"AGGREGATE LIMITATIONS

"SEC. 306. Without the approval of the Administration, the aggregate amount of obligations and securities acquired and for which commitments may be issued by any small business investment company under the provisions of this Act for any single enterprise shall not exceed 20 per centum of the combined capital and surplus of such small business investment company authorized by this Act."

SEC. 5. The last sentence of section 308(b) of the Small Business Investment Act of 1958 is amended to read as follows: "Such companies may invest funds not reasonably needed for their current operations in direct obligations of, or obligations guaranteed as to principal and interest by the United States, or in insured savings accounts (up to the amount of the insurance) in any institution the accounts of which are insured by the Federal Savings and Loan Insurance Corporation."

SEC. 6. (a) The Small Business Investment Act of 1958 is further amended by adding at the end of title III a new section as follows:

"CONFLICTS OF INTEREST

"SEC. 312. For the purpose of controlling conflicts of interest which may be detrimental to small business concerns, to small business investment companies, to the shareholders of either, or to the purposes of this Act, the Administration shall adopt regulations to govern transactions with any officer, director, or shareholder of any small business investment company, or with any person or concern, in which any interest, direct or indirect, financial or otherwise, is held by any officer, director, or shareholder of (1) any small business investment company, or (2) any person or concern with an interest, direct or indirect, financial or otherwise, in any small business investment company. Such regulations shall include appropriate requirements for public disclosure (including disclosure in the locality most directly affected by the transaction) necessary to the purposes of this section."

(b) That part of the Table of Contents of such Act which describes the matter included in title III is amended by adding at the end thereof the following: "Sec. 312. Conflicts of interest."

Approved February 28, 1964.

Mr. MITCHELL. I have one more question.

One of the complaints that have been brought up is against your rule compelling divestiture when the SBIC has financed a small business and the business either merges or is purchased by another business—perhaps a large corporation-and becomes a large business.

It is my understanding, if it grows into a larger business, just through the inherent nature of its own growth, you do not compel divestiture.

Is that true?

Mr. KELLEY. That is true.

Mr. MITCHELL. But if not, you do compel divestiture?

Mr. KELLEY. Yes, sir. If it is within a reasonable time, I think that has been true. I think there are instances where we need to take another look at that policy though.

For instance, I was talking to an SBIC the other day with respect to a problem of this sort. The company had invested-the figures may not be precisely right but they demonstrate the point-$800,000 in a small business concern. This, of course, would be a larger SBIC. Then the small business had gotten into difficulty and the value of the investment had gotten down to, maybe, $250,000.

So the SBIC sold its interest in the business to a larger business. Now, at this particular time the business had appreciated up to a point where it was worth $500,000 we will say, and we were telling the SBIC that it should divest because it was holding stock in a large

concern at this point and the SBIC said to me, and I think rightfully, that where they had been, in effect, operating in a salvage situation they should be allowed to hold on to that investment for at least a period of time to see whether or not they could get the $800,000 back that they invested in the first place. And I think they have a reasonable point there.

I believe this is something that we perhaps have been a little too sticky on with respect to divestiture of a larger investment.

Another thing, even if a merger occurs our position has always been, where a couple of small businesses merged, that we were not going to be too concerned about that, but if there were a series of mergers involving several small businesses and resulting in a large business then we would be concerned about it.

I think this is an area of discretion that we have to reexamine also because you could have a small business acquiring a number of other smaller concerns and still carrying out its proper business function during this period.

But it would not be right, in my opinion, if the SBIC, on the other hand, had forced the members of three or four of its portfolio companies into making one big company out of the situation. That would be a different thing.

It was not the prerogative of the small business moving ahead that resulted in this. So I think that there are areas that we have to look at with discretion with respect to this divestiture rule.

Mr. MITCHELL. Mr. Kelley, I believe you mentioned in your statement that you felt a $2 million company was necessary to operate with its own management properly and well.

To tie that in with the present law a company that has $700,000 private capital could reach that with full utilization of 302 or 303 funds?

Mr. KELLEY. Correct.

Mr. MITCHELL. Do we understand from this that you feel the present law pertaining to 302 funds gives sufficient leverage?

Mr. KELLEY. Yes, Mr. Mitchell. I think the present law is sufficient to permit the companies to get up to a good operating level.

