Business development companies, commonly known as BDCs, are a type of closed-end investment fund that lends money to small and mid-sized private businesses. They were created by Congress in 1980 to channel capital to growing American companies, and they have been marketed aggressively to individual investors as high-yield income investments. With advertised dividend yields often ranging from 8% to 13%, BDCs can appear attractive to investors seeking steady income in retirement or as an alternative to traditional bonds.
But BDCs are not bonds. They are complex, high-risk, leveraged credit vehicles that expose investors to below-investment-grade borrower defaults, severe illiquidity, opaque valuations, and fee structures that heavily favor fund managers over shareholders. Many investors have suffered devastating losses in BDC products—including those offered by Prospect Capital and FS Investments (formerly Fifth Street Finance)—after being told these products were “safe” or “like bonds.”
If you invested in a BDC and lost money, or if your broker recommended a BDC without properly explaining the risks, you may have a claim for recovery. The investment fraud attorneys at the Law Offices of Robert Wayne Pearce, P.A. have more than 45 years of experience representing investors in FINRA arbitration and securities litigation. Contact us today at (561) 338-0037 or through our website for a free consultation.
What Is a Business Development Company?
A business development company is a type of investment fund regulated under the Investment Company Act of 1940 (Sections 54–65). A company elects BDC status by filing Form N-54A with the SEC. To qualify, a BDC must invest at least 70% of its total assets in “eligible portfolio companies”—generally private U.S. businesses or public companies with market capitalizations under $250 million—and must offer “significant managerial assistance” to those companies.
In practical terms, most BDCs function as leveraged lending funds. They raise capital from investors, borrow additional money (up to twice their equity), and use those funds to make loans to middle-market companies that typically cannot access traditional bank financing or the public bond markets. These borrowers are generally below investment grade, meaning they carry a meaningfully higher risk of default than the investment-grade issuers whose bonds most individual investors are familiar with.
Most BDCs elect Regulated Investment Company (RIC) status under the Internal Revenue Code, which requires them to distribute at least 90% of their taxable income to shareholders annually. This pass-through structure avoids entity-level taxation but means that BDC distributions are taxed as ordinary income—not as qualified dividends—and BDCs do not receive the 20% pass-through deduction available to REITs under the Tax Cuts and Jobs Act.
Three Types of BDCs: Traded, Non-Traded, and Private
Not all BDCs are structured the same way. The three main categories differ significantly in how shares are priced, how easily investors can sell, and what risks investors face:
Publicly Traded BDCs
Approximately 50 BDCs trade on the NYSE or NASDAQ. Their shares are bought and sold on exchanges like stocks, with prices determined by supply and demand. This provides daily liquidity, but it also means that shares frequently trade at significant premiums or discounts to the fund’s net asset value (NAV). During market stress, publicly traded BDC shares have declined 20% or more in a single day. As of early 2026, the average publicly traded BDC was trading at roughly 80% of reported NAV—a 20% discount reflecting widespread market skepticism about underlying portfolio valuations.
Non-Traded BDCs
Approximately 47 non-traded BDCs hold over $205 billion in aggregate assets. Their shares are not listed on any exchange. Instead, shares are priced at NAV as determined periodically by the fund’s board, using appraisals and valuation models for illiquid portfolio holdings. Investors who wish to sell can typically only do so through periodic share repurchase programs—usually quarterly tender offers capped at approximately 5% of NAV at the board’s discretion. During periods of market stress, these repurchase programs can be reduced, suspended, or eliminated entirely, trapping investors in a product they cannot exit.
Private BDCs
Approximately 59 private BDCs hold about $69 billion in assets. These are sold through private placements to accredited investors only and generally provide no liquidity until a designated liquidity event—such as an IPO, fund wind-down, or portfolio sale—typically five to ten years after the initial investment.
BDC Interval Funds and Tender-Offer Funds
Within the non-traded BDC universe, two important subtypes have emerged that investors should understand: interval funds and tender-offer funds.
