheti
    was talking--and I referenced this concept as well about--would
    all of the BDCs be able to access more leverage, and the answer
    is no, they won't. And they won't whether it is because of the
    rating agencies that Mr. Foster talked about.
        They won't because of the covenants that the banks
    require--I'm sorry, the regulators require the banks to have in
    their loans to us. They won't because the analyst community and
    the investor community is going to look at the substance of
    those portfolios.
        And so if you see mission creep, if you will, or if you see
    growth in the overall BDC in fin co investments, you are going
    to see downgraded ratings. You are going to see BDCs
    potentially violating existing covenants.
        So there are these natural governors in place. And I think
    as we work through this language and think about the full
    impact of it, we have to keep in mind those natural governors
    that are in the system.
        Mr. Himes. Could the industry--and I don't have a lot of
    time--live with a modification whereby those investments in
    companies--in the small businesses for which this instrument
    was created, were allowed to lever 2-to-1 as is proposed, but
    in the 30 percent bucket or in the financial bucket, the 1-to-1
    ratio obtained. Is that a reasonable proposal?
        Mr. Gerber. Yes. I think we have heard that. I think it
    would be somewhat complicated to sparse it out like that, money
    is fungible. So I think in effect what you really would be
    saying is instead of going to 2-to-1, you are going to 1.75 and
    1, or something along those lines. But whether or not there is
    a practical way to ensure that any increase in leverage isn't
    being applied to some subset of investments, I think would be
    somewhat difficult.
        Chairman Garrett. Thank you.
        Mr. Himes. Thank you. Thank you, Mr. Chairman.
        Chairman Garrett. Mr. Poliquin is recognized for 5 minutes.
        Mr. Poliquin. Thank you, Mr. Chairman, very much. I
    appreciate it.
        And thank you gentlemen for all coming today. If we all as
    a country look at the state of our economy, where it has gone
    and where it is going, in the last 5 or 10 years, my
    understanding is that about 80 percent of the new job hires in
    this country were in the small-to medium-sized business space.
    So we want to make sure that we do everything humanly possible
    to help our small businesses grow.
        I just looked at a survey a short time ago saying something
    like 42 percent of business executives believe that the lack of
    financing is one of the key reasons that they just don't have
    the confidence to hire more workers and grow their business.
        So I know that Dodd-Frank is a smothering regulation that
    is reducing the available credit among lots of players in your
    space. And so I salute you folks for trying to fill that void.
        I just heard something, Mr. Gerber, a short time ago that I
    want to drill down with you a little bit if I may, something
    that for a non-traded BDC like you folks that the information
    that is provided tends to be opaque. Now, we want to make sure
    that investors who are investing in these sort of financial
    products, that they have all the information they need to go
    forward. Could you address that, sir?
        Mr. Gerber. Sure. Thank you, Congressman.
        It is often a misconception with non-traded because when
    you hear the term non-traded, it just sounds different. But
    non-traded BDCs follow all the same regulatory processes and
    procedures as traded BDCs.
        So, non-traded BDCs are in the 1933 Act, the 1934 Act, and
    the 1940 Act. We have all the same public disclosures as traded
    BDCs. At Franklin Square we manage both traded and non-traded
    BDCs. And we manage more non-traded BDCs than any other
    manager. And I can just tell you the hours that our legal staff
    and accounting folks put into those filings is significant.
        But just because we are non-traded does not mean we are
    opaque. It does not mean that we are not providing the same
    level of disclosure that traded BDCs provide. We absolutely do.
        Mr. Poliquin. Okay. So contrary to what was said here today
    by a member of this committee is that an investor will have the
    same type and same amount and detailed information if I am
    buying a traded or non-traded BDC, is that correct, sir?
        Mr. Gerber. That is, and actually more. And let me explain
    to you why. Because when a firm like Franklin Square
    distributes a non-traded BDC, we also fall under FINRA and blue
    sky regulations.
        So, all 50 States are regulating our products. We are
    filing in all 50 States. We have to meet the suitability
    standards in all 50 States. The advisers and brokers that put
    their clients in our funds have to get a wet signature from
    their clients, our investors.
        So the reality is the non-traded investor probably has more
    opportunity to understand the investment than even an investor
    in our traded BDC. So it is I would say even heightened for the
    non-traded investor--more disclosure, more transparency.
