troller General as to the legal authority of the Reconstruction Finance Corporation to enter into this transaction. That letter is dated March 28, 1950. I insert a copy of my letter to the Honorable Lindsay C. Warren of March 28, 1950, in the record at this point.

(The letter referred to follows:)

Hon. LINDSAY C. WARREN,

Comptroller General of the United States,

Washington, D. C.

MARCH 28, 1950.

As

DEAR MR. WARREN: As you know, the Subcommittee on Reconstruction Finance Corporation of the Senate Committee on Banking and Currency is making a study of the lending policies of Reconstruction Finance Corporation. chairman of the subcommittee, I would like to have your opinion on a matter of considerable importance.

On September 29, 1949, the Board of Directors of RFC adopted a resolution approving a $15,100,000 10-year loan to Texmass Petroleum Co., RFC to participate to the extent of $11,100,000 and two insurance companies to participate to the extent of $4,000,000. The loan is to be secured primarily by developed and undeveloped oil- and gas-producing properties.

At the date of this letter no disbursement had yet been made under the commitment. The period during which disbursements may be made was originally set at 60 days and it was extended from time to time until now it ends at about the close of April 1950. Most of the conditions of the loan have been met and in all probability the first disbursement will be made before the end of April, unless new factors of importance are injected into the picture. The first disbursement may be made much earlier than the end of April.

During the course of its consideration of the loan, RFC employed the services of a consulting geologist who undertook to examine the collateral and to advise the Corporation on its worth. This geologist has rendered a report in which he estimates that there are oil reserves of approximately 12,500,000 barrels and that proceeds of some $28,650,000 may be expected from operation of the properties which had been developed at the date of the report. On the basis of these reserves and this potential revenue it is the considered opinion of the geologist that the loan cannot be paid off under its terms in less than 20 years. He has so advised RFC in letters dated September 15, 1949, one of which reads in part as follows:

"As it now stands, the net income to all companies is $1,320,000. During the first year of the loan, interest payments and proposed development would use this entire amount and there would be no Federal income tax. If development continued, this status would prevail over the first 3 years. During that time, unless the loan were set up above the $14,950,000 figure there would be no retirement of principal. After development expenditures were completed, Federal income taxes would be effective and with a large taxable income and interest charges I am unable to see where any large application on principal can be made at any time.

"On a 2 to 1 ratio of net revenue to loan the collateral is sufficient to justify a loan of $14,325,000. On the ability to pay no loan of sufficient size to take care of the company's indebtedness is in any way justified. Only a rapid expansion of both assets and income would justify the loan at the figure given. This can only be effected by placing the loan at a figure so high that it would not be secure."

Another engineer engaged by the Securities and Exchange Commission has made a review of the properties comprising the collateral and he has had the opportunity to examine the estimates submitted by the RFC geologist. This man estimates that the oil reserves would come to only about 7,000,000 barrels as compared with the RFC geologist's 12,500,000, and he considers this a conservative estimate. Based on the calculations of the SEC engineer the loan would take considerably more than 20 years to pay off.

It is interesting to note in this connection that the management of Texmass Petroleum Co., in a prospectus filed with the Securities and Exchange Commission, has stated "On the basis of current income and operating and overhead expenses of the presently developed properties now owned by Texmass and proposed to be acquired pursuant to the plan, with a reasonable allowance for prospective decline in production, the cash available from operations would be insufficient to cover the interest and annual principal installments of the RFC loan."

Under the RFC Act loans to business enterprises may not be made for periods longer than 10 years. It was undoubtedly the intent of Congress when it enacted

this restriction that the resources of the Government be not tied up for more than 10 years in the financing of any single private enterprise by RFC loan, other than as a result of fortuitous circumstances which could not be foreseen when the loan was made. It was undoubtedly the intent of Congress, implicit in this restriction, that financial assistance by RFC should be granted only to those business enterprises which could reasonably be expected to be functioning at the end of 10 years without the need of continued Government assistance.

The circumstances surrounding the Texmass Petroleum Co. loan are such that the loan resolution approved by RFC is in practical effect a commitment for a 20year period or longer, and therefore it would seem clearly beyond the authority of the Corporation.

