by section 404 of S. 3651, which was enacted as section 304 of the Small Business Investment Act.

Finally, whatever the proper interpretation of the existing law, I would like to give you an idea of the importance which I believe should be attributed to this question of the permissibility of security for debenture obligations. Our group of proponents has followed the development of the small-business investment program carefully during the last 12 months; has already expressed its deep interest in the program's objectives by making a considerable investment in time, effort, and professional fees; and has declared its willingness to commit a substantial amount of private capital to the goal of assisting small business in a sane and organized manner. Nevertheless, we have concluded, regretfully, that we can never bring our plan into effective operation if, as an SBIC, we will be prohibited from taking security for debenture obligations. In that case, we would, in effect, find ourselves confined almost exclusively to straight longterm lending under section 305, with the limited possibilities which that activity offers for compensating losses out of profits. The debenture route would be virtually unavailable to us because of our conviction, based on experience, that the vast majority of small-business concerns which need assistance are not proper prospects for long-term, unsecured credit, even when the extention of credit is compensated in part by the speculative advantage of convertibility. Convertibility offers an attraction to the speculator, but it does nothing to reduce the risks of loss or to satisfy the prudent standards of a professional lender.

We recognize that the security which many small-business concerns can offer will be of such inferior quality or value that it might not even be regarded as collateral by a commercial banker. A pledge of unexploited patents, or a security assignment of trademarks and goodwill, would not, for example, appeal to a commercial banker. Still, the availability of such marginal security may make the difference between the success and failure for a long-term lender dealing with risks of the kind which will confront an SBIC. Our group would not, by any means, expect to be fully secured in all of its transactions. It feels that it must, however, have some chance to pick up the pieces after an unsuccessful investment, if it is to be able to offer attractive financing to small-business concerns without incurring bankruptcy itself.

Moreover, we believe that there are many cases in which a needy small-business concern can give security—even relatively attractive security-without undue hardship. It seems clear from the studies made available to Congress last year that the major financial problems confronting small business do not result from their inability to give security for financing. They result, rather, from the fact that most institutional lenders cannot or will not extend long-term credit to small businesses, whether secured or unsecured. It is this institutional gap, rather than the absence of available security, which handicaps the potentially successful small business in its efforts to grow.

As I have indicated, our group of proponents feels that inability to take security for convertible debentures would make it impossible for us to participate in the small-business investment program. We believe that the same obstacle will discourage many other prospective participants. We understand from the SBA that the question has been considered in connection with other proposals. We have also heard from other sources that some of the groups already licensed obtained their licenses on the tacit assumption that they were authorized by the act to require security for convertible debentures. Now that the question has been specifically considered in connection with our proposal, the legal interpretation adopted by the SBA may well provoke a serious curtailment of the activities contemplated by these existing licensees.

For these reasons, I respectfully urge the subcommittee to recognize this problem as a fundamental obstacle to the whole investment program. By deterring the participation of careful investors, it may well deprive the new system of capital banks of the large amounts of private capital which they will need to give effective assistance to the small-business economy.

It would be presumptuous of us to suggest the precise means the subcommittee might wish to use to solve this problem. However, we do point out that the present S. 2139 bill introduced by Senator Saltonstall does contain the same kind of language in section 304 (b) which the counsel for the Small Business Administration construed to mean that collateral could not be obtained by a lender under the act.

In order not to take more of the subcommittee's time I have refrained from commenting in detail on the other provisions of S. 2139. Subject to my suggestion that amended section 304 (b) be deleted from the bill, I would like to make it clear that our group supports the measure enthusiastically and endorses the recommendations made by Mr. Barnes. I have confined my remarks to the subject of security for convertible debentures only because we believe that other problems inherent in the existing legislation have already been called sufficiently to your attention.

In conclusion, I would like to say that our group is grateful for the courteous and efficient attention given by the SBA to our proposal, and that our disagreement with the SBA as to the interpretation of one important provision of the act should not be understood as a citicism of the agency's efforts to organize and administer the investment program.

