The Small Business Administration is satisfied that the terms of the investment are fair and reasonable and would not have been materially different in the absence of any affiliation between the small business investment company and the small business concern. Further, the Small Business Administration is satisfied that this amendment serves the purposes of the Small Business Investment Act of 1958, as amended. ! Senator PROXMIRE. Our next witness is Mr. Jack Whitney, Securities and Exchange Commission, and we are delighted to have you. Senator MCINTYRE. Mr. Chairman, I thought there was going to be some effort made to secure the writer of this article. Senator PROXMIRE. There was indeed. I might say we tried hard to get the Wall Street Journal to send their experts up here, and they did a beautiful job in this article. They said the article spoke for itself, and so many people worked on it they probably couldn't fit at the witness table. Newspapers are always shy. We are delighted to have you, Mr. Whitney. Go ahead. STATEMENT OF JACK M. WHITNEY II, COMMISSIONER, SECURITIES Mr. WHITNEY. Mr. Chairman, Senator Dominick, Senator McIntyre; I am glad to be here today. On my right is Allan F. Conwill, Director of the Division of Corporate Regulation. As such, he is responsible to the Commission for our regulatory activities under the Investment Company Act of 1940, which involves the SBIC's. On my immediate left is Mr. Edmund H. Worthy, Director, Division of Corporation Finance, which by contrast deals with our disclosure activities under the Securities Act of 1933 and the Securities Exchange Act of 1934. On my second left, Mr. Walter P. North, Associate General Counsel. Senator PROXMIRE. What was that name? Mr. WHITNEY. Walter P. North, Associate General Counsel, and on his left, Mr. Robert Bagley, Assistant Director of the Division of Corporation Finance. Mr. Chairman, I have a statement here, which I have provided and I propose to read it in large part although I may abbreviate it in spots. I am here at your invitation to testify on behalf of the Commission with respect to the matters of self-dealing and conflicts of interest in transactions between small business concerns and small business investment companies SBIC's-which are licensed by the Small Business Administration. Three proposals have been suggested as possible methods of dealing with these matters. Each of the proposals would be applicable to transactions in which an SBIC makes a loan to, or purchases any equity security of, a small business conecrn: (1) If an officer or director of the SBIC, or a close relative of such officer or director, is an officer of the small business concern, or owns or controlsdirectly or indirectly-10 percent or more of the stock of the small business concern; (2) if any person who owns or controls directly of indirectly-10 percent or more of the stock of the SBIC also owns or controls directly or indirectly-10 percent or more of the stock of the small business concern, or is a close relative of any such person; or (3) if any person who is an officer or director of the small business concern or owns or controls-directly or indirectly-10 percent or more of the stock of such concern served as an officer or director or owned or controlled-directly or indirectly-10 percent or more of the stock of the SBIC, within 6 months prior to the transaction. The first proposal would impose an outright ban on such transactions; the second would permit such transactions only when prior approval has been obtained from the Small Business Administration in accordance with certain specified standards; and the third would require disclosure of certain of the details of any such transaction by newspaper publication within 30 days following the event. It is our understanding that the proposals are suggested as possible amendments to the Small Business Investment Act of 1958. As is more fully set forth below, we consider the comprehensive regulatory pattern of the Investment Company Act to be an effective and workable aproach for dealing with these problems in transactions affecting publicly held SBIC's. We would urge that this regulatory pattern be left intact as to such SBIC's and that any legislation be drafted so as to avoid possibly conflicting regulation. The Commission on which I am privileged to serve is charged with the responsibility of administering the Federal securities laws. Those acts reflect a recognition by the Congress of the need for a broad range of protections for the investing public. Under the Securities Act of 1933 protections are provided principally through the requirement of full disclosure of pertinent information to persons to whom securities are publicly offered for sale. The Investment Company Act provides protections, in addition to those provided by the Securities Act, which experience had shown were necessary for public investors in companies primarily engaged in the business of investing, reinvesting, and trading in securities. This grew out of the special study made by the Commission and reported to the Congress for the most part in 1939 and 1940, and it was on