Business Loan Program

SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

Business Loan Program

AGENCY: Small Business Administration (SBA).

ACTION: Proposed rule.

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SUMMARY: SBA proposes to amend the regulations governing Certified

Development Companies (``CDCs''). This proposed rule would amend the

rules governing CDC Area of Operations (the geographic area where SBA

authorizes a CDC to make loans under SBA's Development Company Loan

Program (``504 loan'')). The proposed rule would cover an applicant

requesting to become a CDC; an existing CDC applying to expand its Area

of Operations within the State in which it is chartered; an existing

CDC applying to expand its Area of Operations beyond the State in which

it is chartered into a contiguous bi-sected local economic area

(``Local Economic Area''); and an existing CDC applying to expand its

Area of Operations outside the State in which it is chartered into

another State beyond a Local Economic Area.

The proposed rule also revises when SBA considers a county

``adequately served'' (when the 504 loan activity within a county

precludes the county from being available for inclusion in a new CDC's

Area of Operations or an existing CDC's expansion request). In some

cases, counties would be available for inclusion in a new CDC's Area of

Operations or an existing CDC's expansion request under the proposed

rule that are not available under the current regulations.

The proposed rule would clarify under what circumstances and

conditions a CDC may contract out its management and staff functions.

It also would address the purposes for which a CDC may use its net

income generated in different States. The proposed rule would eliminate

a limited liability company from the types of organizations that may

apply to become a CDC. Finally, the proposed rule would expressly

authorize CDCs to establish Loan Committees and set forth conditions

under which they may be used.

DATES: Submit comments on or before December 8, 1999.

ADDRESSES: Comments should be mailed to Jane Palsgrove Butler,

Associate Administrator for Financial Assistance, Small Business

Administration, 409 Third Street, SW., Washington, DC 20416.

FOR FURTHER INFORMATION CONTACT: Gail H. Hepler, (202) 205-7530.

SUPPLEMENTARY INFORMATION: When Title V of the Small Business

Investment Act of 1958--Loans to State and Local Development

Companies--was enacted by Public Law 85-699 on August 21, 1958, it

defined a Development Company as ``an enterprise * * * formed for the

purpose

[[Page 60736]]

of furthering economic development of its community and environs, and

with authority to promote and assist the growth and development of

small-business concerns in the areas covered by their operations * * *

A local development company is a corporation chartered under any

applicable State corporation law to operate in a specified area within

a State * * * A local development company shall be principally composed

of and controlled by persons residing or doing business in the locality

* * *'' (13 CFR part 108, section 2, as of January 1, 1967).

When the Sec. 503 Development Company Loan Program was authorized

in 1980, its purpose was to provide financing through corporations

``formed by local citizens whose primary purpose is to improve their

community's economy. They assist in the planned economic growth of the

community by promoting and assisting the development of small business

concerns in their area.'' (Legislative History, Pub. L. 100-590, p.22.

It continues ``to qualify for this program, a development company must

be chartered in the State where it intends to operate * * *'' (id,

p.23))

Since the inception of the Certified Development Company Program

(``504 Program''), no CDC has been certified to operate permanently in

more than one State, except for relatively few circumstances when a

CDC's operations are in a Local Economic Area. Regulations published on

August 10, 1982, permitted a CDC to operate within two States if ``(i)

a State line bisects a city, in which case the 503 company may operate

city-wide or (ii) the 503 company has obtained prior written approval

to operate within a contiguous economic area, as determined by SBA,

which crosses a State line.'' Since this regulation was published, of

the 270 active CDCs, only nine have applied for and received approval

by SBA to have their permanent Areas of Operations cross State lines to

include a contiguous bi-sected local economic area. The permanent Area

of Operations of the other 261 CDCs are within their State of

incorporation.

Prior to the regulations published on March 1, 1996, all counties

within a CDC's Area of Operations had to be contiguous. The only

exception was Statewide CDCs that were intended to cover those counties

not covered by local CDCs. Many States did not (and continue to not)

have Statewide CDCs. Therefore, many of those States had counties that

were not covered by any CDC resulting in the small businesses in those

counties not having access to the CDC Program. To accommodate these

small businesses, the regulations for the program were modified on July

23, 1987, to permit the temporary expansion of a CDC's Area of

Operations for up to 1 year, to include an area underserved by the 504

Program. In such cases, the CDC needed prior SBA approval of each loan.

The temporary expansion could be renewed by the district office. The

CDC was exempt from a CDC's membership and Board requirements in the

temporary area. (The regulation permitting temporary expansions was

replaced as of March 1, 1996, by Sec. 120.839, case-by-case extension,

which permitted a CDC to apply to make an individual loan for a 504

project outside of its Area of Operations to the SBA district office

serving the area under certain circumstances.)

