SecProbe.io

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
DIVISION OF
INVESTMENT MANAGEMENT
September 27,2012
Steven Grigoriou
Skadden, Arps, Slate,
Meagher & Flom LLP
Four Times Square
New York, New York 10036-6522
Re: Prospect Capital Corporation (the "Company")
File Number 814-00659
Dear Mr. Grigoriou:
On August 22, 2012 Prospect Capital Corporation (814-659)
("Company") filed a Form 10-K for the year ended June 30, 2012 ("10-K").
We have the following comments on that filing.
Background
In December 2011, the Company completed a reorganization of Gas
Solutions Holdings, Inc., a wholly owned portfolio company ("GSHI"),
renaming it Energy Solutions and transferring ownership of its equity
interests in other operating companies with the stated intent of strategically
expanding the operations of Energy Solutions across energy sectors. As part
of this reorganization, the Company transferred its equity interests in
Change Clean Energy Holdings, Inc. ("CCEHI") and Change Clean Energy,
Inc. ("CCEI"), Freedom Marine Holding, Inc. ("Freedom Marine") and
Yatesville Coal Holdings, Inc. C'Yatesville") to Energy Solutions Holdings Inc.
(f/k/a Gas Solutions Holdings Inc.) ("Energy Solutions").
On Januàry 4, 2012, Energy Solutions sold its gas gathering and
processing assets ("Gas Solutions") for a sale price of $199,805,000
adjusted for the final working capital settlement, including a potential
earnout of $28,000,000 that will be paid based on the future performance of
Gas Solutions. We believe that it is the Company's intent to maintain the
loans to and investment in Energy Solutions, as Energy Solutions will
apparently continue as a portfolio company.
The Company received a distribution of $33,250,000 from Energy
Solutions which was recorded as dividend income during the quarter ended

"
June 30, 2012. During the year ended June 30, 2012, the Company states
that the main driver of the increase in investment income is primarily the
result of a larger income producing portfolio and the deployment of
additional capital in revenue-producing assets through increased origination
and increased dividends and other income received from Energy Solutions,
First Tower and NRG.
The Company received dividends from NRG of $15,011,000 and
$3,600,000 during the years ended June 30, 2012 and June 30, 2011,
respectively and it received dividends from Energy Solutions of $47,850,000
and $9,850,000 during the years ended June 30, 2012 and June 30, 2011,
respectively. The incentive fee calculations1 include a net investment
income incentive fee with such base appearing to be approximately
i Item 3(b) of the advisory agreement filed by the Company in its N-2 on July 6, 2004 (333-114552)
provides that the Incentive Fee shall consist of two parts, as follows:
(i) One part will be calculated and payable quarterly in arrears based on the pre-Incentive Fee
net investment income for the immediately preceding calendar quarter. For this purpose, pre-
Incentive Fee net investment income means interest income, dividend income and any other income
(including any other fees, such as commitment, origination, structuring, diligence and consulting fees
and fees for providing significant managerial assistance or other fees that the Corporation receives
from portfolio companies) accrued by the Corporation during the calendar quarter, minus the
Corporation's operating expenses for the quarter (including the Base Management Fee, expenses
payable under the Administration Agreement, and any interest expense and dividends paid on any
issued and outstanding preferred stock, but excluding the Incentive Fee). Pre-Incentive Fee net
investment income includes, in the case of investments with a deferred interest feature (such as
original issue discount, debt instruments with payment-in-kind interest and zero coupon securities),
accrued income that the Corporation has not yet received in cash. Pre-Incentive Fee net investment
income does not include any realized capital gains, realized capital losses or unrealized capital
appreciation or depreciation. Pre-Incentive Fee net investment income, expressed as a rate of return
on the value of the Corporation's net assets at the end of the immediately preceding calendar quarter,
will be compared to a "hurdle rate" of 1.75% per quarter (7% annualized). The Corporation will pay
the Adviser an Incentive Fee with respect to the Corporation's pre-Incentive Fee net investment
income in each calendar quarter as follows; (1) no Incentive Fee in any càlendar quarter in which the
Corporation's pre-Incentive Fee net investment income does not exceed the hurdle rate; (2) 100% of
the Corporation's pre-Incentive Fee net investment income with respect to that portion of such pre-
Incentive Fee net investment income, if any, that exceeds the hurdle rate but is less than 2.1875% in
any calendar quarter (8.75% annualized); and (3) 20% of the amount of the Corporation's pre-
Incentive Fee net investment income, if any, that exceeds 2.1875% in any calendar quarter (8.75%
annualized). These calculations will be appropriately pro rated for any period of less than three
months and adjusted for any share issuances or repurchases during the current quarter.
