The CHAIRMAN. The field work was commenced in November 1980. Mr. Randolph, to the best of your knowledge they offered to return their license when?

Mr. RANDOLPH. December 1980.

The CHAIRMAN. A month after the investigation started. Am I correct?

Mr. REESE. Approximately 2 months, sir. I think the field work started November 1, and I believe their offer to surrender the license was the latter part of December.

The CHAIRMAN. Mr. Reese, I have no further questions at this time, if you would remain in the room while we question the other witnesses.

Mr. REESE. Thank you, sir.

The CHAIRMAN. It will be the intention of the committee to ask Mr. Scaling and Mr. Payne to be the next witnesses of the committee. The committee will now stand in recess while I go downstairs and take care of this vote.

[Recess taken.]

The CHAIRMAN. The committee will come to order.

Mr. Payne and Mr. Scaling, do you swear to tell the truth, the whole truth, and nothing but the truth, so help you God? Mr. PAYNE. Yes.

Mr. SCALING. I do.

The CHAIRMAN. Thank you very much.

Mr. Payne and Mr. Scaling, while testifying before this committee I want you to understand both your rights and your obligations. You have the right to be represented by and to consult with an attorney while testifying. If you are represented by counsel, he may sit with you at the witness table so that you may consult with him. Is this your counsel that you have with you? Would you identify yourself, counsel?

Mr. McSPEDDEN. Yes. R. L. McSpedden, practicing law in Dallas, Tex.

The CHAIRMAN. Thank you very much, Mr. McSpedden.

If you do not invoke any constitutional privileges against testifying, you should also understand that anything you say while testifying before this committee is a matter of public record and can be used against you in any other proceeding. I would also like to advise you that as a sworn witness subject to the law and penalties of perjury, you are obligated to testify truthfully before this committee.

Do you understand your rights and obligations as witnesses?
Mr. PAYNE. Yes.

Mr. SCALING. Yes.

The CHAIRMAN. Now, counsel, do you have anything or do your clients have anything to state before I get to the matter of questions.

Mr. McSPEDDEN. Your Honor, they could make either a brief opening statement about the matters brought up here or you could question them, whichever pleases the chairman.

Mr. PAYNE. I would like to make a brief statement.

The CHAIRMAN. Both will certainly have the privilege to state whatever they care to on this matter.

Mr. Payne?

STATEMENT OF JOHN R. PAYNE, FIRST CAPITAL CORP., FORT WORTH, TEX., ACCOMPANIED BY R. L. McSPEDDEN, ESQ., DALLAS, TEX.

Mr. PAYNE. Well, it is obvious here that Mr. Scaling and I are being accused of increasing capital to enable us to leverage additional funds. Mr. Randolph, he stated in his example that we embezzled $225,000. We did not embezzle anything.

This was done on a transaction that at the time we felt would benefit all concerned, our SBIC. In our opinion it was a legitimate business transaction. It came under the rules and regs as we understood them. We did have a one-man type operation and it is very difficult for a one-man operation to keep up with all the rules and regs.

Nevertheless, at that time we felt that we had not done anything wrong. Specifically he named a $225,000 transaction. I just ask the committee where we were helped if we did not get any financing from the time that we did it for over 10 months after that transaction? It does not stand to reason that we needed these funds at that time or even near that time.

Our company has helped many small concerns, some 30-odd concerns. We had some in the portfolio that have done real well. They have hired lots of people. We have had some that have been bad. We have had some that have increased oil and gas reserves when our country needed them very badly.

We had an investigator that, without giving many of these small business concerns an opportunity to produce their records, subpenaed records, substantially hurting them at banks and other lenders, substantially hurting them. There was no reason.

I do not have any other comments. Mr. Scaling and I paid the loan off. Basically, the only one that can lose in this transaction is Mr. Scaling and I. We paid $3 million, and basically we owe a bunch to the bank. We pay an effective rate of over 18 percent and we had an effective rate of about 8.45 percent or somewhere in that neighborhood in the debentures, and we would not have had to pay off the debentures themselves, the principal part, for several years. You know, at times we did have to exercise control and there were several reasons, but the primary reason is to protect our investment and to protect the Government's investment, which had over $3 million invested here.

