On December 31, 2011, the President signed into law the National Defense Authorization Act for Fiscal Year 2012 (Defense Reauthorization Act), Public Law 112-81, 125-Stat. 1298. Section 5001, Division E of the Defense Reauthorization Act contains the SBIR/STTR Reauthorization Act of 2011 (Reauthorization Act), which amended the Small Business Act and made several amendments to the SBIR Program. The Reauthorization Act required SBA to issue amendments to the SBIR Policy Directive and publish the amendments in the Federal Register within 180 days of when the Reauthorization Act was passed.

On August 6, 2012, SBA published a final SBIR Policy Directive implementing the various provisions of the Reauthorization Act at 77 FR 46806. The directive made several key changes to the SBIR Program relating to eligibility, the SBIR award process, SBIR Program administration, and fraud, waste and abuse. Although the SBIR Policy Directive is intended for use by the SBIR participating agencies, SBA believed that public input on the directive from all parties involved in the program would be invaluable. Therefore, SBA sought public comments on the final directive, and stated that it may amend the directive in response to these comments at a later time.

In response to this request, SBA received comments on various parts of the directive. Several comments recommended that SBA strengthen and clarify the Policy Directive language with regard to SBIR data rights and the obligation of federal agencies to give a preference in contracting to SBIR awardees for follow-on Phase III work. SBA agrees that these are areas of the SBIR policy that are vital to the program and require clarification and improvement. SBA continues to evaluate these issues and will address them in a subsequent Policy Directive revision.

SBA also received comments that the definition of Essentially Equivalent Work in section 3(j) of the Policy Directive should be changed to be more in line with the common usage. The concern is that the definition in the Policy Directive is more stringent than the norm for Government contracting and places a higher burden on the small businesses participating in the SBIR program. The commenter, however, did not provide SBA with this commonly used definition and SBA could not find one. Therefore, SBA has not modified the definition at this time. However, SBA has revised the language in section 7(d) of the Directive to further clarify funding of “essentially equivalent work.”

Section 4(a)(3) of the Policy Directive, “Agency benchmarks for progress towards commercialization” sets forth the program policy regarding an eligibility requirement for Phase I awards. SBA received comments requesting clarification of the time periods used to calculate the transition rate and commercialization rate benchmark requirements. Commenters also requested clarification about how agencies determine which firms must comply with the transition rate and commercialization rate benchmarks. In response to these comments, SBA revised and reorganized section 4(a)(3) to clarify several procedural elements about the benchmark determinations and enhance its readability.

Section 4(a)(3) clarifies the time periods used to calculate awardee rates of transition from Phase I to Phase II and provides two examples of the calculation. While the rate is calculated using Phase I awards received in the most recent 5,10, or 15-year period (agencies choose which period they use), excluding the most recently completed fiscal year; the period used when counting the Phase II awards is lagged one year. That is, when calculating the number of Phase I awards received over a particular time period, the time period evaluated does not include the most recently completed fiscal year; however, when calculating the number of Phase II awards received, the time period evaluated does include the most recently completed fiscal year but does not include the first year of the period evaluated for Phase I awards received. The period used to calculate Phase II awards is lagged one-year because it is unlikely that a new Phase I would transition to a Phase II within the same year. SBA also clarified that the Phase II transition benchmark requirement applies only to awardees that have received more than 20 Phase I awards over the applicable time period and that the commercialization benchmark applies only to firms that received more than 15 Phase II awards over the applicable time period.

Based on additional input from the agencies participating in the SBIR program, SBA also revised several procedural elements of the Phase II transition benchmark requirement in section 4(a)(3) to simplify the process for small businesses and reduce the administrative burden on the agencies. Specifically, in section 4(a)(3)(iii), SBA changed the start date for the one-year ineligibility period for firms that do not meet the benchmarks. The date was changed from the date of application submission to June 1st of each year. SBA made this change for several reasons: (1) It is a clearly defined period for affected small businesses; (2) to provide sufficient time for agencies to enter fully verified award data from the prior fiscal year into the TechNet database; and (3) to eliminate the need for agencies to track multiple periods of ineligibility. SBA will use its TechNet Data system to generate the list of companies that do not meet agency Phase II transition benchmarks and provide this list to the agencies each year on June 1. Finally, SBA also added a procedure to notify awardee firms if they are on the ineligible list and to enable firms to provide feedback directly to SBA if they believe their rate was calculated using incomplete award information.

Some respondents asked if the provision in section 4(b)(5) allowing one Sequential Phase II award included supplementary awards such as Phase 2.5 or Phase IIb awards in the definition of a Phase II award. SBA relocated the language at section 4(b)(6) to new section 4(b)(8) and added new section 4(b)(6) to clarify SBA's policy on supplemental phase II awards. Section 4(b)(6) now clarifies how Phase II award amounts are calculated when supplemental awards are issued. Furthermore, section 4(b)(6) specifies that all supplementary awards, such as a Phase IIb, must be linked to either an initial Phase II or a sequential Phase II award and is added to the amount of that award for the purpose of determining the size of the Phase II award. This means that all supplementary Phase II awards including options, enhancements, administrative supplements, and Phase IIb-type programs are considered as part of the initial Phase II or sequential Phase II from which they derive and are therefore subject to the Phase II per-award guideline amount of $1 million and limit of $1.5 million.

SBA repeated the language in section 9(d)(2) in new section 4(b)(7), which explains how a Phase I awardee may receive an award from one agency and also may receive a subsequent Phase II award from another agency. SBA also clarified in section 4(b)(7) that the same process applies to a second, sequential Phase II award that follows an initial Phase II award from a different agency. This policy is relevant to interagency actions, which are found at section 9 of the Policy Directive, and also to Phase II awards, which is found at section 4 of the Policy Directive.

SBA received comments concerning section 9 of the Policy Directive, which address measures to prevent fraud, waste and abuse in the program. The respondents commented that the administrative requirements contained in section 9 may be too stringent and may discourage small businesses from applying. SBA notes that it developed these requirements, including the procedures and requirements for certification, in consultation with the Council of Inspectors General on Integrity and Efficiency. SBA believes that these provisions can help reduce fraud, waste and abuse in the program and does not think these provisions should be changed at this time.

SBA received comments on the Department of Defense's (DoD's) Commercialization Readiness Program, outlined in section 12(b) of the SBIR Policy Directive. In response to comments that agency efforts to increase transitions to Phase III could reduce the innovative nature of SBIR awards, SBA has added that when DoD reports on its Phase II insertion incentives, it should note efforts to ensure that such incentives do not act to shift the focus of SBIR Phase II awards away from relatively high-risk innovation projects. SBA also amended the provisions relating to the use of SBIR funds for the DoD Commercialization Readiness Program. According to section 1615 of the National Defense Authorization Act for Fiscal Year 2013 (NDAA), Public Law 112-239, 126 Stat. 1632, DoD has the authority to use 1% of its SBIR funding for purposes of administering the Commercialization Readiness Program.

A number of comments asked us to change features that, because they are required by statute, we were not able to modify.

The inadvertent omission of the term “extramural” before “R/R&D budgets” was corrected in section 2(b), which identifies the source of funds for the program.

Section 3 contains definitions of terms that appear throughout the Policy Directive. SBA made an editorial revision to the definition of “Awardee” in section 3(e). SBA revised the word “receiving” to “that receives.”

Section 4(b)(1), which identifies the objective and nature of a Phase II award, includes a statement regarding the eligibility of successor in interest firms for SBIR awards. Because this statement pertains more generally to eligibility for all SBIR awards, it was removed from section 4(b)(1) and added to section 6(a) which addresses program eligibility requirements.

In Section 6, SBA removed the reference to the STTR program regarding the option to make awards to small businesses that are majority owned by multiple venture capital operating companies, hedge funds or private equity firms. When SBA issued its final size regulations on December 27, 2012 (77 FR 76215), it reviewed this issue and determined that such businesses may not participate in the STTR program. Additionally, SBA added the language previously found at section 4(b)(1) regarding successor in interest firms to section 6(a)(5), because section 6(a) addresses general program eligibility. Sections 6(a)(2) through 6(a)(6) were reorganized and renumbered in order to increase readability.

