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Medley Capital: BDC Activist Weighs In On Annual Proxy

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INTRODUCTION

The BDC Daily News Table shows that Medley Capital (MCC) has filed a routine Annual Proxy, requiring shareholders to vote on the re-appointment of the current independent accountant (Ernst & Young) and the election of two Directors to the 7 person staggered Board of Directors for another 3 years. Neither subject is likely to be controversial with MCC shareholders. However, the BDC Reporter – with its BDC Activist hat on – used the opportunity of the filing to consider items that might be positive or negative from a shareholders standpoint. With so much of BDC corporate governance weighted towards the insiders and firms managing the BDCs, shareholder interests rarely get much of a voice. The BDC Activist seeks – with its occasional postings – to offer up news, analysis and views from a shareholders perspective. Here are a few notes:

EXPANDED CO-INVESTMENT

The Proxy discloses that the Investment Advisor has sought and received yet another “exemptive relief” order from the SEC as recently as October 4 2017. This latest waiver of the rules allows the BDC to be included in transactions with the Investment Advisor and other affiliated entities acting in a “principal capacity”. Here is the full text regarding the changing “exemptive relief” provisions over time, copied from the Proxy. The emphasis added is ours:

MCC Advisors and its affiliates may also manage other funds in the future that may have investment mandates that are similar, in whole or in part, with ours. MCC Advisors also focuses on investing primarily in senior secured loans, including first lien, unitranche and second lien debt instruments. MCC Advisors and its affiliates may determine that an investment is appropriate for us and for one or more of its affiliated funds. In such event, depending on the availability of such investment and other appropriate factors, MCC Advisors or its affiliates may determine that we should co-invest with one or more other funds. The Company obtained an exemptive order from the SEC on November 25, 2013 (the “Prior Exemptive Order”). On March 29, 2017, the Company, MCC Advisors and certain other affiliated funds and investment advisers received an exemptive order (the “Exemptive Order”) that supersedes the Prior Exemptive Order and allows affiliated registered investment companies to participate in co-investment transactions with us that would otherwise have been prohibited under Section 17(d) and 57(a)(4) of the 1940 Act and Rule 17d-1 thereunder. On October 4, 2017, the Company, MCC Advisors and certain of our affiliates received an exemptive order that supersedes the Exemptive Order (the “New Exemptive Order”) and allows, in addition to the entities already covered by the Exemptive Order, Medley LLC and its subsidiary, Medley Capital LLC, to the extent they hold financial assets in a principal capacity, and any direct or indirect, wholly- or majority-owned subsidiary of Medley LLC that is formed in the future, to participate in co-investment transactions with us that would otherwise be prohibited by either or both of Sections 17(d) and 57(a)(4) of the 1940 Act. The terms of the New Exemptive Order are otherwise substantially similar to the Exemptive Order. Co-investment under the Exemptive Order is subject to certain conditions, including the condition that, in the case of each co-investment transaction, our board of directors determines that it would to be in our best interest to participate in the transaction. However, neither we nor the affiliated funds are obligated to invest or co-invest when investment opportunities are referred to us or them.
We may, however, co-invest with MCC Advisors and its affiliates’ other clients in certain circumstances where doing so is consistent with applicable law and SEC staff interpretations and MCC Advisors’ allocation policy. For example, we may co-invest with such accounts consistent with guidance promulgated by the SEC staff permitting us and such other accounts to purchase interests in a single class of privately placed securities so long as certain conditions are met, including that MCC Advisors, acting on our behalf and on behalf of other clients, negotiates no term other than price.
The BDC Activist remains uncomfortable in principle with the SEC’s policy of waiving key protection provisions of the 1940 Act, which Medley is only one example amongst many. From our perspective, the danger is that the interests of the Investment Advisor will supercede those of its BDC shareholders when investment selection occurs. This might result in inappropriate investments being made by MCC in order to allow Medley LLC or one of its subsidiaries to close deals divided up amongst controlled funds. With very little public information about which transactions are booked under the waiver, and the terms thereof, MCC shareholders have very little way of knowing if new investments booked were in their interests or not. There is no disclosure in the quarterly filings identifying which investments were the result of the SEC exemptive relief and no discussion as to how the transactions met stated strategic objectives of the BDC.
We also know – based on multiple conversations with other investors, analysts and investment bankers – that nobody else appears much disturbed by the ability of the Investment Advisor to band several funds under its control – including the BDC – to book transactions. Nonetheless, we mention our reservations and note that the protection supposedly afforded by independent director review of any transactions which fall into this category is not convincing given the very little authority exercised by the “non interested” directors on essentially all matters over time.
CHAIRMAN OF THE BOARD
The Proxy reaffirms that the Chairman of the Board of MCC remains an “interested director”: Brook Taube. Mr Taube is the CEO and President of the BDC, as well as a controlling shareholder in the BDC’s Investment Advisor. Notwithstanding those obvious conflicts of interest, MCC – like most externally managed BDCs- has chosen not to appoint an “independent” director as Chairman of the Board. Here is what the Proxy says:
Under the Company’s bylaws, our board of directors may designate a Chairman to preside over the meetings of the board of directors and meetings of the stockholders and to perform such other duties as may be assigned to him or her by the board of directors. We do not have a fixed policy as to whether the Chairman of the board of directors should be an independent director and believe that we should maintain the flexibility to select the Chairman and reorganize the leadership structure, from time to time, based on the criteria that is in the best interests of the Company and its stockholders at such times.
Presently, Mr. Brook Taube serves as the Chairman of our board of directors. Mr. Brook Taube is an “interested person” of the Company as defined in Section 2(a)(19) of the 1940 Act because he is Chief Executive Officer and President of the Company, serves on the Investment Committee and is the Managing Member of MCC Advisors. We believe that Mr. Taube’s history with the Company, familiarity with its investment platform, and extensive knowledge of the financial services industry qualify him to serve as the Chairman of our board of directors. We believe that the Company is best served through this existing leadership structure, as Mr. Taube’s relationship with MCC Advisors provides an effective bridge and encourages an open dialogue between management and the board of directors, ensuring that both groups act with a common purpose.
The currently designated lead independent director of our board of directors is Arthur Ainsberg. We are aware of the potential conflicts that may arise when a non-independent director is Chairman of the board of directors, but believe these potential conflicts are offset by our strong corporate governance policies. Our corporate governance policies include regular meetings of the independent directors in executive session without the presence of interested directors and management, the establishment of the Audit Committee and the Nominating and Corporate Governance Committee comprised solely of independent directors, and the appointment of a Chief Compliance Officer, with whom the independent directors meet regularly without the presence of interested directors and other members of management, for administering our compliance policies and procedures.
The BDC Activist does not agree that having the chief executive of the Investment Advisor (and one of its major shareholders) serving as the BDC’s Chairman is appropriate. There are numerous occasions when the interests of the Investment Advisor and its principals may be at variance with those of MCC’s shareholders on such issues as compensation; credit selection; risk management and corporate governance. The current arrangement reduces the likelihood – already greatly restricted by the insider-friendly provisions of the shareholder agreement- that MCC’s shareholders interests will be protected. Again, though, the BDC Activist accepts that most shareholders – both institutional and individual – do not appear concerned about these unequal and potentially unfair arrangements.  We would only point out that the financial underperformance of MCC over the years may have something to do with the absence of better checks and balances where corporate governance is concerned.  With no change in the Board arrangements going forward, the BDC Activist does not see any reason why the past should be anything but prologue.
INSIDER OWNERSHIP
BDC proxies are useful annual snapshots of insider ownership, which some investors equate with confidence in the entity’s outlook.  At first glance,  the beneficial ownership table in the Proxy suggests insiders are highly invested – literally and figuratively – in MCC with 8,170,448 shares held or 15.0%. However, anybody who’s been reading the BDC Reporter in the past year and a half will know that most of MCC’s shares held by Brooke and Seth Taube are part of a complex financial scheme and are not funded from their personal resources. The shares are actually owned by an entity called Medley Seed Funding I, LLC. The investors in Medley Seed Funding I consist of an affiliate of the Investment Advisor and investors of Fortress Capital in a two tier arrangement, subject to a Preferred return. (For more details, read this prior article on the subject). The Taubes are listed as “beneficial owners” of Medley Seed Funding I’s shares because they serve as the managing members of the LLC.
Outside of the Medley Seed Funding holdings, insider ownership in MCC is much, much lower: 0.4% of total MCC shares outstanding. The biggest stakes are held by the Taubes through various trusts and individually for a total of 190,000 shares.The largest holding by a Director not called Taube is 15,000 shares. Otherwise, the “Independent Directors” own anywhere between zero and 3,000 shares in MCC. With the stock price at $5.40, the maximum value of shares owned by an independent director  is $16,200. Compare the value of insider ownership amongst the “Independent Directors” with the annual compensation for serving at MCC which is listed in the Proxy at $165,000. As the Proxy reveals, there is an option for the independent directors “to receive all or a portion of the directors fees to which they would otherwise be entitled in the form of common shares of our common stock”. However the Proxy also states that no individual availed themselves of the opportunity in the year ended September 30, 2017.
In total non-Taube insiders – including both independent directors and officers – own 46,000 shares. MCC has 54,474,121 shares outstanding.
CONCLUSION
We’ve been looking at BDCs from a BDC Activist perspective for several years now. The current MCC Proxy illustrates that nothing much has changed, except for the increase in the “beneficial ownership” by Brook and Seth Taube through the bias of Medley Seed Funding I, LLC. In fact, the intersection of the interests of the Investment Advisor; its principals and the shareholders of MCC only becomes more pronounced and more needing of checks and balances. However nothing in the Proxy suggests that any change is imminent or that the insiders have great confidence in the outlook for the beleaguered BDC, which hit its All-Time Low a few days ago, as reported to our Premium subscribers in the Daily News Table.
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