Mr. ROBISON. Mr. Kelley, on page 7 of your statement you refer to your-I guess you would call it "portfolio spread," as indicating that as of June 30, 1963, SBIC loans accounted for some 41 percent of outstanding investments, debt securities with stock warrants about 48 percent, and the remaining 1012 percent was in capital stock. Mr. KELLEY. Yes, sir.

Mr. ROBISON. In your judgment, is this an appropriate spread or would you prefer to see it a little different?

Mr. KELLEY. I would prefer to see, Mr. Robison, a greater amount of either debt securities with the right to buy stock or capital stock investments.

Mr. ROBISON. Moving away from loans then?

Mr. KELLEY. Moving away from loans because while the loans serve a very definite purpose I think that the real-the most urgent equity gap is in the area of the actual equity-type security.

And I think this is one of the reasons that I feel the larger rather than the very small SBIC is desirable because the somewhat larger ones can afford to service a direct equity-type investment.

The very small are almost forced into making loans because they cannot properly service investments of equity-type investments.

Mr. ROBISON. Later on you tell us that, in your judgment, the optimum size for an SBIC would be about $2 million in assets.

Mr. KELLEY. Yes.

Mr. ROBISON. How close have we come, with the SBIC's that are now in existence, toward reaching this as an average?

Mr. KELLEY. We are a long way from it, Mr. Robison. I would say that the vast majority of the companies are minimum-sized con

cerns now.

I am hopeful that

Mr. ROBISON. Well, until you change that you are not going to be able to reduce your percentage of loans as compared to equity investments?

Mr. KELLEY. No; that is right, and that is why I have indicated that we would not stand in the way of mergers of smaller concerns. I am not talking about mergers to create super giants in the industry but, perhaps, to get up closer to this $2 million level.

I think there is a danger of getting too big also.

Mr. ROBISON. You also mention the "vigilance" with which your office is going to root out regular and willful violators from the program.

Can you tell me, just in general terms, what the more common violations are, as you have found them so far, either of law or of congressional intent?

Mr. KELLEY. Well, I can name a few and perhaps Mr. Phelan here, who is my compliance chief, can name a few more.

The ones that I know of that have come up quite often-there may be instances where the SBIC has taken a greater amount of the stock than it should, which we have said is wrong.

There are instances where they have, in some instances-fortunately, a minority-willfully misused Government money. I think we have seen two or three publicized instances of this sort. I think I should turn to Mr. James Phelan, who heads our compliance section. I think he could give you a better idea of the more common instances.

33-440-64- -14

Mr. PHELAN. Well, Congressman, in the line of compliance the most common difficulties we have are that some companies do not file reports.

So, if they are not filing reports we have no idea of what kind of loans they are making and whether the loans are proper or not. Then when they do not, we have an examination under section 308 of the act, under which section we can make examinations.

In that examination we can tell just what violations there are. In the 1961 amendment Congress gave us authority to issue a show cause order to suspend the license. Right now we have three show cause orders in process.

We have made 302 examinations thus far.

To get back to your original question, the most common compliance problem is the overline. Under section 306 of the act they can only put 20 percent of their capital in one small business concern. Some do more than that. We have to bring them in line.

The other ones, of course, are the insider transactions, affiliated transactions, loaning to companies that the officers and directors of the SBIC own. Some others that we are running into now are failures to meet reporting responsibilities. Some of these companies are going into the position of impairment of capital. They are losing money. We watch, above all, that these investments, no matter what they are, are in small business and are not in large business according to size standards.

Mr. ROBISON. I will ask this question of any one of the three of you who wants to answer:

Is it your judgment that you have sufficient authority to remove these violations and require compliance without additional legislation? Mr. PHELAN. Yes, sir, at this point.

I think that it was great wisdom of Congress in 1961 when they gave us the power to have show cause orders, and to have investigations.

Under investigations we also have the power to issue subpenas, the power to get the books and records of the company, to supena anybody, the company or any person whom we feel might be violating the act. These provisions have had a great prophylactic effect because now when we find a company is violating one of these provisions we will tell them that unless they shape up, unless they divest, that we will go forward with our other compliance regulations. Mr. ROBISON. Thank you.

One other question, Mr. Chairman. There has been a good deal of discussion, both yesterday and today, of "dual regulation." It is my understanding that the SEC restrictions against what is called selfdealing are a little more strict, in application at least, than SBA's restrictions.

I am not sure that any witness, particulary a Government witness, unless I have missed it, has come close to recommending to us that, if one-half of the dual regulation is going to be dropped, which half should be dropped, the SBA regulation or the SEC regulation.

Mr. FOLEY. Well, Mr. Robison, I have to be responsible for that

answer.