(ii) The second part of the Incentive Fee (the "Capital Gains Fee") will be determined and
payable in arrears as of the end of each calendar year (or upon termination of this Agreement as set
forth below), commencing on December 31, 2004, and will equal 20.0% of the Corporation's realized
capital gains for the calendar year, if any, computed net of all realized capital losses and unrealized
capital depreciation at the end of such year; provided that the Incentive Fee determined as of
December 31, 2004 will be calculated for a period of shorter than twelve calendar months to take into
account any net realized capital gains, if any, computed net of all realized capital losses and unrealized
capital depreciation for the period ending December 31, 2004. In the event that this Agreement shall
terminate as of a date that is not a calendar year end, the termination date shall be treated as though
it were a calendar year end for purposes of calculating and paying a Capital Gains Fee.
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$233,351,000 for the year ended June 30, 2012 (based on net investment
income of $186,684,000 plus the $46,671,000 income incentive fee and
multiplying that total by 200/0).
Thus, it appears that shareholders apparently paid a 200/0 income
incentive fee on the $47,850,000 dividend paid by Energy Solutions. It
appears that the dividend may have been paid at least in part with proceeds
from the sale of Gas Solutions by Energy Solutions, a wholly owned portfolio
company. It appears that the Gas Solutions sale transferred .most of the
operating assets of Energy Solutions that it held before the reorganization.
We further note that there have been no capital gains incentive fees paid
pursuant to Section 3(b )(ii) of the advisory contract for the three years
ended June 30, 2012, June 30, 2011 and June 30, 2010.
Page 86 of the annual report states that "(tJhe sale of Gas Solutions
by Energy Solutions has resulted in significant earnings and profits, as
defined by the Internal Revenue Code, at Energy Solutions for calendar year
2012. As a result, distributions from Energy Solutions to us will be required
to be recognized as dividend income, in accordance with ASC 946, Financial
Services-Investment Companies, as cash distributions are received from
Energy Solutions to the extent there are current year earnings and profits
sufficient to support such recognition". Presumably, the treatment of the
distribution by Energy Solutions to the Company as a dividend subjects the
distribution to the income incentive fee described in Section 3(b)(i) of the
advisory contract.
Page 145 of the Company's 10-K states that (with dollar amounts in
thousands) :
Energy Solutions has indemnified us against any legal action arising from its
investment in Gas Solutions, LP. We have incurred approximately $2,093 from the
inception of the investment in Energy Solutions through June 30, 2012 for fees
associated with a legal action, and Energy Solutions has reimbursed us for the entire
amount. There were no such legal fees incurred or reimbursed for the year ended June
30, 2012 and June 30, 2011.
Additionally, certain other operating expenses incurred by us which are
attributable to Energy Solutions have been reimbursed by Energy Solutions and are
reflected as dividend income: control investments in the Consolidated Statements of
Operations. For the years ended June 30, 2012, June 30, 2011 and June 30, 2010,
such reimbursements totaled as $16,236, $5,704 and $6,944, respectively (emphasis
added).
The Company's Energy Solutions positions2 are presented on the 10-K
Schedule of Investments as a Level 3 Control Investment (250/0 or greater
2 Footnote (8) states that "(dJuring the quarter ended December 31, 2011, our ownership of Change
Clean Energy Holdings, Inc. ("CCEHI") and Change Clean Energy, Inc. ("CCEI"), Freedom Marine
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voting control). The positions show an aggregate cost of $63,245,000 with
an aggregate current value of $126,868,000 as of June 30, 2012. The
operations of Energy Solutions are not consolidated with the Company.
Page 93 of the Company's 10-K states "(oJur June 30, 2012 and June 30,
2011 financial statements include our accounts and the accounts of Prospect
Capital Funding, LLC, our only wholly-owned, closely-managed subsidiary
that is also an investment company. All intercompany balances and
transactions have been eliminated in consolidation".
Discussion
The staff requests that the dividend paid by Energy Solutions and the
reorganization transaction and asset sale be explained in a written response
letter filed on EDGAR.
1. Describe how Energy Solutions, and its predecessor Gas Solutions, are
structured for legal and tax purposes. Are these entities corporate tax
payers or pass-through vehicles for tax purposes?
2. Describe how the transfers of assets (CCEHI, CCEI, Freedom Marine
and Yatesville) to Energy Solutions by the Company were accounted for both
under US GAAP and for federal tax purposes, including appropriate
authoritative support. Did the accounting for these transfers have any
impact on the sale of assets by Energy Solutions in 2012, and if so, how.
3. Please explain why the Energy Solutions distribution should be treated
as a dividend subject to the income incentive fee calculation in Section
3(b)(i) of the advisory contract.