Interval funds are governed by SEC Rule 23c-3 and adopt a fundamental policy requiring the fund to offer to repurchase a stated percentage of outstanding shares—typically 5% to 25%—at NAV on a mandatory, recurring schedule (every 3, 6, or 12 months). If repurchase requests exceed the stated percentage, repurchases are made on a pro-rata basis. The key distinction is that these repurchases are mandatory—the fund cannot simply decide not to honor them.
Tender-offer funds operate under Rule 13e-4 of the Securities Exchange Act and make share repurchases entirely at the board’s discretion. There is no required schedule and no guaranteed minimum repurchase amount. In practice, most non-traded BDCs operate as tender-offer funds with quarterly repurchases capped at 5% of NAV. In 2024, roughly half of all tender-offer funds conducted four offers during the year, while more than a third held none at all. When investor redemption requests spike during market stress, boards can and do gate or suspend repurchases, leaving investors with no way to exit.
The practical difference matters enormously to investors. An interval fund provides a baseline level of guaranteed liquidity, while a tender-offer fund provides none. Investors in tender-offer BDCs who were told they could “access their money quarterly” often discover this access is illusory precisely when they need it most.
BDC Fee Structures: How Managers Profit at Investor Expense
One of the most significant—and most frequently undisclosed—risks of BDC investing is the layered fee structure that heavily favors fund managers. BDC fees are among the highest in the investment fund industry, and their structure creates fundamental conflicts of interest between managers and investors.
Management fees typically range from 1.5% to 2.0% of gross assets annually. Because these fees are calculated on total assets—including borrowed money—the effective fee on an investor’s equity is significantly higher when leverage is employed. A 1.5% fee on gross assets with 2:1 leverage translates to an effective fee of 4.5% on investor equity. Managers are compensated for growing the asset base regardless of whether returns justify the expansion.
Incentive fees are typically 20% of net investment income above a hurdle rate of 6% to 8%. A “catch-up” provision common in BDC advisory agreements allows the manager to receive 100% of income above the hurdle until “caught up” to 20% of total net investment income. Capital gains incentive fees are typically 20% of realized gains net of losses. This structure means managers share generously in the upside but bear none of the downside—a misalignment that encourages excessive risk-taking.
Upfront sales loads for non-traded BDCs historically reached 7% to 10% of invested capital. An investor who wrote a $100,000 check might have only $90,000 to $93,000 actually working in the portfolio from day one. Newer perpetual-life structures have reduced upfront loads in some cases, but ongoing distribution and servicing fees of 0.25% to 0.85% annually continue to erode returns over time.
The combined impact of these fees is staggering. Industry analysis has shown that the worst externally managed BDCs send approximately 40% of investment profits to the management company. One BDC-focused ETF reports acquired fund fees and expenses of 8.77%, reflecting the extreme cost structure embedded in BDC products. Houlihan Lokey demonstrated that increasing leverage from 0.75x to 1.75x—with an unchanged fee structure—increases total manager compensation by 34% for the same return on equity to shareholders. These fee structures create a powerful incentive for managers to maximize leverage and grow assets under management regardless of whether doing so benefits investors.
The 2018 Leverage Expansion: Doubling the Risk
In March 2018, Congress passed the Small Business Credit Availability Act, which amended the Investment Company Act of 1940 to reduce the minimum asset coverage ratio for BDCs from 200% to 150%. In practical terms, this doubled the maximum debt-to-equity ratio from 1:1 to 2:1. A BDC with $100 million in investor equity can now borrow up to $200 million, putting $300 million in total assets to work.
This change dramatically increased the risk profile of BDC investments. As former SEC Chair Mary Jo White warned, at the new 150% asset coverage level, a BDC’s assets would have to lose only 33⅓% of their value before exposing shareholders to a total loss of their investment. At the prior 200% level, that figure was 50%.
The leverage expansion also amplifies the fee conflict described above. Higher leverage means management fees are collected on a larger asset base, increasing manager compensation without any corresponding improvement in net returns to shareholders. For investors who were told BDCs are “like bonds,” the reality that their investment is leveraged 2:1 into below-investment-grade loans is a material fact that fundamentally changes the risk profile of the product.