I should like to have your opinion in response to these questions: If the circumstances at the time a loan is approved by RFC are such as to indicate, on the basis of expert opinion, that there is not a reasonable prospect of its repayment in 10 years, is the undertaking to make the loan an act without authority of law, notwithstanding the fact that a maturity of 10 years is specified by the loan resolution? Is the commitment to make the Texmass loan an act without authority of law?

I have no authority and it is not my responsibility as chairman of this subcommittee to intervene in any transaction undertaken or contemplated by the Board of Directors of Reconstruction Finance Corporation. I am aware of the fact that, as Comptroller General of the United States, you are also without authority to intervene, and certainly you have no responsibility which would require that you do so. The law clearly requires that the Board of Directors of Reconstruction Finance Corporation be responsible for all of the business judgments made in the conduct of that Corporation's affairs.

I think it much to be desired that the Government or its agencies refrain from entering upon a transaction which is not backed up fully by the authority of law. I think it much to be desired also that the various branches and agencies in the Government assist one another to gain this end, through the exchange of ideas and the presentation of opinions which could help to prevent the making of mistaken judgments. If you find that the Texmass Petroleum Co. loan is without authority of law because it is deemed by experts to be incapable of being repaid in the 10-year period specified in the loan agreement, I think it would be very helpful to the Directors of RFC if your opinion were made known to them so that it may receive their consideration before the first disbursement is made.

Sincerely yours,

J. W. FULBRIGHT.

Senator FULBRIGHT. On Tuesday, April 11, 1950, I received a reply from the Comptroller General to my letter of March 28. I immediately advised Chairman Hise of the Reconstruction Finance Corporation that I had asked for and received the views of the Comptroller General on the Texmass loan and arranged with the General Accounting Office to have a copy of the Comptroller General's letter sent to the Reconstruction Finance Corporation. I also invited Mr. Hise to be present at this hearing to discuss the matter.

One of the purposes of this hearing is to bring to the attention of the board of directors of the Reconstruction Finance Corporation formally, officially and publicly the views of the Comptroller General. Accordingly, I shall call first upon the Comptroller to present his opinion on the Texmass loan at this time.

Mr. Warren, will you come forward, please?

STATEMENT OF LINDSAY C. WARREN, COMPTROLLER GENERAL OF THE UNITED STATES

Senator FULBRIGHT. Mr. Warren, we are always very glad to wel come you before the committee, having been a Member of Congress for a long time, having the full confidence of the Congress in the supervision of the activities of our Government; and I am particularlv glad that you were able to come this morning.

Mr. Warren, as I stated, I wrote you a letter and requested your opinion on a question arising in this subcommittee study of the lending policies of the RFC. I understand that you have prepared a statement which includes your response to my letter, and I understand also that you have furnished a copy of your response to the directors of the RFC.

Mr. WARREN. That is correct.

Senator FULBRIGHT. Will you present your statement to the committee at this time?

Mr. WARREN. Mr. Chairman, and gentlemen, I am glad to accept your invitation to appear before you in connection with your study of the operations of the RFC.

I am particularly glad to appear before you, Mr. Chairman, for, as you will recall, you reported out of this committee the Government Corporation Control Act under which the General Accounting Office has been auditing all Government corporations since 1945 and reporting on their operations to the Congress.

As you know, our audit reports are on a fiscal year basis and the last report sent to Congress on RFC covers the period through June 30, 1947. Our audit for 1948 and 1949 has been completed and the report is in course of preparation. I have set a dead line on all 1949 reports to insure that they will be completed before the end of this fiscal year.

The loan to the Texmass Petroleum Co., which I understand is the subject of your inquiry this morning, was not authorized until September 29, 1949, and will, therefore, not be included in our forthcoming audit report.

However, on March 28 your chairman sent down a letter asking certain questions concerning this loan and concerning the authority of the RFC to make loans. The questions asked in the chairman's letter are set out in my reply of April 11, which I would like to read at this time if the committee so desires.