Section 7 addresses issues related to program funding processes. SBA revised the language in paragraph 7(d) to clarify that while duplicate or similar proposals may be submitted in response to apparently similar solicitation topics, essentially equivalent work may not be funded. In addition, SBA revised paragraph (h)(1), which says that funding agreement modifications should be kept to a minimum, to address only modifications that increase the dollar amount of awards. Paragraph (h)(1) also referred to modifications of periods of performance and scope of work. SBA clarified section 7(h)(1) to specify that the concern regarding the number of modifications made to an award pertains only to changes that increase the dollar amount of awards.

Section 8 of the Directive addresses the terms of agreement under SBIR awards. SBA clarified section 8(a) by removing language stating that agencies should discourage SBCs from submitting proprietary information and revised section 8(d) to clarify that the continued use of agency-owned property applies to property acquired by the awardee under the contract.

In response to concerns regarding the cost and accountability of the continuing study by the National Academy of Sciences, SBA modified section 9(h) to clarify that the agreement required between the agencies and the National Academy of Sciences must be made in consultation with the SBA and must comprehensively address the scope and content of the work to be performed.

Section 10(h) explains the process for agencies to submit their SBIR program annual reports to SBA. Paragraph (h)(4) contains a list of information that must be included in each agency's annual report. SBA clarified section 10(h)(4)(xi) to note that agencies must report all instances in which an agency pursued R/R&D, services, production, or any combination thereof of a technology developed under an SBIR award with an entity other than that SBIR awardee.

Section 10(j) contains information on the other reporting requirements for SBIR participating agencies. Section 10(j)(2) discusses a system that will list any individual or small business concern that received an SBIR award and that has been convicted of a fraud-related crime involving SBIR funds or found civilly liable for a fraud-related violation involving SBIR funds. SBA clarified this section to note that SBA will list those individuals and small business concerns of which SBA has been made aware.

Section 12(b) addresses the Commercialization Readiness Program at the Department of Defense (DoD). SBA clarified the source of funding for this program by removing the sentence in paragraph (b)(4)(ii) stating that funds for the program would come from the 3% administrative set-aside, and by clarifying that the funds shall not be subject to the limitations on the use of funds in section 9(e)(3). In addition, in section 12(b)(6)(iii)(C), SBA clarified that the DoD must include, along with its description of the incentives used for this program, information on measures taken to ensure that such incentives do not shift the focus of the SBIR Phase II awards away from the relatively high-risk innovation projects they are intended to promote.

Section 12(b)(5) addresses DoD's Commercialization Readiness Program. The Policy Directive states that DoD may establish transition goals and reporting requirements for awards less than $1,000,000,000. The amount listed in section 12(b)(5) contained a typographical error, which was corrected to $100,000,000.

Appendix I provides instructions for the preparation of program solicitations. In Appendix I, SBA revised the certification check box regarding notification if work is subsequently funded by another Federal agency to clarify that it pertains to work funded and completed under the award rather than to the work proposed for the award.

The updated SBIR Policy Directive, incorporating all changes noted here, will be posted on www.sbir.gov .

To: The Small Business Innovation Research Program Managers.

Subject: Amendments to SBIR Policy Directive Published on August 6, 2012 at 77 FR 46806.

1. Purpose. The purpose of this notice is to inform SBIR agencies of amendments made to the recently published SBIR Policy Directive.

2. Authority. Section 9(j)(3) of the Small Business Act (15 U.S.C. 638(j)) requires the Administrator of the U.S. Small Business Administration (SBA) to issue an SBIR Program Policy Directive for the general conduct of the SBIR Program.

3. Procurement Regulations. It is recognized that the Federal Acquisition Regulations and agency supplemental regulations may need to be modified to conform to the requirements of the final Policy Directive. SBA's Administrator or designee must review and concur with any regulatory provisions that pertain to areas of SBA responsibility. SBA's Office of Innovation coordinates such regulatory actions.

4. Personnel Concerned. This Policy Directive serves as guidance for all federal government personnel who are involved in the administration of the SBIR Program, issuance and management of Funding Agreements or contracts pursuant to the SBIR Program, and the establishment of goals for small business concerns in research or research and development acquisition or grants.

5. Originator. SBA's Office of Innovation and Technology.

6. Date. The policy directive is effective on January 8, 2014.

SBA amends the SBIR Policy Directive as follows:

1. Amend section 2(b) by adding the term “extramural” before “R/R&D budgets” each place it appears.

2. Revise section 3(e) to read as follows:

(e) Awardee. The organizational entity that receives an SBIR Phase I, Phase II, or Phase III award.

3. Revise section 4(a)(3) to read as follows:

(3) Agency benchmarks for progress towards commercialization. Each agency must determine whether an applicant for a Phase I award that has won multiple prior SBIR awards meets the agency's benchmark requirements for progress towards commercialization before making a new Phase I award to that applicant. For the purpose of this requirement, applicants are assessed using their prior Phase I and Phase II SBIR and STTR awards across all SBIR agencies.

(i) Agencies must apply two benchmark rates addressing an applicant's progress towards commercialization—the Phase II Transition Rate Benchmark and the Commercialization Rate Benchmark.

(A) The Phase II Transition Rate Benchmark sets the minimum required number of Phase II awards the applicant must have received for a given number of Phase I awards received during the specified period. This Transition Rate Benchmark applies only to Phase I applicants that have received more than 20 Phase I awards over the time period used by the agency for the benchmark determination.

(B) The agency Commercialization Rate Benchmark sets the minimum Phase III commercialization results that a Phase I applicant must have realized from its prior Phase II awards in order to be eligible to receive a new Phase I award from that agency. This benchmark requirement applies only to Phase I applicants that have received more than 15 Phase II awards over the time period used by the agency for the benchmark determination.

(ii) Consequence. If an awardee fails to meet either of the benchmarks, that awardee is not eligible for an SBIR Phase I award (and any Phase II award issued pursuant to paragraph (b)(1)(ii) below) for a period of one year from the time of the determination.

(iii) Timing of the determination and consequence period. The SBIR awardee Phase II transition rates and commercialization rates are calculated using the data in SBA's TechNet database. For the purpose of these benchmark requirements, awardee firms are assessed once a year, on June 1st, using their prior SBIR and STTR awards across all agencies. SBA makes this tabulation of awardee transition rates and commercialization rates available to the agencies. Each SBIR agency uses this tabulation to determine which companies do not meet that agency's benchmark rates and are therefore ineligible to receive new Phase 1 awards from that agency during the one-year period beginning on June 1st and ending on May 31st. SBA notifies these ineligible firms of the determination and the one year restriction on Phase I awards. Agencies must notify SBA of any applications denied because of the failure to meet the benchmarks.

(iv) Phase II Transition Rate Benchmark. Each agency must establish an SBA-approved Phase II Transition Rate Benchmark and applicable time period. The benchmark rates and time periods are posted at www.sbir.gov . Agencies must seek approval for any subsequent changes from SBA.

(A) The agency Phase II Transition Rate Benchmark establishes the number of Phase II awards a small business concern must have received for a given number of Phase I awards received over the past 5, 10 or 15 fiscal years, excluding the most recently completed fiscal year. Each agency selects both the rate to be applied and the length of time that the agency will use to evaluate whether a small business concern has met the Transition Rate Benchmark. The period over which Phase I awards are counted excludes the most recently completed fiscal year. The time period over which Phase II awards are counted includes the most recently completed fiscal year and excludes the first year of the time period evaluated for Phase I awards.

(B) An SBC that has received more than 20 Phase I awards in the relevant time period can view its Phase II transition rate on the Company Registry page at SBIR.gov. Generally, the award data used to calculate an SBC's transition rate will be complete by the end of March each year. An SBC may view its SBIR/STTR award information on the Company Registry at any time. If an awardee believes its Phase II transition rate is calculated using incomplete award information, the awardee may dispute the rate using the link provided on the Company Registry, provide the additional award information, and request a reconsideration of its transition rate. Requests for reconsideration of a firm's transition rate received by SBA from April 1st through April 30th of each year will be considered for the June 1st transition rate assessment.

