Small Business Investment Companies

SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

Small Business Investment Companies

AGENCY: Small Business Administration.

ACTION: Proposed rule.

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SUMMARY: The Small Business Reauthorization Act of 1997 made a number

of changes to the Small Business Investment Act of 1958, as amended.

For the Small Business Investment Company (SBIC) Program, the changes

include provisions affecting capital requirements, Leverage

eligibility, and the timing of tax distributions by SBICs that have

issued Participating Securities. This proposed rule would implement

these statutory provisions; in addition, it would prohibit political

contributions by SBICs and would modify regulations governing the

refinancing of real estate by SBICs, portfolio diversification

requirements, takedowns of Leverage, and in-kind distributions by

Participating Securities issuers.

DATES: Submit comments on or before May 14, 1999.

ADDRESSES: Address comments to Don A. Christensen, Associate

Administrator for Investment, U.S. Small Business Administration, 409

3rd Street, SW., Suite 6300, Washington, DC 20416.

FOR FURTHER INFORMATION CONTACT: Leonard W. Fagan, Investment Division,

at (202) 205-7583.

SUPPLEMENTARY INFORMATION: This proposed rule would implement the

provisions of Subtitle B of Pub. L. 105-135 (December 2, 1997), the

Small Business Reauthorization Act of 1997, which relate to small

businesses investment companies (SBICs). This rule would also establish

regulations prohibiting political contributions by SBICs and would

modify regulations governing the refinancing of real estate by SBICs,

portfolio diversification requirements, procedures for drawing down

Leverage from SBA, and in-kind distributions by SBICs that have issued

Leverage in the form of Participating Securities.

Private Capital

Section 213 of Pub. L. 105-135 amended the statutory definition of

private capital to include certain funds invested in a Licensee by a

federally chartered or Government-sponsored corporation established

prior to October 1, 1987. Under the revised definition, private capital

may include funds obtained from the business revenues of such entities;

appropriated Government funds are specifically excluded. Proposed

Sec. 107.230(b)(3) would implement this change by incorporating the

statutory language in the regulatory definition of Private Capital. In

this context, SBA's view is that ``business revenues'' means earnings

that are generated by a corporation through activities of a commercial

nature and that are reflected in the retained earnings of the

corporation.

Definition of ``Associate''

SBA is proposing a technical correction in the definition of

``Associate'' in Sec. 107.50. Under paragraph (8)(i) of the current

definition, a business concern becomes an Associate of an SBIC if it

has one or more officers who have a business or personal relationship

with the SBIC of a type listed in subparagraphs (1) through (6) of the

definition. This provision does not explicitly encompass business

concerns organized as partnerships or limited liability companies,

which may be managed by persons who are not designated as officers. To

clarify the applicability of paragraph (8)(i) to all concerns,

regardless of their form of organization, the proposed rule would

replace ``officer'' with ``officer, general partner, or managing

member.''

Leverageable Capital

An SBIC's Leverageable Capital is a subset of its Private Capital.

It is used to determine the maximum amount of SBA Leverage funds which

the SBIC may have outstanding. The current definition of Leverageable

Capital in Sec. 107.50 excludes ``Qualified Non-private Funds [as

defined in Sec. 107.230(d)] whose source is Federal funds.'' SBA has

determined that the Act does not require this exclusion and is

proposing to remove it.

Internet Access and Electronic Mail

As the SBIC program grows in size and sophistication, SBA is

seeking ways to improve administrative efficiency. The Agency is

particularly interested in improving its ability to communicate with

Licensees electronically. Many SBICs are already using the Internet to

obtain updated regulations and software from SBA and to submit

financial statements and other required information. To further promote

the use of this highly efficient means of communication, proposed

Sec. 107.504(a) would require all SBICs to have Internet access and

Internet electronic mail no later than June 30, 1999.

To improve the organization of the regulations, the proposed rule

also would consolidate three current sections into a single section.

Current Secs. 107.504, 107.505, and 107.508 would become Sec. 107.504

(a), (b), and (c), respectively. These sections require an SBIC to

maintain an office accessible to the public and to have certain office

equipment to facilitate communications with SBA. Except for the

proposed new requirement for Internet access and electronic mail, there

would be no substantive change in these provisions.

Political Contributions

It has come to SBA's attention that a few SBICs have made

contributions to organizations formed to promote the election of

political candidates or the advancement of a political or legislative

agenda. In at least one case, an SBA examiner cited an SBIC's

contribution to an organization of this type as an ``activity not

contemplated by the Act.'' SBA has upheld this interpretation of the

Act and would apply it even where the SBIC has no outstanding Leverage

at the time of the contribution.

The Act states that the purpose of the SBIC program is ``to

stimulate and supplement the flow of private equity capital and long-

term loan funds which small-business concerns need for the sound

financing of their business operations and for their growth, expansion,

and modernization. . . .'' 15 U.S.C. 661. Under a longstanding

interpretation of this statutory provision, SBA does not permit

activities by an SBIC that do not contribute to the growth, expansion,

and modernization of a small business. Since SBA is concerned that an

SBIC's political contributions can have, at best,

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only a remote and speculative connection to the growth, expansion, and

modernization of small businesses, SBA is proposing this rule to

confirm that such activities are not permissible.

