Mr. Salik's company can only loan to a small business. They have to loan to a business that qualifies as a small business. These are loans to small businesses that are being made, otherwise he can't get the benefit of the act. The argument I make is that this does give the small business, as defined in the law, an opportunity to get the kind of long-term financing that every study-and we have had 25 of them shows that they haven't been able to achieve in the past.

So even though his firm is large and isn't limited by the $60,000 limit you suggest for the minimal firm, with 20 percent of capital and surplus, he is very limited by the fact that it must go to small business; he can't make a loan to General Motors or a medium size business and get any benefit. It has to be a small business.

On that score the argument that his loans are going into the small business community is cogent.

Mr. DEVORE. I would like to comment on the relative inactivity that he suggested of the small business companies.

Senator PROXMIRE. I would like to hear that. We want to get statistics. I am concerned about that.

Mr. DEVORE. We don't have statistics, but Mr. Noone can get them for you. I do know this. I am president of the Southwestern Regional Association, which is an affiliate of our national association, and I know of no inactivity there on the part of the minimum sized companies. In fact, most of them I have contact with are either loaned up or are almost loaned up. And I think that the statistics will reveal that most of the 303(b) money has been obtained by the minimum-sized companies, simply because they need it. They want to do as much as they can.

Senator PROXMIRE. But how about the practicality of this? It seems to me that you are the gentlemen who brought out the fact with a minimum size company you are working with $21,000 a year. You can't carry on any kind of an efficient operation where you have competent people to do any kind of a real job on $21,000 a year, can you?

Mr. DEVORE. No, sir; that was my testimony. In order to have such a company, you have to operate it as a sideline activity to some other business.

Senator PROXMIRE. You all agree that this just doesn't work out. If you can get up to the middle level matching which you are suggesting, which is in the bill, then

Mr. DEVORE. Then we feel we have reached a practical point where we can employ full-time executive talent.

Senator PROXMIRE. Something in the neighborhood of $85,000 to $100,000.

Mr. DEVORE. If we had a million dollars capital, as our shareholders have indicated they would be in favor of trying to get, and the benefits of this bill, we would have altogether a $4 million operation. Senator PROXMIRE. That is right. So you would have $200,000. Mr. DEVORE. We think that would certainly be economically sound. There may be a difference of opinion. Mr. Salik says $5 million, but we are dealing primarily with companies that we are not expecting to go public. The larger companies are more concerned and rightly so with the bigger small business companies, those which they think that they can help to go public. Each concept is good, but there is a place for everybody in this program.

Senator PROXMIRE. How about the companies that have started small and stayed small and are operating at close to the minimum. level; that haven't gone above, say, half a million, are they able to be active and perform a service, in your judgment?

Mr. DEVORE. Yes.

Senator PROXMIRE. Are they still in a position where if they make one mistake, that is the end?

Mr. DEVORE. No, not necessarily one mistake, but a mistake. That is leverage in the wrong way, where you have a mistake in a small company. It can be harmful. You have to be very careful because you not only have your money, but you have some of the Government's funds and you want to stay in business. So there are a lot of advantages to operating at a level above $150,000. There are a lot of disadvatages in operating at that minimum level.

Senator PROXMIRE. The difficulty is that you have agreed with Mr. Salik that this minimum level just doesn't work out very well for anybody concerned and yet we have overwhelming majority of firms at that level. As long as the Congress permits a company to be formed at $150,000, perhaps we are going to be plagued with that. Maybe we ought to increase the minimum up to half a million.

Mr. DEVORE. That would, of course, be a policy decision. My thought was that the Congress would perhaps be interested from a national standpoint in having a national minimum. There would be many areas of the country where perhaps a minimum size company would be more practical.

Senator PROXMIRE. The minimum seems to become the norm, if 90 percent of them get pretty close to it.

Mr. DEVORE. I think the great question about the future of this program is that 80 percent of the companies are minimum sized companies and the question is what are they going to do? They are either going to be locked in or they are going to struggle along and try to progress by various means. We think that the benefits of this legislation will help build these companies from the minimum size up to something more effective and significant in the program. That is why we are in favor of it.

Senator PROXMIRE. Mr. Noone.