(C) Agencies must set the Phase II Transition Rate Benchmark as appropriate for their programs and industry sectors. When setting the Transition Rate Benchmark, agencies should consider that Phase I is designed and intended to explore high-risk, early-stage research ideas and, as a result, not all Phase I awards are expected to result in a Phase II award.

(v) Commercialization Rate Benchmark. By October 1, 2013, each agency will establish an SBA-approved Commercialization Rate Benchmark that establishes the level of Phase III commercialization results an SBC must have received from work it performed under prior Phase II awards, over the prior 5, 10 or 15 fiscal years, excluding the most recently completed two fiscal years. Agencies may define this benchmark:

(A) in financial terms, such as by using the ratio of the dollar value of revenues and additional investment resulting from prior Phase II awards relative to the dollar value of the Phase II awards received over the time period;

(B) in terms of the share of Phase II awards received over the time period that have resulted in the introduction of a product to market; or

(C) by other means such as using a commercialization scoring system that rates awardees on their past commercialization success.

(vi) Agencies must submit their Transition Rate Benchmark, Commercialization Rate Benchmark, and time periods to SBA for approval. SBA will publish the benchmarks and time periods, seek public comment, and maintain a table of the current requirements on www.sbir.gov. The benchmarks and time periods become effective when SBA posts the approved measures on www.sbir.gov. Agencies must submit any changes to the benchmarks or time periods to SBA for prior approval.

(vii) SBA maintains a system that records all Phase I, Phase II and Government Phase III awards, and other commercialization information; and calculates the Phase II transition rates for all Phase I awardees and the commercialization rates for all Phase II awardees.

(viii) If an applicant fails to meet an agency's benchmark, its name will appear on the list of companies made available to the agencies on June 1 of each year. An agency may not make a Phase I award to an applicant that does not meet the agency's benchmark.

(ix) If an awardee believes its determination was made in error, it may provide SBA with the pertinent award information and request a reassessment. To do so, awardees may use the link on the Company Registry at www.sbir.gov .

4. Amend section 4(b) by revising paragraph (b)(1) by moving language to 6(a)(4), renumbering paragraph (b)(6) as (b)(8), and inserting paragraphs (b)(6) and (b)(7) to read as follows:

(b) Phase II.

(1) The object of Phase II is to continue the R/R&D effort from the completed Phase I. Unless an exception set forth in paragraphs (i) or (ii) below applies, only SBIR Phase I awardees are eligible to participate in Phase II.

(i) A Federal agency may issue an SBIR Phase II award to an STTR Phase I awardee to further develop the work performed under the STTR Phase I award. The agency must base its decision upon the results of work performed under the Phase I award and the scientific and technical merit, and commercial potential of the Phase II proposal. The STTR Phase I awardee must meet the eligibility and program requirements of the SBIR Program in order to receive the SBIR Phase II award.

(ii) During fiscal years (FY) 2012 through 2017, the National Institutes of Health (NIH), Department of Defense (DoD) and the Department of Education (DoEd) may issue a Phase II award to a small business concern that did not receive a Phase I award for that R/R&D. Prior to such an award, the heads of those agencies, or designees, must issue a written determination that the small business has demonstrated the scientific and technical merit and feasibility of the ideas that appear to have commercial potential. The determination must be submitted to SBA prior to issuing the Phase II award.

. . . [paragraphs (2) through (4) are unchanged] . . .

(5) A Phase II awardee may receive one additional, sequential Phase II award to continue the work of an initial Phase II award. The additional, sequential Phase II award has the same guideline amounts and limits as an initial Phase II award.

(6) Agencies may offer special SBIR awards, such as Phase IIB awards, that supplement or extend Phase II awards. For example, some agencies administer Phase IIB awards that differ from the base Phase II in that they require third party matching of the SBIR funds. Each such supplemental award must be linked to a base Phase II award (the initial Phase II, or the second sequential Phase II award). Any SBIR funds used for such special or supplementary awards are aggregated with the amount of the base Phase II to determine the size of that Phase II award. Therefore, while there is no limit on the number of such special/supplementary awards, there is a limit on the total amount of SBIR funds that can be administered through them—the amounts of these awards count towards the size of the initial Phase II or the sequential Phase II, each of which has a guideline amount of $1 million and a limit of $1.5 million. (Note that Phase IIB awards under the NIH SBIR program are administered as second, sequential Phase II awards, not supplemental awards. As such, they are base Phase II awards and subject to the Phase II guideline amounts and limits of $1 million and $1.5 million).

(7) A concern that has received a Phase I award from an agency may receive a subsequent Phase II award from another agency if each agency makes a written determination that the topics of the relevant awards are the same and both agencies report the awards to the SBA including a reference to the related Phase I award and initial Phase II award if applicable.

(8) Agencies may issue Phase II awards for testing and evaluation of products, services, or technologies for use in technical or weapons systems.

5. Revise section 6(a)(2) through § 6(a)(6)to read as follows:

(2) For Phase I, a minimum of two-thirds of the research or analytical effort must be performed by the awardee. For Phase II, a minimum of one-half of the research or analytical effort must be performed by the awardee. Occasionally, deviations from these requirements may occur, and must be approved in writing by the funding agreement officer after consultation with the agency SBIR Program Manager/Coordinator. An agency can measure this research or analytical effort using the total contract dollars or labor hours, and must explain to the small business in the solicitation how it will be measured.

(3) For both Phase I and Phase II, the primary employment of the principal investigator must be with the SBC at the time of award and during the conduct of the proposed project. Primary employment means that more than one-half of the principal investigator's time is spent in the employ of the SBC. This precludes full-time employment with another organization. Occasionally, deviations from this requirement may occur, and must be approved in writing by the funding agreement officer after consultation with the agency SBIR Program Manager/Coordinator. Further, an SBC may replace the principal investigator on an SBIR Phase I or Phase II award, subject to approval in writing by the funding agreement officer. For purposes of the SBIR Program, personnel obtained through a Professional Employer Organization or other similar personnel leasing company may be considered employees of the awardee. This is consistent with SBA's size regulations, 13 CFR 121.106—Small Business Size Regulations.

(4) For both Phase I and Phase II, the R/R&D work must be performed in the United States. However, based on a rare and unique circumstance, agencies may approve a particular portion of the R/R&D work to be performed or obtained in a country outside of the United States, for example, if a supply or material or other item or project requirement is not available in the United States. The funding agreement officer must approve each such specific condition in writing.

(5) An SBIR awardee may include, and SBIR work may be performed by, those identified via a “novated” or “successor in interest” or similarly-revised funding agreement, or those that have reorganized with the same key staff, regardless of whether they have been assigned a different tax identification number. Agencies may require the original awardee to relinquish its rights and interests in an SBIR project in favor of another applicant as a condition for that applicant's eligibility to participate in the SBIR Program for that project.

(6) NIH, Department of Energy and National Science Foundation may award not more than 25% of the agency's SBIR funds to SBCs that are owned in majority part by multiple venture capital operating companies, hedge funds, or private equity firms through competitive, merit-based procedures that are open to all eligible small business concerns. All other SBIR agencies may award not more than 15% of the agency's SBIR funds to such SBCs. SBIR agencies may or may not choose to utilize this funding option. A table listing the agencies that are currently using this authority can be found at www.SBIR.gov. This authority is set forth in 13 CFR 121.701 through 121.705.

(i) Before permitting participation in the SBIR program by SBCs that are owned in majority part by multiple venture capital operating companies, hedge funds, or private equity firms, the SBIR agency must submit a written determination to SBA, the Senate Committee on Small Business and Entrepreneurship, the House Committee on Small Business and the House Committee on Science, Space, and Technology at least 30 calendar days before it begins making awards to such SBCs. The determination must be made by the head of the Federal agency or designee and explain how awards to such SBCs in the SBIR program will:

(A) induce additional venture capital, hedge fund, or private equity firm funding of small business innovations;

(B) substantially contribute to the mission of the Federal agency;

(C) address a demonstrated need for public research; and

(D) otherwise fulfill the capital needs of small business concerns for additional financing for SBIR projects.

