business concerns are being asked to do. A small businessman historically is the kind of person who creates a business, who goes into business for himself, has a great deal of independence. He wants to be independent. He goes to a SBIC with some reluctance, because he knows that most SBIC's are going to require an equity interest. He is very jealous of revealing facts about his company to the public at large and particularly where competitors can get such information. So disclosure and the amount of such disclosure is a material fact as far as the small business applicant is concerned.

Senator PROXMIRE. You say disclosure and amount of such disclosure. Supposing the disclosure is confined to what we propose as one of the alternatives, that is, the affiliation of the borrower and also the terms of the loan, and not the product and all the rest, that you indicate here has been so damaging. What is the matter with that kind of disclosure?

Mr. HOWARD. The basic problem, Mr. Chairman, is that it is rather like the camel putting his head under the tent; you never know where he is going to stop.

Senator PROXMIRE. We stop in the law, and just say this is all that is required.

Mr. HOWARD. I can speak with a great deal of experience, sir, that laws can be changed. We had a law passed in 1958 that purported to do certain things and under which we were permitted to operate and make investments up to 20 percent of our capital and surplus. That is not the case today. There are many other restrictions that have been made involving material changes in the program. The ground rules have been drastically altered since most of us were licensed.

Senator PROXMIRE. An overwhelming majority of SBIC's are not affected by the limitation and that limitation is probably going to be eliminated, unfortunately.

Mr. HOWARD. We certainly hope the committee

Senator PROXMIRE. I am for the Proxmire amendment; I am probably a minority.

Mr. HOWARD. We were also for the Proxmire bill, sir, and I personally thought it was an excellent bill. I refer to the bill when the act was expanded, to permit SBIC's to invest in other securities. The Proxmire amendment, I always have been against, as you know. However, conceding an outright prohibition would affect less than 2 percent, and this is distorted somewhat. I go back to the question of how you define self-dealing transactions. Is any transaction with an affiliate self-dealing? If you use the definition of self-dealing and affiliate, as defined by the 1940 act, you get into much broader areas, and the amount of disclosure to be pertinent would have to be far more revealing. If you use, for the moment, we will say, that definition of self-dealing, then, as I see it, you could possibly raise problems where an SBIC made an investment in a company, and elected a man to the board, or merely nominated a man for election to the board of directors of that small business. If the small business then needed additional funds, again there would be the problem of disclosure and prior approval, simply by virtue of the fact that a self-dealing transaction came about because the director of the company was put on by the SBIC or nominated by the SBIC. It might be a staff member of the

SBIC or a director of the SBIC. This is very common. The first investment would not be self-dealing, but the second would by virtue of the fact the SBIC was trying to exercise good judgment in superintending and watching its investment and had placed a director on the board of the borrower.

Senator PROXMIRE. The proposed policy of the SBA on self-dealing is simply a partial disclosure policy.

Mr. HOWARD. Why should additional requirements and restrictions be imposed on a small business simply because the SBIC was trying to protect its investment and was acting in the interests of the SBIC's shareholders by having a director on the board of the small business borrower?

Senator PROXMIRE. The reason for it, of course, is so that there will be some public scrutiny and some opportunity to regulate this without having complete reliance on a Washington office, which can't possibly provide the kind of regulation which some public knowledge at least, of the transactions, accurate knowledge, would provide.

Mr. HOWARD. What you are doing then is to require the resignation of a director.

Senator PROXMIRE. No, no; all you are requiring is people know what is going on.

Mr. HOWARD. No; the practical effect, Mr. Chairman, would be that the SBIC would not put a director on the board of the small business concern and neither

Senator PROXMIRE. I don't say, and I don't think anybody has said, that there is any evil about a self-dealing operation, necessarily. I agree with the Senator from Colorado when he says they are not necessarily wrong. I would say the overwhelming majority of such loans are right, good, and necessary and desirable, but what I say is there is no reason in the world why they shouldn't be known, shouldn't be public. If there is something wrong about it, then I think they are less likely to be done if it is known that they have to be made public. Mr. HOWARD. You have to look at the transaction and regulations involving SBIC's and the overall umbrella of restrictions under which SBIC's are required to operate. Every time you add more restrictions on the operations of the business of lending money by the SBIC and superintending of its investments, you tend to discourage borrowers. Now I have been told that in the Washington area, as a result of the wide publicity that this transaction has received and others of a similar nature, that many companies who might otherwise go to SBIC's are no longer interested in seeking financing from SBIC's, because of the delay and disclosure required, if they run into problems. Their attorneys are advising them not to go to SBIC's, because things that today are confidential information might tomorrow become public information by virtue of transactions and disclosure such as I have outlined here.

