are paying somewhere between 311⁄2 and 4 percent for our money from the Government. In fact, a number of Government issues over recent months have been pretty close to 4 percent. We, in the agency, I would imagine would have no objection to considering the question of lowering the rate, but there are budgetary considerations involved, and I think this is something that is beyond our particular ability to form an opinion on. In other words, it is a question for another agency in the sense of how far we could go in not defraying our expenses from the difference in the rate that we pay and the rate that is charged. With respect to the rates that are charged by the small business investment companies to their borrowers or investors, as I have indicated, the average rates that are shown would seem to indicate that they are not too high. Also, we have to remember that many times the interest which other institutions charge is put on what is called an add-on basis. When you borrow from a bank, for instance, on a piece of machinery, the bank may say the interest is 6 percent on this, but actually, it is 6 percent of the original amount borrowed and, in fact, this will work out more truly to 12 percent. So we are talking about a venture-type of an investment being made with the maximum limit of 15-percent simple interest and, by and large, very few of the concerns are going that high. The CHAIRMAN. Now, we understand these long-term loans or equity-type loans are made for only 5 years. I think we talked earlier about long-term capital loans and some of the witnesses come in now and tell us that they, of course, may be renewed or may be refinanced or they may set a new schedule, but they are all made for a period of only 5 years. Did you not envisage longer type loans to the companies than a 5-year period? Mr. KELLEY. Yes, Mr. Chairman. We have obtained permission from the Bureau of the Budget to set a 6-year basic term with a 4-year renewal on section 303 loans. Section 302 loans are now made for a period of 20 years with the maximum amortization being in the last 5 years. So I think that we will soon be able to afford the industry some relief with respect to their section 303 loans. The CHAIRMAN. Complaint has been made that you make the 303 loans for a 5-year period and then expect the small business investment companies to make long-term loans Mr. KELLEY. I think this is unfair. I mean, I think that we should alter this and we have in mind getting out a new regulation very shortly to provide this 6 plus 4-year system. I am hopeful, in the long run, that we may be able to do better than that, but that again is something that will have to be discussed between our agency and the Bureau of the Budget. The CHAIRMAN. Will you discuss for the committee the allegation that SBIC's need more flexibility, more leverage? Mr. KELLEY. You mean-I presume, Mr. Chairman, you refer to the fact that some of the companies refer to the fact that they do not think $2 of Government money to $1 of private money is sufficient? The CHAIRMAN. Yes. Mr. KELLEY. I think, perhaps, Mr. Chairman, that there are some ways in which the leverage within those figures could be increased somewhat. We have in mind the possibility of allowing small business investment companies to guarantee loans made to their portfolio companies by other institutions, thus sort of giving added credit to the small business. In turn, it might be possible, and this has not been fully studied out yet, but it might be possible then to allow the SBIC to reserve less than 100 percent against this contingency. This would tend to increase the leverage to a degree. The CHAIRMAN. I do not want to consume all of the time, but do you think there exists a need for creation of a secondary market for the SBIC's at this time? Mr. KELLEY. I do not feel, Mr. Chairman, that there is an urgent need at this time. I think this is because of the recent passage of the new public law providing additional funds. I think that perhaps a year from now this will become a very important issue, and there have been a number of proposals made with respect to a capital bank or some sort of discounting agency which might take over the paper of some of these companies at that point. We intend to make a thorough study of some of these possibilities so that when it does become a critical issue we will have some recommendations to make to the Congress with respect to this or we may find that there are some actions we can take within our administrative prerogatives. But we do have the matter under study. The CHAIRMAN. Mr. Kelley, there have been considerable news stories in the press-not recently but some time back-about the question of self-dealing in which a number of cases have been cited, and we have heard the testimony as to the reasons why it is necessary to make loans to your close cousins. We have also placed in the record your regulations in this regard. Do you think that your present regulations control this matter properly or do you think that they should be strengthened? Do you want to discuss this issue of self-dealing? Mr. KELLEY. Well, Mr. Chairman, we intend to make some changes in the regulations on self-dealing, recognizing some of the problems that have come to light, and at the direction of the Congress. You will