B-149685, JUN. 3, 1969

B-149685, JUN. 3, 1969

TO MR. SANDOVAL:

YOUR LETTER OF APRIL 30, 1969, REQUESTS OUR CONCURRENCE IN YOUR OPINION THAT THE SMALL BUSINESS ADMINISTRATION (SBA) IS AUTHORIZED UNDER SECTION 303 (B) OF THE SMALL BUSINESS INVESTMENT ACT (SBI ACT), AS AMENDED, 15 U.S.C. 683 (B), TO GUARANTEE DEBENTURES ISSUED BY LICENSED SMALL BUSINESS INVESTMENT COMPANIES (SBICS) IN CONNECTION WITH A PUBLIC OFFERING EFFECTED THROUGH A GROUP OF FIRM UNDERWRITERS COMPOSED OF NATIONAL BANKS AND INVESTMENT BANKING HOUSES.

SECTION 303 (B) OF THE ABOVE-CITED ACT, AS AMENDED, PROVIDES THAT: "TO ENCOURAGE THE FORMATION AND GROWTH OF SMALL BUSINESS INVESTMENT COMPANIES THE ADMINISTRATION IS AUTHORIZED * * * TO PURCHASE, EITHER DIRECTLY OR IN COOPERATION WITH BANKS OR OTHER LENDING INSTITUTIONS THROUGH AGREEMENTS TO PARTICIPATE ON AN IMMEDIATE (OR DEFERRED (STANDBY) ( BASIS, THE DEBENTURES OF ANY SUCH COMPANY. * * *"

ALTHOUGH THE WORDS "OR DEFERRED (STANDBY)" IN BRACKETS IN THE QUOTE ABOVE ARE NOT CONTAINED IN SECTION 303 (B), IN OUR DECISION OF MARCH 20, 1968, B -149685, WE STATED THAT FROM THE STANDPOINT OF THE CONGRESSIONAL INTENT IN REWRITING SECTION 303 (B), WE BELIEVED THE OMISSION OF SUCH WORDS MAY WELL HAVE BEEN INADVERTENT. ACCORDINGLY, WE ADVISED THE THEN ADMINISTRATOR OF SBA THAT WE WOULD NOT OBJECT TO HIS EXERCISING HIS AUTHORITY TO GUARANTEE BANK LOANS (ON A DEFERRED OR STANDBY BASIS) MADE BY INSTITUTIONAL LENDERS TO SBICS "PROVIDED THAT THE COMMITTEES ON BANKING AND CURRENCY OF BOTH THE SENATE AND THE HOUSE OF REPRESENTATIVES STATE THEIR APPROVAL OF THE PROPOSED PLAN.' SINCE BOTH COMMITTEES APPROVED THE PROPOSED PLAN, IT COULD REASONABLY BE CONCLUDED THAT THE COMMITTEES AGREED THAT THE WORDS IN QUESTION WERE INADVERTENTLY OMITTED FROM SECTION 303 (B), AND WE WILL SO ASSUME FOR PURPOSES OF THE INSTANT CASE.

YOU NOTE THAT THE PHRASE,"BANKS OR OTHER LENDING INSTITUTIONS," IN SECTION 303 (B) ALSO APPEARS IN SECTION 7 (A) OF THE SMALL BUSINESS ACT (15 U.S.C. 631, 636). YOU STATE THAT, MINDFUL OF THE POLICY OF THE CONGRESS EXPRESSED IN SECTION 102 OF THE SMALL BUSINESS INVESTMENT ACT THAT THE SBIC PROGRAM SHOULD "STIMULATE AND SUPPLEMENT THE FLOW OF PRIVATE * * * LONG-TERM LOAN FUNDS WHICH SMALL-BUSINESS CONCERNS NEED FOR THE SOUND FINANCING OF THEIR BUSINESS OPERATIONS," SBA HAS CONSTRUED "OTHER LENDING INSTITUTIONS" IN SECTION 303 (B) AS INCLUDING INSURANCE COMPANIES, SAVINGS AND LOAN ASSOCIATIONS, CREDIT UNIONS, PENSION FUNDS AND OTHER INSTITUTIONAL LENDERS, CERTAIN INVESTMENT, MORTGAGE, AND COMMERCIAL/INDUSTRIAL FINANCE COMPANIES, AS WELL AS OTHER ENTITIES REGULARLY PROVIDING CAPITAL FOR COMMERCIAL OR INDUSTRIAL PURPOSES.

