(b) The sole bases upon which the affiliated company is affiliated with the registered investment company are that the registered investment company (1) controls the affiliated company or (2) directly or indirectly owns, controls, or holds with power to vote, 5 percent or more of the outstanding voting securities of the affiliated company.

(c) (1) No affiliated person or promoter of or principal underwriter for the registered investment company, and no 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 in the affiliated company or in any affiliated person thereof, or in the controlled company of the registered company, or in any affiliated person of such controlled company, if the transaction is with such controlled company.

(2) The term "financial interest" as used in paragraph (c) (1) shall not include (i) usual and ordinary fees for services as a director; (ii) any interest through ownership of securities issued by the registered investment company; (iii) any interest held by a wholly owned subsidiary of the registered investment company; or (iv) an interest acquired in a transaction described in paragraph (d)(3) of rule 17d-1 under the act.

(d) The outstanding securities (other than short-term paper) of any party to the transaction other than the registered investment company are beneficially owned by not more than 100 persons. For the purpose of this subparagraph, beneficial ownership by a company shall be deemed to be beneficial ownership by one person; except that, if a company other than the registered investment company owns 10 percent or more of the outstanding voting securities of the issuer, the beneficial ownership shall be deemed to be that of the holders of such company's outstanding securities (other than short-term paper).

All interested persons are invited to submit views and comments on the proposed amended rule 17a-6. Written statements of views and comments in respect of the proposed amended rule should be submitted to the Securities and Exchange Commission, Washington, D.C., on or before October 31, 1963. All such communications will be available for public inspection.

By the Commission:

ORVAL L. DuBois, Secretary.

The CHAIRMAN. It is quite true, as Mr. Robison has said, that every witness who has appeared here has complained about the dual regulation of the SBA and the SEC and, perhaps, as the SBIC's get larger, and more of them go public, there may be even more of this.

If a joint agreement between the two agencies could help alleviate the situation, it will be helpful.

Mr. Multer, any further questions?

Mr. MULTER. No, thank you, Mr. Chairman.

The CHAIRMAN. Mr. Mitchell, the counsel.

Mr. MITCHELL. First, on the compliance matter, how many licenses have been revoked because of violations of the Small Business Administration's regulations since its inception?

Mr. PHELAN. There have been no licenses revoked as such. The original act provided that only through a court action could you revoke a license. Now, some have been voluntarily surrendered, when the threat of revocation and court proceedings has been put to them, but, as such, there have been no revocations through a court action.

At the present time we have two injunctions going, one brought by our agency against a company in the Midwest where there was an injunction and the appointment of a receiver. That is still in the hands of the court.

Eventually, perhaps the proceedings will be developed, but when you get to this stage the company throws up its hands, when you say it has violated the regulations, and when you move in they just turn in the license.

Mr. MITCHELL. Thank you.

Mr. PHELAN. And we have one other company in the South against which action is being brought in close cooperation with our General Counsel's Office in an injunction proceeding.

That is presently in a Federal court in Louisiana.

Mr. MITCHELL. Mr. Kelley, concerning the self-dealing policing, it is our understanding that the SBA had proposed that the SBIC's be required to submit tax numbers of their stockholders and of their portfolio companies.

It has been suggested that that might be of assistance to SBA in detecting and policing self-dealing arrangements which are not reported to you.

Now, we understand that proposal has been withdrawn by SBA. Is that correct?

Mr. KELLEY. That is correct, Mr. Mitchell.

There was such a policy proposed, and I believe it would have been helpful to us in the self-dealing area, without question, but these facts were brought out by the industry, and I think rightfully so, that this would impose a very heavy amount of excess work upon them to do it in this particular way; they would have to go back and get the tax numbers of all of the shareholders that held 10 percent or more of the stock of their portfolio companies, each of their portfolio companies, and the officers and directors of those portfolio companies as well as the officers and directors and 10 percent or more shareholders of the SBIC.

The principal objection was extending it to the portfolio company. Another objection was the amount of paperwork that this would require.

A further objection was the fact that there could be a great deal of resentment on the part of the small business being financed if it were required to do this.