        Mr. Poliquin. Thank you for clarifying that, Mr. Gerber. I
    appreciate it very much.
        Mr. Gerber. Thank you.
        Mr. Poliquin. You bet.
        Now, I want to pivot a little bit here. And we only have a
    couple of minutes left. I will start with you, Mr. Arougheti.
        You folks, and all you folks in the financial industry
    space live under this net, this Dodd-Frank net, which was
    intended for a small number of money center banks that really
    have tentacles throughout our economy that could cause a
    problem if something happens, but are certainly not designed
    for everybody.
        I want to know if you could wave a wand, what one
    regulation now within the Dodd-Frank net would be best to
    remove, repeal, or reform such that you folks are able to grow
    your portfolio companies and hire more workers?
        Mr. Arougheti. Yes. I will answer.
        We are not Dodd-Frank-regulated, so for us we are not
    focused on Dodd-Frank. As we have said numerous times, we are
    heavily regulated under the 1933 Act, the 1934 Act, and the
    1940 Act. I think Representative Mulvaney has done a wonderful
    job putting forward legislation that would actually advance the
    industry.
        Mr. Poliquin. What about you folks possibly being regulated
    by the DOL or by the Federal Reserve or the SEC? How does that
    make you feel?
        Mr. Arougheti. It comes with a different set of regulations
    and a different set of opportunities. So as I highlighted
    earlier, if we were a bank and we were levered 10-to 15-to-1
    and we took depositor money we would be subject to a separate
    set of regulations versus the 1940 Act closed-end fund who is
    taking retail and institutional investments.
        So again, I, for better or worse haven't put myself in that
    theoretical construct. We are focused on the regulatory regime
    that we are subject to.
        Mr. Poliquin. Okay.
        Mr. Foster, do you want to add anything to that?
        Mr. Foster. Sure. I asked our lead investment bank Raymond
    James if the DOL rule that is about to come out would impact
    them because a lot of our shareholder are individuals but they
    invest through IRAs and 401(k)s. And they canvassed their
    system and did not think it would be significant. But you think
    it could be.
        Mr. Poliquin. Thank you.
        Mr. Quaadman, would you like to respond in my waning
    seconds here?
        Mr. Quaadman. Yes. Just to--investment advisers are
    extremely concerned about the fiduciary duty role that it is
    going to have a very significant impact on their ability to
    invest.
        In fact, we issued a study last week that 9 million small
    businesses in the United States are going to be prevented or
    severely crimped in their ability to provide retirement
    vehicles for their employees if that rule goes through.
        Mr. Poliquin. Thank you, Mr. Chairman, for the additional
    time. I yield back. Thank you.
        Chairman Garrett. Thank you. The gentleman yields back.
        Mr. Carney is recognized for 5 minutes.
        Mr. Carney. Thank you, Mr. Chairman, and Ranking Member
    Maloney for holding this hearing today. And thank you to Mr.
    Mulvaney and Mr. Schweikert for these proposals.
        I would like to--I have to admit I don't know a lot about
    BDCs. And so I found your testimony very interesting. And I
    just have really two questions.
        One is to you, Mr. Foster. On page five, I would like to
    understand a little bit about how these BDCs are operating in
    my area. I am the Representative from the State of Delaware,
    the whole State, which is a very small place.
        But I notice on here that it has a pretty big number under
    it on your map on page five, particularly relative to States
    that are much, much larger. Can you explain that? Is that a
    function of our fact that we are the State to incorporate your
    business? Does that have anything to do with that? Or is that a
    function of greater BDC activity in my State?
        Mr. Foster. I can't really explain why there is--I guess it
    says a billion five--
        Mr. Carney. Yes. We are doing better than New Jersey--
        Mr. Foster. Oh yes.
        Mr. Carney. --Connecticut and Maryland, just about.
        Mr. Foster. Maybe one of the two Michaels--
        Mr. Carney. Anybody else? Mr. Gerber, you are from our
    region, right?
        Mr. Gerber. Yes. I think what Mr. Foster wanted to say is
    it is the excellent representation in Congress that is driving
    the heavy investment--
        Mr. Carney. All right.
        Mr. Gerber. I think you hit the nail on the head.
        Mr. Carney. Flattery will get you everywhere.