YOU ADVISE THAT A FIRM-COMMITMENT UNDERWRITER, AS DISTINGUISHED FROM A "BEST-EFFORTS" UNDERWRITER, PURCHASES THE SECURITIES FROM THE ISSUER; THAT THE FIRM-COMMITMENT TYPE OF UNDERWRITING ACCOUNTS FOR THE LARGEST PORTION (IN TERMS OF DOLLARS) OF PUBLIC FINANCING IN THE UNITED STATES; AND THAT THE FORMAL UNDERWRITERS IN THIS COUNTRY ARE INVARIABLY INVESTMENT BANKERS. YOU FURTHER ADVISE THAT THE ADVANTAGE TO THE SMALL OR LESS WELL- ESTABLISHED ISSUER COMPANY IS OBVIOUS; THAT IT MORE OR LESS INSURES THE SUCCESS OF ITS PUBLIC OFFERING WHICH, ON A BEST-EFFORTS" UNDERWRITING BASIS, MIGHT WELL FAIL OF ACCOMPLISHMENT.

YOU STATE THAT IN HIS ROLE OF FIRM-UNDERWRITER, THE INVESTMENT BANKER PROVIDES CAPITAL BY BUYING ISSUES OF SECURITIES AT WHOLESALE. THUS, IN YOUR OPINION, AN INVESTMENT BANKING HOUSE ACTING AS FIRM UNDERWRITER IS CLEARLY A LENDING INSTITUTION WITHIN THE MEANING AND PURPOSE OF SECTION 303 (B) OF THE SMALL BUSINESS INVESTMENT ACT.