Mr. NOONE. Mr. Chairman, I wanted to add this point. There is a positive inducement in the present act for companies to start on a minimum basis and stay close to the minimum. Under section 302 (a), the Small Business Administration can supply to a new company an amount not in excess of $150,000. If the organizers of the company contribute $200,000, then the maximum they can get from SBA is $100,000. This is why 90 percent of the companies are organized with that statutory minimum of $150,000.

Senator PROXMIRE. That is an excellent point.

Mr. NOONE. If they come in with more money, it reduces their leverage.

Senator PROXMIRE. It is a kind of reverse leverage. Mr. NOONE. Yes, it is. When they come in with $150,000, they get straight 2 to 1 leverage. If they come in with more than that, their leverage ratio is reduced. The Sparkman bill cures this defect in the present law, in that there would be a matching or private and Government funds on a dollar-for-dollar basis. If the principals wanted to

get another dollar of Government funds, they would have to invest a matching private dollar. This would be a positive inducement for these companies to increase their private capital.

Mr. HOWARD. Another factor we have to consider relating to the number of small companies as related to the total number of companies licensed is the fact that so many of them are new. Since the new Deputy Administrator, Mr. Fine, took over, I think the number of licenses that he has issued are over 100, which would be almost a third of the total number of licenses outstanding. We have found that many companies will start off small, with $300,000, until they get the feel of the program, and expand from there.

Mr. Ruvelson's company was a $300,000 company originally.
Senator PROXMIRE. That is the exception.

Mr. HOWARD. That is not the exception. There are a number of others who have gone the same way.

Senator PROXMIRE. It is the exception in that it has been said that 80 to 90 percent are still minimum.

Time is getting short. I would appreciate it if Mr. Noone and possibly Mr. Howard, if he chooses, would comment on the position that Mr. Cary, Chairman of the SEC, has taken relative to the suggested amendments to the Investment Company Act of 1940 and the other suggested amendments_made by Mr. Howard. I understand you have had a chance to see Mr. Cary's statement.

Mr. NOONE. We just received a copy of Mr. Cary's statement. Senator PROXMIRE. Mr. Cary will be here this afternoon and we would like to have your views.

Mr. NOONE. On a first reading of his testimony, it appears that the SEC is opposing the proposal for stock options. Mr. Cary is announcing that the Commission has under consideration rules which would answer, at least in part, our requests for exemptions under sections 17 (a), 17(d) and 18 (c).

He is opposing the proposal of the bill for the section 30 (f) exemption. He did not indicate the actual language of the rules in his testimony. We have not seen them, and we would have to reserve com

ment.

Mr. HOWARD. There are a couple of points in Mr. Cary's statement on which I would like to comment.

In commenting on this, he says it is doubtful that the bill will accomplish the purpose of limiting insider trader profits as the bill is currently drafted. These are comments on H.R. 6672. This is probably true because the present language of the bill is technically insufficient. My statement submits language which would cover that. Because of the nature of the transaction, the 6-month period is a sliding period, so that each day you start a new 6-month period. Any purchases and sales during that 6-month period would apply.

The language that I have in my statement which I have submitted covers his written objection. It would cover a continuing period and would specifically restrict the profits on the trading activities of investment bankers to 5 percent. This 5 percent is similar to the provisions of the NASD, which govern activities of investment bankers, and we believe is a reasonable one.

Also, another comment that he made was that the language as drawn would cover all types of insider transactions and this is correct.

We suggest and have submitted language which would restrict this 5-percent trading profit to investment bankers only in the normal course of their business. The language of the bill as drafted is defective in that respect. The proposal that we have in here covers that. Otherwise, Mr. Cary on section 30 (f) has no major comments, except to point out literally that the bill would not accomplish, as it is drawn, what is proposed. I agree with him on that. We have language which would correct that point.

Senator PROXMIRE. Thank you, Mr. Howard and Mr. Noone.

If you gentlemen don't have anything that you would like to add in conclusion here, I would like to thank you very, very much for an excellent presentation, very helpful. I think this has been a very useful morning. We have had two viewpoints from the industry, all practical, all from people who have worked in it, and who understand it, and I think this hearing will be enlightening for all of us. Thank you very, very much.

