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COMMITTEE ON BANKING AND CURRENCY

A. WILLIS ROBERTSON, Virginia, Chairman JOHN SPARKMAN, Alabama

WALLACE F. BENNETT, Utah PAUL H. DOUGLAS, Illinois

JOHN G. TOWER, Texas JOSEPH S. CLARK, Pennsylvania

JACOB K. JAVITS, New York
WILLIAM PROXMIRE, Wisconsin

MILWARD L. SIMPSON, Wyoming
HARRISON A. WILLIAMS, JR., New Jersey PETER H. DOMINICK, Colorado
EDMUND S. MUSKIE, Maine
EDWARD V. LONG, Missouri
MAURINE B. NEUBERGER, Oregon
THOMAS J. MCINTYRE, New Hampshire

MATTHEW HALE, Chief of Staff

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SUBCOMMITTEE ON SMALL BUSINESS

WILLIAM PROXMIRE, Wisconsin, Chairman A. WILLIS ROBERTSON, Virginia

MILWARD L. SIMPSON, Wyoming JOHN SPARKMAN, Alabama

JOHN G. TOWER, Texas
PAUL H. DOUGLAS, Illinois

PETER H. DOMINICK, Colorado
MAURINE B. NEUBERGER, Oregon
THOMAS J. MCINTYRE, New Hampshire

II

CONTENTS

Page

13

WITNESSES

129

128

Alternative proposed amendments submitted by the subcommittee for

SBA and SEC consideration.

National Association of Small Business Investment Companies: Letter

from James W. Howard, president.

Proxmire, William, a U.S. Senator from the State of Wisconsin:

Letter dated July 2, 1963, to John Horne, Administrator, Small Busi-

ness Administration..

Proposed amendment, “Publication of information concerning certain

transactions”

Securities and Exchange Commission:

Excerpts from-

Securities Act of 1933.

Securities Exchange Act of 1934.

Investment Company Act of 1940-

Letter from Jack M. Whitney II, Commissioner..

Small Business Administration:

Comments on the proposed amendment, “Publication of information

concerning certain transactions”

Letter dated July 9, 1963, from John Horne, Administrator, to

Senator Proxmire.--

Letter dated September 13, 1963, from James L. Parris, Deputy

Administrator, and Lawrence S. Casazza, Director, 'Office of

Investment, to Senator Proxmire...

Existing regulation on self-dealing-
Letter dated October 4, 1963, from Eugene P. Foley, Administrator,
to Senator Proxmire, with enclosures-

Exhibit A.-Section 107.716: Affiliated transactions -
Exhibit B.- Procedure on disclosure of affiliated transactions

Exhibit C.-Sample summary on section 107.716 transactions..
Wall Street Journal article entitled “Double Standard: Usual Federal

Frown on Conflict of Interest Absent in SBIC Cases'

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CONFLICT OF INTEREST PROBLEMS IN SBIC'S

THURSDAY, SEPTEMBER 5, 1963

U.S. SENATE,
COMMITTEE ON BANKING AND CURRENCY,
SUBCOMMITTEE ON SMALL BUSINESS,

Washington, D.C.
The subcommittee met, pursuant to recess, at 10:07 a.m., Senator
William Proxmire, chairman of the subcommittee, presiding:
Present:

Senators Proxmire (presiding), Dominick, and McIntyre. Senator PROXMIRE. Today the Small Business Subcommittee will receive testimony from representatives of SBA, SEC, and NASBIC regarding conflict of interest in the SBIC program.

This question received nationwide attention when, on July 2, 1963, the Wall Street Journal carried as its lead article a report entitled “Usual Federal Frown on Conflicts of Interest Absent in SBIC Cases." The article was very critical of SBA's handling of certain loans made by some SBIC's.

In considering small business legislation, the Small Business Subcommittee decided to hold additional hearings in order to gain a better understanding of this problem as it relates to SBIC's.

We have invited Mr. Foley, the new Administrator of SBA; Commissioner Whitney of the SEC, since the SEC has self-dealing problems with the investment companies under its jurisdiction; and Mr. Howard, president of NASBIC, to give us their views on this important question.

Without objection the Wall Street Journal article, my letter to SBA and Mr. Horne's reply, together with SBA regulations on self-dealing and a copy of the bill, s. 298, will be made part of the record of the hearings.

(The documents follow :)

[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 COMPANIES—WHERE 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

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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 in a recent court case. “It is sufficient that the transaction be fraught with the possibility that the company might be injured by action based upon something less than disinterested motives on the part of its fiduciaries.”

Of course, no sinister motive, need be implied by any loan application to an SBIC. The purpose of creating these lending institutions and giving them governmental financial support is to make money available to small businesses when they can't get it from banks—or at least can't get it for so long a repayment period, or for so low interest charges. This can be motive enough, either for arm's-length borrowing or for self-dealing borrowing.

When the SEC does get requests for approval of self-dealing arrangements, it makes them public. The Small Business Administration reveals no details of self-deals submitted or approved : Mr. Horne says his lawyers advise it should not. According to its officials, self-dealing has been permitted by SBA ever since Congress created the SBIC program 5 years ago, and nobody knows how many such transactions have occurred. Only last October the staff began keeping a current count, and by May discovered they had approved 33 self-dealing applications—at the rate of about 1 a week—while rejecting just 3.

Pressed by Wall Street Journal reporters, the Small Business Administration did reveal the names of these 36 SBIC's-while refusing to state even how

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