Senator PROXMIRE. Mr. Howard, these are just strawmen.

not asking for confidential information, all we are asking for is the identity of the person who is getting the loan, his affiliation with the SBIC, and the terms of the loan disclosed. I don't think we are going to press for the exact requirements of the Investment Act of 1940 be adopted for all SBIC's. There is no intention to do that. What we are proposing, I think, most of us are interested in providing

publicity. This case is dated August 6, 1963, and appears on page 8265, Saturday, August 10, 1963, Federal Register:

Notice is hereby given that Greater Washington Industrial Investments, Inc. (applicant), 1725 K Street, Northwest, Washington 6, D.C., a District of Columbia corporation licensed under the Small Business Investment Act of 1958 and a closed-end, non-diversified management investment company has filed an application under Section 17(b) of the Investment Company Act for an order exempting from the provisions of Sections 17(a) (1) and 17(a)(2) of the Act, the proposed amendment of the loan agreement between applicant and S. J. Tesauro & Company, Inc. ("Tesauro"), a Michigan corporation, and a small business concern as defined by the Small Business Administration for purposes of the SBI Act. All interested persons are referred to the application filed with the Commission for a full statement of applicant's representations which are summarized below.

On August 30, 1961, applicant and Tesauro entered into a loan agreement under which applicant agreed to purchase at principal amount, an aggregate of two hundred thousand dollars ($200,000) principal amount of 8 percent convertible debentures of Tesauro to be due 5 years from date of issuance, as follows: (a) One hundred thousand dollars on the signing of the agreement.

(b) One hundred thousand dollars prior to December 31, 1962 in minimum increments of twenty-five thousand dollars.

Applicant purchased $100,000 principal amount of debentures on August 31, 1961 and $100,000 principal amount on December 1, 1961.

Said agreement and the debentures issued thereunder provide for an option in the debenture holder to convert all or part of the debentures, at any time within five years from date of issuance, into Tesauro's Class B (voting) common stock at the rate of one share for each $5 principal amount of debentures. If all the debentures are converted, applicant will have a 28 percent equity interest in Tesauro. Samuel J. Tesauro, President of Tesauro, has given his personal guarantee for repayment of said debentures. Tesauro is primarily engaged in the business of data processing, advertising and direct mail service.

On November 26, 1962, applicant agreed to subordinate its Tesauro debenture holdings to loans to Tesauro by the National Bank of Detroit in the amount of approximately $20,000. Said Bank, which had been supplying short-term credit for Tesauro's day to day cash needs, has recently curtailed such credit and is requiring full repayment of existing loans. As a result of such curtailment Tesauro has made arrangements for substitute short-term credit with James Talcott Inc. ("Talcott"), a commercial financing institution, subject to applicant and Tesauro's entering into an agreement whereby Tesauro's $200,000 debenture now held by applicant, will be subordinated to up to $100,000 of loans advanced by said Talcott.

Applicant states that it is advised and believes that Tesauro will find it difficult or impossible to survive if it does not obtain immediate short-term credit and that such credit cannot be obtained unless the proposed agreement is entered into immediately. Kecent operations of Tesauro have been profitable and applicant represents that there appears to be no other satisfactory way to help safeguard and enhance the value of applicant's investment.

Applicant also states that to the best of its knowledge, no officer, director, employee or five percent shareholder of applicant has any interest, direct or indirect, in Tesauro or in the subject amendments.

The loan agreement between Tesauro and applicant provides that Tesauro will exercise its best efforts to cause the election to the Board of Directors of such person as may from time to time be designated by applicant. Applicant has exercised the right so provided by placing one nominee on the five member board of directors of Tesauro. In view of this, applicant may be deemed to hold five percent or more of the outstanding voting securities of Tesauro, and Tesauro and applicant may be affiliated persons. The amendment to the loan agreement between such affiliated persons may involve a purchase and sale of securities by Tesauro subject to the provisions of Sections 17(a)(1) and 17(a) (2) of the Act and the rules thereunder.

Section 17(a) (1) and Section 17(a) (2) of the Act, as here pertinent, prohibit an affiliated person of a registered investment company from selling to or purchasing from such registered company securities or property, unless the Commission upon application pursuant to Section 17(b), grants an exemption from such provisions upon a finding that the terms of the proposed transaction,

including the consideration to be paid, are reasonable and fair and do not involve overreaching on the part of any person concerned, that the proposed transaction is consistent with the policy of each registered investment company concerned, as recited in its registration statement and reports filed under the Act, and is consistent with the general purposes of the Act.

