SEC Notices Simplified Co-Investment Relief: A Sigh of Some Relief for Regulated Funds and Their Affiliates

On April 3, 2025, the SEC filed a notice of intent to grant FS Credit Opportunities Corp. et. al.’s (“FS”)¹ amended application for an order permitting certain business development companies (“BDCs”) and closed-end management investment companies (“Closed-End Funds,” and, together with BDCs, “Regulated Funds”) to participate in co-investment joint transactions with affiliated funds and accounts that are otherwise prohibited by Section 17(d) and 57(a)(4) of the 1940 Act and Rule 17d-1 thereunder (the “New Relief”). The New Relief streamlines the requirements of standard existing co-investment exemptive orders granted by the SEC (the “Existing Relief”) and expands the scope of the relief in certain important respects, marking a meaningful shift from the existing framework. Unless the SEC receives a request for a hearing during the 25-day public comment period, the SEC will grant FS’s exemptive order.

Background

Section 17(d) of the 1940 Act generally prohibits any affiliated person or principal underwriter of a Regulated Fund, or their affiliated persons, from engaging in transactions where the Regulated Fund or its controlled entities participate with such persons, absent compliance with SEC rules or in reliance on SEC exemptive relief. The SEC staff views negotiated transactions where a Regulated Fund invests alongside an affiliated private fund or account as joint transactions prohibited by Section 17(d) and Rule 17d-1 (each, a “Co-Investment Transaction”). Currently, advisers to Regulated Funds and affiliated private funds and accounts operate in reliance on the Existing Relief, which imposes rigid and detailed conditions regarding (i) Regulated Fund board approval of Co-investment Transactions, (ii) detailed representations regarding the adviser’s order allocation process, and (iii) Co-Investment Transactions in issuers in which a “related party” (which term includes a broad range of affiliated persons) has a pre-existing interest.

At a high level, the New Relief alleviates the strict allocation requirements imposed by the Existing Relief in favor of policies focused on fair and equitable allocations. Additionally, in many instances, the New Relief relies upon the existence of reasonable policies and procedures for monitoring the fairness of Co-Investment Transactions, rather than the onerous board pre-approval requirements under the Existing Relief. While FS’s noticed application would not extend the relief to open-end investment companies, as contemplated in a prior version of FS’s application, it nonetheless reflects a welcome relaxing of many of the Existing Relief’s more rigid requirements.

Key Changes Under the New Relief

1. Board Approval No Longer Required for Many Co-Investment Transactions

The Existing Relief requires a Regulated Fund’s board to pre-approve each Co-Investment Transaction and all follow-on investments, unless such follow-on investment is allocated pro-rata or consists of tradable securities. The New Relief requires only that a Regulated Fund’s board pre-approve (i) follow-on investments or dispositions that are not effected pro rata based on current holdings and (ii) investments in an issuer in which a “related party” is an existing investor. Instead of board pre-approval, the New Relief requires quarterly board reporting regarding all new Co-Investment Transactions and all follow-on investments, as described below.

2. No Prohibition on Co-Investments in Which a “Related Party” Has a Pre-Existing Investment

The Existing Relief prohibits a Regulated Fund from participating in any Co-Investment Transaction in which a “related party” has a pre-existing interest. Similarly, under the Existing Relief, Regulated Funds and affiliated funds may not participate in any follow-on investment in which they did not participate in the initial Co-Investment Transaction under an existing order.

The New Relief allows a Regulated Fund to participate in these investments, subject to board pre-approval. Board pre-approval would not be required for follow-on investments where the Regulated Fund already holds the same security as the affiliate and the new investment is made in approximately the same proportion as current holdings.

3. No Detailed Representations Regarding the Adviser’s Order Allocation Process

The Existing Relief requires a Regulated Fund’s adviser to independently consider each opportunity that falls within the scope of the Regulated Fund’s investment criteria, formulate an “internal order” pursuant to an allocation process and, if needed, reduce the opportunity pro rata. This process can disrupt an adviser’s typical allocation process. 