Mr. MITCHELL. The question has come to the committee-not a question, but some information concerning what might be a unique situation, where the committee is advised that two or three of the larger companies are planning or have asked permission to actually underwrite stock issues for a small business concern. Would you care to give an opinion on that?

Is it being done and is it a proper thing to do?

Mr. KELLEY. I might say that we have two requests with regard to that activity. We have not reached final determinations on it.

I believe that our feeling is that, to a certain degree, this may be a good and worthwhile thing, primarily to allow these companies to stand by to pick up shares from a separate underwriter, shares of a portfolio company that are left unsold in a public issue.

For instance, if we had an SBIC that holds an interest in a portfolio company, and this portfolio company is to make a public issue of stock, it might be desirable to allow the SBIC to stand behind an underwriter with respect to that issue and say, "If part of the issue is not sold to the public then we will pick up the unsold portion or some part of it."

This would help the new issues' market, I think. I would be a little reluctant to see them getting in to being a full fledged

Mr. MITCHELL. Is this not one of the troubles right now? Both the portfolio companies and the SBIC's themselves report that they have difficulty getting proper underwriting.

Might not that be a proper answer especially under the conditions of the market now?

Mr. KELLEY. That is correct, Mr. Mitchell. Many of the small companies today are suffering from the almost complete lack of a new issues market, and I think that we could assist these small businesses that are held in SBIC's portfolios and assist the SBIC's themselves with some such arrangement.

We are presently working on the exact details now. The objective, I think, is laudable and one that we should turn our attention to. Mr. MITCHELL. There are several of the companies now concerning which the market price is quoted considerably below book-all of them I believe

Mr. KELLEY. Yes.

Mr. MITCHELL. And I believe there are quite a few of them that the market is quoted even below cash and equivalent. Is that correct? Mr. KELLEY. Nearly all of them, Mr. Mitchell, are quoted below book.

I do not believe too many of them are quoted at below cash and equivalent. I think there may be half a dozen of them.

Mr. MULTER. Mr. Chairman, may I ask one question?

The CHAIRMAN. Mr. Multer.

Mr. MULTER. Where would you draw the line between the partial underwriting and full underwriting?

Mr. KELLEY. Well, Mr. Multer, I think the full underwriting activity would be this:

If an underwriter is participating in what we call making the market for the issue, sustaining the price of the issue during the offering period, which requires him to buy and sell securities, possibly buying and selling stock rights, then he is engaged in full underwriting. It is this particular type of activity that we would not want to see the SBIC's get directly into for many reasons.

One reason is that SBIC's might get to be more underwriters than SBIC's and, second, I think we might be severely criticized for using an institution that is licensed by the Federal Government to compete with the underwriting fraternity. I do not think this would be

proper.

As I would envision it, as a standby type of arrangement, the underwriters themselves should be amenable to it as well, because it would not be competing with their functions.

Mr. MULTER. It would be better to compete than having you guaranteeing them to dispose of their issue.

Mr. KELLEY. We are not guaranteeing them, sir.

Mr. MULTER. I understood you to to say that you would undertake to buy what they did not sell-whatever the public did not buy on the public offering the SBIC would pick up.

Mr. KELLEY. The SBIC would pick it up.

Mr. MULTER. This was not intended for SBIC's.

Mr. KELLEY. Well, SBIC's, Mr. Multer, were created to assist small businesses in getting funds, and this would be one means whereby they could assist the small business in getting funds. So I think it would be within the intent of the act.

Mr. MULTER. I think you would be treading on very dangerous ground if you were permitted to get into that field or permit the SBIC's. It is just one step of underwriting and

Mr. KELLEY. Well, Mr. Multer, from a practical standpoint, only the larger SBIC's would be able to do this. In these instances there would be a minimum of Government funds involved.

Mr. MULTER. But they have all the advantages of being federally licensed and everything else that goes with it.

Mr. KELLEY. Well, as I say, there is an argument on that point, but there is also the argument that says that it would benefit the small businesses through doing this.

There is no market today for a public issue by a small business, and this is one of the problems in the SBIC industry today, because to provide venture capital an SBIC must turn over its investments from time to time.

I mean, it is not intended that it be permanently locked into that investment, and one of the reasons that they are not making more venture capital investments is because this market does not exist.

I think it would be desirable to see this market stimulated. Mr. MULTER. As desirable as that would be, I should think that we ought not to encourage the SBIC's to become investment bankers. If you want to let them do that let them be investment bankers, but not let them be SBIC's because sooner or later they will be putting all of their efforts into that.

