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It was distressing to learn of the failure by SBA to check out the people who were going to receive U.S. money; to learn that companies with Government funds could go as long as 4 years without examination; to learn that the accounting system had broken down; to learn that nobody knows and will not know till later how much money the Government may lose in this program; to learn that little has been done to salvage the assets of companies in trouble.
It was shocking to find such a small effort had been made by SBA to weed out the cheats, the swindlers, and the incompetents from the program.
It is a sad commentary that the SBA, which has the responsibility through this program to stimulate, encourage, and nourish small business, has set such a sorry example in its own lax and inefficient business practices in regard to small business investment companies.
The individual companies we have examined have also produced some ugly realities. In one case on which we heard testimony there was a blatant piracy of a corporation financed with Federal funds by men who had no money of their own at risk at all.
The other cases were almost as bad, and they showed the same pattern: "bootstrapping" the operation with somebody else's money; selfserving loans to companies owned and controlled by the same individuals; the use of corporate money-including Government moneyfor personal purposes; and, finally and unfortunately, an apathy and lethargy on the part of SBA which allowed these situations to exist for an intolerably long period.
In one of the cases, based on information from the subcommittee staff, the SBA did move and as a result $400,000 was retrieved for the Government. In the other two, it appears that there will be losses of 100 percent, or a total of almost a million and a half dollars lost by the Government.
We certainly don't want to rock the boat while Mr. Boutin is going ahead full steam with his corrective program. But Congress does have a real interest here and I am going to ask our staff to continue inquiries into other problem areas which we have not discussed in depth here. It is entirely possible that after the crash examination program is completed by SBA and an estimate of losses on a realistic basis is available, we may ask Mr. Boutin to come back and report to us on these subjects. In the meantime, I know we can count on the continued splendid cooperation we have received from Mr. Boutin and his staff.
I will be working closely with the staff to prepare some recommendations on suggested legislation, for consideration by the subcommittee. Finally, in view of some brazenly fraudulent activities which were testified to in the hearings, I am asking the staff to forward the transcript to the Department of Justice, the Internal Revenue Service, and the Federal Deposit Insurance Corporation for appropriate action.
(Letters acknowledging receipt of transcripts by the Department of Justice and the Federal Deposit Insurance Corporation will be found in the appendix on pp. 302-303; also letter from Mr. B. L. Boutin, Small Business Administration appears in the appendix on p. 303.)
Senator HARRIS. Senator Mundt.
Senator MUNDT. Thank you, Mr. Chairman. I want to associate myself first of all with the statement that I, too, feel that Mr. Boutin
has made some constructive suggestions and I share the hope that he will devote his talent and diligence to correct what is indeed a rather sorrowful set of conditions existing within the SBIC program. I think Congress would do well to continue its scrutiny of that program for several months to come.
Our hearings revealed that a GAO examination of six SBIC's, and our staff indepth examination of three SBIC's, indicate serious laxity in the administration of the SBIC program, including considerable dollar losses to the Government in many instances, and in fact the testimony of Mr. Kelley corroborates the fact that there were these laxities and the weaknesses in the administrative setup.
Among other things, we have seen (1) a lack of adequate licensing procedures for new and "change of control" SBIC's; (2) a failure to follow up any supervision or suggestions to these SBIC's; (3) a lack of examinations and auditing of the SBIC's; (4) a failure to act by the Small Business Administration when danger signals were detected.
I think one of the weaknesses in this program is something we have not gone into to any great extent, but there has tended to be too small a proprietary investment on the part of the organizers of SBIC's. They have relied too much on Federal money and not enough on their own. Whenever that happens, as we found in the FHA and other programs, you are heading for disaster. It is an invitation to disaster to tell any private citizen that he can get all of the Federal money he needs without raising some of his own funds to get into some kind of promotional activity.
As stated in the hearings, some 240 of approximately 700 existing SBIC's are in varying degrees of trouble and at least $18 million of Government money has shown to be lost. When Mr. Boutin's program evaluation report comes in, I am sure it will show that considerable more than $18 million will have been lost and a substantially larger sum is in serious jeopardy.
In my opening statement, I posed a question as to whether this “specialty line” SBIC program is necessary and useful, and, if so, whether it is being carried out properly and adequately. Unfortunately, our hearings dealt with the problem companies. I wish we had had testimony available to us of some examples of how the SBIC's have served the small business community and served them successfully. I think we will see that commendable work has been done by SBIC's and something should be done to salvage that kind of activity by putting up an absolute roadblock against the kinds of shenanigans revealed here. There is no justification for a single type of situation such as the nine cases which we have had before us.
Until we learn how to lock the barn door, I think we had better be careful of any new horses we put in the barn. I wish to review the transcript carefully, including information that the Small Business Administration will supply to us as to how we can really safeguard the taxpayers' interest, before I finalize in my own mind whether or not in fact this SBIC venture is even worth trying to salvage.