Senator FULBRIGHT. Yes; we would like to have you read it.
Mr. WARREN (reading):

MY DEAR MR. CHAIRMAN: I have your letter of March 28, 1950, outlining certain facts involved in a commitment by the Reconstruction Finance Corporation to make a loan of $11,100,000 to Texmass Petroleum Co., Dallas, Tex. You request my opinion on the following questions:

1. If the circumstances at the time a loan is approved by RFC are such as to indicate, on the basis of expert opinion, that there is not a reasonable prospect of its repayment in 10 years, is the undertaking to make the loan an act without authority of law, notwithstanding the fact that a maturity of 10 years is specified by the loan resolution?

2. Is the commitment to make the Texmass loan an act without authority of law?

The facts with respect to this loan as disclosed by the record before this office are as follows: Texmass owns or proposes to acquire certain oil properties in Texas and surrounding States which formerly had been the property of certain corporations and individuals, including two insurance companies which are expected to participate in the loan.

The application for a loan from Reconstruction Finance Corporation, in an amount in excess of that now proposed, first was made to the Dallas office, and on June 8, 1949, the examiner there recommended disapproval for the following

reasons:

"1. The purposes for which the proceeds are to be used do not conform with the policies of the Corporation with respect to loans to business enterprises, inasmuch as too large a portion of the loan (approximately 681⁄2 percent) is to be applied to repayment of existing indebtedness.

"2. The loan value which could be assigned to the collateral tendered, is not, in my opinion, of sufficient amount to reasonably secure the loan requested, or for a loan of an amount which would meet the applicant's requirements."

It appears that notwithstanding this recommendation the advisory committee and the agency manager at Dallas decided to recommend a loan of $15,925,000 and the application was forwarded to the Washington office of Reconstruction Finance Corporation in accordance with what is understood to be standard practice. The examiner to whom the case was assigned in the Washington office recommended that the application be "declined from a credit standpoint." It appears that this recommendation may have been influenced by the reports of a consulting geologist, M. M. Garrett, employed by Reconstruction Finance Corporation. One such report dated September 15, 1949, is quoted in your letter of March 28, 1950, and indicates that on the basis of ability to pay no loan of sufficient size to take care of the company's indebtedness is in any way justified, that only a rapid expansion of both assets and income would justify the loan at the figure given and that this can only be effected by placing the loan at a figure so high that it would not be secure. Mr. Garrett's comments as to the likelihood of the loan being repaid in 10 years are equally pessimistic. In a second letter dated September 15, 1949, to Mr. R. E. Burton, Reconstruction Finance Corporation, he stated:

* * *11

"Attached is a schedule of income, costs, etc. prepared by Mr. Morris Porter and others. I have examined this schedule and the supporting data. On the basis of the present price of oil, it is reasonable to assume that this schedule can be met and that the interest and principal applications on the loan will be as shown. "It might be further pointed out that to fully retire the loan on the basis of this schedule will require the time originally estimated of nearly 20 years. Further light on the security of the proposed loan and the likelihood of its repayment within 10 years is furnished by two prospectuses prepared on behalf of the borrower and filed with the Securities and Exchange Commission. first of these under the heading 'Nature of Offering' reads, in part, as follows: 66* * * On the basis of current income and operating and overhead expenses of the presently developed properties now owned by Texmass and proposed to be acquired pursuant to the Plan, with a reasonable allowance for prospective decline in production, the cash available from operations would be insufficient to cover the interest and annual principal installments of the RFC loan.

* * *""

The

Under the same heading in the final prospectus, we find the following language: "Even if during the 10-year loan period the company makes the minimum payments required by the loan agreement, there will remain at the end of such period an unpaid principal amount of approximately $6,150,000, which will then be due and owing. If this amount is not paid or refunded, the securities offered hereby, all of which rank junior to the loan, will in all probability be wiped out. Considering the above, investors should realize that the company's securities offered hereby are highly speculative, that they have no present value, and that any future value thereof is very remote and is dependent upon future development of substantial additional oil and gas reserves which cannot be counted upon.” Following the adverse report of the Washington examiner referred to above, the matter was referred to a review committee which after consideration again recommended that the application be declined for the following reasons: "1. The loan has little, if any, public interest.

"2. Proposed rehabilitation is in reality a salvage operation for which there should be a further injection of risk capital. A loan of an amount that would properly rehabilitate and develop the properties is not warranted.