How Investors Lose Money in BDCs
Investors can lose money in BDCs through several mechanisms, many of which are not adequately disclosed at the time of sale:
NAV Erosion and Permanent Capital Loss
When borrowers in a BDC’s portfolio default on their loans or when the value of portfolio investments declines, the BDC’s net asset value drops. Unlike a bond that returns par at maturity (absent default), a BDC has no maturity date and no mechanism to return investors’ principal. NAV erosion is permanent. Prospect Capital’s NAV per share declined from $8.74 in June 2024 to $6.56 by June 2025—a 25% decline in twelve months. Investors who purchased shares at higher prices suffered permanent capital destruction.
Return of Capital Disguised as Income
BDC distributions may include return of capital—meaning the fund is paying investors back their own money, not earned income. When a fund distributes more than its total return, the return-of-capital component represents the investor’s own capital being returned minus fees, steadily eroding NAV. BDC managers maintain unsustainable distribution rates because distribution rates correlate highly with share prices and attract new investors. A 2025 industry analysis found that a majority of sampled BDCs did not cover their dividends with operating cash flow.
Illiquidity Traps
Non-traded BDC investors who need to sell face severe liquidity constraints. During periods of market stress—precisely when investors most need liquidity—redemptions can be delayed, limited, or denied entirely (“gated”). During the COVID-19 pandemic, multiple non-traded funds suspended or limited withdrawals. In the fourth quarter of 2025, investors in large non-traded BDCs withdrew $2.9 billion—a 200% increase from the prior quarter—raising concerns about gating risk across the sector.
Valuation Opacity
Non-traded BDC valuations rely on Level 3 assets under the accounting standard ASC 820, meaning they are valued using “unobservable inputs”—management estimates, models, and assumptions rather than market prices. External managers earning fees on gross assets have incentives to maintain or inflate valuations. Valuations are inherently stale: by the time investors see portfolio valuations, 30 or more days have passed since the calculations were performed. The SEC’s 2025 Examination Priorities specifically target risks associated with “holding and valuing hard-to-value assets.”
Prospect Capital: A Case Study in BDC Risk
Prospect Capital Corporation (NASDAQ: PSEC), managed by Prospect Capital Management, L.P., is one of the largest and most widely held publicly traded BDCs—and one that illustrates the risks BDC investors face.
SEC investigation. The SEC Division of Enforcement conducted a formal investigation of Prospect Capital Management that included what was characterized as an “internal controls shortfall.” Research services obtained copies of four SEC subpoenas through FOIA requests. The investigation ultimately closed in May 2025 without public enforcement action.
Valuation and strategy concerns. A major Bloomberg investigation published in August 2024 raised concerns that Prospect was among the most reluctant firms to mark down its loans compared to peers, had sold non-traded preferred stock to retail investors and used proceeds to fund shareholder dividends even as portfolio performance deteriorated, and maintained high levels of payment-in-kind income—a red flag that borrowers may be unable to make cash interest payments.
Dividend cut. In November 2024, Prospect cut its dividend by 25%—its first reduction in seven years—causing shares to tumble more than 16% on the news. For the many retirees relying on Prospect’s monthly distributions as income, this was a devastating blow.
Persistent NAV erosion and realized losses. NAV per share declined from $8.74 (June 2024) to $7.25 (September 2024) to $6.56 (June 2025). The company reported $141.3 million in net realized investment losses in one recent quarter and $308.5 million in another—totaling nearly $450 million in realized losses across just two quarters. Prospect’s stock has declined approximately 65% over the past decade, and shares trade at roughly a 59% discount to NAV.
Investors who purchased Prospect Capital based on its high dividend yield—or who were told by their brokers that it was a safe, bond-like income investment—have suffered substantial losses. If your broker recommended Prospect Capital without adequately disclosing these risks, you may have a claim for stockbroker fraud or negligence and breach of fiduciary duty.