SBA believes that a regulation on political contributions by

Licensees is necessary to prevent any confusion on this subject in the

future. In proposing this regulation, SBA does not seek to limit

impermissibly any form of constitutionally protected speech. However,

restrictions on the use of SBIC funds for political contributions

appear to be required by the Act.

U.S. taxpayers support SBICs and their investors through the use of

Government-guaranteed Leverage and various tax benefits. SBICs and

their investors are also the recipients of assorted governmental

benefits of a non-tax nature, including exemption from certain

provisions of banking and other statutes. SBA believes that it is

appropriate to require that, in exchange for these benefits, SBICs use

their funds only for the purposes referred to in 15 U.S.C. 661. This

also would eliminate any possibility that a particular contribution by

an SBIC could be misperceived as having been endorsed by SBA.

Proposed Sec. 107.505 would prohibit contributions by an SBIC to

any political campaign, party, or candidate, or to any political action

committee. The proposed regulation is written broadly enough to cover

all political contributions, including so-called ``soft money''

contributions, that are used by organizations to support activities

other than the influencing of federal elections. Nothing in the

proposed rule would affect the right of investors in and managers of

SBICs to make political contributions with their own funds, outside of

the SBIC.

SBA encourages comment from the SBIC industry and, in particular,

from the legal community on this proposed change.

Financing of Smaller Enterprises

Since April 1994, SBICs have been required to direct a certain

percentage of their investment activity to businesses that fall

significantly below the maximum size permitted for a Small Business.

These businesses are referred to as ``Smaller Enterprises.'' This

proposed rule includes three changes related to the financing of

Smaller Enterprises; one implements a provision of Pub. L. 105-135, the

second is a technical correction, and the third is an editorial change.

Section 215(b) of Pub. L. 105-135 increased the maximum amount of

SBA Leverage for which an SBIC could be eligible (see the section of

this preamble entitled ``Maximum Amount of Leverage''). The statute

further required that 100 percent of any Leverage over $90 million the

previous limit, be invested in Smaller Enterprises. Proposed

Sec. 107.710(d) would implement this financing requirement, which is in

addition to the Smaller Enterprise financing requirements in

Sec. 107.710(b) and (c). For example, an SBIC is required under current

Sec. 107.710(b) to make at least 20 percent of its total cumulative

investments in Smaller Enterprises. If the SBIC has $100 million of

outstanding Leverage at the end of its fiscal year, it must meet the 20

percent standard and have at least $10 million of additional

investments in Smaller Enterprises in its portfolio.

Current Sec. 107.710(c), which was effective February 5, 1998,

implemented a provision of Pub. L. 104-208 that required certain SBICs

to make at least 50 percent of their total investments in Smaller

Enterprises. The Licensees to whom the provision applies are those

licensed on or before September 30, 1996, that issued Leverage after

that date, and whose Regulatory Capital is ``less than $10 million if

such Leverage was Participating Securities'' or ``less than $5 million

if such Leverage was Debentures.'' The regulation does not make clear

which standard applies to an SBIC that has issued both Participating

Securities and Debentures. Proposed Sec. 107.710(c)(1) would clarify

that the $10 million threshold applies to a Licensee that has issued

any amount of Participating Securities, while the $5 million applies to

a Licensee that has issued Debentures only.

Finally, in proposed Sec. 107.710(f), the cross-reference to

certain paragraphs in Sec. 107.1120 would be revised to reflect

proposed revisions in that section.

Real Estate Refinancing

Current Sec. 107.720(c)(2) permits SBICs to provide financing to a

Small Business for the purpose of acquiring or refinancing real estate

only under certain conditions. Specifically, the Small Business must

either be acquiring real property or building or renovating a building.

The regulation does not permit refinancing of real estate currently

owned and occupied by the Small Business. SBA believes that Small

Businesses should be able to obtain financing from SBICs for this

purpose, just as they currently can refinance other debt. Accordingly,

proposed Sec. 107.720(c)(2)(iii) would allow proceeds to be used to

refinance debt obligations on property that is owned and occupied by a

Small Business, provided it uses at least 67 percent of the usable

square footage for an eligible business purpose. The occupancy

requirement is the same as that applied to a building that is being

built or renovated by a Small Business.

Co-Investment With Associates

Section 107.730(d)(3) sets forth circumstances under which an

SBIC's co-investment with an Associate is presumed to be on terms that

are equitable to the SBIC, so that no specific demonstration of

fairness is required. Under current Sec. 107.730(d)(3)(iv), this

presumption applies to co-investments by two non-leveraged SBICs, or by

a non-leveraged SBIC and its non-SBIC Associate. The proposed rule

would modify this provision by removing the term ``non-leveraged'' and

referring instead to Licensees that ``have no outstanding Leverage and

do not intend to issue Leverage in the future.'' Thus, the provision

would apply only to an SBIC that intends to operate permanently as a

non-leveraged company. SBA is proposing this change to protect its

interests in all cases where the Agency may have either current or

future financial exposure.

Portfolio Diversification Requirement (``Overline'' limit)

In a final rule published on February 5, 1998 (63 FR 5859), SBA

made certain changes to Sec. 107.740, under which a leveraged SBIC may

not have more than 20 percent of its Regulatory Capital invested in or

committed to a single Small Business or group of related businesses

without SBA's prior written approval (for SSBICs, the limit is 30

percent of Regulatory Capital). The changes addressed the problem faced

by an SBIC that reduced its Regulatory Capital in a manner permitted by

the regulations, and then found that one or more of its existing

investments exceeded its reduced overline limitation. The solution to

this problem was to base a Licensee's maximum permitted investment in

or commitment to a Small Business on its Regulatory Capital at the time

the investment or commitment is made.