        Mr. Gerber. At Franklin Square we have a portfolio company,
    it is U.S. coatings acquisition. I do think it is in part
    because of the corporate laws in Delaware and the number of
    firms that are headquartered there--
        Mr. Carney. It is more a question that these are domiciled
    in some kind of way.
        Mr. Gerber. I think that is exactly right. Now in our case,
    our investment has more to do with just the work that is done
    at the portfolio company. But I think the phenomenon you
    referenced is--
        Mr. Carney. Can you--obviously you are located in our
    region. Is most of your activity in the region?
        Mr. Gerber. No. As I mentioned, sir, earlier in my
    testimony, we have deployed capital in 39 of the 50 States. And
    between the 3 of us, our entire industry, we have invested in
    companies in all 50 States. I think it probably depends on the
    scale of the BDC. In our case we have the largest platform. We
    have national reach. So we are sourcing deals all over the
    country.
        Mr. Carney. I think this is a pretty reasonable approach to
    updating regulations from BDCs. I do share Mr. Himes' concern
    about the leverage question.
        So I would like to kind of follow up where he left off,
    which was, is there a way--Mr. Gerber, you started to respond
    to how you might consider addressing that concern. Would you
    like to follow up on that, or Mr. Arougheti, or Mr. Foster,
    would you like to address that?
        Mr. Arougheti. I will make a couple of comments.
        Mr. Carney. Please.
        Mr. Arougheti. And it harkens back to some of my earlier
    comments--
        Mr. Carney. It just gives us a little heartburn.
        Mr. Arougheti. Yes. I think anybody here would struggle to
    actually get leverage on the types of investments that you are
    expressing concern over.
        So first and foremost, the draft legislation, as I read it,
    excludes CLOs. And Representative Himes--
        Mr. Carney. He mentioned that.
        Mr. Arougheti. --mentioned CLOs. That is excluded.
        However, Ares is actually one of the larger CLO managers in
    the broadly syndicated market. And getting leverage on a CLO
    equity investment is not possible in the market. So it goes
    back to some of the natural governors that exist in both the
    banking sector and the investment grade bond sector that
    regulate what can and can't be leveraged.
        So if we put together a portfolio that was 50 percent CLO
    equity, even though it is excluded, but for arguments sake, if
    we did and we took that portfolio to the rating agencies and
    the bank, we would not have an investment grade rating and we
    would not be able to get a loan on it. So--
        Mr. Carney. There are market-based controls on that, is
    that what you are saying?
        Mr. Arougheti. Yes. Market-based, bank and capital markets.
        Mr. Mulvaney. Will the gentleman yield for a second?
        Mr. Carney. Sure. Absolutely.
        Mr. Mulvaney. Very briefly, and I appreciate the question,
    just because I was hoping to get to this while Mr. Himes was
    still here. But the draft legislation specifically excludes
    investments in CLOs, hedge funds, and private equity. So some
    of the examples he gave would not have been permitted under the
    draft legislation.
        Mr. Carney. Great. Anybody else?
        Mr. Foster. I will add, I think it is--we have given some
    thought to it. I think it is theoretically attractive to
    provide the 1-to-1 to the 70, but not the 30. But if the 30
    gets bigger, then the bill begins to lose its effectiveness.
        And I do--I am concerned because most of us are on--all of
    us are owned primarily retail investors. And they get 1-to-1 or
    they get 2-to-1. But when you start explaining the baskets and
    how we are going to report that to them and how we are going to
    monitor it, and what it does to this, I don't think it is a
    practical solution.
        Mr. Carney. So maybe what we could do is get some feedback
    to those Members who have concerns. I am looking at the sponsor
    just to give us some level of comfort. That is great.
        I yield back. Thank you.
        Chairman Garrett. Thank you. Thank you, gentlemen.
        It looks like our last two questioners are Mr. Hultgren and
    then Mr. Mulvaney. And then we vote, I think.
        Mr. Hultgren. Thank you, Mr. Chairman.
        Thank you all for being here.
        Chairman Garrett. But not on your bill. You looked as if we
    are ready to vote on your bill, but no, on the Floor.
        Mr. Mulvaney. I thought you could pull some strings, Mr.
    Chairman. I usually look at you in a confused fashion most of
    the time--that is nothing new.
        Chairman Garrett. That is kind of a normal look.
        Mr. Hultgren. Thank you all. I appreciate you being here. I
    do want to thank all of you for your input and the work that
    you are doing.