The district offices were authorized to approve temporary

expansions for up to 1 year so that small businesses could have access

to the program where there were no existing CDCs. Under this

regulation, CDCs received temporary authority to operate in other

contiguous counties in their States or in a Local Economic Area in an

adjoining State. If the CDC wanted to expand its permanent Area of

Operations to include the temporary area, it had to comply with the

regulations governing the eligibility requirements for CDCs including

membership and board representation. Often, CDCs were better able to

assess whether or not they wanted a particular geographic area

permanently by temporarily marketing and doing projects in it. Some

decided not to include the area permanently and withdrew; others

permanently expanded into the areas. In other cases, new CDCs or other

local CDCs were approved by SBA to include these areas in their

permanent Areas of Operations.

During the mid-1990s, three CDCs temporarily expanded beyond their

State of incorporation and beyond a Local Economic Area. In each case,

local CDCs covering these areas were inactive or did not exist and the

SBA district offices wanted their small businesses to have access to

the 504 Program. When the temporary authority expired, one CDC

sponsored a new CDC incorporated in the State to service the area with

the required membership and board representation. The application was

approved. However, the other two CDCs submitted applications to expand

to include their temporary areas in their permanent Areas of

Operations. Since, in each case, the areas were beyond the CDC's State

of incorporation and beyond a Local Economic Area, SBA could not

consider these requests under its existing regulations.

However, given the low 504 lending volume in several parts of the

country, SBA believes that it is in the best interests of underserved

communities to permit active CDCs in good standing to permanently

expand their Areas of Operations beyond their State of incorporation

and beyond a Local Economic Area. SBA proposes to call such a CDC a

``Multi-State CDC'' (a CDC that is operating as a foreign corporation

in another State and is permitted by SBA under certain circumstances to

include in the CDC's permanent Area of Operations counties in that

State that are located beyond a Local Economic Area). At the same time,

SBA wants to ensure that the congressional intent for CDCs is followed

and that they are formed by local citizens whose primary purpose is to

improve their community's economy. Therefore, the proposed regulations

would require the following:

1. The requirements in Sec. 120.822, Membership, must be met

separately for the Area of Operations within the State in which the CDC

is incorporated and each additional State in which it operates as a

Multi-State CDC.

2. The requirements in Sec. 120.823, CDC Board of Directors, must

be met separately for the State in which the CDC is incorporated and

for each additional State in which it operates as a Multi-State CDC. In

addition, in order for the Board of Directors (``Board'') to maintain

the appearance of independence and objectivity regarding the loan

decisions, CDC staff or management must not be voting members of the

Board. This will eliminate any appearance of a conflict of interest.

3. Each State must have a separate Loan Committee comprised of

members residing or working in that State, and representing at least

three of the four membership groups (government organizations

responsible for economic development in the Area of Operations in the

State; financial institutions that provide commercial long-term fixed

asset financing in the Area of Operations in the State; community

organizations dedicated to economic development in the Area of

Operations in the State; and businesses in the Area of Operations in

the State) including at least one member with commercial loan

experience acceptable to SBA. In order for the Loan Committee to

maintain the appearance of independence and objectivity regarding loan

decisions, CDC staff or management must not be voting members of the

Loan Committee. Again, this will eliminate any appearance of a conflict

of interest.

[[Page 60737]]

4. The CDC's Board must ratify, at least quarterly, the actions of

its Loan Committees. As well as meeting the general regulatory

requirements of a CDC's Board, the Board must have equal voting

representation from the State in which the CDC is incorporated and each

of the States the CDC operates in as a Multi-State CDC.

5. The CDC may apply to expand only in those counties that meet the

criteria of Sec. 120.835(a) as proposed in this regulation.

6. The CDC, upon the request of SBA, must provide evidence that the

net income generated in any State where the CDC is operating as a

Multi-State CDC is being invested in that State.

7. Any loans approved by SBA for a Multi-State CDC will not be

considered in the calculations under Secs. 120.810(a) and 120.835(a).

In other words, in determining whether a county is ``adequately

served'' for purposes of a new CDC's Area of Operations or an existing

CDC's expansion request, the 504 loans approved for a Multi-State CDC

will not be used as part of the calculation if the new CDC or expanding

CDC is incorporated within the State.

The proposed regulations require board and membership

representation from each State in which a Multi-State CDC proposes to

operate to ensure that the CDC's community economic development efforts

will be properly tailored to meet the needs of the communities it

serves and that the CDC does not evolve primarily into a loan packager.

Local membership, Board, and Loan Committee representation are more

likely to identify businesses with the greatest potential for

increasing or retaining local employment and helping the community's

economy. For example, a local Loan Committee would more likely know if

the approval of an application from a new business, such as a hotel,

would help other nearby businesses or, instead, would risk the

business's failure, or cause other, established hotels to fail, due to

a surplus of hotels in the area.

The proposed regulations also re-introduce the concept of a Local

Economic Area previously Stated in Sec. 108.503-1(c)(i) prior to March

1, 1996. It would permit a CDC to apply for an Area of Operations that

crosses State lines without meeting the above requirements when the

contiguous areas that lie in different States are part of the same

``local economic area.'' The same Local Economic Area would mean that

the employees and customers of the businesses in that area work and

live in that economic area as if there is no State line dividing it.