I do not have the recommendation. I think it is probably impractical to think that the SEC would ever want to relinquish whatever authority it has on the program.

Mr. Kelley and I are meeting next week with Chairman Cary and the Commissioners of the SEC precisely on this problem to see how we can better coordinate

Mr. ROBISON. To bring your policies more in line, one with the other? Mr. FOLEY. That is correct, and I am not prepared right now to say whether we ought to change ours or they theirs or maybe make some mutual adjustment.

I would like to talk to them personally to see what their views are on it and how strongly they feel about it.

Mr. ROBISON. I think it could be a very salutary thing if you could get closer together in your approach to the controls that you both want to have over your lending programs.

Mr. FOLEY. I think part of the problem here is that the SBIC is of major importance to my agency and, more particularly, to the Investment Division.

So we are most anxious to see that this program is at all times being administered well.

The Securities and Exchange Commission, with no criticism intended, covers a vast field and the problems of the SBIC are hardly preeminent in their attention, and I suspect that this is what has caused the type of friction that does develop when you have at least two agencies jointly regulating a program.

But I have talked to Chairman Cary before on it and I know that the Commissioners really want to see that the program succeeds, and that it is administered fairly and well, and I just think it is a question of our sitting down together and working the problem out.

Mr. ROBISON. You mentioned, Mr. Foley, a pending SEC ruling which, if it goes through, might be of assistance to the SBIC's, but I do not think you told us what the ruling is.

Does that apply in this field that we are talking about?

Mr. FOLEY. Yes, it does. And I would be glad to supplement my statement with more specific information as to what this ruling is, what effect it will have, and what its current status is.

The CHAIRMAN. Will you supply that for the record, Mr. Administrator, and without objection it will be received at this point. (The information follows:)

EXHIBIT 3

COMMENTS ON PROPOSED AMENDMENT OF RULE 17a-6 UNDER THE INVESTMENT COMPANY ACT OF 1940

The present rule exempts the sale of a security by a small business concern to an SBIC and the borrowing of money by the small business concern from the SBIC where an affiliation between the two was created through the SBIC having acquired voting securities of the small business concern. The present exemption calls for reports of these transactions to the shareholders and to the SEC. The proposed amendment to rule 17a-6 broadens the affiliated transaction exemptions in three principal ways, where, generally speaking, the above described affiliation exists:

(1) An SBIC may now convert a convertible debenture or exercise the options issued by the small business concern;

(2) An SBIC may change the terms of the security it purchased from the small business concern, as for example, it may extend the maturity date, the interest date, or it may change the terms of the instrument so as to subordinate its position;

(3) The small business concern may reorganize or merge.

Without these proposed exemptive provisions, it would be necessary to file the proper application and receive an order of the SEC approving these transactions. The proposed rule also contains certain requirements with respect to the reporting of these transactions.

The Securities and Exchange Commission is redrafting the rule in light of the views and comments made by interested persons.

The foregoing statements represent our understanding of the present rule and the changes effected by the proposed amendment.

SECURITIES AND EXCHANGE COMMISSION,
Washington, D.C.

NOTICE OF PROPOSAL TO AMEND RULE 17a-6 TO PROVIDE CERTAIN ADDITIONAL ExEMPTIONS FROM THE REQUIREMENTS OF SECTION 17(a) OF THE INVESTMENT COMPANY ACT OF 1940

Notice is hereby given that the Securities and Exchange Commission has under consideration the amendment of rule 17a-6 under the Investment Company Act of 1940 (act) to provide certain additional exemptions from the requirements of section 17 (a) of the act. The Commission proposes to rescind the present rule 17a-6 and to adopt an amended rule 17a-6 pursuant to sections 6(c) and 38(a) of the act.

It is proposed that the exemptions from section 17 (a) of the act provided by the present rule 17a-6 be broadened (a) to include exemptions for certain additional types of transactions with respect to which the nature of the affiliation between the parties is limited to that which the present rule requires as a condition for exemption and (b) to provide exemptions for such transactions with any registered investment company.

The present rule 17a-6 exempts from the prohibitions of section 17 (a) (1) and 17(a)(3) of the act, subject to certain conditions, the sale of securities or other property to, and the borrowing of money or other property from, a registered investment company which is a small business investment company licensed under the Small Business Investment Act of 1958 (SBIC) where such transactions are prohibited solely because of an affiliation created through the owning, controlling or holding with power to vote, by the SBIC of voting securities of a small business concern. The exemption is not available if any person having an affiliate, promoter or principal underwriter relationship with the SBIC also has a direct or indirect financial interest in the small business concern. The proposed amended rule 17a-6 would not be limited to transactions with SBIC's, and would extend the exemptions provided by the present rule to any type of transaction between (1) an affiliated company of a registered investment company, or an affiliated person of such affiliated company and (2) the registered investment company or any company controlled by the registered investment company, provided that the transaction would be prohibited by section 17(a) only because (a) the registered investment company controls the affiliated company or (b) the registered investment company directly or indirectly owns, controls, or holds with power to vote 5 percent or more of the securities of the affiliated company.