FS Investments (Formerly Fifth Street Finance): Enforcement Actions and Investor Losses
FS Investments and its predecessor entity, Fifth Street Finance, have been the subject of significant regulatory enforcement actions and investor litigation that illustrate the risks of BDC investing.
SEC enforcement action. In December 2018, the SEC settled charges against Fifth Street Management LLC (Administrative Proceeding File No. 3-18909). The SEC found that Fifth Street improperly allocated approximately $1.3 million in expenses to its BDC clients that should have been borne by the adviser. Fifth Street also failed to conduct quality control reviews of quarterly valuation models for illiquid assets, causing one BDC to overvalue portfolio investments and produce material misstatements in SEC filings. Penalties totaled approximately $3.98 million in disgorgement, prejudgment interest, and civil penalties. A Fair Fund was established to compensate harmed investors.
Securities class action litigation. In a related securities class action (Case No. 15-cv-07759, S.D.N.Y.), investors alleged that defendants engaged in a scheme to inflate the fund’s assets and investment income ahead of the management company’s IPO. That case settled for $14.05 million. A separate class action against Fifth Street Asset Management alleged that the IPO offering documents contained materially false statements; FSAM stock declined from $17 per share at its IPO price to $4.03 per share—a 76% decline. That case settled for $9.25 million.
FS Energy and Power Fund—devastating losses. The FS Energy and Power Fund, a non-traded BDC, launched at $10.00 per share in July 2011. NAV declined steadily for years. In March 2020, the fund terminated its quarterly tender offer, suspended share repurchase, and suspended regular cash distributions—trapping investors with no exit. NAV fell to approximately $3.32 per share by September 2020, and secondary market trades went as low as $1.86 to $2.15 per share—representing approximately a 77% loss from the original offering price.
Multiple law firms have filed FINRA arbitration claims against broker-dealers that sold FS Investment non-traded BDCs, alleging unsuitable recommendations, failure to supervise, over-concentration, and misrepresentation of the products as safe income investments. Many affected investors were retirees with conservative risk profiles.
GPB Capital: A Cautionary Tale of Private Placement Fraud
While not a BDC in the traditional sense, the GPB Capital Holdings case powerfully illustrates the risks of illiquid, high-commission alternative investment products sold through broker-dealer networks—the same distribution channels used to sell non-traded BDCs.
In February 2021, the SEC charged GPB Capital, its CEO David Gentile, and others with running a scheme that raised over $1.7 billion from more than 17,000 investors. According to the SEC, defendants lied about the source of distribution payments—telling investors that distributions came from portfolio company profits when they actually used investor capital. A federal jury convicted Gentile on all counts in August 2024, and he was sentenced to seven years in prison in May 2025.
FINRA has also sanctioned broker-dealers involved in GPB sales. In November 2024, FINRA fined Concorde Investment Services $110,000 plus restitution for failing to supervise GPB recommendations made to six retail customers—five of whom were seniors with conservative or moderate risk tolerances whose accounts exceeded the firm’s own concentration limits for alternative investments.
The GPB case underscores how high-commission private placement products can be aggressively marketed to unsuitable investors, with broker-dealers failing to conduct adequate due diligence or supervision.
