[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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                 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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