There was an implication that it might be a tax type of audit or that the information might be available to the Internal Revenue Service even though we had no such intention.

There was also the feeling on the part of the small businessesthat this was an undue imposition on them.

Another thing we felt was that it would be administratively very difficult, as we analyzed it further, to enforce the reporting of these numbers. It would require us to have quite a lot of people constantly going to these individuals in order to get the information in. We have experienced, as Mr. Phelan has said, some difficulty in getting reports out of the small business investment companies now, and we have asked, in one of our requests for new legislation this year, that we be able to levy fines for not filing reports.

So, based upon our experience in that field, we felt it would be very difficult administratively as well.

Mr. MITCHELL. Then as far as the agency is concerned it is a dead proposal now?

Mr. KELLEY. That particular proposal is dead, but we are not giving up the study of the matter of more effective ways of getting the information needed to determine any possible self-dealing.

Mr. MITCHELL. Mr. Kelley, the question has been raised at these hearings concerning the 303 funds wherein SBA would loan 303 funds in the amount of one-half or 50 percent of the paid in capital and surplus.

One witness specifically raised a question, stating that SBA does not allow them to issue a stock dividend on their earnings, to capitalize that, and to utilize that as a part of paid-in capital surplus in order to draw down 303 funds.

Is that correct?

Mr. KELLEY. Mr. Mitchell, I understand that that statement was made. I would have to check the particular instance, but our policy now would be-and I am not sure what it might have been a year ago— but our policy presently would be to allow the capitalization of earnings as a part of the paid-in surplus.

So that if this has been a problem it would no longer be a problem. Exactly when this transition-if there was a transition in policy, took place I don't know.

I would have to refer to the specific instance.

Mr. MITCHELL. Then we understand that if they capitalize their earned surplus then it would be permissible with you for them to borrow 303 funds based on that.

Mr. KELLEY. 303, but not 302.

Mr. MITCHELL. Yes. If earned surplus is just put in the earned surplus account and treated as capital and not locked in capital then you would not allow that to be used?

Mr. KELLEY. No; it would have to be locked in, Mr. Mitchell.

Mr. MITCHELL. Mr. Kelley, I have some questions pertaining to Public Law 88-273. The committee is interested in the implementation of that and just what it will mean to the industry.

First on the increase of 302 funds from $400,000 to $700,000, will that be made immediately available in the full lump sum to any SBIC that should apply for it?

Mr. KELLEY. Mr. Mitchell, it would be our inclination to do so. We have not fully reviewed each of these as yet. The only thing that would prevent us from doing so would be if there were a budgetary problem, and we would not be able to meet the demands upon our available funds by allowing the full amount to be available.

If we extend the potential demands against this fund out and find that we have ample funds available, and if there is no objection on the part of the Bureau of the Budget to this, we will.

Mr. MITCHELL. Have you made no projection as to what it will cost and what it would do to your budget?

What would be the budgetary effect if they were to all draw it down? Mr. KELLEY. If they were all to draw it down, Mr. Mitchell, we might not have enough funds but we think that we will be within the probable amount that would be drawn down.

Mr. MITCHELL. When I say "all of them drawn down" I am speaking of those who have already utilized their $400,000 or have indicated that they are utilizing it.

Of course, some are just not interested in it at all.

Mr. KELLEY. Yes; well, for instance, if each of the 40-some public companies drew down this it would be a matter of $28 million involved there, 28 or more.

That would make a pretty large haul. Then it becomes a matter of judgment with respect to how many of those companies will come in for it and how many of the private ones. I do not have the exact figures available on that.

I know we have made some projections but we have not reached our final conclusion on the implementation of this.

As I said, if in our judgment we possibly can make it all available we intend to.

Mr. MITCHELL. On the amendment, which would allow SBA to stand by on bank loans to SBIC's, that is 303 loans

Mr. KELLEY. Yes.

Mr. MITCHELL (continuing). I noticed in your statement that you referred to it, and I may have overlooked it, but there was some indication where you felt this might help in giving more leverage to companies.

