[Federal Register Volume 60, Number 129 (Thursday, July 6, 1995)]
[Notices]
[Pages 35244-35247]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-16577]



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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-21174; 812-9132]


Harris & Harris Group, Inc.; Notice of Application

June 29, 1995.
AGENCY: Securities and Exchange Commission (``SEC'').

ACTION: Notice of Application for Exemption under the Investment 
Company Act of 1940 (the ``Act'').

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APPLICANT: Harris & Harris Group, Inc.

RELEVANT ACT SECTIONS: Order requested pursuant to sections 6(c) and 
61(a) granting an exemption from sections 18(d), 23(b), 61(a)(3)(B), 
and 61(b).

SUMMARY OF APPLICATION: Applicant is a closed-end registered investment 
company that intends to elect business development company (``BDC'') 
status under the Act. Before becoming a registered investment company, 
applicant issued warrants that currently are held by two of its 
officers (the ``Warrants'') and issued stock options to certain 
officers and non-employee directors (the ``Options''). Upon applicant's 
election of BDC status, the requested order would permit the Warrants 
and Options to remain exercisable pursuant to their terms as if they 
had been issued pursuant to an executive compensation plan conforming 
to section 61(a)(3)(B) of the Act.

FILING DATES: The application was filed on July 29, 1994 and amended on 
November 3, 1994 and June 29, 1995.

HEARING OR NOTIFICATION OF HEARING: An order granting the application 
will be issued unless the SEC orders a hearing. Interested persons may 
request a hearing by writing to the SEC's Secretary and serving 
applicant with a copy of the request, personally or by mail. Hearing 
requests should be received by the SEC by 5:30 p.m. on July 24, 1995, 
and should be accompanied by proof of service on applicant, in the form 
of an affidavit or, for lawyers, a certificate of service. Hearing 
requests should state the nature of the writer's interest, the reason 
for the request, and the issues contested. Persons who wish to be 
notified of the date of a hearing may request notification by writing 
to the SEC's Secretary.

ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, D.C. 
20549. Applicant, One Rockefeller Plaza, New York, NY 10020.

FOR FURTHER INFORMATION CONTACT:
Marianne H. Khawly, Staff Attorney, at (202) 942-0562, or C. David 
Messman, Branch Chief, at (202) 942-0564 (Division of Investment 
Management, Office of Investment Company Regulation).


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SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application is available for a fee from the 
SEC's Public Reference Branch.

Applicant's Representations

    1. In 1981, applicant was incorporated under the laws of New York. 
In 1982, applicant first registered securities under the Securities Act 
of 1933. Also in 1982, applicant began filing periodic reports under 
the Securities Exchange Act of 1934. From its inception to 1984, 
applicant was primarily engaged in the breeding and syndication of 
thoroughbred horses. In 1985, applicant began developing its financial 
and consulting services and by November 1986 had no operations 
pertaining to the thoroughbred industry.
    2. On September 25, 1985, applicant acquired a minority interest in 
a subsidiary by exchanging applicant's common stock and issuing 
Warrants to purchase common stock of applicant. On March 26, 1986, C. 
Richard Childress and Charles E. Harris, officers of applicant, 
purchased 149,965 and 335,657 of these Warrants (then due to expire in 
September 1989), respectively, from the holders of the Warrants in a 
negotiated transaction for cash. The exercise price of the Warrants was 
floating with the minimum exercise price equal to $1.24 per share and 
the maximum exercise price equal to $2.06 per share.
    3. On August 3, 1989, applicant's shareholders approved 
modifications to the terms of the Warrants. The modifications decreased 
the number of shares subject to Mr. Childress's and Mr. Harris's 
Warrants to 106,158 and 237,605 shares, respectively, extended the 
expiration date to September 1999, and changed the exercise price to a 
flat $2.06 per share. Currently, the shares subject to the Warrants 
constitute approximately 3.34% of applicant's outstanding voting 
securities.
    4. Also on August 3, 1989, applicant's shareholders approved a 
proposal by the Board of Directors to institute applicant's Long-Term 
Incentive Compensation Plan (the ``Plan''). The Plan provides for the 
grant of stock-based awards, including incentive stock options and non-
qualified options to officers, directors, and employees, up to a 
maximum of 1,200,000 shares of applicant's common stock.
    5. On July 31, 1992, applicant registered as a closed-end, non-
diversified, investment company under the Act. Applicant was internally 
managed and its primary investment objective was long-term growth 
through capital appreciation.
    6. On April 20, 1994, the Board determined that it would be in the 
best interests of the shareholders to elect to be regulated as a BDC 
under sections 55 through 65 of the Act.\1\ Also on that date, in 
anticipation of electing BDC status, the Board adopted amendments to 
the Plan in order to increase the reserved shares and to otherwise 
conform the Plan to the requirements of section 61 of the Act (the 
``Amended Plan''). On June 30, 1994, applicant's shareholders approved 
the Amended Plan, with the continued existence of the outstanding 
Warrants and Options, and applicant's conversion to BDC status.