(ii) The SBC that is majority-owned by multiple venture capital operating companies, hedge funds, or private equity firms must register with SBA in the Company Registry Database, at www.SBIR.gov , prior to the date it submits an application for an SBIR award.

(iii) The SBC that is majority-owned by multiple venture capital operating companies, hedge funds, or private equity firms must submit a certification with its proposal stating, among other things, that it has registered with SBA.

(iv) Any agency that makes an award under this paragraph during a fiscal year shall collect and submit to SBA data relating to the number and dollar amount of Phase I awards, Phase II awards, and any other category of awards by the Federal agency under the SBIR program during that fiscal year. See section10 of this directive for the specific reporting requirements.

(v) If an agency awards more than the percentage of the funds authorized under section 6(a)(2) of the Policy Directive, the agency shall transfer from its non-SBIR and non-STTR R&D funds to the agency's SBIR funds any amount that is in excess of the authorized amount. The agency must transfer the funds not later than 180 days after the date on which the Federal agency made the award that exceeded the authorized amount.

(vi) If a Federal agency makes an award under a solicitation more than 9 months after the date on which the period for submitting applications under the solicitation ends, a Covered Small Business Concern is eligible to receive the award, without regard to whether it meets the eligibility requirements of the program for a SBC that is majority-owned by multiple venture capital operating companies, hedge funds, or private equity firms, if the Covered Small Business Concern meets all other requirements for such an award. In addition, the agency must transfer from its non-SBIR and non-STTR R&D funds to the agency's SBIR funds any amount that is so awarded to a Covered Small Business Concern. The funds must be transferred not later than 90 days after the date on which the Federal agency makes the award.

6. Revise section 7(d) to read as follows:

(d) Essentially Equivalent Work. SBIR participants often submit duplicate or similar proposals to more than one soliciting agency when the announcement or solicitation appears to involve similar topics or requirements. However, “essentially equivalent work” must not be funded in the SBIR or other Federal programs, unless an exception to this rule applies. Agencies must verify with the applicant that this is the case by requiring them to certify at the time of award and during the lifecycle of the award that they do not have essentially equivalent work funded by another Federal agency.

7. Revise section 7(h)(1) to read as follows:

(h) Periods of Performance and Extensions.

(1) In keeping with the legislative intent to make a large number of relatively small awards, modification of funding agreements to increase the dollar amount should be kept to a minimum, except for options in original Phase I or II awards.

8. Revise section 8(a) to read as follows:

(a) Proprietary Information Contained in Proposals. The standardized SBIR Program solicitation will include provisions requiring the confidential treatment of any proprietary information to the extent permitted by law. The solicitation will require that all proprietary information be identified clearly and marked with a prescribed legend. Agencies may elect to require SBCs to limit proprietary information to that essential to the proposal and to have such information submitted on a separate page or pages keyed to the text. The Government, except for proposal review purposes, protects all proprietary information, regardless of type, submitted in a contract proposal or grant application for a funding agreement under the SBIR Program, from disclosure.

9. Revise section 8(d) to read as follows:

(d) Continued Use of Government Equipment. Agencies must allow an SBIR awardee participating in the third phase of the SBIR Program continued use, as a directed bailment, of any property transferred by the agency to the Phase II awardee or acquired by the awardee for the purpose of fulfilling the contract. The Phase II awardee may use the property for a period of not less than 2 years, beginning on the initial date of the concern's participation in the third phase of the SBIR Program.

10. Revise section 9(h) to read as follows:

(h) National Academy of Sciences Report. The National Academy of Sciences (NAS) will conduct a study and issue reports on the SBIR and STTR programs.

(1) Prior to and during the period of study, and to ensure that the concerns of small business are appropriately considered, NAS shall consult with and consider the views of SBA's Office of Investment and Innovation and the Office of Advocacy and other interested parties, including entities, organizations, and individuals actively engaged in enhancing or developing the technological capabilities of small business concerns.

(2) The head of each agency with a budget of more than $50,000,000 for its SBIR Program for fiscal year 1999 shall, in consultation with SBA, and not later than 6 months after December 31, 2011, cooperatively enter into an agreement with NAS regarding the content and performance of the study. SBA and the agencies will work with the Interagency Policy Committee in determining the parameters of the study, including the specific areas of focus and priorities for the broad topics required by statute. The agreement with NAS must set forth these parameters, specific areas of focus and priorities, and comprehensively address the scope and content of the work to be performed. This agreement must also require the NAS to ensure there is participation by and consultation with, the small business community, the SBA, and other interested parties as described in paragraph (1).

(3) NAS shall transmit to SBA, heads of agencies entering into an agreement under this section, the Committee on Science, Space and Technology, the Committee on Small Business of the House of Representatives, and to the Committee on Small Business of the Senate a copy of the report, which includes the results and recommendations, not later than 4 years after December 31, 2011, and every subsequent four years.

11. Revise section 10(h)(4)(xi) to read as follows:

(xi) All instances in which an agency pursued R/R&D, services, production, or any combination thereof of a technology developed under an SBIR award with an entity other than that SBIR awardee. See section 9(a)(12) for minimum reporting requirements.

12. Revise section 10(j)(2) to read as follows:

(2) The system will include a list of any individual or small business concern that has received an SBIR award and that has been convicted of a fraud-related crime involving SBIR funds or found civilly liable for a fraud-related violation involving SBIR funds, of which SBA has been made aware.

13. Revise section 12(b)(4) to read as follows:

(4) Funding.

(i) Beginning with FY 2013 and ending in FY 2015, the Secretary of Defense and each Secretary of a military department is authorized to use its SBIR funds for administration of this program in accordance with the procedures and policies set forth in section 9(e)(3) of this directive.

(ii) In addition, the Secretary of Defense and Secretary of each military department is authorized to use not more than an amount equal to 1% of its SBIR funds available to DoD or the military departments for payment of expenses incurred to administer the Commercialization Program. Such funds—

(A) shall not be subject to the limitations on the use of funds in 9(e)(2) or 9(e)(3) of this directive; and

(B) shall not be used to make Phase III awards.

14. Revise section 12(b)(5) to read as follows:

(5) Contracts Valued at less than $100,000,000. For any contract awarded by DoD valued at less than $100,000,000, the Secretary of Defense may:

(i) establish goals for the transition of Phase III technologies in subcontracting plans; and

(ii) require a prime contractor on such a contract to report the number and dollar amount of the contracts entered into by the prime contractor for Phase III SBIR projects.

15. Revise section 12(b)(6) to read as follows:

(6) The Secretary of Defense shall:

(i) set a goal to increase the number of SBIR Phase II contracts that lead to technology transition into programs of record of fielded systems;

(ii) use incentives in effect as of December 31, 2011 or create new incentives to encourage agency program managers and prime contractors to meet the goal set forth in paragraph (6)(i) above; and

(iii) submit the following to SBA, as part of the annual report:

(A) the number and percentage of Phase II SBIR contracts awarded by DoD that led to technology transition into programs of record or fielded systems;

(B) information on the status of each project that received funding through the Commercialization Program and the efforts to transition these projects into programs of record or fielded systems; and

(C) a description of each incentive that has been used by DoD, the effectiveness of the incentive with respect to meeting DoD's goal to increase the number of SBIR Phase II contracts that lead to technology transition into programs of record of fielded systems, and measures taken to ensure that such incentives do not act to shift the focus of SBIR Phase II awards away from relatively high-risk innovation projects.

16. Revise paragraph 1(a) of the Appendix I: Instructions for Preparation of SBIR Program Solicitation to read as follows:

(a) Summarize in narrative form the request for proposals and the objectives of the SBIR Program.