I thank you sincerely for giving me this opportunity to express our views.

MAY 21, 1959.

SMALL BUSINESS ADMINISTRATION,
Washington, D.C.

(Attention: Mr. John B. Morris, Small Business Investment Division.)

GENTLEMEN: On March 16, 1959, I submitted to your New York office, on behalf of the proponents, a proposal to organize a small-business investment company tentatively named Northeastern Aid to Small Business, Inc. The proposal was received under identification No. 02-0003.

On May 5, 1959, Mr. Morris, of your Washington office, requested in a telephone conversation that I submit certain additional documents and information to clarify or supplement the proposal.

In answer to this request, I have been authorized by all of the proponents to submit to you, herewith, the attached series of amendments to the proposal, preceded by a title page entitled “List of Amendments to Form 414, Part I, and Exhibits Thereto."

I believe these amendments comply fully with your request, except in the following respects:

(1) I was asked to submit a copy of any communication received from the Banking Board of the State of New York in answer to the request by Colonial Trust Co., one of the proposed subscribers, for permission to invest in the stock of the proposed operator. At present, the form of this request by Colonial Trust Co. is under discussion with the superintendent of banks, and no action in reference to it has yet been taken by the banking board. I am authorized to say that a copy of the decision of the banking board will be submitted to you as soon as Colonial Trust Co. has been informed of the decision.

(2) I was asked to delete from the proposal item 13(n) (1) (form 414, pt. I), which contains the following provision in reference to the policies of the proposed operator with respect to the purchase of convertible debentures:

"The proposed operator may require that the debenture obligation be secured by any form of available collateral."

Having considered the suggestion which was made to me, the proponents nevertheless prefer to maintain the provision in question as part of their proposal. It is not their intention that the proposed operator should purchase convertible debentures only when the debenture obligation can be secured. They recognize that, in many cases, it will be unnecessary or inappropriate to insist on security. They suggest, however, that the proposed operator should be authorized to take security when sound business judgment requires it, for the following reasons:

(a) Neither the Small Business Investment Act nor your related regulations contain any express prohibition against the purchase of secured debentures by a small-business investment company. Section 304 of the act does not expressly contemplate that debentures be secured; but neither does it exclude the possibility that they may be secured in an appropriate case. Indeed, section 304 (b) (1) clearly provides that debentures may be purchased on terms other than those expressly contemplated by the law. Likewise, section 107.304 (1) of the regulations recognizes that "a licensee and small-business concerns may negotiate the specific terms and conditions applicable to the financing of the particular small-business concern" and "may negotiate any special terms and conditions that are reasonably applicable to the situation."

3

(b) It is true that in conventional public financing a “debenture" is, more frequently than not, understood to refer to an unsecured debt obligation. The word does not, however, have any such necessary connotation in legal usage. In fact, according to Black's Law Dictionary, a "debenture" is a debt instrument "usually creating a charge on the whole or part of the company's stock or property, though not necessarily in the form of a mortgage"; or, again, "a charge in writing on certain property, with repayment at a time fixed of money lent by a person therein named, at a given rate of interest." The conventional financial usage of the word relates to the financing of large corporations, which ordinarily have sufficient capital and surplus to give their debentures strong standing without security. There is no basis for an inference that Congress, dealing with the more difficult problem of financing small-business concerns, meant to prohibit security merely through the use of the word "debenture."

(c) Nor would a requirement of security for a particular issue of debentures be inconsistent with the spirit of the act. Section 304 (o) authorizes a small-business investment company, at the time of its purchase of debentures, to require the issuer to refinance all existing indebtedness, so that the investment company will be its only creditor, and to prohibit the issuer from incurring further indebtedness without the consent of the investment company. The clear intention of these provisions is to enable the investment company to eliminate all priorities in the hands of other creditors and to secure for itself, through its debentures, a first claim against all of the property of the issue. Such a course of action would limit the flexibility of the issuer's financial policy far more drastically than a mere requirement that the debenture obligation constitute a first claim against certain specified items of collateral available for pledge at the time of purchase. If the more drastic form of protection is encouraged by the act, it is difficult to infer that the taking of specific security would be inconsistent with congressional intention.