With these remarks, since we did not have the opportunity on 2 days' notice to do these elaborate charts, I think Mr. Scaling can probably explain.

STATEMENT OF HARRY S. SCALING, FIRST CAPITAL CORP., FORT WORTH, TEX., ACCOMPANIED BY R. L. McSPEDDEN, ESQ., DALLAS, TEX.

Mr. SCALING. I would like to say, first, sir, that it has been indicated that we paid this thing off because of the investigation. That was not the fact at all.

The reason we decided to pay this off was, in the normal audit which happens every year, around that summer the auditor informed us that we were in serious violation because we had invested our legal limit, $200,000, in a company called Sun Belt Explora

tion. We had spent the time, money, and effort to secure funding through Denver, SEC funding through Denver. Blinder Robinson did the underwriting. We were under the impression, just like everything else, that we could own 49 percent of the company.

Apparently on a public company you can only own, I think, 20 percent. They said we would have to divest ourselves of that. Mr. Payne and I met and said-we had another one coming with another oil venture-we would get hurt too badly because if we have to go from 50 percent down to 20 percent, after spending all the time, money, risk, and everything, to heck with it. We will just take our lumps, pay off the loan, and goodbye.

Those are my comments. Now I will be happy to explain those transactions, if you would like.

The CHAIRMAN. Well, does that consist of your opening statements? I want to make sure you have every opportunity to―

Mr. PAYNE. Well, I think he should have the opportunity to explain point by point on-

The CHAIRMAN. Believe me, there will be ample opportunity to go ahead and explain those transactions.

The financial investigator for the Office of Inspector General testified that in August 1976, November 1978, and July 1979 you made representations to the Small Business Administration of increased private capital in First Capital Corp. totaling $620,000. He also testified that $390,000 of this amount was not increased private capital at all but funds which originated in First Capital and through circular financing schemes were returned to First Capital's bank account.

Now according to the investigator's testimony, these fraudulent representations of capital allowed you to qualify for a substantial portion of the $3.725 million that you received in loans from the Federal Government. How do you respond to these charges? This will give you the opportunity to go step by step on each one of these matters that was presented before the committee. I wonder if Mr. Reese might put up the first chart? Can you just put up the first chart?

All right. Proceed in any way you want.

Mr. SCALING. This is the $40,000 deal, right? All right. I have loaned Mr. McCleary and his various entities personal money going back to 1970 and maybe before. No telling what it has been because I loan him interim money, he pays me back, and I have helped him in his financing.

This particular deal, on this short notice I just went back to my check stubs and I had loaned Regional Manufacturing personally $70,000, I think, in March or April 1976 of that year. He was putting together an operation in Ennis, Tex. We had agreed that once he got all his equipment, his building, his land together, we would make him a long-term real estate loan because that is going to help him get long-term financing, which he needs, you know, to space out his payments.

Therefore, I said, “OK, I will loan you the money," and then obviously when we put this package together it is just like an interim financing deal. He is going to pay me back just like if he had gone to the bank, he would be paying the bank back. That check was my check from my personal account to First Capital Corp. He very

likely paid me $40,000 or something that month, which is fine. He owed it to me. He owes me $40,000, $50,000, $60,000 right now. He is also a year behind in his loan to the First Capital Corp., and we haven't foreclosed or anything on him. He is 1 year behind on his monthly payments. This is a real estate, land and building loan and equipment, and it is certainly worth more than that.

We are personally working with him because he is a good man. He will work 14 or 16 hours a day. He presents a quality product. The State of Texas has awarded him these guardrail deals, for powder coating, you know. He is a good man and we are working with him all we can. That is all I have to say about that one.

Mr. PAYNE. May I make a comment about that? It is not unusual in our situation, it is not unusual for banks and other lenders to do similar things where they go out, they help the man to some degree and once the package is put together, then they fund it. This is not unusual in any financial dealings. The money in question, Mr. Scaling had put the money up.

The CHAIRMAN. All right. Mr. Reese, you may participate in this discussion here, just so that we get all the facts straight.

Now as I understand this, this is a check from First Capital Corp. is that correct?-to Regional Manufacturing.