17. In Appendix I, in the SBIR Funding Agreement Certification and the SBIR Funding Agreement Certification—Life Cycle Certification, revise the checkbox addressing potential duplicative funding to read as follows:

On December 31, 2011, the President signed into law the National Defense Authorization Act for Fiscal Year 2012 (Defense Reauthorization Act), Public Law 112-81, 125-Stat. 1298. Section 5001, Division E of the Defense Reauthorization Act contains the SBIR/STTR Reauthorization Act of 2011 (Reauthorization Act), which amended the Small Business Act and made several amendments to the STTR Program. The Reauthorization Act required SBA to issue amendments to the STTR Policy Directive and publish the amendments in the Federal Register within 180 days of when the Reauthorization Act was passed.

On August 6, 2012, SBA published a final STTR Policy Directive implementing the various provisions of the Reauthorization Act at 77 FR 46855. The directive made several key changes to the STTR Program relating to eligibility, the award process, program administration, and fraud, waste and abuse. Although the STTR Policy Directive is intended for use by the STTR participating agencies, SBA believed that public input on the directive from all parties involved in the program would be invaluable. Therefore, SBA sought public comments on the final directive, and stated that it may amend the directive in response to these comments at a later time.

In response to this request, SBA received comments on various parts of the directive. If SBA received comments on a section of the SBIR Policy Directive that also appears in the STTR Policy Directive, SBA clarified the relevant sections in both the SBIR and STTR Policy Directives, when appropriate, in order to maintain concordance between the programs. Several comments recommended that SBA strengthen and clarify the Policy Directive language with regard to SBIR/STTR data rights and the obligation of federal agencies to give a preference in contracting to SBIR/STTR awardees for follow-on Phase III work. SBA agrees that these areas of SBIR/STTR policy are vital to the programs and require clarification and improvement. The SBA continues to evaluate these issues and will address them in a subsequent Policy Directive revision.

Section 4(a)(3) “Agency benchmarks for progress towards commercialization” sets forth the program policy regarding an eligibility requirement for Phase I awards. SBA received comments requesting clarification of the time periods used to calculate the transition rate and commercialization rate benchmark requirements. Commenters also requested clarification about how agencies determine which firms must comply with the transition rate and commercialization rate benchmarks. In response to these comments, SBA revised and reorganized section 4(a)(3) to clarify several procedural elements about the benchmark determinations and enhance its readability.

Section 4(a)(3) clarifies the time periods used to calculate awardee rates of transition from Phase I to Phase II and provides two examples of the calculation. While the rate is calculated using Phase I awards received in the most recent 5, 10, or 15-year period (agencies choose which period they use), excluding the most recently completed fiscal year; the period used when counting the Phase II awards is lagged one year. That is, when calculating the number of Phase I awards received over a particular time period, the time period evaluated does not include the most recently completed fiscal year; however, when calculating the number of Phase II awards received, the time period evaluated does include the most recently completed fiscal year but does not include the first year of the period evaluated for Phase I awards received. The period used to calculate Phase II awards is lagged one-year because it is unlikely that a new Phase I would transition to a Phase II within the same year. SBA also clarified that the Phase II transition benchmark requirement applies only to awardees that have received more than 20 Phase I awards over the applicable time period and that the commercialization benchmark applies only to firms that received more than 15 Phase II awards over the applicable time period.

Based on additional input from the agencies participating in the SBIR and STTR programs, SBA also revised several procedural elements of the Phase II transition benchmark requirement in section 4(a)(3) to simplify the process for small businesses and reduce the administrative burden on the agencies. Specifically, in section 4(a)(3)(iii), SBA changed the start date for the one-year ineligibility period for firms that do not meet the benchmarks. The date was changed from the date of application submission to June 1st of each year. SBA made this change for several reasons: (1) It is a clearly defined period for affected small businesses; (2) to provide sufficient time for agencies to enter fully verified award data from the prior fiscal year into the TechNet database; and (3) to eliminate the need for agencies to track multiple periods of ineligibility. SBA will use its TechNet Data system to generate the list of companies that do not meet agency Phase II transition benchmarks and provide this list to the agencies each year on June 1. Finally, SBA also added a procedure to notify awardee firms if they are on the ineligible list and to enable firms to provide feedback directly to SBA if they believe their rate was calculated using incomplete award information.

Some respondents asked if the provision in section 4(b)(5) allowing one Sequential Phase II award included supplementary awards such as Phase 2.5 or Phase IIb awards in the definition of a Phase II award. SBA relocated the language at section 4(b)(6) to new section 4(b)(8) and added new section 4(b)(6) to clarify SBA's policy on supplemental phase II awards. Section 4(b)(6) now clarifies how Phase II award amounts are calculated when supplemental awards are issued. Furthermore, section 4(b)(6) specifies that all supplementary awards, such as a Phase IIb, must be linked to either an initial Phase II or a sequential Phase II award and is added to the amount of that award for the purpose of determining the size of the Phase II award. This means that all supplementary Phase II awards including options, enhancements, administrative supplements, and Phase IIb-type programs are considered as part of the initial Phase II or sequential Phase II from which they derive and are therefore subject to the Phase II per-award guideline amount of $1 million and limit of $1.5 million.

SBA repeated the language in section 9(d)(2) in new section 4(b)(7), which explains how a Phase I awardee may receive an award from one agency and also may receive a subsequent Phase II award from another agency. SBA also clarified in section 4(b)(7) that the same process applies to a second, sequential Phase II award that follows an initial Phase II award from a different agency. This policy is relevant to interagency actions, which are found at section 9 of the Policy Directive, and also to Phase II awards, which is found at section 4 of the Policy Directive.

The reauthorization legislation included a provision giving SBIR agencies the option to use a portion of their program funds to make awards to small businesses that are majority owned by multiple venture capital operating companies, hedge funds or private equity firms. SBA applied this option to the STTR program in section 6(a)(2) of the Policy Directive. SBA received comments that the option should not apply to the STTR program because the reauthorization legislation did not extend the participation of these firms to the STTR program. SBA agrees with commenter. When SBA issued the final regulations amending Title 13, Part 121, Small Business Size Regulations, Small Business Innovation Research (SBIR) Program and Small Business Technology Transfer (STTR) Program, on December 27, 2012 (77 FR 76215), it reviewed this issue and concluded that such firms may not participate in the STTR program. SBA has removed paragraph (a)(2) from section 6 and all other sections of the directive where this provision was applied, including section 6(b)(1)(i) and the related certification in Appendix I, Instructions for Preparation of STTR Program Solicitation, section 2(b)(i).

SBA received comments concerning section 9 of the Policy Directives that addressed measures to prevent fraud, waste and abuse in the program. The respondents commented that the administrative requirements contained in section 9 may be too stringent and may discourage small businesses from applying. SBA notes that it developed these requirements, including the procedures and requirements for certification, in consultation with the Council of Inspectors General on Integrity and Efficiency. SBA believes that these provisions can help reduce fraud, waste and abuse in the program and does not think these provisions should be changed at this time.

SBA received comments on the Department of Defense's (DoD's) Commercialization Readiness Program, outlined in section 12(b) of the STTR Policy Directive. In response to comments that agency efforts to increase transitions to Phase III could reduce the innovative nature of SBIR awards, SBA has added that when DoD reports on its Phase II insertion incentives, it should note efforts that the agency has made to ensure that such incentives do not act to shift the focus of SBIR and STTR Phase II awards away from relatively high-risk innovation projects. SBA also amended the provisions relating to the use of SBIR funds for the DoD Commercialization Readiness Program, which is funded from SBIR funds, but may benefit both the SBIR and STTR programs. According to section 1615 of the National Defense Authorization Act for Fiscal Year 2013 (NDAA), Public Law 112-239, 126 Stat. 1632, DoD has the authority to use 1% of its SBIR funding for purposes of administering the Commercialization Readiness Program.

A number of comments asked us to change features that, because they are required by statute, we were not able to modify.

The inadvertent omission of the term “extramural” before “R/R&D budgets” was corrected in section 2(b), which identifies the source of funds for the program.