Re-introducing the concept in the regulations will help differentiate

this type of expansion from the proposed one in which a CDC

incorporated in one State is applying to expand as a Multi-State CDC

into another State.

The proposed rule revises the definition for ``Area of Operations''

and adds definitions for ``Multi-State CDC'' and ``Local Economic

Area'' to Sec. 120.802.

Under the proposed rule, for a 24-month period after a new CDC has

been approved to operate in a county in its State of incorporation or

an existing CDC has been approved to expand into an area within its

State of incorporation, SBA will not accept an application to include

the county in the Area of Operations of a new CDC or an application

from an existing CDC to expand into that county. This would give the

CDC that received permission to operate in the counties an opportunity

to recoup up-front costs of establishing itself in the new area.

The proposed regulations would also change Secs. 120.810 and

120.835 to permit a new CDC or an existing CDC incorporated in a State

to apply to operate in a county within that State with a population of

100,000 or more, even if the county is being ``adequately served'' by

an existing CDC incorporated in that State. Currently, if a CDC is

doing one 504 loan per year per 100,000 population averaged over 24

months in a particular county, another CDC may not apply to include

that county in its Area of Operations. Under the current regulations,

the county is ``adequately served.'' The proposed regulations would

permit SBA to consider an application for that county from another CDC

incorporated in that State if the county has a population of 100,000 or

more and there is only one CDC incorporated in that State that includes

that county in its permanent Area of Operations. This will give small

businesses more choices.

The proposed rule further amends Secs. 120.810 and 120.835 to

direct an applicant for certification as a new CDC and for expansion

within its State of incorporation or into a Local Economic Area to

apply to the SBA district office serving the area where the CDC's

headquarters is located. The current regulation requires an applicant

to apply to the district office serving a proposed area of operations.

If a CDC is applying to expand into another State as a Multi-State CDC,

it must apply to the SBA district office serving the area where the CDC

will headquarter its Multi-State CDC operations in that State. A new

CDC may not apply to cover an area as a Multi-State CDC during the

first 24 months after SBA approves it to be a CDC. SBA believes that a

CDC should demonstrate that it has actively serviced an Area of

Operations within its State of incorporation (including any Local

Economic Areas) before it applies to cover an area as a Multi-State

CDC. SBA will review a CDC's 504 performance history when it considers

an application to serve an area as a Multi-State CDC.

Proposed regulation Sec. 120.837 would be retitled ``SBA decision

on application for certification or expansion.'' Current Sec. 120.837

applies only to decisions on requests for expansion. Under the proposed

rule, the provisions of Sec. 120.837 would apply to applicants applying

to become CDCs and CDCs wishing to expand. In either case, the proposed

regulation would require the processing district office to solicit

comments from all other district offices serving the CDC's existing and

proposed area of operations to determine if the applicant is in

compliance with all of SBA's regulations, policies, and performance

benchmarks, including pre-approval and annual review of any management

or staff contracts, and the timely submission of all annual reports.

The proposed rule further amends Sec. 120.837 to delete the

examples of the types of information a district office might consider

in reviewing an application for expansion. The amended rule would

clarify that the district office, in making its recommendation, and the

Associate Administrator for Financial Assistance (AA/FA), in making the

decision on the application, may consider any available information

regarding the proposed area of operations, the requesting CDC, and the

existing CDCs serving the area. Some CDCs and district offices have

treated the examples in the current regulation as a prescribed list

that could not be supplemented.

The proposed regulations would delete the requirement in

Sec. 120.837 that the AA/FA must make his or her final decision within

30 days of receipt of the district office's recommendation. Because of

staffing limitations, SBA has not been able to meet this deadline.

However, SBA will continue to place a priority on these requests.

The proposed regulation Sec. 120.837(c) also would establish that

any unilateral authority that a CDC has in its State of incorporation

(such as Accredited Lenders Program (ALP), Premier Certified Lenders

Program (PCLP), or Priority CDC) does not carry over into a State in

which it is operating as a Multi-State CDC. The CDC must earn any such

status in each State based solely on the activity in that State. SBA's

grant of any special unilateral authority in an Area of

[[Page 60738]]

Operations depends on the quality of a CDC's performance history,

relationship with its SBA district office(s), and its processing,

closing, servicing, and liquidation abilities in that Area of

Operation. There is no guarantee that the quality of a CDC's operations

in one State will be duplicated in another State with a separate

membership, Board, Loan Committee, management, and staff.

The proposed rule would amend Sec. 120.820 to delete a limited

liability company from the types of organizations that may apply to be

certified as a CDC. SBA believes that since a limited liability company

structure only benefits its members when it is a for-profit entity

providing its members certain tax advantages over a C Corporation while

still offering its members some of the liability protection enjoyed by

C Corporation shareholders, a limited liability company structure would

not be appropriate to be used to fulfill the non-profit, local economic

development role intended for CDCs. (SBA has never received an

application from a limited liability company to become a CDC.) Section

120.822 sets forth a CDC's membership requirements. The proposed rule

adds to Sec. 120.822 the requirement that the membership must meet at

least annually. It emphasizes that a CDC must meet the membership

requirements separately for its State of incorporation and for each

State in which it proposes to and is operating as a Multi-State CDC.