Mr. REESE. Yes, sir, that is correct. The check was issued by Mr. Payne, payable to Regional Manufacturing Corp.

The CHAIRMAN. In the amount of $40,000.

Mr. REESE. Yes, sir.

The CHAIRMAN. It was a First Capital Corp. check. Is that correct?

Mr. REESE. That is correct.

The CHAIRMAN. Not an individual check, a First Capital Corp. check for $40,000, issued on August 27, 1976-

Mr. REESE. That is correct, sir.

The CHAIRMAN [continuing]. To Regional Manufacturing.

Mr. REESE. Yes, sir.

The CHAIRMAN. Then on August 30, 1976, $40,000 comes back to First Capital.

Mr. REESE. Yes, sir, into the same account that this check was issued on disbursing it from First Capital.

The CHAIRMAN. Well, I do not understand what this is all about. Mr. SCALING. I do not understand that. I am just saying that my personal check went into First Capital in August 1976. All Mr. McCleary did

The CHAIRMAN. I am not interested in the personal check. I am interested in the fact that——

Mr. SCALING [continuing]. McCleary did pay me back $40,000 of the $70,000 he owed me.

The CHAIRMAN. This is not a personal check. This is a First Capital Corp. check. Am I correct on that point?

Mr. PAYNE. That is correct. Absolutely. No question.

The CHAIRMAN. Then 3 days later the $40,000 comes back into First Capital.

Mr. PAYNE. It could have been the same day. I mean, Mr. McCleary, we had already advanced him the money, Mr. Chairman. We were trying to consolidate a loan. We were not trying to

hide anything. If Mr. Reese had asked Mr. Scaling, he would have shown him. He never talked to the man.

The CHAIRMAN. Mr. Reese?

Mr. REESE. I have never seen Mr. Scaling.

Mr. PAYNE. That is right.

Mr. REESE. I saw Mr. Payne several times and asked him, and he has never offered any explanation for this.

The CHAIRMAN. If the matter is as you portray it, why then on the books of First Capital did this not appear as repayment of a loan rather than an increase in capital?

Mr. PAYNE. Because Mr. Scaling, when he made the loans back several months-and it was in increments, it might have been $10,000 here, $15,000 here, $20,000 here, or he might have gone to the bank to get it—you know, we did not do it until we just came up to a certain point, and then we booked the loan.

However, Mr. Reese is saying that the funds, that $40,000 was not Mr. Scaling's funds. Mr. Scaling had a lot more in

Mr. SCALING. I have more than that in my bank account. I do not know where he did all this business but I have a check from my personal account to First Capital for $40,000 which they have in their records. I did not bring it because-I mean, that was the investment, out of my account to First Capital.

The CHAIRMAN. Now let's get one thing clear: As far as I am concerned, I am not going to be in a position to determine which moneys in First Capital are yours and which comes from the taxpayers of this country. There is no way I am going to catch up on that.

You are subject to the rules and regulations of the Small Business Administration, and——

Mr. PAYNE. Mr. Chairman, at the time that that was made we did not even need the $40,000 in there to be still in compliance with the rules and regs. We had not borrowed that much money. The CHAIRMAN. I still want to know why a Small Business Investment Company loan goes out on August 27, 1976, and then comes back 3 days later. What is there, in other words, in the nature of the objectives of the SBIC program that is being fulfilled by that kind of a transaction?

Mr. PAYNE. That particular transaction is more of a bookkeeping transaction, so Mr. Scaling can keep up with his investment, First Capital can keep up with the loans that they have. Again, this was not uncommon, to go to a bank and help somebody, one of these small business concerns, and then you come back later and have to pay off the bank, or pay off Mr. Scaling, or pay off me.

Mr. SCALING. You see, Regional did owe me the money.

The CHAIRMAN. It is my understanding from counsel that regulations require that loans be for a minimum of 5 years. Is that correct?

Mr. PAYNE. When we make them, that is correct.

Mr. SCALING. Yes, sir. This was packaged eventually in a real estate loan that was for 10 years.

The CHAIRMAN. Mr. Reese, are there any further comments you have on this case? I want to get to the explanations of the other two here.

Mr. REESE. I have no others.