the basis of that report that the Congress decided disclosure was not enough in this field. Now, among other things, the Investment Company Act requires disclosure of financial and investment policies of investment companies, prohibits such companies from changing the nature of their business or their investment policies without the approval of their shareholders, regulates the safekeeping of the companies' assets, places certain restrictions on the composition of the boards of directors of such companies, requires management contracts to be submitted to se curities holders for their approval, requires the filing with the Commission and the transmittal to shareholders of periodic reports, requires compliance with the Commission's proxy rules in connection with meetings of shareholders, and places certain limitations on the amount of debt securities which may be issued by investment companies. In particular, in respect of the matters which this committee is now considering, the Investment Company Act includes provisions designed to regulate transactions of affiliated persons affecting investment companies having substantial public stockholder interest. When the Securities Act was adopted the Congress made a basic policy determination that the national public interest was affected when securities are sold or offered for sale to the public. Again, in adopting the Investment Company Act the Congress made a similar determination that different considerations are applicable to investment companies in which public stockholders are interested than are applicable to investment companies which are private in nature. These policy determinations were not disturbed in 1958 when the Small Business Investment Act was enacted by the 85th Congress. At that time the Congress determined that with certain minor exceptions the provisions of both the Securities Act and the Investment Company Act should apply to SBIC's whose securities are offered or sold to the investing public to the same extent as to investment companies generally. SBIC's in which there is not the requisite public investor interest are not subject to the registration and regulatory provisions of the Federal securities laws. However, all SBIC's must satisfy the requirements of the Small Business Adminstration in order to be licensed as an SBIC and to qualify for loans of Federal funds to assist them in a program of supplying equity capital to small business concerns. An SBIC must file a registration statement under the Securities Act only when it proposes to make a public offering of its securities and must register under the Investment Company Act if it makes or proposes to make such a public offering, or if its outstanding securities are beneficially owned by more than 100 persons. As of September 4, 1963, a total of 70 SBIC's were registered with the Commission under the Investment Company Act, all of which had filed registration statements under the Securities Act. In view of the basic policy underlying the enactment of the Securities Act and the Investment Company Act, that is, the recognition of the distinction between public investor interests and private interests, the Congress might decide that, if legislation is necessary, the pattern of regulation presently applicable to investment companies in which there is public investor interest is not appropriate for SBIC's which do not have a significant number of public shareholders. any event, we believe that an explanation of our administration of the Securities Act and Investment Company Act should contribute to this subcommittee's consideration of the problems before it. In The provisions of the Investment Company Act relating to conflicts of interest are contained principally in section 21 and section 17 of the act. Section 21 of the act flatly prohibits an investment company from lending money or property to any person or company who controls or is under common control with the registered investment company. Senator PROXMIRE. May I ask at this point, what does "lending" mean? Does that include an equity investment or include simply a loan in the usual sense? Mr. WHITNEY. I believe the term "equity security" in the SBIC sense would include the debt instruments, such as the convertible debenture or the loan accompanied by warrants, but if you had an outright purchase of stock without any debt connection, you would not be under this provision. Mr. CONWILL. That is correct, the convertible, however, would be. Mr. WHITNEY. That would be a debt instrument and therefore be evidence of a loan. Senator PROXMIRE. In other words, if the SBIC should buy outright the equity security from a small business, in which case the owner of the small business was also a director or major stockholder and so forth, qualified clearly as a principal in the SBIC, under this provision of the law at least, it would not be banned? Mr. WHITNEY. That is correct. It would be caught by the next provision, which is not a flat prohibition. I would like to refer to that. This is a matter I believe Mr. Parris was commenting on earlier. In considering this section 21, which I have just mentioned, and