Section 120.823 sets forth the requirements regarding a CDC's Board

of Directors. The proposed regulation clarifies that a quorum

represents at least five Directors authorized to vote. There may be no

conflict of interest or self-dealing, or any appearance of a conflict

of interest or self-dealing in regards to any action of a CDC Board.

Board members often must recuse themselves from voting on a project.

The proposed regulation clarifies that it is the number of Board

members voting, not present, that determines whether there is a quorum.

A CDC Board must be independent, objective, and composed of

qualified representatives of the required community groups with a nexus

to the mission and activities of the CDC. For example, an individual is

not a qualified representative of the business community merely because

he or she works for a business located in the community. A board member

must be a responsible official of the represented organization. An

example of a responsible official of a business would be the owner of

the business. An example of a responsible official of a bank would be a

commercial loan officer.

The Board is responsible for hiring and providing oversight of the

CDC's management and staff, which in turn is responsible for the day-

to-day marketing, processing, closing, and servicing of the loans. In

order to maintain the appearance of objectivity on the part of the

Board, the proposed regulation prohibits any member of a CDC's staff or

management from being a voting member of the Board. If a member of a

CDC's staff or management is present as a non-voting member of the

Board, his or her presence does not count toward a quorum.

Many CDC Boards designate a Loan Committee to review and decide on

loan approvals and servicing actions on an interim basis between Board

meetings. SBA's current regulations do not address Loan Committees. The

proposed regulation clarifies that a Board may establish a Loan

Committee. The Loan Committee must meet the same organizational

requirements as the full Board. It must be independent and objective,

providing objective analysis of the actions recommended by the CDC

management and staff. It must represent at least three of the four

membership groups; and include at least one person with commercial

lending experience acceptable to SBA. Like the Board, the Loan

Committee must have at least five voting members to establish a quorum

and the Loan Committee must not include any CDC staff or management as

a voting member. Members must be responsible members of the represented

organizations with a nexus to the missions and activities of the CDC.

All members must live or work in the Area of Operations of the State in

which the 504 project on which they are voting is located, unless the

project qualifies under one of the exceptions in Sec. 120.839, Case-by-

case Extensions. For example, a representative Loan Committee might

include three bankers (lenders), a CPA (business), a commercial real

estate agent (business), a representative of the local economic

development authority (government), and a member of the Board of

Directors who represents the community (community). If there is a Loan

Committee, the Board must still meet at least quarterly and ratify the

actions of the Loan Committee.

The proposed rule makes it clear that a CDC must meet the Board and

Loan Committee requirements for its State of incorporation and for each

State in which it proposes to and is operating as a Multi-State CDC.

Also, there can be no conflict of interest or self-dealing, or any

appearance of a conflict of interest or self-dealing, on the part of

any Board or Loan Committee member in regard to any action of the Board

or Loan Committee. If there is a potential for an appearance of a

conflict of interest, the Board or Loan Committee member must recuse

him or herself from voting on the action. For example, if a Loan

Committee member is an officer of the bank that will have the first

mortgage on the 504 project being reviewed for approval, he or she

should not vote on the project. At least one other member of the Loan

Committee with commercial lending experience will have to be present to

vote on the project. Also, the language allowing an alternative,

approved by SBA, to a voting Board member with lending experience has

been deleted because SBA believes that a CDC should have several Board

or Loan Committee members with commercial lending experience available

to vote on loans, rather than needing an exception to the requirement

because its member is unavailable.

In Sec. 120.824, the proposed rule clarifies under what

circumstances a CDC may contract out its management and staffing.

Section 503(e) of the Small Business Investment Act of 1958 states that

a qualified State or local development company must have: (1) A full-

time professional staff; and (2) professional management ability

(including adequate accounting, legal, and business-servicing

abilities). Public Law 100-590, approved November 3, 1988, permitted an

exception to these requirements for a CDC in a rural area. It states

that the rural CDC ``shall be deemed to have satisfied the requirements

of a full-time professional staff and professional management ability

if it contracts with another certified development company which has

such staff and management ability and which is located in the same

general area to provide such services.'' The Congressional Record dated

October 3, 1988, states that this would allow ``a certified development

company in a rural area to contract out for professional staff and

professional management ability rather than hiring the employees in-

house. This will help development companies in rural areas which do not

do a sufficient loan volume to justify a full time staff.''

(Congressional Record--H9279). This is the only exception Congress made

to the requirement that a CDC must have in-house full-time professional

management and staff.

In recent years, many CDCs have entered into contracts with outside

parties for CDC staffing and management. Questions have arisen

[[Page 60739]]

regarding the extent and propriety of such contracts.