Notice is further given that any interested person may, not later than August 22, 1963, at 5:30 p.m. submit to the Commission in writing a request for a hearing on the matter accompanied by a statement as to the nature of his interest, the reason for such request and the issues of fact or law proposed to be controverted, or he may request that he be notified if the Commission shall order a hearing thereon. Any such communication should be addressed: Secretary, Securities and Exchange Commission, Washington, D.C., 20549. A copy of such request shall be served personally or by mail (air mail if the person being served is located more than 500 miles from the point of mailing) upon applicant at the address set forth above. Proof of such service (by affidavit or in case of an attorney-at-law by certificate) shall be filed contemporaneously with the request. At any time after said date, as provided by Rule 0-5 of the rules and regulations promulgated under the Act, an order disposing of the application herein may be issued by the Commission upon the basis of the showing contained in said application, unless an order for hearing upon said application shall be issued upon request or upon the Commission's own motion.

It is ordered, That the Secretary of the Commission shall give notice of the filing of this application by mailing a copy of this notice by registered mail to the applicant and to the Director, Office of Investment, Small Business Administration, Washington, D.C., 20416; that notice to all other persons shall also be given by publication of this Notice in the Federal Register; and that a general release of this Commission in respect of this Notice be distributed to the press and mailed to the mailing list for releases.

For the Commission (pursuant to delegated authority).

ORVAL L. DUBOIS, Secretary.

I cite this case as an illustration of self-dealing under the 1940 act. It is not self-dealing under SBA's current regulations. The 1940 act defines transactions with affiliates, and a small business concern automatically becomes an affiliate according to the assumed facts as herein stated, where the small business concern has the right to elect a director to the board of that company. They do not have to do so, but if they have a right to elect a director, or to nominate a director for election, SEC says they are affiliates.

Therefore self-dealing, under the 1940 act, has much broader implications and restrictions than it does under SBA's regulations. This transaction would probably not be subject to SBA approval, but did require approval of SEC.

Any material change in a loan agreement of an affiliate requires an order from SEC. For example, in this instance, where there was a change of subordination from a bank to a finance company, it took the SBIC about 2 months to get such approval. I understand that the small business concern was very adversely affected. They have had a difficult time getting orders because of their precarious financial position, which has been publicly revealed, as a result of the SBIC's request for an order. This is not true for their competitors, even though their competitors may be even worse off. No other financial institution reveals information of this nature about its loans and clients.

Now, I am sure that most of you, if you had borrowed money, would be very reluctant to have the bank reveal the fact that you have a dollars borrowed from the bank at 6 percent and the bank has had to extend the loan for 5 years, because you couldn't pay it. Also that you are delinquent on your interest. The transaction may also only involve a few changes in your loan. Yet this is what these small

business concerns are being asked to do. A small businessman historically is the kind of person who creates a business, who goes into business for himself, has a great deal of independence. He wants to be independent. He goes to a SBIC with some reluctance, because he knows that most SBIC's are going to require an equity interest. He is very jealous of revealing facts about his company to the public at large and particularly where competitors can get such information. So disclosure and the amount of such disclosure is a material fact as far as the small business applicant is concerned.

Senator PROXMIRE. You say disclosure and amount of such disclosure. Supposing the disclosure is confined to what we propose as one of the alternatives, that is, the affiliation of the borrower and also the terms of the loan, and not the product and all the rest, that you indicate here has been so damaging. What is the matter with that kind of disclosure?

Mr. HOWARD. The basic problem, Mr. Chairman, is that it is rather like the camel putting his head under the tent; you never know where he is going to stop.

Senator PROXMIRE. We stop in the law, and just say this is all that is required.

Mr. HOWARD. I can speak with a great deal of experience, sir, that laws can be changed. We had a law passed in 1958 that purported to do certain things and under which we were permitted to operate and make investments up to 20 percent of our capital and surplus. That is not the case today. There are many other restrictions that have been made involving material changes in the program. The ground rules have been drastically altered since most of us were licensed.

Senator PROXMIRE. An overwhelming majority of SBIC's are not affected by the limitation and that limitation is probably going to be eliminated, unfortunately.

Mr. HOWARD. We certainly hope the committee

Senator PROXMIRE. I am for the Proxmire amendment; I am probably a minority.

Mr. HOWARD. We were also for the Proxmire bill, sir, and I personally thought it was an excellent bill. I refer to the bill when the act was expanded, to permit SBIC's to invest in other securities. The Proxmire amendment, I always have been against, as you know. However, conceding an outright prohibition would affect less than 2 percent, and this is distorted somewhat. I go back to the question of how you define self-dealing transactions. Is any transaction with an affiliate self-dealing? If you use the definition of self-dealing and affiliate, as defined by the 1940 act, you get into much broader areas, and the amount of disclosure to be pertinent would have to be far more revealing. If you use, for the moment, we will say, that definition of self-dealing, then, as I see it, you could possibly raise problems where an SBIC made an investment in a company, and elected a man to the board, or merely nominated a man for election to the board of directors of that small business. If the small business then needed additional funds, again there would be the problem of disclosure and prior approval, simply by virtue of the fact that a self-dealing transaction came about because the director of the company was put on by the SBIC or nominated by the SBIC. It might be a staff member of the