    \1\ Section 2(a)(48) defines a BDC to be any closed-end 
investment company that operates for the purpose of making 
investments in securities described in sections 55(a)(1) through 
55(a)(3) and makes available significant managerial assistance with 
respect to the issuers of such securities. Such issuers are small, 
nascent companies whose securities typically are illiquid. Certain 
of the regulatory restrictions of the Act are relaxed for BDCs.
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    7. As of May 26, 1995, applicant and 10,304,542 shares of 
outstanding common stock and outstanding Options written on 531,349 
shares of common stock. All outstanding Options are held by officers 
(191,349 shares) or non-employee directors (350,000 shares). The shares 
subject to the Options constitute approximately 5.16% of applicant's 
outstanding voting securities.
    8. The Options expire 10 years from their date of issuance, except 
173,349 Options issued to Mr. Harris that expire only five years after 
their issuance. All of the Options were immediately exercisable at the 
time of issuance, except 8,000 Options issued to Rachel Pernia, an 
officer, that vest over a five year period. Of those 8,000 Options, 
4,800 Options currently are exercisable and the remaining 3,200 Options 
vest over the next two years.
    9. All Warrant and Option holders have executed an undertaking 
stating that the Warrants and Options are deemed to have been issued 
pursuant to the Amended Plan and are governed by the terms of the 
Amended Plan in accordance with section 61(a)(3)(B) of the Act.
    10. Applicant's non-employee directors hold quarterly meetings, set 
general policy, review with management proposed and current investment 
ideas and prospects, and either approve or disapprove the expenditures 
of applicant's assets in such ventures. The Board expects the non-
employee directors to continue to function in the same manner after 
election of BDC status. Applicant's non-employee directors receive 
nominal cash compensation and benefits as salaries for their services.

Applicant's Legal Analysis

    1. Applicant states that due to the outstanding Warrants and 
Options, its capital structure did not comply with section 18 at the 
time of its registration as an investment company.\2\ A company whose 
capital structure does not comply with section 18 may register, 
however, as an investment company without changing its capital 
structure.\3\