In Sec. 120.824, the proposed rule requires a CDC to have a full-

time professional, including an Executive Director (or the equivalent)

managing daily operations. At a minimum, this means a CDC must have at

least one full-time salaried professional employee that is employed

directly to manage the CDC. A CDC may petition the AA/FA to waive this

requirement in only two circumstances: (1) When the management of a

rural CDC with insufficient loan volume to justify its own management

employee is to be contributed by another CDC located in the same

general area; or (2) when the management of a CDC is to be contributed

by a non-profit affiliate of the CDC that is financially subsidizing

the CDC's operation and has the economic development of the CDC's Area

of Operations as one of its principal activities. In the latter case,

the management contributed by the affiliate may work on and operate

other economic development programs of the affiliate, but must be

available to 504 customers during regular business hours. The first

exception is authorized by statute. SBA proposes to permit the second

exception because it considers the CDC and the affiliate to be

sufficiently related to have the same or similar mission and objectives

for the Area of Operations.

A CDC must possess a full-time professional staff that is capable

of packaging, processing, closing, and servicing loans. The staff

capacity of the CDC may be procured from salaried employees or, under

certain circumstances, on a contractual basis that is acceptable to

SBA, as long as at least one full-time professional manager in charge

of the day-to-day operations of the CDC is a salaried employee of the

CDC. The purpose of permitting a CDC to contract for staff functions,

in certain cases, is to allow those CDCs that do not have sufficient

503/504 project-related income to provide the cash flow to support a

full-time staff for each of the functions to be able to contract for a

qualified individual on a part-time basis. If a CDC contracts for some

of the staff functions, the services must be billed at rates that are

reasonable and customary for the service and the geographic area.

The proposed regulation eliminates the reference in the current

Sec. 120.824 to Lender Service Providers, as defined in 13 CFR 103.1.

This reference has been confusing to CDCs, and SBA believes it is not

necessary. The proposed rule clarifies that the contractors must either

live or work in the CDC's Area of Operations.

In contracting out for management and staff services, there must be

no evidence of a conflict of interest or self-dealing, or any

appearance of a conflict of interest or self-dealing on the part of the

CDC's Board, management, or staff that could result in increased costs

to a small business borrower or the CDC, or which would adversely

affect the financial condition of the CDC including its ability to

become self-sustaining. Any contracted staff must be qualified for the

function that he or she is providing and live or do business in the

CDC's Area of Operations.

SBA believes that Congress intended a CDC to sustain its operations

continuously with reliable sources of funds, including income from

services rendered from the Development Company Loan Program. A CDC's

Board is not acting in the best interests of the CDC, SBA, or small

business borrowers if it is permitting fee income generated from the

Development Company Loan Program to be diverted to another organization

through a contractual relationship rather than retained in the CDC to

support its operations and economic development mission. The reason for

the present clarification to the regulations is to ensure that the

congressional intent is followed and that CDCs are not doing indirectly

what they are not permitted to do directly, such as becoming

effectively a shell for a for-profit organization through a contractual

relationship. This would be in direct conflict with the intent of the

Development Company Loan Program. Except for a few for-profit CDCs

certified before January 1, 1987, and grandfathered in 1986, when the

eligibility requirements for a CDC were changed, a CDC must be non-

profit. The preamble to the 1986 regulations stated that ``The purpose

of a 503 company shall be to foster economic development in its area of

operations; any benefit flowing to shareholders, members or other

related parties shall be merely incidental to such purpose.'' The

preamble went on to say that the reason for the change was ``the desire

to emphasize the pro bono publico character of the industry over the

profit incentive. The nature of the 503 company is to be a catalyst in

fostering economic development, and not a profit center for owners or

members * * *'' (64 FR 20765).

Conflict of interest and self dealing, or any appearance of a

conflict of interest or self dealing by related parties (which includes

the CDC's professional management, staff, and Board of Directors) to

the detriment of a small business borrower, the CDC, or SBA is

prohibited.

If a CDC Board proposes to contract for staff rather than hire that

staff directly, SBA must preapprove and annually review each contract

to ensure that the contracts are reasonable and customary for the area

and that there is no self-dealing or conflict of interest, or any

appearance of self-dealing or conflict of interest. If the CDC's Board

believes that it is in the best interest of the CDC to contract for a

function, the CDC's Board must justify to SBA why SBA should favorably

consider the contract for the services. SBA-approved contractors must

not be compensated directly from the small business and must be

compensated only by the CDC from the eligible 504 project-related fees

that the CDC receives. No contractor or Associate of a contractor may

be a voting or non-voting member of the CDC's Board or Loan Committee.

Finally, the proposed rule amends Sec. 120.825 to clarify and

emphasize that any funds generated from 503 and 504 loan activity by a

CDC remaining after the payment of staff and overhead expenses must be

retained in the CDC as a reserve for future operations or to be

invested in other local economic activity in its Area of Operations.

One of the primary missions of the CDC's Board must be to ensure that

the CDC is, or is becoming, self-sufficient through the fee income

generated while maintaining its local economic focus. If the CDC's

Board approves a contract that benefits the contractor at the expense

of the CDC, then the CDC's Board is failing its mission.

