ORGANIZATIONAL CHANGES IN SBA

Section 2 of the bill repeals title II of the Small Business Investment Act of 1958, which I will refer to hereafter in this statement as the act.

In contrast to the other divisions of the Small Business Administration, which are creatures of the Administrator and can be abolished or reformed by him at any time, the Investment Division (ID) is established by title II on a statutory basis. In substance, title II also provides that the powers conferred upon the Administration under the act are to be exercised by the Administration through the Investment Division and that the powers conferred upon the Administrator thereunder are to be exercised by him through the Deputy Administrator in charge of such Division.

Title II could be, perhaps has been, construed as meaning that all actions by the Administrator pursuant to the act must, without exception, be taken by him through the Deputy Administrator for ID. Such an interpretation is erroneous, because it is entirely inconsistent with the responsibilities vested in the Administrator by the act. Rather, the underlying intent of title II is simply that ID is to be the normal instrumentality of the Administrator in promoting the small business investment program. It does not preclude him from taking direct action, independently of ID, where he finds such action appropriate.

The repeal of title II, placing ID on the same basis as the other Divisions of SBA, will eliminate any question as to the validity of actions taken by the Administrator. Such clarification is particularly important at the present time in view of the extensive efforts which I am now making to strengthen the small business investment company program.

The repeal of title II should be viewed as a prelude to a more successful, a more effective program. It opens the way to more extensive supervision and more active participation by the Administrator. It brings to the investment program all of the benefits of a diversified agency with wide experience in conducting financial and management assistance programs.

A related organization change, contemplated by section 8 of the bill, revises the title of the present Deputy Administrators to that of Associate Administrators. At the same time it authorizes the appointment of a single Deputy Administrator to assist the Administrator. This new Deputy will be empowered to function as Acting Administrator during the absence or disability of the Administrator or in the event of a vacancy in the office of Administrator.

At the present time SBA is one of the few agencies of the Government which lacks specific authorization for such an acting head. This should be remedied. It is important to note that the salaries and status of the present Deputy Administrators are not affected by the proposed change. Under perfecting language which we are submitting, the Deputy Administrator would be established at level IV of the pay scale and the Associate Administrators, the present Deputy Administrators, would remain at level V.

AUTHORITY OF SBA TO ACT AS RECEIVER

Section 7 of the bill would authorize SBA to act as trustee or receiver of an SBIC, when so appointed by a court. This proposal is in the nature of a clarifying amendment. It is believed that the authority already exists. In at least one case, it has been exercised.

Experience has demonstrated the difficulty of obtaining a qualified person to act as trustee or receiver of an SBIC. In many cases the search for such a person has led to delays during which the position of the company has deteriorated. In other cases unqualified appointees, finding themselves unable to handle the affairs of the company, have asked the court to be relieved.

In large part this situation is due to the fact that SBIC's represent a relatively new type of financial institution whose nature and characteristics are not commonly known, even among people otherwise versed in the fields of banking and investment. Similarly, the applicable laws and regulations are not widely

known and understood.

On the other hand SBA has at its disposal personnel who are familiar with the industry and who, in most cases, are familiar also with the background of the particular SBIC involved-its problems and the causes thereof, the nature of its investments, its financial status, etc. Such knowledge, which cannot readily be transmitted to a person new to the situation, may thus be promptly brought into play by the appointment of SBA as trustee or receiver.

In every instance, it should be noted, the question whether SBA is to be appointed as trustee or receiver rests entirely with the court. Such an appointment would never be made where it would be to the disadvantage of creditors of the SBIC other than SBA. The agency would serve usually only where it is the principal creditor or, as is often the case, the sole creditor.

ADMINISTRATIVE REVOCATION OF SBIC LICENSES

In substance, section 5 of the bill would authorize SBA to revoke by administrative action the licenses of SBIC's guilty of violation so serious as to call for their removal from the program. The only existing means of obtaining this result is through court action, pursuant to section 308 (d) of the act, entailing the delays which usually accompany such litigation.

Specifically, such administrative revocation would be authorized for willful or repeated failure to observe any provision of the act or of any rule or regulation issued thereunder; or for willful or persistent violation of any cease-anddesist order issued by SBA. It would also be authorized for falsehoods or misleading assertions knowingly included in any statement required by SBA.

Under existing law the strongest administrative sanction available for such offenses is suspension of the violator's license; and, in the case of falsehoods or misleading assertions, even this remedy can be invoked only where the statement involved was filed for the purpose of obtaining a license.

Suspension is not an adequate administrative tool for dealing with SBIC's which have demonstrated, by the gravity of their offenses, that they are likely beyond redemption. In such cases suspension does not reach the issue, because it contemplates the eventual restoration to the program of parties who likely should not remain in it.

Typically, the more appropriate solution is prompt revocation, prompt expul sion from the program. Section 5 of the bill would provide this solution without depriving such companies of their rights. It should be emphasized that they would enjoy all of the protection afforded by the Administrative Procedure Act, and by judicial review, against arbitrary action.