When this regulatory change was proposed, SBA received several

comments suggesting that SBA should make further changes. The

commenters argued that an SBIC, particularly a limited life partnership

that expects to return capital to investors as investments are

harvested, should be permitted to base its overline limit on its

original Regulatory Capital, with no reduction for subsequent returns

of capital. The rationale was that an SBIC should not be forced to

reduce the intended investment size reflected in its

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business plan because of an early distribution. One commenter pointed

out that this imposes a penalty that is particularly unjustified in the

case of an SBIC which makes a distribution resulting from a profitable

realization of a portfolio company investment.

SBA understood these concerns, but the comments were not adopted

because SBA believed that the suggested changes were prohibited by

section 306(a) of the Act. Since that time, the Agency has reconsidered

its position on the proper interpretation of the statutory provision,

and has now concluded that the statute permits SBA to determine, by

regulation, the point as of which Regulatory Capital is measured for

the purpose of establishing an SBIC's overline limit.

Accordingly, under proposed Sec. 107.740(a), an SBIC's overline

limit would be computed based on the sum of: (1) Its Regulatory Capital

at the time an investment or commitment is made, and (2) any

distributions permitted under the regulations that were made within the

preceding 5 years and reduced Regulatory Capital. The effect of this

change would be greatest for SBICs that issue Participating Securities.

Under Sec. 107.1570(b), these Licensees are permitted to make

distributions that reduce Regulatory Capital, as long as they also

redeem outstanding Participating Securities on a pro rata basis. Such

distributions can be substantial; since 1995, when Participating

Securities were first issued, 15 SBICs have elected to make

distributions that reduced Regulatory Capital by a total of about $39

million. SBA expects the frequency and amount of such distributions to

grow as Licensees' portfolios mature.

For SBICs that use other forms of SBA Leverage (Debentures or

Preferred Securities), the proposed rule would be less significant,

although it could have some effect. Under current Sec. 107.585, such

SBICs cannot reduce their Regulatory Capital by more than 2 percent in

any fiscal year without SBA's prior written approval. Any distribution

that falls within the 2 percent limitation could be added back to

Regulatory Capital for overline purposes. SBA would determine whether a

distribution exceeding 2 percent of Regulatory Capital could be added

back to the Licensee's overline limit. SBA believes that it must have

this discretion because of the wide variety of circumstances under

which various SBICs may seek to reduce their Regulatory Capital.

SBA is also proposing a clarification of the introductory text in

Sec. 107.740(a). The proposed rule states that the provisions of

Sec. 107.740 would apply to Licensees that ``have outstanding Leverage

or intend to issue Leverage in the future.'' This phrase would replace

current language referring to Licensees that ``have outstanding

Leverage or want to be eligible for Leverage.'' The purpose of the

proposed change is to clarify that the overline limit does apply to

``temporarily'' non-leveraged SBICs whose business plans indicate that

they expect to become leveraged.

Leverage Application Procedures and Eligibility

SBA is proposing a technical correction in Sec. 107.1100(b) to

reflect recent changes in Leverage funding procedures, under which a

Licensee can issue Leverage only by first obtaining a Leverage

commitment from SBA, and then drawing down funds against the

commitment.

Proposed Sec. 107.1120(d) would implement a requirement in section

215(b)(1) of Pub. L. 105-135 that applies to Licensees seeking Leverage

in excess of $90 million. To be eligible for the Leverage, such

Licensees must certify that they will use 100 percent of all proceeds

over $90 million to provide financing to Smaller Enterprises. See also

the section of this preamble entitled ``Financing of Smaller

Enterprises.''

Maximum Amount of Leverage

Section 215(b) of Pub. L. 105-135 increased the maximum amount of

SBA Leverage for which an SBIC could be eligible. The previous limit,

for either a single SBIC or a group of SBICs under common control, was

$90 million. The statute indexed this amount to the Consumer Price

Index (CPI) retroactive to March 1993, with annual adjustments to take

place following the initial adjustment.

Proposed Sec. 107.1150(a) and (b)(1) would implement the statutory

change. The Leverage eligibility table in Sec. 107.1150(a)(1) reflects

increases in the CPI from March 1993, through September 1998, the final

month of the Federal Government's 1998 fiscal year. SBA proposes to

make subsequent adjustments each year based on the September-to-

September increase in the CPI. The proposed rule would result in a new

Leverage ceiling of $102.5 million.

Below the overall Leverage ceiling, there are also several

Leverageable Capital brackets within which a Licensee is eligible for

certain maximum Leverage amounts. These individual brackets would also

be indexed to the CPI. For example, the first bracket currently

consists of Leverageable Capital of not more than $15 million on which

a Licensee may be eligible for maximum Leverage in the ratio of 3:1.

Based on increases in the CPI from March 1993 to September 1998, the

$15 million cutoff would increase to $17.1 million.

Under proposed Sec. 107.1150(a)(2), SBA would publish an annual

notice in the Federal Register to update the maximum Leverage amounts.

The Bureau of Labor Statistics normally publishes the CPI for September

in mid-October, and SBA would expect to publish its Federal Register

notice shortly thereafter.