SBA invites comment on all aspects of this proposed rule, including

the underlying policies. SBA may rely on its own expertise in

promulgating the final rule. Submitted comments will be available to

any person or entity upon request.

Compliance With Executive Orders 13132, 12988, and 12866, the

Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the

Paperwork Reduction Act (44 U.S.C., Ch. 35)

For the purposes of Executive Order 13132, SBA certifies that this

proposed rule has no federalism implications warranting preparation of

a federalism assessment.

This proposed rule does not constitute a significant rule within

the meaning of Executive Order 12866, since it is not likely to have an

annual effect on the economy of $100 million or more, result in a major

increase in costs or prices, or have a significant adverse effect on

competition or the U.S. economy.

[[Page 60740]]

SBA certifies that this proposed rule will not have a significant

economic impact on a substantial number of small entities within the

meaning of the Regulatory Flexibility Act, 5 U.S.C. 601-612. Currently,

out of approximately 24 million small businesses in the United States,

about 4000 receive 504 loans annually. As described in the preamble,

through this regulation, SBA hopes to increase the number of loans made

to small businesses. Even if SBA were to assume a generous result of a

20 percent increase in loans, it would only result in an annual

increase of 800 loans per year. SBA does not consider this a

significant economic impact on a substantial number of small entities.

Other aspects of this rule clarify management and structural

requirements for CDCs. These aspects would have no economic impact on

small entities, as they merely alter CDC requirements.

SBA certifies that this proposed rule does not impose any

additional reporting or recordkeeping requirements under the Paperwork

Reduction Act, 44 U.S.C., chapter 35.

For purposes of Executive Order 12988, SBA certifies that this

proposed rule is drafted, to the extent practicable, to accord with the

standards set forth in paragraph 3 of that Order.

List of Subjects in 13 CFR Part 120

Loan programs--business, Small business.

For the reasons stated in the preamble, SBA proposes to amend 13

CFR part 120 as follows:

PART 120--BUSINESS LOANS

1. The authority citation for part 120 continues to read as

follows:

Authority: 15 U.S.C. 634(b)(6) and 636(a) and (h).

2. Amend Sec. 120.802, to revise the definition of ``Area of

Operations'' and add definitions of Local Economic Area and Multi-State

CDC in alphabetical order to read as follows:

Area of Operations is the geographic area where SBA has approved a

CDC's request to provide 504 program services to small businesses on a

permanent basis.

* * * * *

Local Economic Area is an area, as determined by SBA, that is in a

State other than the State in which an existing CDC (or an applicant

applying to become a CDC) is incorporated, shares a border with the

CDC's existing Area of Operations (or applicant's proposed Area of

Operations) in its State of incorporation, and is a part of a local

trade area that is contiguous to the CDC's Area of Operations (or

applicant's proposed Area of Operations) within its State of

incorporation. Examples would be a city that is bi-sected by a State

line or a metropolitan statistical area that is bi-sected by a State

line.

Multi-State CDC is a CDC that is incorporated in one State and is

authorized by SBA to operate as a CDC in another State beyond any

contiguous Local Economic Areas.

* * * * *

3. Revise Sec. 120.810 to read as follows:

Sec. 120.810 Applications for certification as a CDC.

Applicants for certification as a CDC must apply to the SBA

District Office serving the area in which the applicant proposes to

locate its headquarters.

(a) An SBA District Office may accept an application for a county

only if:

(1) The county is part of the Area of Operations of only one CDC

that is incorporated in the State where the county is located; the

county has a population of 100,000 or more; the county has not become

part of an Area of Operations within the last 24 months of a CDC that

is incorporated in the State where the county is located; and the

applicant is incorporated in the State where the county is located.

(2) For all counties other than those that qualify under paragraph

(a)(1) of this section:

(i) There is no CDC that includes the county in its Area of

Operations; or

(ii) The CDCs that include the county in their Areas of Operations

have not averaged together at least one 504 loan approval per 100,000

population per year averaged over the previous 24 months prior to SBA

receiving a complete application from the applicant (loans that are

approved by SBA for a Multi-State CDC outside of its State of

incorporation are not to be used in the calculation if the applicant is

incorporated in the State); and the county has not become part of an

Area of Operations within the last 24 months of a CDC that is

incorporated in the State where the county is located.

(b) An applicant whose application has been accepted must

demonstrate that it satisfies the certification and operating criteria

in Secs. 120.820 through 120.829 and the need for 504 services in the

Area of Operations (if there is already a CDC in the Area of

Operations, the applicant must justify the need for another and present

a plan to avoid duplication or overlap). Applications must also include

an operating budget approved by the applicant's Board of Directors, and

a plan to meet CDC operating requirements (without specializing in a

particular industry). An applicant's proposed Area of Operations may

include Local Economic Areas. An applicant may not apply to cover an

area as a Multi-State CDC. The AA/FA shall make the certification

decision.

4. Revise Sec. 120.820 to read as follows:

Sec. 120.820 CDC non-profit status.

