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.

(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.