Draws Against SBA Leverage Commitments

In May 1998, SBA instituted a new interim Leverage funding

mechanism, sometimes described as ``just-in-time'' funding. Under the

new procedures, an SBIC that has obtained a Leverage commitment from

SBA may draw funds against the commitment on any business day. All

SBICs with Leverage commitments must file quarterly financial

statements on SBA Form 468 within 30 days after the end of each fiscal

quarter. Under current Secs. 107.1220 and 107.1230(d)(1), if an SBIC

wishes to draw funds after the end of a quarter, but before the normal

quarterly reporting deadline, it must submit quarterly financial

statements with its draw request. With the advent of just-in-time

funding, these provisions can result in an SBIC having as little as 1

week after the end of a quarter to prepare and submit financial

statements to SBA.

SBA believes that most SBICs cannot reasonably comply with such a

tight time frame, and that attempts to do so may result in the filing

of incomplete or erroneous statements. Furthermore, the Agency believes

that it can properly evaluate a draw request based on financial

statements from a Licensee's previous fiscal quarter, together with the

Licensee's certification that there has been no material adverse change

in its financial condition since that time. Therefore, proposed

Secs. 107.1220 and 107.1230(d)(1) would eliminate the requirement that

draw requests submitted within 30 days of the end of a Licensee's

fiscal quarter be accompanied by updated quarterly financial

statements. In addition, proposed Sec. 107.1230(d)(1) would clarify

that every draw request must be accompanied by a statement certifying

that there has been no material adverse change in the Licensee's

financial condition since its last filing of SBA Form 468.

Finally, proposed Sec. 107.1230(d)(2) would require a Licensee to

provide preliminary unaudited year end

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financial statements when it submits a draw request more than 30 days

following the end of its fiscal year if the Licensee has not yet filed

its audited annual financial statements. SBA expects these preliminary

financial statements to be as close to final as possible, but

understands that they may not be exactly the same as the audited

statements submitted later.

Under current Sec. 107.1230(d)(3), which is proposed to be

redesignated as Sec. 107.730(d)(4), an SBIC applying for a draw must

submit a statement of need showing the names of the Small Businesses

that will be financed with the proceeds. SBA recognizes that an SBIC

may sometimes wish to draw funds to provide necessary liquidity for its

day-to-day operations, and is willing to consider draw requests for

this purpose. Accordingly, under proposed Sec. 107.1230(d)(4), the

Licensee could apply for a draw based on operating liquidity needs, on

specific financings it expects to close, or on a combination of the

two.

Tax Distributions

Section 215(c) of Pub. L. 105-135 amended provisions of the Act

governing the timing of ``tax distributions'' that SBICs with

outstanding Participating Securities may make to their private

investors and SBA. Previously, such distributions could be made once a

year, based on the income allocated by a Licensee to its investors for

Federal income tax purposes for the fiscal year immediately preceding

the distribution. The statutory change now gives a Licensee the option

of making a tax distribution at the end of any calendar quarter based

on a quarterly estimate of tax liability. However, if the aggregate

quarterly distributions made during any fiscal year exceed the amount

that the Licensee would have been permitted to make based on a single

computation performed for the entire year, future tax distributions

must be reduced by the amount of the excess.

Proposed Secs. 107.1550 and 107.1575 would implement these changes.

The timing of tax distributions is addressed in proposed

Sec. 107.1550(d) and Sec. 107.1575(a). SBA believes that the statutory

language permitting tax distributions ``at the end of any calendar

quarter'' does not require that such distributions be made only on the

last day of a quarter, and wishes to give Licensees the flexibility to

make the distributions later if they so choose. The proposed rule would

permit interim tax distributions to be made on the last day of a

calendar quarter or on any succeeding day through the first Payment

Date following the end of the quarter (Payment Dates are February 1,

May 1, August 1, and November 1 of each year). As before, Licensees

would be able to make annual tax distributions as late as the second

Payment Date following the end of their fiscal year. If the

distribution is not made on a Payment Date, SBA's prior approval would

be required (see the current introductory text of Sec. 107.1575(a),

which SBA does not propose to change).

Proposed Sec. 107.1550(e) implements the statutory provision

concerning excess tax distributions. The determination of the excess

amount and the corresponding reduction of future distributions should

be straightforward in most cases. One complexity that may arise is best

illustrated by an example. Assume that an SBIC made quarterly tax

distributions of $2.5 million in year 1. At the end of the year, it was

determined that the permitted tax distribution for the full year would

have been only $2 million so the excess tax distribution for the year

was $500,000. In year 2, the SBIC computes a first quarter tax

distribution of $900,000. It must reduce this distribution by the

$500,000 excess from year 1, so its actual distribution is only

$400,000. It then makes additional quarterly tax distributions of $1.5

million and $1.1 million during the year, so that its actual aggregate

quarterly distributions are $3 million. At the end of year 2, the SBIC

determines that its maximum permitted tax distribution for the full

year would have been $3 million. Although it appears at first glance

that there is no excess tax distribution for year 2, this is not the

case. Under proposed Sec. 107.1550(e)(2), the SBIC must recompute its

aggregate quarterly distributions, ignoring the $500,000 reduction that

was required in the first quarter. Taking this adjustment into account,

the aggregate quarterly distributions would be $900,000 + $1,500,000 +

$1,100,000 = $3,500,000. Thus, there would be an excess tax

distribution of $500,000. SBA believes this formulation yields a result

that is consistent with the intent of the Act. The point can best be

seen by looking at years 1 and 2 together: Actual tax distributions

were $5.5 million while the total that would have been permitted based

on full-year computations was only $5 million. Thus, it is appropriate

for the SBIC to have a $500,000 excess tax distribution computed as of

the end of year 2.