As I see it, they would set up to be an aid to the small businessman who otherwise could not get in there, and I think this is the way to do it.

This is one man's opinion.

The CHAIRMAN. Mr. Williams, do you have any questions?

Mr. WILLIAMS. No questions, Mr. Chairman.

The CHAIRMAN. Mr. Administrator, I am sure you are familiar with the Wall Street Journal article of July 7, 1963, on this issue of self-dealing.

They point out where one man made an investment of $50,000 and got a loan of $75,000. I think probably some answers can be made to a lot of these things and, without objection, I am going to include this in the record and ask you to give the answers for the record so that both sides may be included.

Mr. FOLEY. We appreciate that very much, Mr. Chairman. (The article follows:)

[From the Wall Street Journal, July 2, 1963]

DOUBLE STANDARD-USUAL FEDERAL FROWN ON CONFLICTS OF INTEREST ABSENT IN SBIC CASES

SBA APPROVES MANY LOANS BY INVESTMENT GROUPS TO OFFICERS' OWN COMPANIESWHERE SOME TAX DOLLARS GO

(A Wall Street Journal News Roundup)

When the Government discovers what look like conflict-of-interest practices, it usually tries to stamp them out. But one adventurous Federal agency, the Small Business Administration, is taking a liberal tack: Officially, though in a shroud of secrecy, it is sponsoring intricate and interesting business arrangements which it designates as "self-dealing."

The Small Business Administration pours taxpayer money into hundreds of small business investment companies (SBIC's) scattered around the Nation, and these in turn mix it with private funds and lend to little businesses. In many instances the agency is formally authorizing these SBIC's to grant loans to enterprises in which SBIC officers themselves have a personal stake. The phrase "self-dealing" refers to such interlocking intimacy between those who grant the money and those who get it.

Here's one sample of these perfectly legal arrangements:

James C. Nichols, is vice president and secretary of Coast Small Business Investment Co., Pacific Grove, Calif. He put $50,000 into this SBIC, as did each of two other owners. The Small Business Administration put in $150,000, and guaranteed another $150,000 in funds obtained from a bank.

Mr. Nichols is also sole owner of Nichols Plumbing & Heating Co., in Monterey, Calif. This year he wanted to buy a new building for his plumbing firm, but says he found "banks aren't too free with their money." He turned to the SBIC and received $75,000, for 10 years, on terms which Coast SBIC Executive Secretary Robert W. Tuttle reports were more favorable than banks were willing to grant.

Surprised at approval

"Obviously the loan wasn't made at arm's length," remarks Mr. Tuttle, though he and the two other SBIC owners thoroughly examined its soundness. "Frankly I was not optimistic," he recalls, about getting the deal approved by Small Business Administration headquarters in Washington. He was surprised when the agency quickly OK'd it, with an exchange of letters. But like others who are fostering such arrangements, he does consider them beneficial. "If the transaction is the kind you would have made with a stranger, then why not go ahead with your own people?"

Typically, SBIC officers, when seeking SBIC loans to ventures in which they have a personal stake, absent themselves from SBIC board meetings when their requests are being considered.

A majority of the Nation's 600-plus SBIC's apparently still avoid self-dealing. But in Washington, the boss of the Small Business Administration (SBA), John Horne, heartily contends the practice is desirable, to give SBIC officials "flexibility" in investment. Deputy Administrator James Parris, who signs the letters authorizing specific SBIC self-deals, adds: “Our main concern is securing capital for small businesses. We don't want to bog small SBIC's down with too many regulations."

This view contrasts with the proclaimed attitude of other Federal agencies, notably the Securities and Exchange Commission. Though all SBIC's come under Small Business Administration jurisdiction, those selling shares to the general public are further scrutinized by the SEC-and its officials declare most such SBIC's have "quit asking us to approve self-dealing because they know we won't." Privately, those SEC officials contend standards should be just as rigorous for SBIC's that escape SEC rules. Without discussing actual cases, they maintain that self-dealing SBIC officers could influence lending to their own failing enterprises or get a "free ride" for their own investments in ventures made profitable by the injection of SBIC money.

Challenging self-dealing

"It is not necessary to prove actual damage,” to the lending company "or even actual profit to (an) individual" to challenge self-dealing, SEC lawyers contended