The proposed amended rule would provide that an exemption under the rule is unavailable if any affiliated person, promoter, or principal underwriter of the registered investment company, or an affiliated person of (i) such promoter or principal underwriter; (ii) any person directly or indirectly owning, controlling, or holding with power to vote, 5 percent or more of the outstanding voting securities of the registered investment company; (iii) any person directly or indirectly controlling or under common control with the registered investment company; (iv) any officer, director, or employee of the registered investment company; and (v) any investment adviser or depositor of the registered investment company, has a direct or indirect financial interest (with limited exceptions) in the affiliated company, in any controlled company of the registered investment company involved in the transaction, or in any affiliated person of such affiliated or controlled company.

In addition, the proposed amended rule would adopt as a condition for an exemption under the rule a requirement that the outstanding securities (other than short-term paper) of any party to the transaction other than the registered investment company be beneficially owned by not more than 100 persons.

The basic purpose of the amended rule would be substantially the same as that of the existing rule; i.e., to eliminate filing and processing applications in cir

cumstances in which there appears to be no likelihood that the statutory finding for a specific exemption under section 17 (b) could not be made.

Section 17 (b) of the act provides that the Commission shall exempt a proposed transaction from the prohibitions of section 17(a) if evidence establishes that the terms thereof are reasonable and fair and do not involve overreaching on the part of any person concerned and that the proposed transaction is consistent with the policy of each registered investment company concerned and with the general purposes of the act. Section 6(c) of the act provides that the Commission by rule, regulation, or order may exempt any person or transaction or any class of persons or transactions from any provision of the act if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the act. Section 38(a) of the act authorizes the Commission to issue such rules as are necessary or appropriate to the exercise of the powers conferred upon the Commission in the act.

The proposed rule 17a-6 includes conditions to the availability of an exemption which are intended to assure that the exemption will be available only where there appears to be no likelihood of overreaching of the investment company. Moreover, the proposed rule includes a condition to assure that the exemption will not be available for transactoins which might involve overreaching of other groups of public investors. Under the terms of the proposed rule, where the outstanding securities of any party to the transaction, other than the registered investment company, are beneficially owned by more than 100 persons, no exemption from the provisions of section 17 (a) is provided by the rule. (Of course, an application for exemption of such a transaction may be filed pursuant to sec. 17(b). Under the standards of sec. 17(b), the Commission will issue an order exempting the transaction if it is reasonable and fair and does not involve overreaching on the part of any person concerned.)

Illustrative of the type of transaction involving the sale and purchase of securities or other property, by an affiliated company or an affiliated person thereof to or from a registered investment company or a controlled company thereof, which would be exempt under the proposed rule, providing all of its conditions are met, are the following:

(a) The conversion of convertible securities or exercise of options issued by an affiliated company. (If its conditions are met, rule 17a-4 may also exempt such transactions.)

(b) A material revision of the terms of securities issued by an affiliated company, or a loan agreement with respect thereto; e.g., to extend the maturity date or interest rate of a loan or to provide for subordination in respects not previously agreed to.

(c) A reorganization of the capital structure of an affiliated company, or a merger of an affiliated company and a controlled company.

The present rule 17a-6 requires that the pertinent details of each transaction for which exemption is claimed under the rule shall be reported by the investment company in its next annual report to its stockholders and in a report filed with the Commission within 30 days after the end of each semiannual accounting period of the investment company. The proposed rule does not contain such a requirement. Instead, the Commission intends to give consideration to an amendment to forms N-30A-1 and form N-5R, used in filing annual reports to the Commission, to include therein a specific item calling for the pertinent details of transactions exempt pursuant to rule 17a-6. As an alternative to including this information in the annual report to the Commission, consideration is also being given to a requirement that a registered investment company keep a separate record of all transactions exempt pursuant to rule 17a-6 in which such company or a controlled company thereof participates, which record would be maintained for a stated period of time and would show the pertinent details of each such transaction and the bases upon which it is claimed that the requirements of the rule are met. The Commission invites comments on these or other alternatives to the reporting requirements of present rule 17a-6.

The text of the proposed amended rule 17a-6 reads as follows:

Rule 17a-6. Exemption of transactions with certain affiliated persons.

A transaction with a registered investment company, or any company controlled by a registered investment company, shall be exempt from the provisions of section 17 (a) of the act, provided all of the following conditions are met:

(a) The other party to the transaction is an affiliated company of a registered investment company, or an affiliated person of such affiliated company.