Distributions on Other Than Payment Dates

SBA is proposing a technical correction in Sec. 107.1575 to resolve

a potential conflict between two provisions governing the timing of

distributions. Current Sec. 107.1575(a)(1) permits Licensees to make

annual distributions, as required or permitted under various sections

of the regulations, on dates other than one of the four quarterly

Payment Dates. Clearly, in order to retain their character as

``annual'' distributions, such amounts must be computed as of the end

of a Licensee's fiscal year, regardless of the date on which payment is

actually made. However, under current Sec. 107.1575(b)(2), any

distribution made on a date other than a Payment Date must be computed

as of the distribution date. To resolve this inconsistency, the

proposed rule would modify Sec. 107.1575(b)(2) so that annual

distributions would be computed as of a Licensee's fiscal year end but

could be paid at a later date other than a Payment Date.

In-Kind Distributions

SBA is proposing two substantive changes in Sec. 107.1580, which

governs in-kind distributions by SBICs that have issued Participating

Securities. First, under proposed Sec. 107.1580(a)(1), all in-kind

distributions would require SBA's prior approval. This change

represents a slight expansion of the requirement in current

Sec. 107.1570(a) that SBA approve distributions made on dates other

than Payment Dates. Because in-kind distributions may subject SBA to

significant market risk, the Agency strongly believes that it must have

the ability to review and approve all such distributions, regardless of

when they are made.

Second, under proposed Sec. 107.1580(a)(2), only ``Distributable

Securities'' could be distributed in kind. This new term, which is

defined in proposed Sec. 107.50, would replace the term ``Publicly

Traded and Marketable'' that currently appears in Sec. 107.1580

(``Publicly Traded and Marketable'' securities would continue to be

used in the Capital Impairment computation under Sec. 107.1840).

Although the two terms are technically different, SBA does not expect

the change to have a major effect on Licensees' ability to distribute

securities.

The first difference between the current and proposed rules

involves ``Rule 144'' stock, i.e., stock that is subject to resale

volume restrictions pursuant to Rule 144 under the Securities Act of

1933, as amended. The definition of ``Publicly Traded and Marketable''

includes securities that are ``salable within 12 months pursuant to

Rule 144''. The proposed definition of ``Distributable Securities''

would also include Rule 144 stock, but only if SBA

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determined that it could immediately sell all of its shares without

exceeding the volume restrictions. For purposes of determining whether

a security meets this requirement, SBA would assume a ``worst-case''

scenario in which all the securities of the issuer being distributed by

a Licensee were being sold simultaneously by the distributees.

The second difference between the current and proposed rules

involves securities that are not traded on a regulated stock exchange

or listed in the National Association of Securities Dealers Automated

Quotation System (NASDAQ), such as stocks traded on the ``pink

sheets.'' The definition of ``Publicly Traded and Marketable'' includes

such securities if they have at least two market makers, while the

proposed definition of ``Distributable Securities'' would exclude them.

SBA is proposing this change because it believes that the current

regulation may encompass stocks with extremely low trading volume, the

disposition of which may be a prolonged and high-risk process. As a

practical matter, no Licensee has sought to distribute such securities

and SBA believes the change would have no effect on the vast majority

of in-kind distributions proposed by Licensees.

SBA is also proposing a non-substantive change in

Sec. 107.1580(a)(4), which deals with the disposition of securities

distributed to SBA. The current provision requires an SBIC distributing

securities to deposit SBA's share with the Central Registration Agent

(an agent employed by SBA to handle certain functions related to the

pooling of Debentures and Participating Securities) who then selects a

disposition agent. Having gained some experience with in-kind

distributions, SBA has found it unnecessary to involve the CRA in the

process. Accordingly, proposed Sec. 107.1580(a)(4) would direct an SBIC

to deposit SBA's share of securities directly with a disposition agent

designated by SBA.

Compliance With Executive Orders, 12612, 12778, and 12866, the

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

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

SBA certifies that this proposed rule would not be a significant

regulatory action for purposes of Executive Order 12866 because it

would not have an annual effect on the economy of more than $100

million, and that it would 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, et seq. The purpose of the

proposed rule is to implement provisions of Pub. L. 105-135 which

relate to small business investment companies, and to make certain

other changes, primarily technical corrections and clarifications, to

the regulations governing SBICs. There are 330 SBICs, not all of which

are small businesses. In addition, the changes would have little or no

effect on small businesses seeking funding from SBICs; rather they

would only affect definitions for and activities of the SBICs.

For purposes of the Paperwork Reduction Act, 44 U.S.C. Ch. 35, SBA

certifies that this proposed rule, if adopted in final form, would

contain no new reporting or recordkeeping requirements.

For purposes of Executive Order 12612, SBA certifies that this rule

would not have any federalism implications warranting the preparation

of a Federalism Assessment.