"3. Loan is largely a bail-out of investors and certain creditors who presently appear to be faced with a loss.

4. Report of consultant, Mr. M. M. Garrett, is not encouraging as to repayment of loan from earnings and does not find sufficient tangible collateral."

On September 29, 1949, despite the adverse recommendations of the Dallas examiner, the consulting geologist, the Washington examiner and the review committee, the board of directors of Reconstruction Finance Corporation, apparently in complete reliance on reports submitted by the borrower's petroleum engineers who apparently did not inspect the properties, voted to authorize a loan of $15,100,000, Reconstruction Finance Corporation to participate to the extent of $11,100,000 with two insurance companies furnishing the remaining $4,000,000, a sum understood to be less than that which they shall receive from the proceeds of the Reconstruction Finance Corporation loan. Minutes of the meeting of the board of directors indicate that the resolution passed by a 2-to-1 vote, one director being absent and one present but not voting.

Section 4 (a) (1) of the Reconstruction Finance Corporation Act, as amended, 15 U. S. C. 604 (a) (1), provides that the Reconstruction Finance Corporation may make loans to any business enterprise organized or operating under the laws of any State or the United States subject to the limitations, inter alia, that (15 U. S. C. 604 (b) (1)) all such loans shall be of such sound value or so secured as reasonably to assure retirement or repayment and that (15 U. S. C. 604 (b) (2)) no such loan, including renewals or extensions thereof, may be made for a period or periods exceeding 10 years.

Replying specifically to the first question asked in your letter of March 28 and without particular reference to the loan here under consideration, it appears clear that the approval of a loan which reasonably cannot be expected to be repaid within 10 years, or in connection with which all parties recognize the probability that it cannot be so repaid would be an act without authority of law despite recitals in the loan resolution that the notes securing the loan should mature in 10 years.

Your letter recognizes that the law clearly requires the board of directors of the Reconstruction Finance Corporation to be responsible for all business judgments made in the conduct of that Corporation's affairs and that there is no authority either in your committee or in this Office to intervene in any transaction undertaken or contemplated by said board of directors. Nevertheless, the facts outlined above, gathered from information presently available, are such as to raise a serious question as to whether the granting of the loan here involved was in strict compliance with the law. Consequently, in the absence of additional evidence satisfactorily explaining the transaction, I shall feel compelled to make appropriate comment relative thereto in an audit report to the Congress under the Government Corporation Control Act (59 Stat. 597). The second question in your letter of March 28 is answered accordingly.

Sincerely yours.

As you will see, gentlemen, we simply have raised a question as to the propriety of this loan on the basis of the facts presently known to us. It may be that in the further consideration of the matter, additional facts will be brought to light which will remove such question. If not, then we will appropriately comment on the loan in our audit report for the fiscal year 1950.

Senator FULBRIGHT. Thank you, Mr. Warren. I have just a few questions I would like to raise. In your last paragraph there I wanted to draw you attention specifically to this language. I quote your letter:

The facts outlined above, gathered from information presently available, are such as to raise a serious question as to whether the granting of the loan here involved was in strict compliance with the law. Consequently, in the absence of additional evidence satisfactorily explaining the transaction, I shall feel compelled to make appropriate comment relative thereto in an audit report to the Congress under the Government Corporation Control Act.

It is true, is it not, that the audit report to which you refer under the law shall show specifically any program expenditure or other financial transaction or undertaking observed in the course of the audit which, in your opinion, has been carried on or made without authority of law? Mr. WARREN. That is absolutely correct, Senator.

In order that our authority and responsibility for auditing and reporting on the financial transactions of Government corporations may be perfectly clear, I will read sections 105 and 106 of the Government Corporation Control Act. These sections provide as follows:

SEC. 105. The financial transactions of wholly owned Government corporations shall be audited by the General Accounting Office in accordance with the principles and procedures applicable to commercial corporate transactions and under such rules and regulations as may be prescribed by the Comptroller General of the United States: Provided, That such rules and regulations may provide for the retention at the offices of such corporations, in whole or in part, of any accounts of accountable officers, covering corporate financial transactions, which are required by existing law to be settled and adjusted in the General Accounting Office,