while at the same time lending greater stability and strength to this new industry.

We believe that sections 3 and 4 are sound and well conceived. Licensees will benefit by those provisions as proposed only if they themselves invest the increased funds necessary to enable them to qualify for the benefits proposed under sections 3 and 4.

This is in line with the expressed intent of Congress to encourage private investment in this program.

At the same time, the Government funds will be returning interest to the Government and will be repayable in full by the licensees receiving them.

In a sense then, sections 3 and 4 of Senator Sparkman's bill propose simply that the Government join hands with privates citizens for a limited period of time to insure the accomplishment of the purposes set forth by the Congress in its enactment of the Small Business Investment Act of 1958.

The present law provides for a partnership between the Government and the private citizens who invested their own funds to launch small business investment companies. On the basis of the record to date, the program shows great promise, but it is clear that it needs an important stimulant if it is to achieve its full potential.

Sections 3 and 4 of the Sparkman bill suggest the nature of that stimulant-increased contributions to the partnership by both the Government and private investors-to bring all companies up to a more realistic and more effective operating level.

After 2 years of operating experience as president of a minimumsize SBIC, I can state without qualification that

(a) Such an SBIC must exist as a part-time business, a sideline to other business activities;

(b) As a sideline operation, it is insufficient, both in management time and capital, to effectively meet the equity needs of small business; and

(c) Section 303 (b) of the present law, offering just 50 cents of additional Government funds for each new dollar of private funds invested in an SBIC, is insufficient to attract additional private funds to a minimum-size SBIC.

In the case of our company, we are planning to increase our capital to at least $1 million through private subscription if S. 902 is enacted. The enactment of this bill would also justify our employment of fulltime management.

We have found great interest among our shareholders in increasing their contributions to the capital of our company if they are permitted to do so on the basis proposed in this bill.

With the enactment of this legislation, we are confident that private capital will be forthcoming to build all present minimum-size ŜBIC's into profitable and dynamic sources of equity capital throughout America.

The entire membership of our association enthusiastically supports and urges the adoption of S. 902. If enacted into law, this legislation will enable us to more effectively meet the great challenge of American capitalism today, and that is to see that small business grows and survives.

In addition to that, Mr. Chairman, I would like to comment on a proposal made Monday by Mr. John Horne, the SBA Administrator.

Mr. Horne suggested that Congress set a limit of $5 million on the total of section 303 (b) funds which any one licensee might borrow from the Small Business Administration. While our association as an association has taken no formal position on this suggestion in view of the recentness of it, we can and do admit to some logic in setting a maximum limit to these borrowings.

On the other hand, we would like to point out and call to your attention that several SBIC's have already received public funds totaling more than $10 million. By "public funds" we are talking about funds from a public issue of their stock. They have sold stock in the amount of more than $10 million.

The stockholders of these companies have been told that the SBIC could borrow up to 50 percent of the total capital and surplus from the SBA.

Mr. Horne's proposal would change the ground rules for these companies.

Therefore, we feel that this limitation, if made at all, should be set at no less than $10 million.

That concludes my testimony, and it has been a pleasure to be here. Senator PROXMIRE. Thank you very much, Mr. DeVore.

The final statement is by Mr. Howard. We welcome it, but it is a pretty formidable looking one. It is 20 pages. We would appreciate it if you can summarize it and we can put the whole statement in the record. You can summarize it like Mr. Salik did, if you would be willing to do that.

Mr. HOWARD. That is perfectly all right.

Senator PROXMIRE. Without objection, the entire statement of Mr. Howard will be placed in the record at the end of his oral presentation. Go ahead and summarize.

Mr. HOWARD. I would like to hit a few of the key points in the

statement.

First, my name is James W. Howard. I am president of Growth Capital, Inc., of Cleveland, and second vice president of the National Association of Small Business Investment Companies.

I appear today in my capacity as chairman of the Committee on Publicly Owned SBIC's of the National Association of Small Business Investment Companies.