Why BDCs Are Not “Like Bonds”
One of the most common misrepresentations made by brokers selling BDCs to moderate-risk, income-seeking investors is that BDCs are “like bonds” or “a bond alternative.” This characterization is materially misleading. The following comparison highlights the critical differences:
| Characteristic | Investment-Grade Bonds | BDCs |
| Credit Risk | BBB or above; annual default rates typically under 1% | Below-investment-grade middle-market borrowers; rising non-accruals |
| Liquidity | Active secondary markets; highly liquid | Traded BDCs can trade at 20%+ discounts; non-traded limited to quarterly tenders subject to gating |
| Volatility | Relatively low price movement | Approximately 2.5x more volatile than high-yield bonds; 20%+ single-day declines possible |
| Principal | Return par at maturity (absent default); strong recovery rates | No maturity date; NAV erodes permanently; no principal guarantee |
| Fees | Minimal; bond fund expense ratios 0.1% to 0.5% | Non-traded: 7–10% upfront, 1.5–2% annual management, 20% incentive; total drag 3–5%+ annually |
| Income Source | Contractual interest from investment-grade issuers | Distributions may include destructive return of capital; many BDCs have cut dividends |
| Leverage | The bond itself is a fixed obligation | BDCs can lever 2:1 debt-to-equity; leverage amplifies losses |
| Transparency | Real-time pricing; standardized credit ratings | Board-determined quarterly NAV using Level 3 unobservable inputs; stale by 30+ days |
Any broker who characterized a BDC as “like a bond” to a moderate-risk investor failed to provide a fair and balanced presentation of the product’s risks. Under both FINRA’s suitability rules and SEC Regulation Best Interest, this type of misrepresentation may give rise to a claim for damages.
How FINRA and the SEC Protect BDC Investors
Multiple layers of federal and state regulation govern the sale of BDCs to retail investors. When brokers and their firms fail to comply with these rules, investors who suffer losses may pursue claims through FINRA arbitration or in court.
FINRA Rule 2111: Suitability
FINRA Rule 2111 imposes three suitability obligations on brokers: reasonable-basis suitability (the broker must understand the product’s risks and rewards before recommending it to anyone), customer-specific suitability (the recommendation must fit the individual customer’s investment profile, risk tolerance, and financial situation), and quantitative suitability (even suitable recommendations become unsuitable when excessive). FINRA has emphasized that a firm’s approval of a product for sale does not automatically satisfy the reasonable-basis obligation.
SEC Regulation Best Interest
Since June 2020, SEC Regulation Best Interest has imposed a higher standard on broker-dealers recommending securities to retail customers. Reg BI requires disclosure of material facts including fees, costs, and conflicts; a care obligation requiring reasonable diligence and consideration of reasonably available alternatives; a conflict-of-interest obligation; and a compliance obligation. The SEC’s adopting release specifically notes that “complex or risky” products require especially rigorous analysis. BDCs are precisely the type of product that triggers heightened Reg BI scrutiny.
FINRA Guidance on Non-Traded BDCs and Complex Products
FINRA has issued multiple regulatory notices and targeted examination letters addressing BDC sales practices. Regulatory Notice 12-03 requires heightened supervision of complex products. FINRA’s 2016 Targeted Examination Letter on non-traded BDCs required firms to produce comprehensive documentation on all BDCs offered, selling agreements, due diligence procedures, and customer account information. The SEC’s Investor Bulletins published in December 2024 warned investors that BDCs are “complex and have certain unique risks” and that investors “could lose money.”
NASAA Concentration Limits
The North American Securities Administrators Association (NASAA) amended its omnibus guidelines in September 2025 (effective January 1, 2026) to impose a new 10% concentration limit for non-accredited investors. Aggregate investment in non-traded REITs, BDCs, oil and gas programs, equipment leasing programs, and commodity pools cannot exceed 10% of liquid net worth. NASAA also increased income and net worth requirements for eligible purchasers. NASAA’s public comment documentation included enforcement examples of elderly investors aged 73 to 88 being steered toward non-traded products due to high broker compensation, with some unable to access funds for nursing care.
Common Broker Misconduct in BDC Sales
Based on our experience representing investors in BDC-related claims, the most common forms of broker and brokerage firm misconduct in BDC sales include:
Misrepresenting BDCs as “bond-like” or “safe income” investments. As the comparison table above demonstrates, BDCs bear almost no resemblance to investment-grade bonds. Characterizing them as such to moderate-risk investors is a material misrepresentation that may violate FINRA suitability rules and Regulation Best Interest.
Failure to disclose illiquidity risks. Non-traded BDC investors often discover too late that their investment cannot be readily sold. Brokers who fail to explain that redemptions are discretionary, subject to caps, and can be suspended entirely during market stress have failed in their disclosure obligations.