(The prepared statement of Mr. Howard, with exhibits, follows:) STATEMENT OF JAMES W. HOWARD, SECOND VICE PRESIDENT, NATIONAL ASSOCIATION OF SMALL BUSINESS INVESTMENT COMPANIES

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 those 28 companies are members of our national association. As a result of my conferences and correspondence with the managers of the publicly owned SBIC's, I can state that the views I am about to express accurately reflect the views of the vast majority of the publicly owned SBIC's.

Small business investment companies raising funds through public offerings of their stock 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 and at the annual meeting of the membership of our association held here in Washington last December, the membership voted to urge Congress this year to consider enacting specific exemptions for SBIC's from those sections of the Investment Company Act of 1940 causing particular difficulties for licensees. We are gratified to 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.

Before I discuss section 9 of S. 902 and section 10 of H.R. 6672, I would like to review briefly the history and purpose of the 1940 act and to compare the regulation of SBIC's with that of investment trusts.

In 1935 Congress, in section 30 of the Public Utility Holding Company Act, directed the Securities and Exchange Commission ("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 company 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." These companies had been in existence since before the turn of the century but had grown tremendously in size and number during the 1920's. As of 1940 investment trusts held assets of an approximate value of $4 billion although

some $7 billion had been invested by the public in these companies. The Commission's reports revealed many abuses which had occurred in the management and operation of these companies.

Judge Robert E. Healy, a member of the Commission, was in charge of the investment trust investigation. Judge Healy testified at length before congressional committees conisdering the enactment of the 1940 act. During the hearings before the Senate Subcommittee on Banking and Currency in April of 1940, Judge Healy described the basic problem in a written statement (beginning at p. 34):

"Speaking generally these organizations have made comparatively little original contribution of capital to industry, the investments for the most part being in securities already issued and outstanding. The reason for that I think will appear before the hearings are over. * * *

"Because of the large public interest in these organizations, and because these investment trusts and investment companies represent unsurpervised pools of savings, these institutions have been a matter of concern to representatives of the investment company industry, stock exchange, financial writers, and governmental bodies from the early period of their existence in this country. The potential dangers of these organizations have been indicated and with the passing years criticism has increased. * * *

"In general, everyone seems to be pretty much agreed that the functions of the investment trusts should be to afford the small investor an opportunity to spread his investment risks by a diversification of security holdings, to furnish competent and continuing investment supervision, and to assist in making capital available for industry. In a great many instances these objectives have not been realized. The failure may be attributed to certain fundamental causes. "First, there has been no regulation with respect to the individuals who may organize and operate these companies. The bill provides for the registration of officers, directors, managers, and underwriters of investment trusts and companies. *** The purpose of this provision is to prevent persons with unsavory records from occupying these positions where they have so much power and where faithfulness to the fiduciary obligation is so important.

"Second, it is perhaps not too much to say that the disregard of fiduciary standards lies at the root of many investment-company problems. The fiduciary obligation of the management to stockholders is too often violated or disregarded. The bill undertakes to impose specific conditions which will insure the observance of this fundamental obligation.

"Third, many investment companies have adopted complicated and precarious forms of capital structure. Under this bill they will be required to follow more conservative standards. In view of the nature and functions of these companies, I believe that there is no excuse for pyramiding or for more than one class of securities in their capital structures.

"Fourth, adequate accounting regulation is in my opinion fundamental, if these companies are ever to serve the purposes for which they should be designed. "Fifth, some public supervision over mergers, consolidations, and other reorganizations is necessary for the protection of investors. The investor is singularly helpless under such circumstances."

The resulting Senate report (No. 1775, 76th Cong., 3d sess., June 6, 1940), 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. These assets can and have been easily misappropriated and diverted by such types of managements, and have been employed to foster their personal interests rather than the interests of public security holders. It is obvious that in the absence of regulatory legislation, individuals who lack integrity will continue to be attracted by the opportunities for personal profit available in the control of the liquid assets of investment companies and that deficiencies which have occurred in the past will continue to occur in the future" (at p. 6).

In section 1 of the 1940 act the congressional findings and declaration of policy is set forth. This section itemizes the various abuses found to have existed and follows closely the statement of Judge Healy before the Senate committee quoted above.