(d) Finally, it seems plain that the use of security in connection with particular issues of convertible debentures may make possible the extension of capital to small-business concerns which could not otherwise be financed in a manner consistent with sound business judgment. The convertibility feature attached to such debentures may provide an inducement to speculation, but it does not reduce the risk of the financing-which may be such, in the absence of security, as a deter all but the most adventurous sources of capital. If a small-business investment company is never allowed to take security for a debenture obligation, it seems likely that the small-business investment program will either fail to provide assistance to a large class of small-business concerns, or fail to attract the participation of banks, insurance companies, and other reasonably prudent investors.

For these reasons, the proponents ask your permission to maintain their proposal without amendment of the provision in question.

I look forward to receiving your further communication in reference to the proposal, and will be happy to supply any further information which may be helpful to you.

Very truly yours,

CHARLES H. NEUMAN DE VEGVAR.

MAY 26, 1959.

Re identification No. 02-0003.

SMALL BUSINESS ADMINISTRATION,
Washington, D.C.

(Attention: Mr. John B. Morris, Small Business Investment Division.)

GENTLEMEN: In a letter to you dated May 21, 1959, written on behalf of the proponents of Northeastern Small Business Investment Corp., I suggested several reasons why the proposed small-business investment company should be authorized to require security in connection with certain purchases of convertible debentures. I pointed out, in particular, that section 304 of the Small Business Investment Act does not prohibit the taking of security for debenture obligations.

I understand that, in your consideration of my letter, it has been suggested that if Congress had not intended to prohibit the taking of security for debentures, it would not have bothered to draw a distinction between debenture financing and loan financing. This argument implies that there is no under43183-59-17

standable distinction between section 304 and section 305 of the act, unless section 304 is interpreted to prohibit the taking of security.

I am surprised that this argument should be made because it seems to me that there are a number of very clear and marked differences between sections 304 and 305, and many understandable reasons why the legislative draftsmen should have chosen to treat the problem of debenture financing separate from that of loan financing. In particular, I would like to submit the following comments for your consideration:

(1) It seems clear that convertible debentures of the kind referred to in section 304 can be issued only by a corporate borrower, whereas the loan financing authorized in section 305 can be extended to corporations, unincorporated associations, partnerships, individuals, or any other category of borrowers. If Congress had not enacted section 305, a large percentage of small-business concerns in the country would have been excluded from the benefits of the new financing program because of the fact that they are not incorporated. If, on the other hand, Congress had not enacted section 304, a separate legislative statement of some kind would certainly have been required to make it clear that, in the case of loans to corporations, the obligations may be made convertible into capital stock.

(2) Various regulatory problems arise in connection with the purchase of convertible debentures which do not arise at all in connection with conventional loan financing. One of the clearest examples is the problem of regulating the determination of the conversion price. Another example is the problem of fixing the time or times at which the conversion privilege can be exercised. The necessity to deal with these problems would, in itself, clearly justify the draftsman's use of a separate section on convertible debentures.

(3) Finally, in addition to the inherent distinctions already referred to, Congress has chosen to introduce certain additional distinctions between the permissible terms of a debenture transaction and those of a conventional loan. For example, section 305 (d) provides that a conventional loan shall have a maturity not exceeding 20 years, whereas section 304 contains no requirement with respect to the maturity of a convertible debenture. Again, section 304(d), provides that an issuer of convertible debentures shall become a "stockholderproprietor" of the small-business investment company, whereas section 305 contains no such provision with respect to conventional borrowers.