As of July 1, stocks of 28 licensed small business investment companies were being publicly traded; 22 of these 28 companies are members of our association.

As a result of my conferences and correspondence with the managers of the various publicly owned SBIC's, I can state that the views that I am about to express accurately reflect the views of the majority of those publicly owned SBIC's.

Small business investment companies having private offerings are, of course, subject to registration with the Securities and Exchange Commission under both the Securities Act of 1933 and the Investment Company Act of 1940. In the hearings in the House last year on S. 2611, after that bill had passed the Senate, representatives of our association strongly urged the committee to exempt SBIC's in toto from the provision of the 1940 act.

The House committee did not act on this recommendation.

At the annual meeting of our membership here in Washington last December, the membership voted to ask for certain exemptions from rather specific provisions that we felt could permit us to operate satisfactorily.

We note that the companion bill to S. 902, H.R. 6672, does propose certain exemptions for SBIC's from some of the most troublesome features of the 1940 act.

With the exception of certain technicalities on which I shall offer suggestions in a moment, I can assure the committee that the publicly owned companies belonging to our association are strongly in favor of these proposals.

I offer copies of H.R. 6672 for reference purposes.

Senator PROXMIRE. May I ask at this point: Have you had any kind of mail referendum or any kind of meeting where the members have gone on record in any way?

Mr. HOWARD. We have a committee on publicly held SBIC's, and we have had considerable discussion with them, correspondence with the majority of them, all of those who are members of our association, and we have had correspondence both on my part and through our national office represented by Mr. Noone.

Senator PROXMIRE. How many letters have you had on it?

Mr. HOWARD. I have received about five letters. I have had telephone conversations with perhaps 15. And we had a committee meeting here in Washington about 4 weeks ago discussing various features of the proposed legislation.

In 1935, Congress, in section 30 of the Public Utility Holding Company Act, directed the Securities and Exchange Commission to make a study of investment trusts. This direction was motivated by the discovery that investment trusts were often found at the top of the pyramid in the public utility holding companying complexes of that period.

Pursuant to this instruction, the Commission made an extensive investigation of this industry which resulted in a series of reports. It should be noted that these reports were based on a study of an existing industry generally referred to as "investment trusts.'

Judge Robert E. Healy of the Commission was in charge of the investment trust investigation. Judge Healy testified at length before congressional committees considering the enactment of the 1940 act and described the basic problem in a written statement as follows: Speaking generally—

he said:

these organizations have made comparatively little original contribution to capital to industry * * *

He also went on to say:

First, there has been no regulation with respect to the individuals who may organize and operate these companies.

Second, it is perhaps not too much to say that the disregard of fiduciary standards lies at the root of many investment company problems.

Third, many investment companies have adopted complicated and precarious forms of capital structure.

Fourth, adequate accounting regulation is in my opinion fundamental.

Fifth, some public supervision over mergers, consolidations, and other reorganizations is necessary for the protection of investors.

The resulting Senate report recommending the bill for passage contained the following analysis of the basic reason for the necessity of regulation of investment trusts:

Basically the problems flow from the very nature of the assets of investment companies. The assets of such companies invariably consist of cash and securities, assets which are completely liquid, mobile and readily negotiable. Because of these characteristics, control of such funds offers manifold opportunities for exploitation by the unscrupulous managements of some companies.

Section 3 of the 1940 act exempts from the act certain types of companies. Both the Senate and House reports are silent as to the reasons for the various exemptions made.

The congressional intent must therefore be derived from the nature of the exemptions themselves.

Section 3 exempts, among others, security dealers and brokers, banks, insurance companies, savings and loan associations, cooperative banks, homestead associations, small loan companies, industrial banking companies or "similar businesses," mortgage loan companies, and companies subject to regulation under the Interstate Commerce Act or the Public Utility Holding Company Act.

It can be readily seen that most, if not all, of the companies listed are subject to some type of State or Federal regulation or licensing, or are essentially financing companies.