        Thanks, Mr. Gerber, for your clarification too. I think
    there were some inaccuracies that I had heard in some
    statements on the other side with some of the non-traded BDCs,
    and some statements that those were less than transparent. And
    I really appreciate you clearing that up, that there is an
    incredible amount of transparency and accountability available
    there. And that was very helpful.
        I want to shift gears just a little bit if that is all
    right. And I think I will address this first one to Mr. Gerber,
    but then also, Mr. Foster and Mr. Quaadman, I would appreciate
    your thoughts on this as well, and maybe Mr. Arougheti, as
    well.
        But I have heard a great deal about access to capital, and
    its role in creating jobs. I wonder, could you tell me a little
    bit more about the reality of how your business, Mr. Gerber,
    helps with job creation in the middle-market?
        Mr. Gerber. Sure. In its really most basic form companies
    are coming to us, looking to grow or looking to stay in
    business and in need of capital. And when we provide that
    capital, and as Mr. Arougheti explained, sometimes because of
    the permanent nature of our funds we can be long-term partners
    and provide managerial assistance to these firms.
        We are helping them stay in business and we are helping
    them grow. And it does have a direct impact on jobs. In your
    State, Congressman, Franklin Square alone has 10 portfolio
    companies. We have deployed over $380 million. And to firms
    that represent over 33,000 jobs.
        Across our entire portfolio we have invested in over 300
    companies, representing more than a million jobs. And you heard
    earlier in our testimony and some of the comments from some of
    the members of the subcommittee, we are lending primarily to
    small middle-market all the way up to large middle-market
    firms.
        And they now represent a third of the private sector
    workforce. So there is a direct correlation between the work
    that we do in deploying capital and the growth of the middle-
    market and the job creation in the middle-market.
        Mr. Hultgren. That is fantastic. I appreciate it. The
    number one thing we continue to talk about is job creation and
    how do we get this economy growing, and growing more quickly.
    And so that is great news, especially for my State of Illinois.
    We are looking for good news, so it is nice to hear about jobs
    being created there.
        Mr. Quaadman, any thoughts from your membership on what you
    are hearing as far as access to capital, and specifically this
    tool that really is potentially beneficial on both ends,
    certainly from the investor side but also from the recipient of
    access to capital?
        Mr. Quaadman. Yes. We are seeing very severe problems in
    terms of access to capital, primarily with small businesses and
    larger businesses. Part of it is the slow implementation of
    Basel III, which is slowly drying up bank loans. But we are
    also going to see if total loss absorbency coverage goes
    through in 2019.
        That is actually going to siphon hundreds of billions of
    dollars of capital out of the global markets. So what we are
    seeing is we are seeing this slow combination of events
    happening where logically, each of these different regulatory
    initiatives would make sense by themselves.
        When you put them together, they have very dramatic
    impacts. And what we have seen, and this is a Census Department
    report I had mentioned, I think in April, that we are seeing a
    net destruction of firms in the United States over the last 6
    years.
        So we are not seeing the smaller firms being created at the
    same rate that we used to. So the BDC legislation is good that
    we are helping the middle-market companies and the like. So,
    but we need to help the smaller guys as well.
        Mr. Hultgren. Yes. And it is something that is really part
    of my heartbeat is I just believe so strongly that really the
    foundation of this country is the ability for someone to have
    an idea, be passionate about it, have some gifts and talents
    that they want to put into this, but also to have partners that
    could come alongside where they can get access to capital to
    turn that into truly the American dream. We talk about that,
    but this is the reality.
        But so, Mr. Foster and Mr. Arougheti, any other thoughts on
    this as far as job creation with this--
        Mr. Arougheti. I think one additional comment which I don't
    think we have mentioned before is that by regulations, BDCs are
    actually required to provide managerial assistance to their
    portfolio companies, which is often overlooked, but also
    contributes to the strategic value that we add to middle-market
    companies.
        So to put that in perspective, within Ares Capital
    Corporation we sit in on, or sit on the boards of directors of
    over half of our portfolio companies. So our portfolio
    companies look at us as their bank or their lender of choice.
    But I think they also look at us as a strategic adviser as they
    grow their business.
        Mr. Hultgren. That is great I don't think that was
    something that I understood fully: the value that could come
    from that, and learning from other companies that are
    succeeding. Quite honestly, learning from successes and
    failures can be certainly beneficial to these small and medium-
    sized companies, as well.