    \2\ Section 18(a) limits the ability of a registered, closed-end 
investment company to issue senior securities, and section 18(d) 
prohibits a registered, closed-end investment company from issuing 
warrants unless they expire within 120 days of issuance.
    \3\ Although section 18 clearly reflects Congressional concern 
with the dilutive effect on an investment company's common stock of 
senior securities in general, and long-term warrants in particular, 
the SEC staff has taken the position that the statute only prohibits 
an investment company from issuing certain securities concurrent 
with or subsequent to its registration. See Surfcastle (pub. avail. 
Mar. 14, 1988); The South America Fund N.V., (pub. avail. Sept. 2, 
1993).
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    2. Section 61(b) requires that a BDC shall comply with the 
provisions of section 61 at the time it becomes subject to sections 55 
through 65, as if it were issuing a security of each class which it has 
outstanding at such time. Thus, absent exemptive relief, applicant 
cannot have a non-conforming capital structure at the time it elects 
BDC status.
    3. Applicant requests an order under sections 6(c) and 61(a) 
exempting it from the provisions of sections 18(d), 23(b), 61(a)(3)(B), 
and 61(b) of the Act. Upon Applicant's election of BDC status, the 
requested order would permit the Warrants, currently held by two 
executive officers, and the Options, currently held by officers and 
non-employee directors, to remain exercisable pursuant to their terms 
as if they had been issued pursuant to an executive compensation plan 
under section 61(a)(3)(B) of the Act.
    4. Section 61(a)(3)(B) states that a BDC may issue to its 
directors, officers, employees, and general partners, warrants, 
options, and rights to purchase its voting securities pursuant to an 
executive compensation plan, provided that: (a) Such warrants, options, 
and rights, expire by their terms within ten years, have an exercise 
price that is not lees than the current market value of the underlying 
securities at the date of issuance, and are not transferable except for 
dispositions by gift, will or intestacy; (b) the proposal to issue such 
warrants, options, and rights is authorized by the BDC's shareholders; 
(c) no investment adviser of the BDC receives any compensation 
described in section 