It is still limited by the 50 percent of capital and surplus?

Mr. KELLEY. I think we are talking about two different guarantees there. I will cover that point with respect to this one.

I was speaking of the guarantee made by an SBIC of a small business loan obtained from another financial institution.

The type of guarantee that I was referring to would increase the leverage of the SBIC if we did not require the SBIC to maintain 100percent reserve behind that contingency.

Now, with respect to this particular question, it would not be possible to increase leverage, even assuming that we would guarantee a loan to an SBIC from another financial institution. As you say, we cannot exceed the 50 percent. The only way in which it might conceivably result in additional leverage is if through these other institutions, in gaining experience in dealing with SBIC's and handling their paper, would then see fit in their wisdom to go beyond the Governmentguaranteed amounts, and I would hope that this would happen.

It has happened in some of the publicly owned companies, I know. Mr. MITCHELL. That was generally the intent of Congress in putting that provision in the act.

Mr. KELLEY. Yes. So I think we should pursue this for that reason, because we want as soon as possible to reduce the Government financial support for this program, and it makes sense to get outside concerns interested in making loans.

Mr. MITCHELL. Concerning the amendment to the act pertaining to self-dealing, what change in your regulations does SBA anticipate on that, especially in light of the full disclosure matter?

Mr. KELLEY. Well, with respect to the full disclosure we anticipate that we will ourselves publish the details of such transactions and, in addition, we will require the transaction to be published in a local publication of some sort in the community, in which is located the firm that has entered into the self-dealing transaction.

Mr. MITCHELL. Do you not anticipate-I believe, from your answer then, you do not anticipate any basic change in the present self-dealing regulation other than the full disclosure?

I am speaking now generally about the three criteria which you have given to us in the past; one, that there must be a noninterested person in the SBIC with power to block the transaction; another that the terms must be reasonable, and the other that it must properly implement the act.

As section 107.716 now reads, you do not anticipate any change in that?

Mr. KELLEY. I think they may be tightened up a little bit, Mr. Mitchell. We have not determined how much. It is quite a complex area because there are so many possible routes of affiliation that could develop. We think that we may tighten them up somewhat with respect to third parties.

Mr. MITCHELL. Mr. Chairman, I do not believe we have in the record the entire text of Public Law 88-273.

May it be received in the record at this point?

The CHAIRMAN. There being no objection, it will be included in the record.1

(The document referred to follows:)

Public Law 88-273

88th Congress, S. 298

February 28, 1964

AN ACT To amend the Small Business Investment Act of 1958

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, That this Act may be cited as the "Small Business Investment Act Amendments of 1963".

SEC. 2. The second sentence of section 302(a) of the Small Business Investment Act of 1958 is amended by striking out "$400,000" and inserting in lieu thereof "$700,000", by striking out "three years" and inserting in lieu thereof "five years", and by striking out "1961" and inserting in lieu thereof "1963". SEC. 3. Section 303 (b) of the Small Business Investment Act of 1958 is amended to read as follows:

"(b) To encourage the formation and growth of small business investment companies, the Administration is authorized (but only to the extent that the necessary funds are not available to the company involved from private sources on reasonable terms) to lend funds to such companies either directly or by loans made or effected in cooperation with banks or other lending institutions through agreements to participate on an immediate or deferred (standby) basis. Such loans shall bear interest at such rate (in no case lower than the average investment yield, as determined by the Secretary of the Treasury, on marketable obligations of the United States outstanding at the time of the loan involved) and contain such other terms as the Administration may fix, and shall be subject to the following restrictions and limitations:

"(1) The total amount of obligations of any one company which may be purchased and outstanding at any one time by the Administration under this subsection (including commitments to purchase such obligations) shall not exceed 50 per centum of the paid-in capital and surplus of such company or $4,000,000, which ever is less.

"(2) All loans made under this subsection (b) shall be of such sound value as reasonably to assure repayment."

SEC. 4. Section 306 of the Small Business Investment Act of 1958 is amended to read as follows:

1 SBA Regulation 107.716 on "self-dealing" can be found at p. 22 of this hearing record.