        Mr. Foster, any last thoughts?
        Mr. Foster. Sure. And a good example is we specialize in
    change control transaction with retired business owners. The
    kids aren't in the business, they are too small for a public
    company to buy, too small for private equity.
        We will come in there and arrange a change control
    transaction. And then in the last 10 years prior to retirement,
    the last thing they want to do is open up a new plant. So very
    frequently we are able to come in and regain a growth
    trajectory. And if it wasn't for us, not only are you creating
    jobs you might not even retain those jobs.
        Mr. Hultgren. My time has expired. Thank you all very much.
        Thank you, Mr. Chairman. I yield back.
        Chairman Garrett. Thank you. And to have the last word, Mr.
    Mulvaney, the sponsor of the underlying legislation.
        Mr. Mulvaney. Thanks, Mr. Chairman. Thanks as well to Mrs.
    Maloney for the work she has done on this bill with me, along
    with a couple other Members.
        And thank you, Mr. Carney, for sticking around because I
    want to address a couple of housekeeping things.
        First, Mr. Chairman, I have a statement from Prospect
    Capital Corporation, which is a BDC that has done business in
    my district. And they would like to enter a statement into the
    record. So I would like to do that without objection if I may,
    please.
        Chairman Garrett. Without objection, it is so ordered.
        Mr. Mulvaney. Thank you.
        Mr. Carney, we talked before and I think we addressed some
    of that stuff about specifically excluding it. But we will
    continue to talk. But one of the things I will point out when
    we have these discussion is that while everybody gets a little
    bit nervous every time we talk about levering up or increasing
    anybody's leverage, I direct your attention to the screen. Even
    with the proposed changes, this is still going to be the least
    levered of any of the major investment facilities that we sort
    of have oversight on this committee.
        So it is still a very, very small thing. And all of the
    rest of the financial matters that you see on the board have
    the same issues that Mr. Himes may have raised. So if we want
    to start worrying about layering on leverage, maybe the place
    to start is on the left side of that graph and not the right
    side of that graph. Thank you. You can take that down.
        Regarding the buckets, it strikes me--and Mr. Himes raised
    this as well. While I understand his point about perhaps his
    suggestion of not allowing it in the financial services area,
    part of the reason we are doing this is because small and
    medium-sized financial institutions are having difficulty
    getting the capital.
        So that is actually one of the expected uses in my
    district. I am a very rural area. We are heavily community-
    banked. And we are trying to figure out a way to provide them
    with additional sources of capital.
        Plus, it strikes me that a well-run community bank or small
    financial institution would probably carry less leverage than
    some of the operating companies that Mr. Himes mentioned. So I
    don't think it is a connection between leverage and the bill.
        I think it comes down to, can we make smart, safe, sound
    capital available to as many people as possible? That is the
    purpose of the bill. And I see no reason to arbitrarily limit
    it to having financial institutions getting one level of
    leverage into operating companies, for lack of a better word,
    getting another.
        Mr. Lynch mentioned go-around on Volcker. I will throw this
    to the panel because it strikes me, gentlemen, that if I was--
    you mentioned Goldman Sachs. I can't remember the European bank
    you mentioned that was thinking about doing this. If I wanted
    to get around Volcker, there are a lot better ways to do it
    than invest in BDCs aren't there, Mr. Gerber?
        Mr. Gerber. As Mr. Arougheti said, Volcker doesn't apply to
    us. But I do think that when we see banks investing in BDCs, it
    is actually a positive consequence to some degree to the
    Volcker Rule in that those assets are no longer on the bank's
    balance sheet. And they are now being invested in a far more
    transparent environment than in a merchant banking private
    operation.
        So, from our perspective, we don't--Volcker doesn't apply
    to us. But in looking at it, it doesn't seem to us to be an
    end-run around Volcker.
        Mr. Mulvaney. Right. And that is a good point that I don't
    think that lots of folks are familiar with; when you say
    Volcker doesn't apply to you, that is not by accident. The Rule
    actually specifically excludes you folks under the rationale
    that these industries are already so heavily regulated and so
    transparent that there was no reason to apply Volcker to you
    folks.
        And again, I would suggest that if I am Deutsche Bank or
    Goldman Sachs and I want to go around Volcker, I can put my
    money in a hedge fund and do it right away. I don't have to go
    through the hassle of going through the BDC application.