This administrative authority will be particularly useful as a means of removing from the program inactive SBIC's the ones which have simply sat on their funds, including those obtained from the Government, and refused to use them for the benefit of small business.

MORE EFFECTIVE ADMINISTRATIVE SANCTIONS

In substance, section 6 of the bill provides that a violation of the act or the regulations by an SBIC is, at the same time, a violation on the part of the officers, directors, or agents of the company who participated in or were otherwise responsible for the company's violation. This is a recognition of the fact that a company can act only through its management personnel and that the guilt for the company's violation is basically theirs.

At the present time SBA can proceed only against the SBIC. Such a proceeding, not including as parties the people who actually committed the offense, can hardly produce satisfactory results. Moreover, it is an anomaly to authorize SBA to investigate individuals as well as SBIC's, pursuant to section 310 of the act, and at the same time deny the agency a prompt and effective means of following up on resulting evidence of violations by such individuals. The amendment, permitting us to reach beyond the company and deal directly with the offenders themselves, will greatly strengthen our enforcement. We could order them, as individuals, to take such action or refrain from such action as may be necessary to remedy the situation. Since failure to comply would expose them to personal liability, such orders will be much more effective than those issued against a company.

In further contrast to existing law, section 5 authorizes SBA to prohibit by administrative action violations which, though not yet consummated, are about to be committed. For example, SBA may discover, while it is still in the executory state, a contract made by an SBIC calling for the performance of an action which will violate the law or the regulations. The agency shoud not be compelled to wait until the performance occurs. Nor should it be limited to court action, pursuant to section 311 of the act, as a means of presenting it. Since time may be of the essence in such a case, SBA should have at its disposal the prompt administrative remedy proposed by section 5.

A related feature of the bill, also contained in section 5, is authority for SBA to direct by administrative action the removal of an SBIC official who violates the act or the regulations and to prohibit him from further participation in the conduct of the company, subject, of course, to the safeguards of the Administrative Procedure Act. Such action would be taken only where serious offenses are involved and only where there is no other means of insuring against a repetition of them.

The removal authority we are requesting is, essentially, a means of saving SBIC's which might otherwise be lost to the program. It will be useful in cases where one or more individuals associated with a company, rather than the company itself, are the root of the trouble.

As a means of minimizing the number of potential troublemakers in the program, section 6 of the bill prohibits anyone from hereafter becoming an SBIC official, without the written consent of the Administrator, who has been convicted of felony or of any crime involving dishonesty or breach of trust or who has had a judgment or court order entered against him in civil proceedings for conduct involving dishonesty or breach of trust. Similarly a person already serving as an SBIC official will not be permitted to continue if he hereafter commits such an offense.

This in my mind makes much sense.

MORE EFFECTIVE JUDICIAL SANCTIONS

Section 6 of the bill contains a provision that any officer or director of an SBIC who knowingly participates in a violation of the act or the regulations relating to the disbursement of funds or the lending of credit by the company shall be personally liable for, and shall unconditionally guarantee repayment of to SBA, all indebtedness then owing to SBA by the company. In no case, however, shall such guarantee or personal liability exceed the lesser of the amount of the resulting loss or damage incurred by the company or the amount of the indebtedness then owing to SBA by the company.

This feature of the bill is directed against individuals who convert to their own use the funds of a company, including the funds furnished by the Government, and thus reduce it to an empty shell. Under existing law our only remedy is against the shell. The amendment would hold the guilty parties personally accountable.

It is hardly necessary to say that this new liability has no practical significance for the great majority of the people in the industry. The honest have nothing to fear from it. The target is the unscrupulous element in the program which, though small enough, presents a real problem.

We must be tough with wrongdoers. This proposal is a measure of my determination to have a full reckoning with anyone who hereafter diverts to his pockets the funds the Government is putting into the program for the benefit of small business.

Another judicial sanction we are requesting is the establishment of penalties and forfeitures for SBIC's which fail to make timely filings of reports required by the act or the regulations. There is going to be no more coaxing or hesitation in dealing with delinquents. The bill would authorize a penalty of up to $100 per day for every day of delay. Finally, the bill closes a jurisdictional loophole which has sometimes prevented us from taking action in a single court proceeding against both an SBIC and its officials.

EXAMINATION OF PORTFOLIO COMPANIES

Section 4 of the bill would authorize SBA to examine small firms receiving financial assistance from SBIC's, where the Administrator considers such examination necessary or appropriate.

There are a number of reasons why SBA may have reason to conduct such an examination, and they all spring from our duty to insure that SBIC's are operating in accordance with the provisions of the act and our regulations. To take an outstanding example, we cannot always tell by examining the books of an SBIC whether its capital has become impaired. Where we have reason to suspect that one or more of its larger investments is unsound, thereby creating danger of impairment, there is only one sure way to get the answer: We have to look at the condition of the recipients of those investments.