recall, the bill that was just passed requires us to take a very close look at this and actually to come up with a requirement at least of public disclosure of such approvals as may be made. Fortunately, this has not been a great problem. There have been very few of these instances coming up to us for approval. We do believe that disclosure here is a good thing. It will probably tend to keep these situations to a minimum. The CHAIRMAN. Do you think that the instances have been magnified? Have there been very few rejected or have most of them been approved when submitted to SBA? Mr. KELLEY. Well, I have some figures here with respect to that. From last June 30th to March 15th we received 22 requests for waiver of our self-dealing provisions. That is section 107.716 (b) of the regulations that presently deals with self-dealing. Of that number, it was determined that this section did not apply to five of the requests. Of the remaining 17, 10 were approved and 7 were denied. So we are talking basically about 17 instances in just a little short of a year's time. The reasons for the seven denials were these: It was judged to be the use of the licensee by those who controlled it as the financing medium for their own undertaking. This applied to a portion of the denials. In another instance there was no disinterested person in the licensee who could have prevented the investment. Those were the basic two reasons. The CHAIRMAN. Do you make any check or any investigation of instances that are not submitted to you for waiver? Mr. KELLEY. Yes, sir. We have a very active compliance program which is auditing these-I shouldn't put it that way. We actually have three steps in our examination process. The first step is that semiannually the companies issue reports to us. These are carefully examined by our accounting and compliance sections. Then once a year we require an audit by an outside public accountant, an independent public accountant. He fills out a form called a compliance report which requires him to answer, in his professional capacity, many questions on this particular subject. Thirdly, we have a group of examiners who conduct a regular program of examinations, as well as spot checks, to determine whether our regulations are being complied with, including the self-dealing regulation. The CHAIRMAN. To some of my colleagues who have just come in I will state that Mr. Foley and Mr. Kelley have testified earlier that there are 706 licensed SBIC's, that they are working exceptionally well in the main, that they have more than $447 million in investments with capital assets of more than a half a billion dollars. Mr. Multer? Mr. MULTER. Thank you, Mr. Chairman. Mr. Foley, you referred to the over-the-counter situation with reference to the publicly owned SBIC's and you told us about how the stock had dropped down in many instances to less than book value. Has your office made any inquiry or any compilation or made any attempt to get any statistics on the number of SBIC's that went public and whose stock was sold on the market shortly after they went public for many times the book value and subsequently fell down to book value or less? Mr. FOLEY. Mr. Multer, if you do not mind, I would like to defer that question to Mr. Kelley inasmuch as he is a little bit closer to the information and intelligence of our compliance unit than I am. Mr. Kelley could answer that and, if not, we could perhaps supply the information for you subsequent to the hearing. Mr. MULTER. Well, if you cannot do it now-I referred it to you because you made the comment in your statement. Mr. Kelley did not, but it does not matter to us as long as we get the information. If you do not have it available now you might get it for us. I am particularly interested in knowing whether or not you have made any inquiries or will make any inquiries to find out who made the killings in connection with these public offers. In many instances, particularly those that were controlled by financial institutions or organized by financial institutions, are the ones we are interested in. The stocks after they went to the market skyrocketed after they went to the public and now, in almost every instance, they are down very low. I would like to know how many insiders sold out. I would like to know how many people in those financial institutions, and those who organized those public companies, still have their stock at the low, how many disposed of them at the high and on the way down, as going from the high to the low. Mr. FOLEY. I am making a note on this, Mr. Multer, and I will do my very best to try to get the information you are looking for. Mr. MULTER. And also, in getting those figures together, if you can, find out for us how many of them sold out to take a tax loss and are now back in the picture. In other words, if you just find out whether or not the original stockholder is still in the picture you will probably find out he is still there. You will probably also find out, if the inquiry is directed to him, that he was in and out, and I think we ought to find out to what extent there has been this kind of, I call it, manipulation and if it has an invidious connotation to some of these people I would like to know whether or not it is justified. Mr. FOLEY. Very good. Mr. MULTER. I think we ought