A CDC must be a non-profit corporation in good standing. (For-

profit CDCs certified by SBA prior to January 1, 1987, may retain their

certifications.) An SBIC may not be a CDC.

5. Revise Sec. 120.822 as follows:

Sec. 120.822 CDC membership.

(a) A CDC must have at least 25 members (or stockholders for for-

profit CDCs approved prior to January 1, 1987). The CDC membership must

meet annually. No person or entity may own or control more than 10

percent of the CDC's voting membership (or stock). Members must be

representative of and provide evidence of active support in the Area of

Operations. Members must be from each of the following groups:

(1) Government organization responsible for economic development in

the Area of Operations and acceptable to SBA;

(2) Financial institutions that provide commercial long-term fixed

asset financing in the Area of Operations;

(3) Community organizations dedicated to economic development in

the Area of Operations such as chambers of commerce, foundations, trade

associations, colleges, or universities; and

(4) Business in the Area of Operations.

(b) A CDC that is incorporated in one State and is operating as a

Multi-State CDC in another State must meet the membership requirements

for each State.

6. Revise Sec. 120.823 to read as follows:

Sec. 120.823 CDC Board of Directors and Loan Committee.

The CDC must have a Board of Directors chosen from the membership

by the members, and representing at least three of the four membership

groups. No single group shall control. The Board members must be

responsible officials of the organizations they represent, and at least

one must possess commercial lending experience. The Board must meet at

least quarterly and shall be responsible for CDC staff decisions and

actions. A quorum shall require at least five Directors authorized to

vote. No person who is a member of a CDC's staff or management may be a

voting member of the Board. When the Board votes on loan approval or

[[Page 60741]]

servicing actions, at least one Board member with commercial lending

experience acceptable to SBA must be present and vote. There must be no

appearance of a conflict of interest with respect to any actions of the

Board.

(a) The Board may establish a Loan Committee that reports to the

Board. The Loan Committee members must represent at least three of the

four membership groups including at least one member with commercial

lending experience acceptable to SBA. All members must live or work in

the Area of Operations of the State where the 504 project they are

voting on is located unless the project falls under one of the

exceptions listed in Sec. 120.839, Case-by-case extensions. No CDC

staff or management is permitted to be a voting member of any Loan

Committee. A quorum shall require at least five voting members. The

CDC's Board must ratify the actions of any Loan Committee on at least a

quarterly basis. There must be no appearance of a conflict of interest

with respect to any actions of the Loan Committee.

(b) If the CDC is incorporated in one State and is approved as a

Multi-State CDC to operate in another State, the CDC must meet the

Board and Loan Committee requirements for each State.

7. Revise Sec. 120.824 to read as follows:

Sec. 120.824 Professional management and staff.

A CDC must have full-time professional management, including an

Executive Director (or the equivalent), managing daily operations. It

must also have a full-time professional staff qualified by training and

experience to market the 504 Program, package and process 504 loan

applications, close 504 loans, service, and, if authorized by SBA,

liquidate the loan portfolio, and sustain a sufficient level of service

and activity in the Area of Operations. CDCs may obtain, under written

contract, marketing, packaging, processing, closing, or liquidation

services provided by qualified individuals and entities who live or do

business in the CDC's Area of Operations under the following

circumstances:

(a) The CDC has at least one salaried professional employee that is

employed directly (not contracted ) full-time to manage the CDC. A CDC

may petition SBA to waive the requirement of at least one full-time

manager if the CDC is rural and has insufficient loan volume to justify

its own management, and another CDC located in the same general area

will provide the management; or the management of a CDC is to be

contributed by a non-profit affiliate of the CDC that is financially

subsidizing the CDC's operations and has the economic development of

the CDC's Area of Operations as one of its principal activities. In the

latter case, the management contributed by the affiliate may work on

and operate other economic development programs of the affiliate, but

must be available to 504 customers during regular business hours.

(b) SBA must pre-approve all contracts. (CDCs may contract for

legal and accounting services without SBA approval.)

(c) If a CDC's Board believes that it is in the best interest of

the CDC to contract for a marketing, packaging, processing, closing,

servicing or liquidation function, the CDC's Board must justify to SBA

why SBA should favorably consider the contract for the services. The

CDC's Board must demonstrate to SBA that compensation under the

contract is only from the CDC, is reasonable and customary for similar

services in the Area of Operations, is only for actual services

performed, and does not evidence any conflict of interest or self-

dealing, or an appearance of conflict of interest or self-dealing, on

the part of any of the CDC's officers, management, and staff, including

members of the Board and any Loan Committee.

(d) Contracts must be for a period not to exceed 2 years (including

options to renew) and must clearly identify procedures satisfactory to

SBA that permit the CDC to terminate the contract prior to its

expiration date. SBA must review all 2-year contracts after the first

year to ensure that there is no conflict of interest or self-dealing,

or an appearance of conflict of interest or self-dealing.

(e) No contractor (under this section) or Associate of a contractor

may be a voting member of the CDC's Board or Loan Committee.

8. In Sec. 120.825 add the following two sentences to the end of

the section as follows:

Sec. 120.825 Financial ability to operate.