We sometimes have difficulty in obtaining such a look, because we lack clear authority to examine portfolio companies. Small firms may be reluctant to submit. We believe that the proposed amendment, providing us with clear authority, would make small firms more receptive to examination by us. It would thus facilitate our efforts to insure that SBIC's are operating in accordance with the provisions of the act and the regulations.

Let me emphasize that there would be no stigma attached to the small business in being examined by SBA. Indeed, in some cases (as where the SBIC has overreached or misrepresented to the detriment of the small concern) the SBA examination could help the small firm by enabling corrective action. And it should be remembered that any such examination could be made only when considered necessary or appropriate in the opinion of the Administrator.

The examination procedure would allow SBA to readily verify the books of an SBIC against the books of a portfolio small concern. It also could be useful in situations where an SBIC is in liquidation, or has been liquidated and SBA as creditor, has had to take over its portfolio.

By providing a means for checking portfolio small concerns in connection with the examination of SBIC's, this amendment would greatly improve the efficiency and effectiveness of SBA's regulatory operations.

CONCLUSION

Mr. Chairman, we believe that this legislation is urgently needed. The SBIC program, once it is operating properly, has enormous potential. The sooner we can make sure that it does operate properly, the sooner this potential will be realized.

Thank you.

Senator HARRIS. I will hand you the examination report of SBA dated November 19, 1965, on Frontiers Capital Corp., and ask you if this is a true and accurate copy of that report which was filed? (The document was handed to the witness.)

Mr. PHELAN. Yes.

Senator HARRIS. It will be received into evidence and marked "Exhibit 44."

(Document referred to marked "Exhibit No. 44" for reference and may be found in the files of the subcommittee.)

Senator HARRIS. I also hand you what is a memorandum identified as a memorandum from the Deputy Administrator with regard to Frontiers Capital Corp., dated November 19, 1965. Attached to it is a cease-and-desist and suspension order.

I ask you if you can identify that as an authentic copy of the original on file with SBA?

(The document was handed to the witness.)

Mr. CAMPBELL. Yes.

Senator HARRIS. I am going to refer to both of these documents. Referring first to the examination report of November 19, 1965-you did say you could identify that, did you?

Mr. CAMPBELL. Yes, I do, Senator.

Senator HARRIS. It will be admitted into evidence as exhibit 45 A and B.

(Documents referred to marked "Exhibits Nos. 45A and 45B" for reference and may be found in the files of the subcommittee.) Senator HARRIS. Now back to exhibit 44.

This examination, though it was rather cursory, did reveal overline loans due to common ownership and affiliation totaling $235,000; is that

correct?

Who is going to testify to that?

That is correct, isn't it, about the overline amounts? It is on page 2 of the examination.

Mr. LEISY. Yes, sir.

Senator HARRIS. It showed conflict-of-interest loans to two companies. It showed several other violations listed there, A through G, and it showed that one of the principals of Frontiers had an overdraft at a bank of $90,000. Yet, nothing was done by SBA, as I understand it, until the investigation was launched in March of this year. Is that correct?

Mr. LEISY. No legal action was taken against them.

Senator HARRIS. Not only that, but no investigation was started. Mr. LEISY. No formal investigation was started, that is right.

Senator HARRIS. Even though these items indicated violations by your own examination, no investigation into them or further into the company was launched at that time, and, indeed, not until March of this year.

Mr. LEISY. That is right, no formal investigation was started until March.

Senator HARRIS. Look at exhibit 45, which was a temporary ceaseand-desist order entered November 19, 1965. Testify whether or not it had anything to do with this examination.

Actually, isn't this true, that it just had something to do with whether or not they were filing their reports on time?

Mr. LEISY. That is true, Senator.

Senator HARRIS. So you just issued a temporary cease-and-desist order about filing reports but did nothing at that time in connection with these violations the examination had revealed, is that correct?

Mr. LEISY. Yes, that is correct. We proceeded to collect other information in various ways, but did not open our order of investigation until March.

Senator HARRIS. You made no move to try to protect the assets of the company or the interest of the Government? You didn't refer the matter to Justice until when?

Mr. LEISY. June 1966.

Senator HARRIS. June of 1966.

Mr. LEISY. June 8, I believe it was.

Senator HARRIS. Was the later decision this year to have a formal investigation as a result of the interest of this subcommittee, and the activity of its staff? Do any of you know that?

Mr. LEISY. I do not know.

Senator HARRIS. Do any of the rest of you know?

Mr. CAMPBELL. I do not know, Senator.

Mr. SHELTON. No, sir.

Senator MUNDT. Somebody ought to know.

Mr. Greenberg, who would know?

Mr. GREENBERG. Bob, don't you know the answer as to whether or not that was

Mr. LEISY. What was the question?

Senator HARRIS. You did not do anything based on violations shown by your own examination in November? What caused you to start a formal investigation in March? Did it have to do with this subcommittee's interest and the activity of its staff?