In summary, it can be concluded that the purpose of the 1940 act was to regulate a therefore unregulated industry which had a defined existence and which had been prone to many abuses. Specific exemptions were afforded for companies which might otherwise be considered to come within the definition of an investment company, but which were subject to other regulations by State or Federal authorities, or which were primarily financing type operations.

In Senate Report No. 833, 86th Congress, 1st session August 27, 1959, the Senate Committee on Banking and Currency, in reporting on proposed amendments to the SBIA, commented as follows:

The Small Business Investment Act of 1958 (Public Law 85-699) established a program to facilitate the formation of an entirely new type of company, licensed by the Small Business Administration and regulated by that agency.

This quotation documents two basic points. The first is that the SBIC program is an entirely new industry. It is not an investment trust as in existence at the time the 1940 act was adopted, but is essentially a financing program to provide long-term loans and equity capital to small business concerns. As such, As such, an SBIC is comparable to the banks, savings and loan associations, insurance companies, and the like, expressly exempted from the 1940 act. In fact, the SBIA was specifically designed to meet the small business "equity gap” not met by these other financing institutions. The second point illustrated by the above quotation is the fact that the SBIC industry is licensed and regulated by the SBA. As hereinafter pointed out, this regulation is far more comprehensive than regulation of many small loan companies, banks, insurance companies, and the like, and in many respects, is more restrictive than that to which investment trusts are subject under the 1940 act.

With respect to the essential nature of an SBIC as a financing or banking operation, it must be remembered that an SBIC can invest only in long-term loans (from 5- to 20-year term) or in various equity

capital securities in accordance with the provisions of the SBIA and the regulations thereunder. Prior to the 1960 amendments to the SBIA, no direct investments in stock were permitted. It appears clear from the nature of the program that the great bulk of investments by SBIC's will continue to be in debt securities. The SBA has reported that as of December 31, 1960, SBIC's had invested approximately $48,540,000 in debt securities and only $4,003,000 in stock of small business concerns.

None of the investments of an SBIC can be in outstanding securities of the small business concern, but must be acquired directly from the issuer. This is in sharp contrast to the practice of investment trusts. As pointed out by Judge Healy in his statement to the Senate committee quoted above:

* these organizations had made comparatively little original contribution of capital to industry, the investments for the most part being in securities already issued and outstanding.

It should also be noted that an SBIC can purchase such securities only from companies coming within the SBA definition of "small business concern." Investment of idle operating funds must be in securities issued by the U.S. Government or guaranteed by it. In the great majority of cases the securities of a small-business concern are, for all practical purposes, nonnegotiable. In relatively few cases is there any "market" in such securities and what market there may be in the few cases where quotations are available is generally an extremely thin market and does not represent a potential for sale or trading of any substantial block of such securities. This situation should be contrasted with the description in the Senate report on the 1940 act quoted above.

In this report it is stated that the basic problems in the investment trust industry flow from the nature of the assets of these companies which

invariably consist of cash and securities, assets which are completely liquid, mobile, and readily negotiable. Because of these characteristics, control of these funds offers manifold opportunities for exploitation by the unscrupulous managements of some companies.

It can be readily seen that what Congress considered to be the basic cause of the problems of the investment trust, which brought on the enactment of the 1940 act, is not found in the SBIC industry.

I would now like to discuss in detail section 9 of S. 902. This section of the bill would permit SBIC's to issue restricted stock options qualifying under section 421 of the Internal Revenue Code of 1954. Companies subject to the Investment Company Act of 1940 are now barred from issuing such options.

The restricted stock options authorized under section 421 of the Internal Revenue Code of 1954 are subject to several important restrictions, among them being the fact that they may be made available only to officers or employees. Regulations issued by the Small Business Administration permit the issuance of options not only to officers and employees but also to others rendering services to a licensee. SBA's position on stock options is, we believe, patently sound and commendable. We believe that in equity, the fact that any SBIC's are subject to the Investment Company Act of 1940 should not pose a bar for their use of restricted stock options. In the larger,

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