Litigation Coverage: Ares Capital Corp. Investor Accuses BDC Advisor of Collecting Excessive Fees, Inflating Marks, Masking Leverage

Relevant Document:
Complaint

On May 26, an Ares Capital Corp., or ARCC, shareholder filed a derivative lawsuit on behalf of the business development company, alleging advisor Ares Capital Management breached its fiduciary duty by extracting “grossly excessive” fees based on “systematically inflated” marks of ARCC’s assets. The complaint also raises concerns about ARCC’s “overconcentration” in software investments at risk of AI-based disruption and accuses ARCC of masking its true leverage through affiliated vehicles with additional software exposure.

The ARCC derivative suit joins a growing list of securities suits challenging BDC valuations as the sector faces increased scrutiny from investors.

In April a Blue Owl Capital Corp. investor filed a similar derivative suit against advisor Blue Owl Credit Advisors for collecting excessive fees based on inflated valuations. Law firms Grant & Eisenhofer and Woolery & Co. represent the shareholder plaintiffs in both the ARCC and Blue Owl Capital Corp. derivative suits. Bernstein Litowitz is also listed as counsel in the ARCC complaint.

Additionally, in December 2025 an investor filed a securities fraud class action focusing on the stock-price decline of BDC manager Blue Owl Capital Inc., as opposed to a particular BDC managed by Blue Owl.

BDC investors have also filed securities class actions against BlackRock TCP Capital Corp. and FS KKR Capital Corp. alleging the BDCs overstated the value of their portfolio investments. An investor in Hercules Capital alleges the BDC overstated its due diligence processes in a proposed class action.

ARCC investor Martin Siegel alleges that Ares Capital Management breached section 36(b) of the Investment Company Act of 1940, which imposes a fiduciary duty on advisors to not charge excessive fees. The complaint notes that ARCC’s advisory fees to Ares Capital Management increased 53% over the past five years – from $504 million in 2021 to $773 million in 2025.

The plaintiff adds that the inflated values assigned to ARCC’s portfolio are underscored by reports that Ares Capital Management and parent Ares Management “may be overvalued by about 10%.”

The plaintiff also says Ares Management is “wrongly downplaying its actual exposure to software investments in ARCC and Ares Management’s other BDCs as fears spread that AI could decimate the software industry.” The complaint notes that Ares Management also capped redemptions at its affiliated nontraded BDC Ares Strategic Income Fund at 5% earlier this year after a surge in investor withdrawal requests that represented $1.2 billion, or 11.6% of shares outstanding.

“ARCC’s overconcentration in software and technology investments further contributes to the overvaluation of the Company’s portfolio,” the complaint continues. The plaintiff notes media reports suggest that ARCC’s portfolio exposure as of Dec. 31, 2025, was closer to 30%, instead of the 23.8% reported by management.

The plaintiff also asserts that ARCC’s first-quarter 2026 valuations “showed little adjustment for software and other higher-risk loans, despite analyst expectations that valuations would reflect” risks from AI-related disruption.

The plaintiff argues that ARCC’s disparate marks for two Pluralsight first lien senior secured loans demonstrate that the defendant’s “valuation process does not consistently reflect the economic reality of the borrower.” The complaint notes that one loan was marked at approximately par while the other was marked at approximately six cents on the dollar.

Additionally, the complaint contends that ARCC has additional exposure to software through portfolio company Ivy Hill Asset Management, or IHAM, which functions as a “strategic aggregator to manage credit assets and boost returns” and through its joint venture Senior Direct Lending Program, or SDLP, where ARCC co-invests with other investors “to make larger loans without heavy syndication.”

Although ARCC does not separately report IHAM’s and SDLP’s software exposure, the plaintiff contends that “software and technology investments make up a whopping 63% of ARCC’s net asset value” on a consolidated basis “when IHAM and SDLP are included.”

The complaint also accuses ARCC of using IHAM and SDLP to “mask reported leverage.” The complaint notes that as of Dec. 31, 2025, ARCC had a 1.12x debt-to-equity ratio but that SDLP had an approximately 2.8x debt-to-equity ratio and IHAM had a 5.5x debt-to-equity ratio. “Adjusting for this by consolidating SDLP and IHAM with ARCC’s reported balance sheet increases ARCC’s debt-to-equity from an innocuous 1.12x to 2.06x, the highest of any public BDC,” the complaint argues (emphasis added).

The complaint also alleges that ARCC is “increasingly transferring riskier or underperforming assets to IHAM and SDLP, which has the effect of making ARCC’s reported metrics appear stronger.”

The plaintiff also criticizes Ares Capital Management’s incentive fees based on net investment income that includes accrued payment-in-kind income. The complaint notes that PIK income comprised 34% of ARCC’s net investment income in 2025, or $490 million. However, the defendant’s income-based incentive fee is paid quarterly on “accrued PIK income when booked, regardless of whether that income is later collected in cash.”

The complaint notes that the advisory agreement lacks a “true clawback” provision requiring the advisor to return incentive fees earned on accrued PIK income that ultimately proves uncollectible.

The plaintiff asks the U.S. District Court for the Southern District of New York to find that Ares Capital Management breached its fiduciary duty and award rescissory damages and disgorgement. The plaintiff also seeks an order rescinding the advisory agreement and requiring restitution to ARCC of excessive advisory fees for the period lasting one year prior to the complaint extended through the pendency of the action.

The plaintiff also seeks additional equitable relief “to remedy the asymmetrical compensation structure” including by ensuring that “advisory compensation is aligned with realized investment performance and does not reward non-cash or unrealized income” and by “imposing clawbacks of fees paid on deferred income not ultimately realized.”

In its first-quarter earnings report, ARCC disclosed that it engaged a management consulting firm to evaluate its software portfolio due to market concerns around AI-based disruption. The company said that the independent assessment found that 85% of ARCC’s software investments carry low AI risk. Another 14% representing 3% of ARCC’s total portfolio at fair value was deemed medium risk, and only 1% of the software portfolio (0.3% of the total portfolio) was classified as high risk, the company said.