I am entirely undecided in my own mind at this time. It certainly is not worth salvaging if it is going to continue to produce scandalous situations such as we now have before us. I would like to reiterate what I said earlier, that my association with the Small Business Ad
ministration has been limited up until now to the three kinds of loans that I have seen operating in my own State, the loans that go direct to small business borrowers and that go to small development community companies plus the disaster program. As far as I know, they have been excellent programs. We have had no serious complaints of reckless handling of the funds.
It is hard for me to understand how, under the aegis of the same administrator in the one area we can have a good, prudent, and proper administration of public funds and in the other area it is almost hard to conceive any mistakes which were not made, all under the administration of the same individual. I hope that Mr. Boutin in his reorganization program will tie into his own office the authority and the responsibility for the administration of the whole shop. I just can't understand how we have this Dr. Jekyll and Mr. Hyde situation going on under the same administrator and in the same office.
I think that the Small Business Administration agency has rendered a great service to America, and I don't like to see it sullied and its future jeopardized and its strength weakened by the kind of operations we have been studying under the SBIC program. I think I should add, Mr. Chairman, that I believe Senator Javits made a good point in his statement. I think we should hold these hearings open and at some convenient time call in the various SBA Administrators and Deputy Administrators responsible for the handling of this program in its various stages—I think they are all available
and see what possible defense they can make of the lax conditions which operated under their respective administrations.
We have a unique situation here, because we are dealing primarily now with an Administrator who has just recently stepped into office, and the deputies and division heads who don't know any more about the program than he does and have not had any more experience than he has and certainly cannot be held responsible for what has taken place. Senator HARRIS. Thank you very much, Senator Mundt.
I certainly want to compliment you for your cooperative attitude and your diligent interest in the subject of these hearings.
Senator MUNDT. I would like to join you, too, in thanking Mr. Walsh and Mr. Adlerman and the other members of the staff for doing a commendable job with what is certainly a very complex and difficult situation, and to congratulate you, sir, on serving as chairman pro tempore of our subcommittee.
Senator HARRIS. Thank you every much.
(Members present at conclusion of hearing: Senators Harris and Mundt.)
EXHIBIT No. 2
FRONTIERS CAPITAL CORP.,
New York, N.Y., January 9, 1964. SMALL BUSINESS ADMINISTRATION Washington, D.O. (Attention: Mr. Gerald S. Fisher).
DEAR SIR: We are inquiring as to whether the Small Business Administration will permit Frontiers Capital Corporation to revert back to “minimum company" status.
At the present time, we have $350,000 in paid-in capital and the Small Business Administration has $350,000 in subordinated debentures. Our objective is to be in a position where we have $150,000 in paid-in capital and the Small Business Administration $150,000 in subordinated debentures.
To effect this change of status, we would, immediately upon your approval, return $200,000 to the Small Business Administration by repurchase of subordinated debentures in that amount. We then would reduce our total stockholders' equity by $200,000.
For your information, we have not as yet used Section 303 funds.
All the cash necessary to effect the plan described above is available in our bank at this time.
We sincerely believe that reduction of our capital at this time in the manner described is in the best interest of the Small Business Administration, our stockholders and the public, inasmuch as this plan would enable a small business investment company, with knowledgeable management and experience, to continue in existence and perform the services of a small business investment company as outlined and intended in the Small Business Investment Act of 1958.
We would appreciate an expression of your reaction to this proposal in the very near future, inasmuch as there is an important Board of Directors meeting scheduled on January 21st to discuss the future status of our small business investment company. Cordially,
EXHIBIT No. 3
JANUARY 31, 1964. Re license No. 02-0091. MR. MILTON HAMMER, President, Frontiers Capital Corp., New York, N.Y.
DEAR MR. HAMMER: This is in reference to your letter of January 9, 1964, requesting advice as to whether Small Business Administration will permit the Licensee to revert to minimum size status through reducing its subordinated debentures from approximately $350,000 to $150,000 and reducing its net paid-in capital and surplus from $350,000 to $150,000. It is represented that the funds necessary to effect the reductions are available and that such reductions would be in the best interests of SBA, the stockholders, and the public.
It is not the policy of SBA to approve voluntary reductions in paid-in capital and paid-in surplus as long as the Licensee is indebted to SBA. The Licensee may, however, prepay its subordinated debentures dated June 12, 1961, and January 9, 1963, in the amounts of $149,974 and $200,000 respectively.
In the event of repayment of such indebtedness to SBA, the Licensee may without SBA approval effect a 10 percent, or $35,000, reduction in its equity capital by a pro-rata distribution of such capital to its stockholders pursuant to Section 107.704(c) (1) of the Regulations.
Appropriate amendments should, of course, be filed to items 4 and 5 of the Proposal, Form 414, in the event of prepayment of the subordinated debentures and such pro-rata distribution of capital. Sincerely,
FRANCES P. MOKERN
(For John B. Morris Director, Office of Investment Assistance).