Over-concentration in BDC and alternative investment products. Placing a disproportionate share of an investor’s portfolio in BDCs—particularly for retirees or investors with moderate risk tolerance—constitutes a lack of diversification that increases portfolio risk beyond what the investor authorized or understood.
Failure to disclose fee structures. Brokers who fail to explain that management fees are calculated on gross assets (including borrowed funds), that incentive fees create manager-investor conflicts, or that upfront loads of 7–10% immediately reduce the investor’s working capital have failed to meet their disclosure obligations under Reg BI and FINRA rules.
Cherry-picking headline yields. Promoting BDC dividend yields of 9–13% without disclosing the below-investment-grade credit risk, the possibility of dividend cuts, or the likelihood that distributions may include destructive return of capital is misleading and potentially actionable.
Failure to supervise. Brokerage firms have a duty under FINRA Rule 3110 to establish and maintain supervisory systems reasonably designed to achieve compliance with applicable laws and regulations. When firms fail to supervise BDC sales—as FINRA found in its actions against broker-dealers selling GPB Capital—both the firm and the individual broker may be liable for resulting losses. Learn more about failure to supervise claims.
Legal Options for BDC Investors Who Have Lost Money
If you invested in a BDC and suffered losses, you may be able to recover your investment through several legal avenues:
FINRA arbitration. Most brokerage account agreements contain mandatory arbitration clauses requiring disputes to be resolved through FINRA arbitration rather than in court. FINRA arbitration is generally faster and less expensive than traditional litigation and provides a forum for investors to pursue claims for unsuitable recommendations, misrepresentation, failure to supervise, and breach of fiduciary duty.
State securities claims. Many states have investor protection statutes that provide additional remedies for securities fraud, including statutory damages, rescission (unwinding the transaction), and attorneys’ fees.
Claims against selling broker-dealers. Even if a BDC’s sponsor is primarily responsible for the fund’s poor performance, the broker-dealer that sold the product to you had an independent obligation to conduct due diligence, ensure suitability, and supervise the recommendation. Claims against the selling firm do not require proving fraud by the fund sponsor—only that the broker’s recommendation was unsuitable or that the firm failed to supervise.
Elder financial abuse claims. Investors aged 65 and older who were sold unsuitable BDC products may have additional claims under elder financial abuse statutes, which provide enhanced remedies and protections for senior investors.
Safer Alternatives for Income-Seeking Investors
Moderate-risk investors seeking reliable income have multiple alternatives that offer substantially better liquidity, transparency, and risk-adjusted returns than BDCs:
Investment-grade bond funds yield approximately 4% to 5% with expense ratios as low as 0.05% to 0.15%, daily liquidity, and dramatically lower credit risk.
Dividend ETFs yield approximately 2.5% to 3.5% with expense ratios around 0.06%, daily liquidity, and broad diversification across hundreds of dividend-paying stocks.
High-yield bond funds yield approximately 5.5% to 6.5% with daily liquidity, much lower fees, public market pricing, and rated securities with transparent pricing.
Publicly traded REITs yield approximately 4% with daily exchange liquidity, lower fees, and the benefit of the 20% pass-through deduction that BDCs do not receive.
None of these alternatives carry the combination of illiquidity risk, leverage risk, valuation opacity, and excessive fees that characterize BDC investments. A broker who recommended a BDC to a moderate-risk income investor without considering these readily available alternatives may have violated Regulation Best Interest’s requirement to consider “reasonably available alternatives.”
Contact an Experienced BDC Investment Fraud Attorney
If you invested in a BDC—including products offered by Prospect Capital, FS Investments, or any other BDC sponsor—and suffered losses, we can evaluate your case at no cost and determine whether you have a claim for recovery. We handle most investment loss cases on a contingency fee basis, meaning you pay nothing unless we recover money for you.
Attorney Robert Wayne Pearce and the investment fraud attorneys at the Law Offices of Robert Wayne Pearce, P.A. have spent more than 45 years fighting to protect investors from broker misconduct and securities fraud. Our firm has recovered over $185 million for investors nationwide.
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