For purposes of Executive Order 12778, SBA certifies that this rule

is drafted, to the extent practicable, in accordance with the standards

set forth in Section 2 of that Order.

List of Subjects in 13 CFR Part 107

Investment companies, Loan programs-business, Reporting and

recordkeeping requirements, Small businesses.

For the reasons stated above, the SBA proposes to amend 13 CFR part

107 as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

1. The authority citation for part 107 continues to read as

follows:

Authority: 15 U.S.C. 681 et seq., 683, 687(c), 687b, 687d, 687g

and 687m.

2. In Sec. 107.50 revise paragraph (8)(i) of the definition of

Associate and the definition of Leverageable Capital, and add in

alphabetical order a definition of Distributable Securities to read as

follows:

Sec. 107.50 Definitions of terms.

* * * * *

Associate of a Licensee means any of the following:

* * * * *

(8) * * *

(i) Any person described in paragraphs (1) through (6) of this

definition is an officer, general partner, or managing member; or

* * * * *

Distributable securities means equity securities that meet each of

the following requirements:

(1) The securities (which may include securities that are salable

pursuant to the provisions of Rule 144 (17 CFR 230.144) under the

Securities Act of 1933, as amended) are determined by SBA, in its sole

discretion, to be salable immediately without restriction under Federal

and state securities laws;

(2) The securities are of a class:

(i) Which is listed and registered on a national securities

exchange, or

(ii) For which quotation information is disseminated in the

National Association of Securities Dealers Automated Quotation System

and as to which transaction reports and last sale data are disseminated

pursuant to Rule 11Aa3-1 (17 CFR 240.11Aa3-1) under the Securities

Exchange Act of 1934, as amended; and

(3) The quantity of such securities to be distributed to SBA can be

sold over a reasonable period of time without having an adverse impact

upon the price of the security.

* * * * *

Leverageable Capital means Regulatory Capital, excluding unfunded

commitments.

* * * * *

3. In Sec. 107.230, revise paragraph (b)(3) to read as follows:

Sec. 107.230 Permitted sources of Private Capital for Licensees.

* * * * *

(b) Exclusions from Private Capital. * * *

(3) Funds obtained directly or indirectly from any Federal, State,

or local government agency or instrumentality, except for:

(i) Funds invested by a public pension fund;

(ii) Funds obtained from the business revenues (excluding any

governmental appropriation) of any federally chartered or Government-

sponsored corporation established before October 1, 1987, to the extent

that such revenues are reflected in the retained earnings of the

corporation; and

(iii) ``Qualified Non-private Funds'' as defined in paragraph (d)

of this section.

* * * * *

4. Revise Sec. 107.504 to read as follows:

Sec. 107.504 Equipment and office requirements.

(a) Computer capability. You must have a personal computer with a

modem, and be able to use this equipment to prepare reports (using SBA-

provided software) and transmit them to SBA. In addition, by June 30,

1999, you must have access to the Internet and the capability to send

and receive electronic mail via the Internet.

(b) Facsimile capability. You must be able to receive facsimile

messages 24 hours per day at your primary office.

[[Page 18380]]

(c) Accessible office. You must maintain an office that is

convenient to the public and is open for business during normal working

hours.

5. Revise Sec. 107.505 to read as follows:

Sec. 107.505 Prohibition against political contributions.

You may not make a contribution to any national, State, or local

political party, campaign or candidate, or to any political action

committee that makes contributions to one or more political parties,

campaigns, or candidates.

6. Remove Sec. 107.508.

Sec. 107.508 [Removed]

7. In Sec. 107.710 revise paragraphs (c)(1)(i) and (ii),

redesignate paragraphs (d) and (e) as paragraphs (e) and (f), revise

the last sentence of new paragraph (f), and add a new paragraph (d) to

read as follows:

Sec. 107.710 Requirement to Finance Smaller Enterprises.

* * * * *

(c) Special requirement for certain leveraged Licensees.

(1) * * *

(i) Less than $10,000,000 if such Leverage included Participating

Securities; or

(ii) Less than $5,000,000 if such Leverage was Debentures only.

* * * * *

(d) Special requirement for Leverage over $90,000,000. In addition

to the applicable requirements in paragraphs (b) and (c) of this

section, at the close of each of your fiscal years, 100 percent of any

outstanding Leverage over $90,000,000 (including aggregate Leverage

over $90,000,000 issued by two or more Licensees under Common Control)

must have been invested in Smaller Enterprises.

* * * * *

(f) Non-compliance with this section. * * * However, you will not

be eligible for additional Leverage until you reach the required

percentage (see Sec. 107.1120(c) through (e)).

8. In Sec. 107.720 revise paragraph (c)(2) to read as follows:

Sec. 107.720 Small Businesses that may be ineligible for Financing.

* * * * *

(c) Real Estate Businesses. * * *

(2) You are not permitted to finance a business, regardless of SIC

classification, if the Financing is to be used to acquire or refinance

real property, unless the Small Business:

(i) Is acquiring an existing property and will use at least 51

percent of the usable square footage for an eligible business purpose;

or

(ii) Is building or renovating a building and will use at least 67

percent of the usable square footage for an eligible business purpose;

or

(iii) Occupies the subject property and uses at least 67 percent of

the usable square footage for an eligible business purpose.

* * * * *

9. In Sec. 107.730 revise paragraph (d)(3)(iv) to read as follows:

Sec. 107.730 Financing which constitute conflicts of interest.