[[Page 35246]]
205(1) of the Investment Advisers Act of 1940, except to the extent 
permitted by clause (A) or (B) of that section; and (d) the BDC does 
not have a profit-sharing plan as described in section 57(n) of the 
Act. In addition, Commission approval is required if warrants, options, 
and rights are to be issued to directors who are not officers or 
employees of the BDC.
    5. The Warrants and Options expire by their terms within ten years 
and their issuance was approved by shareholders. Applicant is 
internally managed and does not have a profit-sharing plan. The Options 
are not transferable except for dispositions by gift, will or 
intestacy. While the Warrants are transferable, each Warrant holder has 
executed an undertaking agreeing that the Warrants will not be 
transferred except for dispositions by gift, will or intestacy.
    6. Applicant requests relief from section 61(b) to permit the 
Warrants and Options to remain outstanding at their current exercise 
prices after applicant elects BDC status. Applicant states that at the 
time the Warrants and Options were granted, applicant was not subject 
to the Act and did not expect to become subject to the Act. Applicant 
asserts that Congress intended section 61(b) to require that a company 
have an appropriate capital structure if it sought to take advantage of 
the more liberal provisions of the Act applicable to BDCs. Congress 
stated that ``a highly leveraged company'' could not elect to be 
subject to sections 55 through 65 until it had a capital structure that 
conformed to the leverage limitations established by section 18. 
Applicant states that it does not have any leverage because it has not 
issued any debt securities. Thus, applicant asserts that it does not 
fall within the category of ``a highly leveraged company'' that 
congress sought to cover and therefore should not be required to cancel 
the Warrants and Options and reissue them with current market prices 
when it elects BDC status.
    7. Section 18(d) of the Act makes it unlawful for any registered 
management investment company to issue any warrant or right to 
subscribe to or purchase a security of which such company is the 
issuer, except in the form of warrants or rights to subscribe expiring 
not later than 120 days after their issuance and issued exclusively to 
a class or classes of such company's security holders. Section 61(a) 
makes section 18(d) applicable to BDCs, subject to certain 
modifications not applicable here. Thus, applicant requests exemptive 
relief from section 18(d) because the Warrants expire more than 120 
days after their issuance.
    8. Section 23(b) states that no registered closed-end investment 
company shall sell any common stock of which it is the issuer at a 
price below the current net asset value of such stock. Section 63 makes 
section 23(b) applicable to BDCs, subject to certain exceptions. 
Section 63(3) provides that a BDC may sell any common stock of which it 
is the issuer at a price below the current net asset value of such 
stock upon the exercise of any warrant, option, or right issued in 
accordance with section 61(a)(3). Applicant contends that since the 
relief sought hereby would treat the Warrants and Options as if they 
had been issued pursuant to an executive compensation plan under 
section 61(a)(3)(B), the Warrants and Options should be excluded from 
section 23(b) by reason of section 63(3).
    9. Section 61(a)(3)(B)(iv) states that the amount of voting 
securities that would result from the exercise of all outstanding 
warrants, options, and rights at the time of issuance shall not exceed 
25% of the outstanding voting securities of the BDC, except that if the 
amount resulting from the exercise of outstanding warrants, options, 
and rights issued pursuant to any executive compensation plan meeting 
the requirements of section 61(a)(3)(B) would exceed 15% of the 
outstanding voting securities, then the total amount of voting 
securities that would result from the exercise of all outstanding 
warrants, options, and rights at the time of issuance shall not exceed 
20% of the outstanding voting securities. Applicant states that it 
meets the requirements of section 61(a)(3)(B)(iv). As of May 26, 1995, 
the aggregate amount of applicant's voting securities that would result 
from the exercise of all options issued or issuable under the Amended 
Plan and the exercise of all outstanding Warrants would be 1,543,763 
shares, or approximately 14.98%, of the 10,304,542 shares of 
applicant's common stock outstanding. Applicant has no other options or 
rights outstanding other than those granted to its officers and non-
employee directors as part of the Amended Plan and no other warrants 
outstanding other than those granted to Mr. Childress and Mr. Harris.
    10. Applicant believes that its proposal addresses the major 
concerns of the Small Business Investment Incentive Act of 1980 
(``SBIIA''). The SBIIA established BDCs and provided an alternative 
system of regulation for such companies that is modelled on, but less 
restrictive than that applicable to, registered closed-end investment 
companies. Applicant asserts that it would be unfair to the holders of 
the Warrants or Options to ask them to exercise early. Premature 
exercise deprives the Warrant or Option holder of an element of value. 
Applicant contends that early exercise of the Warrants and Options 
could have adverse consequences on applicant's shareholders. First, 
nearly fifty percent of the shares received on exercise might have to 
be sold promptly in the market to raise cash and pay taxes due on 
exercise. Given the relatively low levels of trading volume in 
applicant's stock, such sales could have an adverse effect on the 
market prices of applicant's stock. Second, requiring early exercise 
would increase the pool of outstanding shares thereby increasing the 
number of shares available for grant under employee stock option plans 
and the potential dilution to shareholders pursuant these plans. As of 
May 26, 1995, applicant's net asset value was $3.52. Applicant asserts 
that if all the Warrants and Options (875,112 shares, collectively) 
were exercised, the pro-forma net asset value would equal $3.41, a 
dilution of $0.11 per share, or 3.13%.
    11. Applicant further asserts that because the Warrants and Options 
are currently ``in the money'' and exercisable, failure to obtain the 
requested exemptive order would not reduce the potential dilution to 
shareholders. Because employee and director Warrants and Options do not 
adversely affect cash flow, applicant contends that they are a more 
favorable form of compensation. Specifically, because applicant is able 
to continue investing the cash it would otherwise have been required to 
spend on employee and director cash compensation programs during the 
Option period, applicant believes it will be able to produce higher 
returns for shareholders that if it must increase the cash compensation 
of its directors.
    12. In addition, applicant does not seek relief to permit future 
issuances of options to non-employee directors pursuant to the Amended 
Plan. Thus, applicant contends that because the Options already issued 
to non-employee directors have been approved by both applicant's 
shareholders and directors the risks of management self-dealing, 
embezzlement, and abuse of trust that the Act is designed to prevent 
are significantly reduced.
    13. Section 6(c) provides, in relevant part, that the SEC may, 
conditionally or unconditionally, by order, exempt any person or class 
of persons from any provision of the Act or from any rule thereunder, 
if such exemption is necessary or appropriate in the public 

[[Page 35247]]
interest, consistent with the protection of investors, and consistent 
with the purposes fairly intended by the policy and provisions of the 
Act. Applicant submits that its request satisfies this standard, does 
not involve any overreaching, and is fair and reasonable.


    For the SEC, by the Division of Investment Management, under 
delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-16577 Filed 7-5-95; 8:45 am]
BILLING CODE 8010-01-M