* * * Any funds generated from 503 and 504 loan activity by a CDC

remaining after payment of staff and overhead expenses must be retained

in the CDC as a reserve for future operations or to be invested in

other local economic development activity in its Area of Operations. If

a CDC is operating as a Multi-State CDC, it must maintain separate

accounting for each State of all 504 fee income and expenses and

provide, upon SBA's request, evidence that the funds resulting from its

Multi-State CDC operations are being invested in economic development

activities in each State in which it was generated.

9. Revise Sec. 120.835 to read as follows:

Sec. 120.835 Application to expand a CDC's Area of Operations.

An existing, active CDC applying to expand its Area of Operations

must be operating in conformance with all existing SBA regulations,

policies, and performance benchmarks and be well-qualified to serve the

proposed area. A CDC seeking to expand its Area of Operations must

apply in writing to the SBA District Office where the CDC is

headquartered, unless it is applying as a Multi-State CDC. In that

case, the CDC must apply to the SBA District Office that services the

area where the Multi-State CDC is locating its principal office in that

State.

(a) An SBA District Office may accept a CDC's application to expand

its Area of Operations into a county within its State of incorporation,

in a Local Economic Area or in another State beyond a Local Economic

Area that it would service as a Multi-State CDC only if:

(1) The county is part of the Area of Operations of only one CDC

that is incorporated in the State where the county is located; the

county has a population of 100,000 or more; the county has not become

part of an Area of Operations within the last 24 months of a CDC that

is incorporated in the State where the county is located; and the

applicant CDC is incorporated in the State where the county is located.

(2) For all counties other than those that qualify under paragraph

(a)(1) of this section:

(i) There is no CDC that includes the county in its Area of

Operations; or (ii) The CDCs that include the county in their Areas of

Operations have not averaged together at least one 504 loan approval

per 100,000 population per year averaged over the previous 24 months

prior to SBA receiving a complete application from the applicant CDC

(loans that are approved by SBA for a Multi-State CDC outside of its

State of incorporation are not to be used in the calculation if the

requesting CDC is incorporated in the State); and the county has not

become part of an Area of Operations within the last 24 months of a CDC

that is incorporated in that State.

(b) An applicant whose application for expansion has been accepted

must demonstrate to the satisfaction of SBA that it satisfies all of

the certification and operating criteria in Secs. 120.820 through

120.829. It must demonstrate that it has the ability to provide full

service to small businesses in the

[[Page 60742]]

requested area including processing, closing, servicing, and, if

authorized, liquidating 504 loans. It must also demonstrate the need

for 504 services in the Area of Operations and present a plan for

servicing the area. If there is already one or more CDCs in the

requested Area of Operations, the applicant must justify the need for

another. In addition, an applicant to service an area as a Multi-State

CDC must show that:

(1) The requirements in Sec. 120.822, Membership, are met

separately for the Area of Operation within the CDC's State of

incorporation and for each additional State in which it operates or

seeks to operate as a Multi-State CDC;

(2) The requirements regarding Boards of Directors in Sec. 120.823,

CDC Board of Directors and Loan Committees, are met separately for the

State of incorporation and for each additional State in which it

operates or seeks to operate as a Multi-State CDC;

(3) The CDC Board of Directors must have the same number of members

residing or working in the CDC's State of incorporation and each other

State in which it operates or seeks to operate as a Multi-State CDC;

and

(4) The CDC must have separate Loan Committees in its State of

incorporation and in each State in which the CDC operates or seeks to

operate as a Multi-State CDC, comprised of members residing or working

in that State.

10. Revise Sec. 120.837 to read as follows:

Sec. 120.837 SBA decision on applications for a new CDC or for an

existing CDC to expand Area of Operations.

(a) The processing District Office must solicit the comments of any

other District Office in which the CDC operates or proposes to operate.

The processing District Office must determine that the CDC is in

compliance with SBA's regulations, policies, and performance

benchmarks, including pre-approval and annual review by SBA of any

management or staff contracts, and the timely submission of all annual

reports. In making its recommendation on the application, the District

Office may consider any information presented to it regarding the

requesting CDC, the existing CDC, or CDCs that may be affected by the

application, and the proposed area of operation.

(b) The District Office will submit the application,

recommendation, and supporting materials within 60 days of receipt of a

complete application from the CDC to the AA/FA, who will make the final

decision. The AA/FA may consider any available information.

(c) If a CDC is approved to operate as a Multi-State CDC, any

unilateral authority that a CDC has in its State of incorporation under

any SBA program (such as the Accredited Lenders Program (ALP), Premier

Certified Lenders Program (PCLP), or Expedited Closing Process

(Priority CDC)) does not carry over into a State in which it is

operating or is approved to operate as a Multi-State CDC. The CDC must

earn the status in each State based solely on its activity in that

State.

Dated: September 23, 1999.

Aida Alvarez,

Administrator.

[FR Doc. 99-29090 Filed 11-5-99; 8:45 am]

BILLING CODE 8025-01-U