* * * * *

(d) Financings with Associates. * * *

(3) Exceptions to paragraphs (d)(1) and (d)(2) of this section. * *

*

(iv) You have no outstanding Leverage and do not intend to issue

Leverage in the future, and your Associate either is not a Licensee or

has no outstanding Leverage and does not intend to issue Leverage in

the future.

* * * * *

10. In Sec. 107.740 revise paragraph (a) to read as follows:

Sec. 107.740 Portfolio diversification (``overline'' limitation).

(a) General rule. This Sec. 107.740 applies if you have outstanding

Leverage or intend to issue Leverage in the future. Without SBA's prior

written approval, you may provide Financing or a Commitment to a Small

Business only if the resulting amount of your aggregate outstanding

Financings and Commitments to such Small Business and its Affiliates

does not exceed:

(1) For a Section 301(c) Licensee, 20 percent of the sum of:

(i) Your Regulatory Capital as of the date of the Financing or

Commitment; plus

(ii) Any Distribution(s) you made under Sec. 107.1570(b), during

the 5 years preceding the date of the Financing or Commitment, which

reduced your Regulatory Capital; plus

(iii) Any Distribution(s) you made under Sec. 107.585, during the 5

years preceding the date of the Financing or Commitment, which reduced

your Regulatory Capital by no more than 2 percent or which SBA approves

for inclusion in the sum determined in this paragraph (a)(1).

(2) For a Section 301(d) Licensee, 30 percent of a sum determined

in the manner set forth in paragraph (a)(1)(i) through (iii) of this

section.

* * * * *

11. In Sec. 107.1100, revise the section heading and paragraph (b)

to read as follows:

Sec. 107.1100 Types of Leverage and application procedures.

* * * * *

(b) Applying for Leverage. The Leverage application process has two

parts. You must first apply for SBA's conditional commitment to reserve

a specific amount of Leverage for your future use. You may then apply

to draw down Leverage against the commitment. See Secs. 107.1200

through 107.1240.

* * * * *

12. In Sec. 107.1120 redesignate paragraphs (d) through (f) as

paragraphs (e) through (g) and add a new paragraph (d) to read as

follows:

Sec. 107.1120 General eligibility requirements for Leverage.

* * * * *

(d) Certify, if applicable, that you will use 100 percent of any

Leverage over $90,000,000 (including aggregate Leverage over

$90,000,000 issued by two or more Licensees under Common Control) to

provide Financing to Smaller Enterprises (see also Sec. 107.710).

* * * * *

13. In Sec. 107.1150 revise paragraph (a) and the first sentence of

paragraph (b)(1) to read as follows:

Sec. 107.1150 Maximum amount of Leverage for a Section 301(c)

Licensee.

(a) Maximum amount of Leverage.

(1) Amounts before indexing. If you are a Section 301(c) Licensee,

the following table shows the maximum amount of Leverage you may have

outstanding at any time, subject to the indexing adjustment set forth

in paragraph (a)(2) of this section:

------------------------------------------------------------------------

Then your maximum

If your Leverageable Capital is: Leverage is:

------------------------------------------------------------------------

(1) Not over $17,100,000..................... 300 percent of

Leverageable Capital

(2) Over $17,100,000 but not over $34,100,000 $51,300,000 + [2 x

(Leverageable Capital -

$17,100,000)]

(3) Over $34,100,000 but not over $51,300,000 $85,300,000 +

(Leverageable Capital -

$34,100,000)

(4) Over $51,300,000......................... $102,500,000

------------------------------------------------------------------------

[[Page 18381]]

(2) Indexing of maximum amount of Leverage. SBA will adjust the

amounts in paragraph (a) of this section annually to reflect increases

through September in the Consumer Price Index published by the Bureau

of Labor Statistics. SBA will publish the indexed maximum Leverage

amounts each year in a Notice in the Federal Register.

(b) Exceptions to maximum Leverage provisions--(1) Licensees under

Common Control. Two or more Licensees under Common Control may have

aggregate outstanding Leverage over $102,500,000 (subject to indexing

as set forth in paragraph (a)(2) of this section) only if SBA gives

them permission to do so. * * *

* * * * *

14. Revise Sec. 107.1220 to read as follows:

Sec. 107.1220 Requirement for Licensee to file quarterly financial

statements.

As long as any part of SBA's Leverage commitment is outstanding,

you must give SBA a Financial Statement on SBA Form 468 (Short Form) as

of the close of each quarter of your fiscal year (other than the fourth

quarter, which is covered by your annual filing of Form 468 under

Sec. 107.630(a)). You must file this form within 30 days after the

close of the quarter. You will not be eligible for a draw if you are

not in compliance with this Sec. 107.1220.

15. In Sec. 107.1230(d) revise paragraph (d)(1), redesignate

paragraphs (d)(2) and (d)(3) as paragraphs (d)(3) and (d)(4), add a new

paragraph (d)(2), and revise the first sentence of redesignated

paragraph (d)(4) to read as follows:

Sec. 107.1230 Draw-downs by Licensee under SBA's Leverage commitment.

* * * * *

(d) Procedures for funding draws. * * *

(1) A statement certifying that there has been no material adverse

change in your financial condition since your last filing of SBA Form

468 (see also Sec. 107.1220 for SBA Form 468 filing requirements).