        Dr. Brown, you mentioned something at the very outset of
    your testimony about operating companies versus financial
    institutions. And again, I don't want to change your words. But
    I thought you said something to the tune of the operating
    companies need it more than the financial institutions. Or--
        Mr. Brown. No, I don't think I quite said that, although
    who knows, I could have misspoken. What I really said was I
    haven't seen the empirical data that says the financial
    companies need it.
        What we know is the operating companies do need it. And I
    am afraid of the bleed of funds away from operating companies
    to financial companies and hurting those companies.
        And I would just add, Congressman, that the comment that
    was made earlier about these operating companies getting not
    only the funds, but getting the managerial assistance, I don't
    know whether the financial companies need the managerial
    assistance in the same way I think a lot of these operating
    companies do.
        So I think if that these operating companies can't access
    as easily these BDCs, I think that is a problem for the
    operating company.
        Mr. Mulvaney. Two things to consider, Mr. Brown, and to my
    colleagues of both parties.
        Number one, it seems that the need for the product would be
    dictated by the market and not by some empirical research.
    Either it is there or it is not there. But perhaps more
    importantly to your point, if these gentlemen want to take an
    equity position or a debt position in a community bank in my
    district, I know where the money is going, which is to the
    local businesses.
        So it is just another way to get the money to the operating
    companies. That is what the community banks and the small
    financial institutions and small investment operations in my
    district do. So if the demand is there within the operating
    business community, I think it probably--capital should be able
    to find a way there.
        Lastly, Mr. Brown, I will close with this. I have 14
    seconds.
        You mentioned some concern about the different levels of
    stock, the different classes of stock, the preferred stock. And
    I guess I can only ask it this way.
        Wouldn't those concerns that you raised here today apply to
    any company that offers preferred stock? Because a lot of
    publicly traded companies that I could buy this afternoon offer
    preferred stock. Aren't your concerns equally applied to them
    as they would be to BDCs?
        Mr. Brown. Well, of course, not investment companies, but
    operating companies, yes.
        Mr. Mulvaney. Right. But if I am an investor, I am either
    going to invest in BDCs or I am going to invest in Norfolk
    Southern Railway and they might have a preferred stock and the
    BDCs might have a preferred stock. And the concerns that you
    raise would apply equally to me as investor as between BDC and
    Norfolk Southern.
        You said the board of directors could change the voting
    rights, they could change the payouts. They could, think about
    me as an unsophisticated investor, might get caught in that.
    That applies anyway, right, in the market.
        Mr. Brown. You are absolutely right. The legal authority
    exists irrespective of the company because it is the authority
    of the board of directors. But what I would say right now, is
    there are protections in the Investment Company Act of 1940
    that don't exist for other companies. So we are talking about
    removing something that is there that does not apply to
    operating companies.
        Mr. Mulvaney. Fair enough. Gentlemen, I appreciate the
    additional 50 seconds, and for the right to participate in the
    hearing since I am not on the subcommittee. Thank you, Mr.
    Garrett.
        Chairman Garrett. Thank you. And welcome to the
    subcommittee.
        So I said that was going to be the last word, but, no, I am
    not going to say the last word. I am going to give the last
    word to the gentlelady from New York.
        Mrs. Maloney. A vote has been called. But very briefly,
    thank you to all of the panelists. And I ask unanimous consent
    to place two letters into the record: one from the North
    American Securities Administrators Association; and one from
    the Consumer Federation of America and Americans for Financial
    Reform.
        And I look forward to continuing to work with you, Mr.
    Mulvaney, to see if we can get a product that has unanimous
    bipartisan support. Getting capital out is important. Thank
    you.
        Chairman Garrett. Without objection, is is so ordered. And
    again, thank you to the witnesses.
        The Chair notes that some Members may have additional
    questions for this panel, which they may wish to submit in
    writing. Without objection, the hearing record will remain open
    for 5 legislative days for Members to submit written questions
    to these witnesses and to place their responses in the record.
    Also, without objection, Members will have 5 legislative days
    to submit extraneous materials to the Chair for inclusion in
    the record.
        And with that, this hearing is adjourned. And again, thank
    you to the panel.
        [Whereupon, at 4:10 p.m., the hearing was adjourned.]

                                A P P E N D I X

                                 June 16, 2015

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