SEC Notices FS Co-Investment Application

On Friday, April 4, 2025, the SEC Staff noticed the application filed by FS Credit Opportunities Corp., et. al, relating to principles-based, co-investment exemptive relief ("FS Co-Investment Application"). The application had originally been filed February 21, 2025, and amended on March 20 and April 3. The notice relates to the April 3 iteration of the application, which is substantially similar to the originally filed draft EXCEPT the April 3 iteration does not allow for open-end funds to rely on the co-investment relief.

ICI had previously filed a letter of support for approving the FS Co-Investment Application on March 4, 2025, noting that approving the FS Co-Investment Application was a first step in an ongoing conversation regarding reforming the co-investment process. Assuming a hearing on the application is not requested (and hearings are extremely rare), the SEC Staff should issue the order for the application shortly after April 28.

Co-investment relief has become a virtual necessity for managers of regulated funds[1] investing in privately placed assets, in particular managers of private credit focused closed-end funds and BDCs. Managers of such regulated funds frequently also manage private funds with overlapping investment strategies. The terms of originated investments to be allocated across the regulated funds and private funds are typically negotiated. Thus, those originated investments are often completed pursuant to co-investment orders because Section 17(d) of the 1940 Act, in accordance with SEC guidance on joint transactions, could otherwise be deemed to prevent such transactions.

The existing co-investment regime is a body of highly technical exemptive applications and orders that has resulted in the development of more than a dozen required conditions and sub-conditions to be satisfied for any particular transaction. For example, the existing co-investment regime requires the board of each regulated fund to consider and approve transactions under a co-investment program, which under some programs requires board members to be "on call" to provide approval of individual deals within a matter of hours (potentially multiple times a week and sometimes per day) or regulated funds risk losing out on time-sensitive investment opportunities.[2]

Further, depending on which parties invest at which times and in which securities, a number of otherwise common transactions are prohibited by the existing co-investment order regime, in our view without any corresponding investor protection benefit. For example, a regulated fund is generally prohibited from investing in reliance on existing co-investment relief if any affiliate has any pre-existing investment in the issuer, even if just one share. This prohibition is the proverbial hammer to swat a fly, preventing an entire category of investments out of a concern that some may present conflicts of interest. It fails to account for the fact that both borrowers and funds have capital needs and lifecycles that do not always perfectly synchronize, cutting off opportunities (including the ability of a regulated fund's board to exercise its discretion) simply because a fund may not have invested in an earlier financing or capital raise.

While the FS Co-Investment Application is unequivocally a step in the right direction in resolving some of the aforementioned undesirable results for retail investors, it does not resolve every issue. After that application is presumably granted, there would still remain various unsolved issues, in particular: 1) a potential safe harbor or other relief from the "same terms, same price, same class, and same security" condition; 2) principal transaction relief regarding portfolio companies that are classified as downstream affiliates; and 3) expansion of co-investment relief to mutual funds and ETFs.

Sincerely,

Kevin Ercoline
Assistant General Counsel

Notes

[1] "Regulated funds" includes investment companies registered under the 1940 Act and closed-end companies that have elected to be regulated under the 1940 Act (i.e., business development companies (BDCs)).

[2] By analogy, the SEC chose to modernize the role of the board in valuing fund assets, recognizing that boards should delegate daily oversight to others, while retaining effective oversight (e.g., specific and detailed reporting). See Good Faith Determinations of Fair Value, Investment Company Act Release No. 34128, 86 Fed. Reg. 748 (Jan. 6, 2021). Requiring approval of individual deals and daily oversight of specific investments detracts from fund boards' time and attention on the matters where they add the most value to investors, including high-level oversight of fund governance, processes, and controls. The FS Co-Investment Application appears to address these board oversight issues and align with the oversight often required of the board under other rules.