YOUR LETTER CONTINUES: "IN PREPARATION FOR THE DISTRIBUTION PROCESS, THE INVESTMENT BANKERS, ACTING AS PRINCIPAL UNDERWRITERS, CONSULT WITH INSURANCE COMPANIES, INVESTMENT COMPANIES AND OTHER INSTITUTIONAL INVESTORS WHO MAY BE COUNTED ON TO HAVE PORTIONS OF THE ISSUE RESERVED FOR THEM BY THE SYNDICATE MANAGER. -* * * (T/HEY ARE IN A SENSE SILENT PARTNERS OF THE SYNDICATE.- "SALES TO LARGE INSTITUTIONAL INVESTORS (LIFE INSURANCE COMPANIES, PENSION FUNDS, ETC.) CONSTITUTE AN IMPORTANT STEP IN ACCOMPLISHING OVERALL PUBLIC DISTRIBUTION EXPEDITIOUSLY AND AT REASONABLE COST. IN THE POST-WORLD WAR II PERIOD, THE VAST BULK OF CORPORATE BOND ISSUES HAVE BEEN ACQUIRED BY INSTITUTIONAL INVESTORS. -WE FIND THAT IN SPITE OF ACCUMULATIONS OF SAVINGS BY INDIVIDUALS THERE WAS LITTLE OR NO INCENTIVE ON THEIR PART TO BUY CORPORATE BONDS. STATISTICS ON INDIVIDUAL SAVINGS SHOW THAT INDIVIDUALS DID PUT THEM IN CORPORATE SECURITIES, * * * IN AMOUNTS OVER $2 BILLION IN SOME YEARS, BUT CORPORATE BONDS WERE NOT FOR THEM. * * * THE CATEGORY OF "DOMESTIC INDIVIDUALS" APPEARS TO BE PRACTICALLY NONEXISTENT AS A MARKET FOR BONDS AND NOTES, AND IT DOESN-T AMOUNT TO MUCH FOR PREFERRED STOCK.- AT THE END OF 1955, FOR EXAMPLE, LIFE INSURANCE COMPANIES HELD 50 PERCENT OF TOTAL OUTSTANDING CORPORATE BONDS (IN CONTRAST TO 17 PERCENT IN 1938); BOND HOLDINGS OF SELF-ADMINISTERED CORPORATE PENSION FUNDS HAD INCREASED 18-FOLD IN THE SAME 17-YEAR PERIOD; AND STATE AND LOCAL GOVERNMENT RETIREMENT FUND BOND HOLDINGS INCREASED 12- FOLD. "THE VAST BULK OF CORPORATE BOND ISSUES ACQUIRED BY INSTITUTIONAL INVESTORS DURING THE POST-WORLD WAR II PERIOD, COMPARED WITH THE RELATIVELY INSIGNIFICANT PORTION SOLD TO INDIVIDUAL INVESTORS, IS STRIKINGLY DEMONSTRATED IN A DETAILED STUDY FOR THE 1945-1967 PERIOD WHICH WAS RELEASED BY THE BOARD OF GOVERNORS OF THE FEDERAL RESERVESYSTEM IN FEBRUARY 1968: -FLOW OF FUNDS ACCOUNTS 1945-1967 -- ANNUAL TOTAL FLOWS AND YEAR-END ASSETS AND LIABILITIES.- NEW OFFERINGS OF CORPORATE BONDS IN RECENT YEARS HAVE BEEN ACQUIRED ALMOST IN THEIR ENTIRETY BY INSTITUTIONAL INVESTORS, PERSONAL TRUSTS, AND NON PROFIT ORGANIZATIONS (PRIVATE SCHOOLS, FOUNDATIONS, CHURCHES, ETC.); IT IS ESTIMATED THAT 1 PERCENT, OR LESS, HAVE BEEN ACQUIRED BY INDIVIDUAL MEMBERS OF HOUSEHOLDS. IT IS APPARENT THAT A PUBLIC OFFERING OF $20 - $30 MILLION OF SBIC DEBENTURE BONDS, UNDERWRITTEN BY A SYNDICATE OF NATIONAL BANKS AND/OR INVESTMENT BANKING HOUSES, WOULD IN PREDOMINANT PART BE SOLD TO LIFE INSURANCE COMPANIES, PENSION FUNDS, AND OTHER INSTITUTIONAL INVESTORS (INCLUDING BANKS) -- ALL OF WHOM ARE CLEARLY FINANCIAL (LENDING) INSTITUTIONS. THE DISTRIBUTION MACHINERY TO ACCOMPLISH THIS FLOW OF PRIVATE CAPITAL FROM INSTITUTIONAL INVESTORS TO SBICS AND THE SMALL BUSINESS SEGMENT OF THE ECONOMY NECESSARILY INCLUDES INVESTMENT BANKS (MANAGING AND/OR PARTICIPATING IN THE UNDERWRITING SYNDICATE) AND THEIR -SILENT-PARTNER INSTITUTIONAL INVESTORS READY AND WILLING TO PURCHASE THE SBIC DEBENTURE BONDS. INDIVIDUALS AND OTHER GENERAL INVESTORS WOULD, ACCORDING TO THE POST-WAR PATTERN OF PUBLIC CORPORATE DEBT FINANCING, PLAY ONLY A MINOR, INCIDENTAL ROLE IN THE PROCESS. SBA WOULD PARTICIPATE AS A GUARANTOR IN THIS JOINT PROJECT, IN COOPERATION WITH OTHER FINANCIAL INSTITUTIONS REPRESENTED BY THE UNDERWRITING BANKS AND INSTITUTIONAL INVESTORS ACQUIRING THE OFFERING OF SBIC DEBENTURE BONDS. ITS PARTICIPATION IS INDISPENSABLE TO THE SUCCESS OF THE PROJECT. WITHOUT SBA'S ASSISTANCE, THE SBICS WOULD BE UNABLE TO ACQUIRE THE FUNDS REQUIRED FOR CAPITAL EXPANSION FROM THE INVESTMENT MARKET, OR SBA. LACK OF SUCH FUNDS SERIOUSLY IMPERILS FURTHER PROGRESS OF THE SBIC PROGRAM.'