Section 3 contains definitions of terms that appear throughout the Policy Directive. SBA made an editorial revision to the definition of “Awardee” in section 3(e). SBA revised the word “receiving” to “that receives.”

Section 4(b)(1), which identifies the objective and nature of a Phase II award, includes a statement regarding the eligibility of successor in interest firms for STTR awards. Because this statement pertains more generally to eligibility for all STTR awards, it was removed from section 4(b)(1) and added to section 6(a) which addresses program eligibility requirements.

Section 6(a) addresses general program eligibility. SBA added the language previously found at section 4(b)(1) regarding successor in interest firms to new section 6(a)(5). Sections 6(a)(3) and (4), renumbered as sections 6(a)(2) and (3), state program requirements regarding the percentage of work performed by the SBC and the place of employment of the principal investigator, respectively. SBA revised these sections to make a technical clarification that the STTR program does not provide small business concerns the opportunity to request a deviation from these requirements. The provision allowing for deviations in these sections was erroneously added to the STTR Policy Directive that was published in August 2012.

Section 7 addresses issues related to program funding processes. SBA revised the language in paragraph 7(d) to clarify that while duplicate or similar proposals may be submitted in response to apparently similar solicitation topics, essentially equivalent work may not be funded. In addition, SBA revised paragraph (i)(1), which says that funding agreement modifications should be kept to a minimum, to address only modifications that increase the dollar amount of awards. Paragraph (i)(1) also referred to modifications of periods of performance and scope of work. SBA clarified section 7(i)(1) to specify that the concern regarding the number of modifications made to an award pertains only to changes that increase the dollar amount of awards.

Section 8 of the Directive addresses the terms of agreement under STTR awards. SBA clarified section 8(a) by removing language stating that agencies should discourage SBCs from submitting proprietary information and revised section 8(e) to clarify that the continued use of agency-owned property applies to property acquired by the awardee under the contract.

In response to concerns regarding the cost and accountability of the continuing study by the National Academy of Sciences, SBA modified section 9(h) to clarify that the agreement required between the agencies and the National Academy of Sciences must be made in consultation with the SBA and must comprehensively address the scope and content of the work to be performed.

Section 10(h) explains the process for agencies to submit their STTR program annual reports to SBA. Paragraph (h)(4) contains a list of information that must be included in each agency's annual report. SBA clarified section 10(h)(4)(xi) to note that agencies must report all instances in which an agency pursued R/R&D, services, production, or any combination thereof of a technology developed under an STTR award with an entity other than that STTR awardee. SBA removed the unnecessary language, “and determined that it was not practicable to enter into a follow-on funding agreement with non-STTR funds with that concern,” because it unintentionally created an additional condition for this reporting requirement.

Section 10(j) contains information on the other reporting requirements for STTR participating agencies. Section 10(j)(2) discusses a system that will list any individual or small business concern that received an STTR award and that has been convicted of a fraud-related crime involving STTR funds or found civilly liable for a fraud-related violation involving STTR funds. SBA clarified this section to note that SBA will list those individuals and small business concerns of which SBA has been made aware.

Section 12(b) addresses the Commercialization Readiness Program at the Department of Defense (DoD). SBA clarified the source of funding for this program by removing the sentence in paragraph (b)(4)(ii) stating that funds for the program would come from the 3% administrative set-aside, and by clarifying that the funds shall not be subject to the limitations on the use of funds in section 9(e)(3). In addition, in section 12(b)(6)(iii)(C), SBA clarified that the DoD must include, along with its description of the incentives used for this program, information on measures taken to ensure that such incentives do not shift the focus of the STTR Phase II awards away from the relatively high-risk innovation projects they are intended to promote.

Section 12(b)(5) addresses DoD's Commercialization Readiness Program. The Policy Directive states that DoD may establish transition goals and reporting requirements for awards less than $1,000,000,000. The amount listed in section 12(b)(5) contained a typographical error, which was corrected to $100,000,000.

Appendix I provides instructions for the preparation of program solicitations. In Appendix I, SBA revised the certification check box regarding notification if work is subsequently funded by another Federal agency to clarify that it pertains to work funded and completed under the award rather than to the work proposed for the award.

The updated STTR Policy Directive, incorporating all changes noted here, will be posted on www.sbir.gov .

To: The Small Business Technology Transfer Program Managers

Subject: Amendments to STTR Policy Directive Published on August 6, 2012 at 77 FR 46855.

1. Purpose. The purpose of this notice is to inform STTR agencies of amendments made to the recently published STTR Policy Directive.

2. Authority. Section 9(j)(3) of the Small Business Act (15 U.S.C. 638(j)) requires the Administrator of the U.S. Small Business Administration (SBA) to issue an STTR Program Policy Directive for the general conduct of the STTR Program.

3. Procurement Regulations. It is recognized that the Federal Acquisition Regulations and agency supplemental regulations may need to be modified to conform to the requirements of the final Policy Directive. SBA's Administrator or designee must review and concur with any regulatory provisions that pertain to areas of SBA responsibility. SBA's Office of Innovation coordinates such regulatory actions.

4. Personnel Concerned. This Policy Directive serves as guidance for all federal government personnel who are involved in the administration of the STTR Program, issuance and management of Funding Agreements or contracts pursuant to the STTR Program, and the establishment of goals for small business concerns in research or research and development acquisition or grants.

5. Originator. SBA's Office of Innovation and Technology.

6. Date. The policy directive is effective on January 8, 2014.

SBA amends the STTR Policy Directive as follows:

1. Amend section 2(b) by adding the term “extramural” before “R/R&D budgets” each place it appears.

2. Revise section 3(e) to read as follows:

(e) Awardee. The organizational entity that receives an STTR Phase I, Phase II, or Phase III award.

3. Revise section 4(a)(3) to read as follows:

(3) Agency benchmarks for progress towards commercialization. Each agency must determine whether an applicant for a Phase I award that has won multiple prior STTR awards meets the agency's benchmark requirements for progress towards commercialization before making a new Phase I award to that applicant. For the purpose of this requirement, applicants are assessed using their prior Phase I and Phase II SBIR and STTR awards across all agencies.

(i) Agencies must apply two benchmark rates addressing an applicant's progress towards commercialization—the Phase II Transition Rate Benchmark and the Commercialization Rate Benchmark.

(A) The Phase II Transition Rate Benchmark sets the minimum required number of Phase II awards the applicant must have received for a given number of Phase I awards received during the specified period. This Transition Rate Benchmark applies only to Phase I applicants that have received more than 20 Phase I awards over the time period used by the agency for the benchmark determination.

(B) The agency Commercialization Rate Benchmark sets the minimum Phase III commercialization results that a Phase I applicant must have realized from its prior Phase II awards in order to be eligible to receive a new Phase I award from that agency. This benchmark requirement applies only to Phase I applicants that have received more than 15 Phase II awards over the time period used by the agency for the benchmark determination.

(ii) Consequence. If an awardee fails to meet either of the benchmarks, that awardee is not eligible for an STTR Phase I award (and any Phase II award issued pursuant to paragraph (b)(1)(ii) below) for a period of one year from the time of the determination.

(iii) Timing of the determination and consequence period. The SBIR/STTR awardee Phase II transition rates and commercialization rates are calculated using the data in SBA's TechNet database. For the purpose of these benchmark requirements, awardee firms are assessed once a year, on June 1st, using their prior SBIR and STTR awards across all agencies. SBA makes this tabulation of awardee transition rates and commercialization rates available to the agencies. Each SBIR/STTR agency uses this tabulation to determine which companies do not meet that agency's benchmark rates and are therefore ineligible to receive new Phase 1 awards from that agency during the one-year period beginning on June 1st and ending on May 31st. SBA notifies these ineligible firms of the determination and the one year restriction on Phase I awards. Agencies must notify SBA of any applications denied because of the failure to meet the benchmarks.

(iv) Phase II Transition Rate Benchmark. Each agency must establish an SBA-approved Phase II Transition Rate Benchmark and applicable time period. The benchmark rates and time periods are posted at www.sbir.gov . Agencies must seek approval for any subsequent changes from SBA.