(2) If your request is submitted more than 30 days following the

end of your fiscal year, but before you have submitted your annual

filing of SBA Form 468 (Long Form) in accordance with Sec. 107.630(a),

a preliminary unaudited annual financial statement on SBA Form 468

(Short Form).

* * * * *

(4) A statement that the proceeds are needed to fund one or more

particular Small Businesses or to provide liquidity for your

operations. * * *

* * * * *

16. In Sec. 107.1550 revise the first sentence of the introductory

text, paragraph (b)(1) and paragraph (d), and add a new paragraph (e)

to read as follows:

Sec. 107.1550 Distributions by Licensee-permitted ``tax

Distributions'' to private investors and SBA.

If you have outstanding Participating Securities or Earmarked

Assets, and you are a limited partnership, ``S Corporation'', or

equivalent pass-through entity for tax purposes, you may make ``tax

Distributions'' to your investors in accordance with this

Sec. 107.1550, whether or not they have an actual tax liability. * * *

* * * * *

(b) How to compute the Maximum Tax Liability. (1) You may compute

your Maximum Tax Liability for a full fiscal year or for any calendar

quarter. Use the following formula:

M = (TOI x HRO) + (TCG x HRC)

where:

M = Maximum Tax Liability

TOI = Net ordinary income allocated to your partners or other owners

for Federal income tax purposes for the fiscal year or calendar quarter

for which the Distribution is being made, excluding Prioritized

Payments allocated to SBA.

HRO = The highest combined marginal Federal and State income tax rate

for corporations or individuals on ordinary income, determined in

accordance with paragraphs (b)(2) through (b)(4) of this section.

TCG = Net capital gains allocated to your partners or other owners for

Federal income tax purposes for the fiscal year or calendar quarter for

which the Distribution is being made, excluding Prioritized Payments

allocated to SBA.

HRC = The highest combined marginal Federal and State income tax rate

for corporations or individuals on capital gains, determined in

accordance with paragraphs (b)(2) through (b)(4) of this section.

* * * * *

(d) Paying a tax Distribution. You may make an annual tax

Distribution on the first or second Payment Date following the end of

your fiscal year. You may make a quarterly tax Distribution on the

first Payment Date following the end of the calendar quarter for which

the Distribution is being made. See also Sec. 107.1575(a).

(e) Excess tax Distributions. (1) As of the end of your fiscal

year, you must determine whether you made any excess tax Distributions

for the year in accordance with paragraph (e)(2) of this section. Any

tax Distributions that you make for a subsequent period must be reduced

by the excess amount distributed.

(2) Determine your excess tax Distributions by adding together all

your quarterly tax Distributions for the year (ignoring any required

reductions for excess tax Distributions made in prior years), and

subtracting the maximum tax Distribution that you would have been

permitted to make based upon a single computation performed for the

entire fiscal year. The result, if greater than zero, is your excess

tax Distribution for the year.

17. In Sec. 107.1575, revise paragraphs (a)(1) and (b)(2) and add a

new paragraph (a)(4) to read as follows:

Sec. 107.1575 Distributions on other than Payment Dates.

(a) Permitted Distributions on other than Payment Dates. * * *

(1) Required annual Distributions under Sec. 107.1540(a)(1), annual

Distributions under Sec. 107.1550, and any Distributions under

Sec. 107.1560 must be made no later than the second Payment Date

following the end of your fiscal year.

* * * * *

(4) Quarterly Distributions under Sec. 107.1550 must be made no

earlier than the last day of the calendar quarter for which the

Distribution is being made and no later than the first Payment Date

following the end of such calendar quarter.

(b) Conditions for making a Distribution.

* * * * *

(2) The ending date of the period for which you compute your

Earmarked Profits, Prioritized Payments, Adjustments, Charges, Profit

Participation, Retained Earnings Available for Distribution, liquidity

ratio, Capital Impairment, and any other applicable computations

required under Secs. 107.1500 through 107.1570, must be:

(i) The distribution date, or

(ii) If your Distribution includes annual Distributions under

Secs. 107.1540(a)(1), 107.1550 and/or 107.1560, your most recent fiscal

year end;

* * * * *

18. In Sec. 107.1580, redesignate paragraphs (a)(1) through (a)(4)

as paragraphs (a)(2) through (a)(5), add a new paragraph (a)(1) and

revise paragraph (b)(2) to read as follows:

Sec. 107.1580 Special rules for In-Kind Distributions by Licensees.

(a) In-Kind Distributions while Licensee has outstanding

Participating Securities. * * *

[[Page 18382]]

(1) You must obtain SBA's written approval before the distribution

date.

(2) You may distribute only Distributable Securities.

* * * * *

(5) You must deposit SBA's share of securities being distributed

with a disposition agent designated by SBA. As an alternative, if you

agree, SBA may direct you to dispose of its shares. In this case, you

must promptly remit the proceeds to SBA.

* * * * *

(b) In-Kind Distributions after Licensee has redeemed all

Participating Securities. * * *

* * * * *

(2) You must obtain SBA's prior written approval of any In-Kind

Distribution of Earmarked Assets that are not Distributable Securities,

specifically including approval of the valuation of the assets.

Dated: March 31, 1999.

Aida Alvarez,

Administrator.

[FR Doc. 99-9265 Filed 4-13-99; 8:45 am]

BILLING CODE 8025-01-P