I hope these comments will sufficiently illustrate that there are reasons for legislative distinctions, having nothing to do with the question of whether or not security can or cannot be taken. Another illustration of the differences between section 304 and section 305 is the fact that section 305(e) requires that a long-term loan "be of such sound value, or so secured as reasonably to assure repayment," whereas section 304 contains no requirement in reference to security. There is no basis, however, for concluding that Congress intended its silence on this question, in section 304, as an implied prohibition against the taking of security for convertible debentures. tI is a basic canon of statutory interpretation that the absence of a mandatory requirement does not create an inference of prohibition. If allowed, such an inference would often lead to absurd results. For example, as already mentioned above, section 305(d) provides that every long-term loan shall have a maturity of 20 years or less. Since section 304 contains no requirement with respect to maturities, should it be inferred that a convertible debenture must not have a maturity of 20 years or less? It seems obvious that no such interpretation was intended. By the same token, I submit that Congress, in requiring sound value or security in the case of a long-term loan, certainly did not intend to prohibit sound value or security in the case of an issue of convertible debentures. Congress merely decided, in the case of convertible debentures, to leave the question to negotiation between the interested parties.

I would appreciate your courtesy in taking these additional comments into account in your consideration of the question discussed in my earlier letter.

Very truly yours,

CHARLES H. NEUMAÑ DE VEGVAR.

SMALL BUSINESS ADMINISTRATION,

Washington, D.C.

Re Northeastern Small Business Investment Corp. proposal No. 02-0003.

Mr. CHARLES H. NEUMAN DE VEGVAR,
New York, N.Y.

DEAR MR. DE VEGVAR: Mr. Read has requested this office to reply to your letters of May 21 and May 26, regarding the security for convertible debentures purchased by a licensee.

Section 304 of the act states that equity capital shall be provided in the manner and subject to the conditions described in such section. Capital can be provided only through the purchase of debentures containing certain terms with respect to call and convertibility as specified in such section and such further terms as may be fixed by the licensee with the approval of SBA. Such terms will include interest, events of default, remedies, etc.

Section 304 (c) states that before any capital is provided, the licensee may require the small-business concern to refinance its existing indebtedness so as to make the licensee its only creditor; and said concern must agree not to thereafter incur any indebtedness without the approval of the licensee and giving the licensee the first opportunity to finance such indebtedness.

Thus, the act directs that equity funds can be provided only in the manner and under the conditions specified in section 304, namely, through debentures containing specified terms as to call and conversion, with further terms approved by SBA, and protected by said creditor position. This is a reasonable security, particularly with an equity right.

In confirmation of this intention, the Senate and House reports state that, in connection with the purchase of convertible debentures, "to protect" the licensee, the small-business concern can be required not to incur further indebtedness without approval of the licensee.

Hence, a licensee is limited in security for a convertible debenture to that specified in section 304 (c) of the act; and a small-business concern cannot nullify such mandate by waiver or otherwise.

We do not question the possible merits and advantages to a licensee, and perhaps an issuer, of other approaches with respect to securing the convertible debentures. However, until amendment of the act, we must administer the program as now directed by Congress. In this regard, however, we are supporting proposed legislation which would allow greater flexibility in providing equity funds.

I can assure you that we are anxious to determine any matter so as to provide impetus to the program, within the limits intended by Congress. Your letters present clearly positions which, prior to your inquiry, we considered thoroughly before concluding the matter.

Sincerely yours,

PHILIP MCCALLUM, General Counsel.

Senator PROXMIRE. The next witnesses are Mr. M. Stuart Roesler of New York City, vice president and director of the Empire Trust Co., and Henry A. Loeb, New York City, partner of Carl N. Loeb, Rhoades & Co., representing the proposed Empire Small Business Investment Co., Inc.

Gentlemen, proceed any way you wish. We have your statement here, and you can put it in the record verbatim, and you can summarize it if that is convenient, or otherwise you can read it.

STATEMENT OF M. STUART ROESLER, VICE PRESIDENT AND DIRECTOR OF EMPIRE TRUST CO., NEW YORK CITY; HENRY A. LOEB, PARTNER, CARL M. LOEB, RHOADES & CO., NEW YORK CITY; AND ROBERT HACK, COUNSEL

Mr. ROESLER. I think probably it would be preferable if I tried to just summarize and maybe emphasize the things that seem a little more important.

Senator PROXMIRE. All right, fine.