(A) The agency Phase II Transition Rate Benchmark establishes the number of Phase II awards a small business concern must have received for a given number of Phase I awards received over the past 5, 10 or 15 fiscal years, excluding the most recently completed fiscal year. Each agency selects both the rate to be applied and the length of time that the agency will use to evaluate whether a small business concern has met the Transition Rate Benchmark. The time period over which Phase I awards are counted excludes the most recently completed fiscal year. The time period over which Phase II awards are counted includes the most recently completed fiscal year and excludes the first year of the time period evaluated for Phase I awards.

(B) An SBC that has received more than 20 phase I awards in the relevant time period can view its Phase II transition rate on the Company Registry page at SBIR.gov. Generally, the the award data used to calculate an SBC's transition rate will be complete by the end of March each year. An SBC may view its SBIR/STTR award information on the Company Registry at any time. If an awardee believes its Phase II transition rate is calculated using incomplete award information, the awardee may dispute the rate using the link provided on the Company Registry, provide the additional award information, and request a reconsideration of its transition rate. Requests for reconsideration of a firm's transition rate received by SBA from April 1st through April 30th of each year will be considered for the June 1st transition rate assessment.

(C) Agencies must set the Phase II Transition Rate Benchmark as appropriate for their programs and industry sectors. When setting the Transition Rate Benchmark, agencies should consider that Phase I is designed and intended to explore high-risk, early-stage research ideas and, as a result, not all Phase I awards are expected to result in a Phase II award.

(v) Commercialization Rate Benchmark. By October 1, 2013, each agency will establish an SBA-approved Commercialization Rate Benchmark that establishes the level of Phase III commercialization results an SBC must have received from work it performed under prior Phase II awards, over the prior 5, 10 or 15 fiscal years, excluding the most recently completed two fiscal years. Agencies may define this benchmark:

(A) in financial terms, such as by using the ratio of the dollar value of revenues and additional investment resulting from prior Phase II awards relative to the dollar value of the Phase II awards received over the time period;

(B) in terms of the share of Phase II awards received over the time period that have resulted in the introduction of a product to market; or

(C) by other means such as using a commercialization scoring system that rates awardees on their past commercialization success.

(vi) Agencies must submit their Transition Rate Benchmark, Commercialization Rate Benchmark, and time periods to SBA for approval. SBA will publish the benchmarks and time periods, seek public comment, and maintain a table of the current requirements on www.sbir.gov. The benchmarks and time periods become effective when SBA posts the approved measures on www.sbir.gov. Agencies must submit any changes to the benchmarks or time periods to SBA for prior approval.

(vii) SBA maintains a system that records all Phase I, Phase II and Government Phase III awards, and other commercialization information; and calculates the Phase II transition rates for all Phase I awardees and the commercialization rates for all Phase II awardees.

(viii) If an applicant fails to meet an agency's benchmark, its name will appear on the list of companies made available to the agencies on June 1 of each year. An agency may not make a Phase I award to an applicant that does not meet the agency's benchmark.

(ix) If an awardee believes its determination was made in error, it may provide SBA with the pertinent award information and request a re-assessment. To do so, awardees may use the link on the Company Registry at www.sbir.gov.

4. Amend section 4(b) by revising paragraph (b)(1), renumbering paragraph (b)(6) as (b)(8), and inserting paragraphs (b)(6) and (b)(7) to read as follows:

(b) Phase II.

(1) The object of Phase II is to continue the R/R&D effort from the completed Phase I. Unless the exception set forth in paragraph (i) below applies, only STTR Phase I awardees are eligible to participate in Phase II.

(i) A Federal agency may issue an STTR Phase II award to an SBIR Phase I awardee to further develop the work performed under the SBIR Phase I award. The agency must base its decision upon the results of work performed under the Phase I award and the scientific and technical merit, and commercial potential of the Phase II proposal. The SBIR Phase I awardee must meet the eligibility and program requirements of the STTR Program in order to receive the STTR Phase II award.

. . . [paragraphs (2) through (4) are unchanged] . . .

(5) A Phase II awardee may receive one additional, sequential Phase II award to continue the work of an initial Phase II award. The additional, sequential Phase II award has the same guideline amounts and limits as an initial Phase II award.

(6) Agencies may offer special STTR awards, such as Phase IIB awards, that supplement or extend Phase II awards. For example, some agencies administer Phase IIB awards that differ from the base Phase II in that they require third party matching of the SBIR funds. Each such supplemental award must be linked to a base Phase II award (the initial Phase II or the second, sequential Phase II award). Any STTR funds used for such special or supplementary awards are aggregated with the amount of the base Phase II to determine the size of that Phase II award. Therefore, while there is no limit on the number of such special/supplementary awards, there is a limit on the total amount of STTR funds that can be administered through them—the amounts of these awards count towards the size of the initial Phase II or the sequential Phase II, each of which has a guideline amount of $1 million and a limit of $1.5 million. (Note that Phase IIB awards under the NIH STTR program are administered as second, sequential Phase II awards, not supplemental awards. As such, they are base Phase II awards and subject to the Phase II guideline amounts and limits of $1 million and $1.5 million).

(7) An STTR Phase II award may be issued by a Federal agency other than the one that made the Phase I award. Prior to award, the head of the Federal agency that awarded the Phase I and the head of the Federal Agency that plans to issue the Phase II award, or designee, must issue a written determination that the topics of the awards are the same. Both agencies must submit the report to the SBA. The same process applies to a second, subsequent Phase II award that follows an initial Phase II award from a different agency.

(8) Agencies may issue Phase II awards for testing and evaluation of products, services, or technologies for use in technical or weapons systems.

5. Remove section 6(a)(2).

6. Redesignate sections 6(a)(3) and (4) as sections 6(a)(2) and (3) and revise to read as follows:

(2) For both Phase I and Phase II, not less than 40 percent of the R/R&D work must be performed by the SBC, and not less than 30 percent of the R/R&D work must be performed by the single, partnering Research Institution. An agency can measure this research or analytical effort using the total contract dollars or labor hours, and must explain to the small business in the solicitation how it will be measured.

(3) For both Phase I and Phase II, the primary employment of the principal investigator must be with the SBC or the research institution at the time of award and during the conduct of the proposed project. Primary employment means that more than one-half of the principal investigator's time is spent in the employ of the SBC or the research institution. This precludes full-time employment with another organization aside from the SBC or the research institution. An SBC may replace the principal investigator on an STTR Phase I or Phase II award, subject to approval in writing by the funding agreement officer. For purposes of the STTR Program, personnel obtained through a Professional Employer Organization or other similar personnel leasing company may be considered employees of the awardee. This is consistent with SBA's size regulations, 13 CFR 121.106—Small Business Size Regulations.

7. Insert new section 6(a)(5) to read as follows:

(5) An STTR awardee may include, and STTR work may be performed by, those identified via a “novated” or “successor in interest” or similarly-revised funding agreement, or those that have reorganized with the same key staff, regardless of whether they have been assigned a different tax identification number. Agencies may require the original awardee to relinquish its rights and interests in an STTR project in favor of another applicant as a condition for that applicant's eligibility to participate in the STTR Program for that project.

8. Revise section 7(d) to read as follows:

(d) Essentially Equivalent Work. STTR participants often submit duplicate or similar proposals to more than one soliciting agency when the announcement or solicitation appears to involve similar topics or requirements. However, “essentially equivalent work” must not be funded in the STTR or other Federal programs, unless an exception to this rule applies. Agencies must verify with the applicant that this is the case by requiring them to certify at the time of award and during the lifecycle of the award that they do not have essentially equivalent work funded by another Federal agency.

9. Revise section 7(h)(1) to read as follows:

(h) Periods of Performance and Extensions.

(1) In keeping with the legislative intent to make a large number of relatively small awards, modification of funding agreements to increase the dollar amount should be kept to a minimum, except for options in original Phase I or II awards.