to know that, too. My original idea, and I do not know how many of the other members of the committee would agree with it, was that in permitting the banking institutions to invest in SBIC's we thought that they would make some of their money available to them. I never, for 1 minute, contemplated that the SBIC's would be organized, owned, and operated and controlled by the financial institutions. I think this is wrong. I think this leads to entirely too much doubledealing and selfdealing, and I think this requires very close inquiry by you and then a submission of the facts to this committee. Whether the rest of the committee will then agree with me as to whether we ought to do something to take the financial institutions out of the SBIC business or not is a matter for appraisal and evaluation after we get the facts. The CHAIRMAN. Without objection, the information requested will be received into the record at this point. (The information referred to follows:) Hon. JOE L. EVINS, SMALL BUSINESS ADMINISTRATION, OFFICE OF THE ADMINISTRATOR, Chairman, Select Committee on Small Business, DEAR MR. CHAIRMAN: Attached is the draft of the testimony taken at the committee hearing on the small business investment company program, held on March 18, 1964, with corrections as noted thereon. The committee or its members asked for additional information. quests covered the following items: These re 1. Information on the price movements of publicly held SBIC's shares and insider trading activity, with particular emphasis on those that were formed or partially owned by financial institutions. Information was also requested on the insider trading for the purpose of taking the tax benefits afforded by the act; 2. Information on the effective cost of money to small business concerns charged by the small business investment companies; 3. Information concerning the expected effect and the current status of the Securities and Exchange Commission's proposed rule 17(a) (6); 4. Our response to the Wall Street Journal article relating to affiliated transactions; and 5. A list of all small business investment companies, indicating company name, location, and capitalization. The attached exhibits deal specifically with each of these questions. If any additional information is desired, we will be happy to comply. Sincerely, RICHARD E. KELLEY, Deputy Administrator for Investment. EXHIBIT 1 INSIDER TRADING Virtually all publicly held SBIC stocks followed the same general pattern of movement from January 1961 to May 1962 and thereafter. Beginning in January 1961 SBIC shares started to increase sharply in market price reaching a peak in April 1961. A steady and at times sharp decline followed. By April 1962 SBIC shares were selling well under their offering prices, and by May 1962 they were selling at about 70 percent of book value. Within the past few months there has been some recovery, but for the most part SBIC shares have been trading below their offering prices for the past 2 years. Twenty publicly held SBIC's are affiliated with or were organized by banks. In order to determine insider trading activity from the time the SBIC shares neared their peaks to the time they were selling below the offering prices, we analyzed insider trading activity from the period beginning March 1961 to April 1962. We were thus able to determine the extent of insider profit taking before the market became severely depressed. Our survey showed there was very little if any profit taking during this period, and virtually no such activity by any financial institution. On the other hand there was extensive accumulation of shares during this period, and many of the individuals and institutions which purchased shares while they were near their peak or above book value continue to hold these shares today. There is no indication that there has been any pattern of profit taking by individuals or institutions associated with these companies. Insider transactions also were analyzed for these companies from the time the market declined to the present date to determine the extent of selling and repurchasing of shares by individuals and institutions. There appears to have been only a modest amount of tax-loss selling by individuals who later repurchased SBIC shares. There was virtually no selling by financial institutions. It is clear from our analysis that there has been relatively little in and out trading activity by insiders with these SBIC's, and virtually no such activity by financial institutions. The following breakdown of insider trading activity in the 20 bank-related, publicly held SBIC's was taken from the Securities and Exchange Commission's monthly report of insider trading activity. Business Capital Corp. There was no significant profit taking by insiders when the shares were selling above offering price. One individual reported selling 200 shares in March 1961, but this represented only about 10 percent of that individual's total holdings. No other sales were reported until June 1962. After June 1962 seven individuals reported the sale of shares, some or all of which were later repurchased by those same individuals. Business Funds, Inc. No insider sales were reported until February and March 1962 when 1,800 shares were purchased and sold for the account of a brokerage firm. Four |