section 17 which I am now coming to, please bear in mind that there is a distinction to be drawn between a person who controls or is under common control with the SBIC and one who is merely affiliated. The terms of affiliation are not, of course, as stringent as the term of control, so the prohibition of section 21 refers to a person who is in control or is under common control with the SBIC. Senator PROXMIRE. How do you define "control"? Mr. WHITNEY. "Control" is defined in the act as the power to influence the management policies of the SBIC. Senator PROXMIRE. A director-stockholder who holds 10 percent or more stock? Mr. WHITNEY. No, sir; there is a statutory presumption that a person who holds 25 percent or more is deemed to be in control, but he may rebut that presumption in a proceeding before us, if he wishes to do so or wishes to attempt to do so. But I mention this because this question of control versus affiliation, which involves usually a 5-percent test, as I will mention in a moment, could be confusing to people. Senator PROXMIRE. You would assume that a director would be in a position to influence the decision of management? Mr. WHITNEY. You and I would say he was as a businessman, as a member of the directorate, that is what he was there for, but under the act he would not be in control unless other circumstances supported that. Now, section 17(a) in general makes unlawful, in the absence of an exemptive order issued by the Commission under section 17 (b), transactions with a registered investment company or a company controlled by a registered investment company involving the sale to such company, or the purchase from it, of securities or other property or the borrowing from such company of money or other property, by an affiliated person, promoter or principal underwriter of the registered investment company or by an affiliated person of such affiliated person, promoter, or underwriter. 23-693-63- 4 An affiliated person is defined to include (a) an officer, director, employee, or partner of such other person, (b) a person holding 5 percent or more of the voting securities of the other person, (c) a person 5 percent or more of the securities of which is held by the other person, or (d) a person who directly or indirectly controls or is controlled by or is under common control with the other person. Senator PROXMIRE. This exemptive order is of the same nature as what the SBA now requires of SBIC's who engage in self-dealing? Mr. WHITNEY. What you have, sir, is this situation. In the case of a publicly held SBIC, which is registered with us, at the same time that they would be applying to the SBA for permission under the SBA's regulation 716, they would be applying to us for an exemptive order under section 17(b). The standards in our statute are not the same as the regulation. I am coming to those standards at this point. Senator PROXMIRE. All right. Mr. WHITNEY. Section 17(b) of the act provides that the Commission shall, upon application, and after notice and opportunity for public hearing, grant an exemption from the prohibitions of section 17 (a) if it finds that (1) the terms of a proposed transaction, including the consideration to be paid, or received, are reasonable and fair and do not involve overreaching on the part of any person concerned, (2) the proposed transaction is consistent with the investment policy of the investment company, and (3) the proposed transaction is consistent with the general purpose of the act. Senator PROXMIRE. You say nothing about disinterested persons having the power to block Mr. WHITNEY. There is nothing in the statute on that subject. In addition to the provisions of section 17(b), which permit the Commission to exempt individual transactions, the act confers upon the Commission the authority to grant exemptions by rule, regulation or order for certain categories of transactions and persons. Pursuant to this authority the Commission has adopted rules to exempt from the prohibitions of section 17 (a) certain banking transactions made in the ordinary course of business rather than as investments; transactions between the investment company and its wholly owned subsidiaries; consummation of contractual commitments of the investment company where certain conditions are satisfied; and certain pro rata distributions made by the investment company. As I previously pointed out, under section 17 (a) an investment company may not lend money to a portfolio company if the investment company owns 5 percent or more of the portfolio company's stock. As an accommodation to the nature of an SBIC's relationship with its portfolio companies, the Commission adopted a rule permitting investments in and loans to a small business concern by an SBIC notwithstanding SBIC's ownership of 5 percent or more of the voting securities of the small business concern. Senator PROXMIRE. That means you made a special exception for SBIC's? Mr. WHITNEY. Generally. Senator PROX MIRE. Not available to others? Mr. WHITNEY. In other words, it was recognized that one of the functions of the SBIC was to make equity investments. I think the |