The New Relief eliminates these specific allocation requirements and instead requires the adviser (i) to adopt co-investment policies designed to ensure fair and equitable allocation of Co-Investment Transactions to the Regulated Funds and (ii) to consider the interests of any participating Regulated Fund in a Co-Investment Transaction.

4. Reduced Board Reporting Burden

The Existing Relief imposes burdensome board reporting requirements, including quarterly reports regarding (i) all investments in potential Co-Investment Transactions by any other Regulated Funds or affiliated funds within the prior quarter that fell within the scope of the Regulated Fund’s investment criteria, (ii) a record of all follow-on investments and dispositions of investments not made available to the Regulated Fund, and (iii) all information regarding Co-Investment Transactions, including those in which the Regulated Fund declined to participate. 

The New Relief’s reporting requirements are far less onerous. The Regulated Fund’s board must (i) review the adviser’s co-investment policies to ensure they are reasonably designed to prevent the Regulated Fund from being disadvantaged by participation in the co-investment program and (ii) approve policies and procedures that are reasonably designed to ensure compliance with the terms of the New Relief. Under the New Relief, the Regulated Fund’s adviser and chief compliance officer must report to the Regulated Fund’s board regarding information requested by the board related to participation in Co-Investment Transactions and a summary of significant matters related to the implementation of the co-investment policies. The New Relief does not require that a Regulated Fund’s board be presented with all relevant Co-Investment Transactions that were not made available to the Regulated Fund and an explanation of why such investment opportunities were not made available.

5. Increased Scope of Relief 

The Existing Relief defines an “Affiliated Fund” as an entity that would be an investment company but for Sections 3(c)(1), 3(c)(5)(C) or 3(c)(7) of the 1940 Act. The New Relief expands this definition to include any entity that would be an investment company but for Section 3(c) of the 1940 Act or Rule 3a-7. This broader definition allows a greater range of affiliated entities to participate in Co-Investment Transactions alongside a Regulated Fund. Among other participants, this would include collective investment trusts that rely on Section 3(c)(11), which is welcome news for 401(k) plan administrators seeking to add investment options with exposure to alternative investments.

 The New Relief also extends to future Regulated Funds or affiliated funds for which the adviser (or an affiliate of the adviser) serves only as sub-adviser (and not also as the primary adviser). Primary advisers to such funds that are not applicants to the New Relief will be deemed to be an “Adviser” within the meaning of the New Relief with respect to conditions 3 (requiring pro rata sharing of co-investment expenses) and 4 (requiring transaction fees be shared pro rata among the participating funds) of the New Relief. 

In contrast with the Existing Relief, the New Relief does not contain a representation stating no entity that relies on another order authorizing Co-Investment Transactions will rely on the subject order. Rather, the New Relief provides that any future entity that subsequently relies on the New Relief will comply with the terms and conditions of the order.

6. Ability to Veto Affiliated-Nominated Director Required

Under the New Relief, if an affiliated fund has the right to nominate the director of an issuer, the Regulated Fund board must have the right to veto a director nominated by the affiliated fund.

Remaining Burdens

Participants in Co-Investment Transactions must continue to invest under the same terms and conditions. Additionally, the New Relief still includes a representation that “all existing entities that currently intend to rely upon the requested Order have been named as applicants.” This will continue to place burdens on applicants with a large universe of existing affiliated entities, each of which must be named and sign the application. 

If a Regulated Fund enters into a transaction that would be a Co-Investment Transaction pursuant to the New Relief in reliance on another exemptive order, the information presented to the Regulated Fund’s board and records maintained by the Regulated Fund must expressly indicate the order relied upon by the Regulated Fund to enter into such transaction. The New Relief otherwise supersedes the Existing Relief with respect to all subsequent investments. 

 While the New Relief retains certain burdens of the Existing Relief, it is a positive step toward modernizing and expanding permitted joint transactions. We expect the New Relief to generate significant interest from funds that have the Existing Relief and funds hoping to file for an exemptive order.

* * *

If you would like to learn more about the issues in this Alert, please contact your usual Ropes & Gray attorney contacts.