YOU STATE THAT SBA'S COOPERATION IN THE PROJECT, VIA ITS DEFERRED BASIS (GUARANTY) PARTICIPATION, WILL MAKE IT POSSIBLE FOR PUBLICLY OFFERED SBIC DEBENTURE BONDS TO BE MARKETED AND SOLD THROUGH THE UNDERWRITING SYNDICATE TO INSTITUTIONAL INVESTORS, THE SAME INVESTORS WHOSE FUNDS ACCOUNT FOR AN OVERWHELMINGLY PREDOMINANT PORTION OF ALL LONG-TERM CORPORATE DEBT FINANCING AT THE PRESENT TIME.

YOU EXPRESS THE VIEW THAT SBA IS AUTHORIZED UNDER SECTION 303 (B)OF THE SMALL BUSINESS INVESTMENT ACT TO GUARANTEE A PUBLIC OFFERING OF SBIC DEBENTURES WHICH ARE PURCHASED BY FIRM-UNDERWRITER INVESTMENT BANKING HOUSES FOR DISTRIBUTION ON THE PUBLIC MARKET WHICH, YOU STATE, ACCORDING TO THE PATTERN ESTABLISHED FOR CORPORATE BOND ISSUES, MEANS DISTRIBUTION OF VIRTUALLY THE ENTIRE AMOUNT TO INSTITUTIONAL INVESTORS.

AN "INSTITUTION" IS BROADLY DEFINED AS AN ESTABLISHED OR ORGANIZED SOCIETY OR CORPORATION, EITHER PUBLIC OR PRIVATE IN CHARACTER. ALTHOUGH THE PRECISE TERM MAY VARY ACCORDING TO THE OPERATIVE CONTEXT, IT SEEMS UNIVERSALLY ACCEPTED THAT "INSTITUTION" IMPORTS A SUBSTANTIAL DEGREE OF INTERNAL ORGANIZATION AND LEGALLY SANCTIONED STABILITY. ASPLUND V MARJOHN CORPORATION, 168 A. 2D 844 (1961). IN THE CITED COURT CASE THE COURT STATED THAT IT CONCEIVED OF A "LENDING INSTITUTION" AS AN ESTABLISHED PUBLIC OR PRIVATE FINANCING BODY INCORPORATED OR OTHERWISE RECOGNIZED UNDER APPROPRIATE LAW. IT WOULD APPEAR THAT AN INVESTMENT BANKING HOUSE IS A FINANCING BODY, INCORPORATED OR OTHERWISE RECOGNIZED UNDER APPROPRIATE LAW. THUS, IN OUR OPINION, AN INVESTMENT BANKING HOUSE MAY BE CONSIDERED A FINANCIAL INSTITUTION.

AS TO WHETHER AN INVESTMENT BANKING HOUSE IS A "LENDING INSTITUTION," WHILE AN INVESTMENT BANKING HOUSE ACTING AS A FIRM COMMITMENT UNDERWRITER GENERALLY PURCHASES DEBENTURES WITH A VIEW TO SELLING THE DEBENTURES TO OTHERS, IF, FOR WHATEVER REASON, SUCH FIRM COMMITMENT INVESTMENT BANKING HOUSE IS UNABLE OR FAILS TO SELL THE DEBENTURES, IT BEARS THE RISK OF LOSS. THUS, IT APPEARS THAT A FIRM COMMITMENT INVESTMENT BANKING HOUSE, IN EFFECT, LOANS FUNDS TO THE ISSUER OF THE DEBENTURES, EVEN THOUGH THE FIRM-COMMITMENT UNDERWRITER INTENDS TO SELL THE DEBENTURES TO OTHERS. THUS, IT IS OUR VIEW THAT IT WOULD NOT BE UNREASONABLE TO CONSIDER A FIRM- COMMITMENT INVESTMENT BANKING HOUSE A "LENDING INSTITUTION" UNDER SECTION 303 (B) OF THE SMALL BUSINESS INVESTMENT ACT.

ACCORDINGLY, WE WOULD NOT DISAGREE WITH YOUR OPINION THAT SBA IS AUTHORIZED UNDER SECTION 303 (B) OF THE SBI ACT TO GUARANTEE DEBENTURES ISSUED BY LICENSED SBICS IN CONNECTION WITH A PUBLIC OFFERING EFFECTED THROUGH A GROUP OF FIRM-COMMITMENT UNDERWRITERS COMPOSED OF NATIONAL BANKS AND INVESTMENT BANKING HOUSES.