Sierra Income: Was Non-Traded BDC Investment Too Risky?

In March 2022 Sierra Income Corp., previously a non-traded business development company (BDC), marked the completion of its merger with Barings BDC Inc., a publicly traded BDC. The successful merger followed a terminated merger attempt with Medley Corporation and Medley Management, which Sierra reportedly attributed to factors including the economic uncertainty caused by the Covid-19 pandemic.

As a non-traded BDC, Sierra Income was likely a highly risky investment for many retail investors, especially investors with a low risk tolerance and investors who needed liquidity. If your financial advisor misrepresented or omitted the risks associated with an investment in Sierra Income, contact our attorneys to discuss whether you have grounds for a FINRA arbitration claim.

What Is Sierra Income?

According to The DI Wire, Sierra Income was a non-traded BDC that invested “primarily in first lien senior secured debt, second lien secured debt and, to a lesser extent, subordinated debt of middle market companies in a range of industries with annual revenue between $50 million and $1 billion.” It held its initial offering in 2012, raising “nearly $1 billion” from investors before closing the offering in 2018. 

What Is Barings Inc.?

Barings BDC is a publicly traded BDC that “invests primarily in senior secured loans to private U.S. middle market companies that operate across various industries,” according to The DI Wire. It is managed by Barings, LLC, described by the company’s website as a $349 billion global investment manager, as of June 30th, 2022. 

Was Sierra Income a Risky Investment?

A prospectus Sierra Income filed with the Securities and Exchange Commission in 2013 states that investments in the BDC’s common stock “may be considered speculative and involves a high degree of risk, including the risk of a substantial loss of investment.” 

Chief among these risk’s is the stock’s illiquidity. “You should not expect to be able to sell your shares of our common stock regardless of how we perform,” the prospectus states. “If you are able to sell your shares, you will likely receive less than your purchase price. We do not intend to list our shares on any securities exchange for the foreseeable future, and we do not expect a secondary market in the shares to develop.” Investments in the BDC are “appropriate only as a long-term investment,” it adds, and are appropriate only for investors who can bear the illiquidity associated with the product, as well as its other risks. 

The prospectus expounds on those risks in its “Risk Factors” section. Those include the BDC’s limited operating history, the recent downgrading of the US credit rating, price declines in the corporate leveraged loan market, the possibility that it may not be able to grow distributions or pay them at all, and the limited avenues in which investors would be able to sell their shares.

Did SIC Advisors Have Any Conflicts of Interest?

Sierra Income was managed by SIC Advisors, which had a joint venture agreement with its affiliate Strategic Capital Advisors entitling the latter to receive distributions of up to 20% of the gross cash proceeds the adviser received in its capacity as the BDC’s investment advisor. 

As Sierra Income explained in its prospectus, this created the risk of a conflicts of interest. “As a result of this compensation arrangement, our dealer manager has a financial interest in the performance of the assets recommended by SIC Advisors,” the document noted. “The dealer manager may face conflicts of interest as a result and may have an incentive to influence our Advisor to select investments that may not be in our best interest.”

That wasn’t the only conflict of interest relating to SIC Advisors described in the prospectus. Others included the investment adviser’s “limited experience managing a BDC,” and the conflicts of interest held by its compensation arrangements with Sierra Income itself. The document adds that the management and incentive fees paid by the BDC to SIC Advisors may induce the firm to make speculative investments. Here’s the section in question:

The incentive fee payable by us to SIC Advisors may create an incentive for SIC Advisors to make investments on our behalf that are risky or more speculative than would be the case in the absence of such compensation arrangements. The way in which the incentive fee is determined may encourage SIC Advisors to use leverage to increase the return on our investments. In addition, the fact that our management fee is payable based upon our gross assets, which would include any borrowings for investment purposes, may encourage SIC Advisors to use leverage to make additional investments. Under certain circumstances, the use of leverage may increase the likelihood of default, which would disfavor holders of our common stock. Such a practice could result in our investing in more speculative securities than would otherwise be the case, which could result in higher investment losses, particularly during cyclical economic downturns.

What Is a Business Development Company?

A business development company (BDC) is closed-end development funds that invests in new businesses and in some cases distressed businesses. The Securities and Exchange Commission’s investor resources observe that BDCs are similar to mutual funds or exchange-traded funds: they pool together money from a large number of retail and/or institutional investors for their own investments. Investors receive shares in the BDC, and the value of these shares increases or decreases depending on the BDC’s own performance. Some BDCs are publicly traded, and therefore subject to the risks of the public securities markets, while others are non-traded (also known as private). 

Are BDCs Risky Investments?

While BDCs are regulated by the SEC, this may not be true of the companies in which they invest. Because BDCs as a matter of practice invest in developing and/or distressed companies, a BDC’s investors are therefore exposed to the risk that those companies do not succeed.

Additionally, a BDC’s investments are often in private businesses that make no public financial disclosures. This means that investors cannot easily access information about the companies. Furthermore, a BDC may also use leverage to make its investments, which can increase the potential losses investors might experience if the BDC suffers performance issues. Like mutual funds and ETFs, BDCs are often also associated with high fees and commissions.

The SEC’s resources note further that the “market price for BDC shares may be greater or less than the shares’ net asset value,” or NAV. (The NAV is the BDC’s total assets minus its total liabilities). What this means is that investors trading their BDC shares at the market price might be selling them at a premium (when the market price is higher than the BDC’s NAV) or at a discount (when the market price is lower than the BDC’s NAV.) “If you purchase shares at a premium, you are paying more than the current value of the underlying investments,” the SEC explains. “If you purchase shares at a discount, you are paying less than the current value of the underlying investments, but you may not be able to sell the shares other than at a discount.”

Investors should also bear in mind that non-traded or private BDCs, like other non-traded funds, pose significant illiquidity risks. In 2016 Financial Industry Regulatory Authority warned investors to exercise caution when considering investments in non-traded BDCs, writing that these entities expose investors “to high commissions and fees, illiquidity risks and uncertainty regarding the time-period BDCs will hold funds before they are invested.” 

Call for a Free Consultation about Your Sierra Income Losses

Carlson Law represents investors involved in claims against financial advisors and investment firms throughout the United States. If you or a loved one have suffered investment losses on your investment in Sierra Income BDC, please call us at 888-976-6111 or complete our contact form for a free and confidential consultation.