4. Please explain why the Energy Solutions distribution should not be
treated as a realized capital gain subject to calculation under Section 3(b )(ii)
of the advisory contract.
5. Please discuss the immediate financial difference and any long-term
financial difference, if any, to the Company's shareholders with respect to
any incentive payment under 3 and/or 4 above.
6. If the difference between an income incentive fee calculation and a
realized capital gain incentive fee calculation is material, discuss the Board
of Directors' role in oversight and their awareness of this issue (specifically
including the independent directors). Does structuring portfolio transactions
Holding, Inc. ("Freedom Marine") and Yatesville Coal Holdings, Inc. ("Yatesville") was transferred to
Energy Solutions Holdings Inc. (f/k/a Gas Solutions Holdings Inc.) ("Energy Solutions") to consolidate
all of our energy holdings under one management team. We own 100% of Energy Solutions".
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for dividends (as opposed to realized capital gains) present any advisory
conflict, and if so, how is such conflict monitored to safeguard shareholder
interests? Are the proceeds from the sale of the Gas Solution assets the
source of the dividend payment the Company received?
7. Provide an accounting analysis under US GAAP for the conclusion to
account for the make-whole payment of $26,936,000 received for the sale of
NRG as interest income.
8. Fully explain both the federal tax treatment and the GAAP accounting
treatment regarding the Gas Solutions sale and all payments as they apply
to Energy Solutions, the Company, and the Company's shareholders.
9. Discuss when negotiations for the Gas Solutions sale started and
whether the December 2011 reorganization was contemporaneous with such
negotiations.
10. Disclose the management team of Energy Solutions, and if any are
affiliated persons, describe their compensation and the source of such
compensation.
11. What are the specific assets owned by Energy Solutions/Gas Solutions
Holdings, Inc. immediately prior to, and immediately after the December
2011 reorganization? Include a description of the specific Gas Solutions
Holdings, Inc. assets remaining, if any, after the Gas Solutions sale, and
excluding cash or receivables from such sale.
Assuming the reorganization did not take place and that the Gas
Solutions assets were still sold for the same price, would there have been
any difference with respect to the amount or accounting treatment of the
dividend payment to the Company? Would there have been any change to
the amount of incentive fee payable to the adviser? If so, were the
Company's directors informed about these transactions and were they made
aware that such transactions would have an impact on the incentive fee to
be paid to the adviser?
12. Did the Gas Solutions sale dispose of most of the assets that were
originally held by Gas Solutions Holdings, Inc. immediately prior to the
reorganization?
13. What is the prospectus disclosure of the potential conflict between the
advisor and the Company regarding the structuring of its investments in
control investments and the impact on any potential incentive fees payable
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by the Company and its shareholders? See comments 3 and 4 above.
Where is this disclosure located?
14. Did the Company pay an income incentive fee to the advisor for any
expenses reimbursed to it by Energy Solutions, and if so, why? In addition,
please explain (including authoritative support) why reimbursement of such
operating expenses is appropriately accounted for as dividend income.
15. What is the cautionary prospectus disclosure with respect to the
sustainability/reliability of portfolio company "dividends" that are received by
the Company that occur due to the sale of portfolio company capital assets.
Where is such disclosure located?
16. Future interest/dividend presentations by the Company should be
appropriately qualified and/or quantified as needed in light of the comments
in this letter.
17. State whether any of the comments in this letter with respect to the
Energy Solutions situation presents a similar issue for First Tower and/or
NRG, or any other portfolio company.
18. Provide an accounting analysis under US GAAP for the conclusion not
to consolidate Energy Solutions, its predecessor Gas Solutions, First Tower
of Delaware, and any other wholly-owned subsidiaries.
19. Pursuant to Article 3-09 of Regulation S-X, discuss whether the
financial statements of Energy Solutions, its predecessor Gas Solutions, First
Tower of Delaware, NRG or any majority wholly-owned subsidiaries are
required to be filed with the financial statements of the Company.
20. Pursuant to Article 4-08(g) of Regulation S-X, discuss whether
summarized financial information of Energy Solutions, its predecessor Gas
Solutions, First Tower of Delaware, NRG or any subsidiaries are required to
be included in the notes to the financial statements of the Company.
21. Please confirm that while not immediately paid, capital gain incentive
fees are accrued during the periods when unrealized appreciation is recorded
on the Company's books and records with respect to the portfolio. Thus,
capital gain incentive fee accruals will be matched with the corresponding
unrealized capital appreciation (and depreciation) for the portfolio so that
future investors do not bear the entire capital gain incentive fee accrual in
the period of sale. Please explain the relationship of the capital ga