10. Revise section 8(a) to read as follows:

(a) Proprietary Information Contained in Proposals. The standardized STTR Program solicitation will include provisions requiring the confidential treatment of any proprietary information to the extent permitted by law. The solicitation will require that all proprietary information be identified clearly and marked with a prescribed legend. Agencies may elect to require SBCs to limit proprietary information to that essential to the proposal and to have such information submitted on a separate page or pages keyed to the text. The Government, except for proposal review purposes, protects all proprietary information, regardless of type, submitted in a contract proposal or grant application for a funding agreement under the STTR Program, from disclosure.

11. Revise section 8(e) to read as follows:

(e) Continued Use of Government Equipment. Agencies must allow an STTR awardee participating in the third phase of the STTR Program continued use, as a directed bailment, of any property transferred by the agency to the Phase II awardee or acquired by the awardee for the purpose of fulfilling the contract. The Phase II awardee may use the property for a period of not less than 2 years, beginning on the initial date of the concern's participation in the third phase of the STTR Program.

12. Revise section 9(h) to read as follows:

(h) National Academy of Sciences Report. The National Academy of Sciences (NAS) will conduct a study and issue reports on the SBIR and STTR programs.

(1) Prior to and during the period of study, and to ensure that the concerns of small business are appropriately considered, NAS shall consult with and consider the views of SBA's Office of Investment and Innovation and the Office of Advocacy and other interested parties, including entities, organizations, and individuals actively engaged in enhancing or developing the technological capabilities of small business concerns.

(2) The head of each agency with a budget of more than $50,000,000 for its SBIR Program for fiscal year 1999 shall, in consultation with SBA, and not later than 6 months after December 31, 2011, cooperatively enter into an agreement with NAS regarding the content and performance of the study. SBA and the agencies will work with the Interagency Policy Committee in determining the parameters of the study, including the specific areas of focus and priorities for the broad topics required by statute. The agreement with NAS must set forth these parameters, specific areas of focus and priorities, and comprehensively address the scope and content of the work to be performed. This agreement must also require the NAS to ensure there is participation by and consultation with, the small business community, the SBA, and other interested parties as described in paragraph (1).

(3) NAS shall transmit to SBA, heads of agencies entering into an agreement under this section, the Committee on Science, Space and Technology, the Committee on Small Business of the House of Representatives, and to the Committee on Small Business of the Senate a copy of the report, which includes the results and recommendations, not later than 4 years after December 31, 2011, and every subsequent four years.

13. Revise section 10(h)(4)(xi) to read as follows:

(xi) All instances in which an agency pursued R/R&D, services, production, or any combination thereof of a technology developed under an STTR award with an entity other than that STTR awardee. See section 9(a)(12) for minimum reporting requirements.

14. Revise section 10(j)(2) to read as follows:

(2) The system will include a list of any individual or small business concern that has received an STTR award and that has been convicted of a fraud-related crime involving STTR funds or found civilly liable for a fraud-related violation involving STTR funds, of which SBA has been made aware.

15. Revise section 12(b)(4) to read as follows:

(4) Funding.

(i) Beginning with FY 2013 and ending in FY 2015, the Secretary of Defense and each Secretary of a military department is authorized to use its SBIR funds for administration of this program in accordance with the procedures and policies set forth in section 9(e)(3) of this directive.

(ii) In addition, the Secretary of Defense and Secretary of each military department is authorized to use not more than an amount equal to 1% of its SBIR funds available to DoD or the military departments for payment of expenses incurred to administer the Commercialization Readiness Program. Such funds—

(A) shall not be subject to the limitations on the use of funds in 9(e)(2) or 9(e)(3) of this directive; and

(B) shall not be used to make Phase III awards.

16. Revise section 12(b)(5) to read as follows:

(5) Contracts Valued at less than $100,000,000. For any contract awarded by DoD valued at less than $100,000,000, the Secretary of Defense may:

(i) establish goals for the transition of Phase III technologies in subcontracting plans; and

(ii) require a prime contractor on such a contract to report the number and dollar amount of the contracts entered into by the prime contractor for Phase III STTR projects.

17. Revise section 12(b)(6) to read as follows:

(6) The Secretary of Defense shall:

(i) set a goal to increase the number of STTR Phase II contracts that lead to technology transition into programs of record of fielded systems;

(ii) use incentives in effect as of December 31, 2011 or create new incentives to encourage agency program managers and prime contractors to meet the goal set forth in paragraph (6)(i) above; and

(iii) submit the following to SBA, as part of the annual report:

(A) the number and percentage of Phase II STTR contracts awarded by DoD that led to technology transition into programs of record or fielded systems;

(B) information on the status of each project that received funding through the Commercialization Program and the efforts to transition these projects into programs of record or fielded systems; and

(C) a description of each incentive that has been used by DoD, the effectiveness of the incentive with respect to meeting DoD's goal to increase the number of STTR Phase II contracts that lead to technology transition into programs of record of fielded systems, and measures taken to ensure that such incentives do not act to shift the focus of STTR Phase II awards away from relatively high-risk innovation projects.

18. Revise paragraph 1(a) of the Appendix I: Instructions for Preparation of STTR Program Solicitation to read as follows:

(a) Summarize in narrative form the request for proposals and the objectives of the STTR Program.

19. In Appendix I, in the STTR Funding Agreement Certification and the STTR Funding Agreement Certification—Life Cycle Certification, revise the checkbox addressing potential duplicative funding to read as follows:

The European Aviation Safety Agency (EASA), which is the Technical Agent for the Member States of the European Community, has issued EASA Airworthiness Directive 2013-0246, dated October 10, 2013 (referred to herein after as “the MCAI”), to correct an unsafe condition for the specified products. The MCAI states:

This product has been approved by the aviation authority of the United Kingdom, and is approved for operation in the United States. Pursuant to our bilateral agreement with the European Community, EASA has notified us of the unsafe condition described in the MCAI and service information referenced above. We are issuing this AD because we evaluated all information provided by EASA and determined the unsafe condition exists and is likely to exist or develop on other products of the same type design. This AD requires a one-time reduction in the cyclic life of certain HP compressor stage 1 and stage 2 discs, and removal of discs that exceed the reduced cycle life.

No domestic operators use this product. Therefore, we find that notice and opportunity for prior public comment are unnecessary and that good cause exists for making this amendment effective in less than 30 days.

This AD is a final rule that involves requirements affecting flight safety, and we did not precede it by notice and opportunity for public comment. We invite you to send any written relevant data, views, or arguments about this AD. Send your comments to an address listed under the ADDRESSES section. Include “Docket No. FAA-2013-1004; Directorate Identifier 2013-NE-34-AD” at the beginning of your comments. We specifically invite comments on the overall regulatory, economic, environmental, and energy aspects of this AD. We will consider all comments received by the closing date and may amend this AD because of those comments.

We will post all comments we receive, without change, to http://www.regulations.gov, including any personal information you provide. We will also post a report summarizing each substantive verbal contact with FAA personnel concerning this AD. Using the search function of the Web site, anyone can find and read the comments in any of our dockets, including, if provided, the name of the individual who sent the comment (or signed the comment on behalf of an association, business, labor union, etc.). You may review the DOT's complete Privacy Act Statement in the Federal Register published on April 11, 2000 (65 FR 19477-78).

We estimate that this AD will affect 0 engines installed on airplanes of U.S. registry. We also estimate that it will take about 0 hours per engine to comply with this AD. The average labor rate is $85 per hour. The prorated cost of the parts, adjusted for lost life, is about $15,940 per engine. Based on these figures, we estimate the total cost of this AD to U.S. operators is $0.

Title 49 of the United States Code specifies the FAA's authority to issue rules on aviation safety. Subtitle I, section 106, describes the authority of the FAA Administrator. “Subtitle VII: Aviation Programs,” describes in more detail the scope of the Agency's authority.

We are issuing this rulemaking under the authority described in “Subtitle VII, Part A, Subpart III, Section 44701: General requirements.” Under that section, Congress charges the FAA with promoting safe flight of civil aircraft in air commerce by prescribing regulations for practices, methods, and procedures the Administrator finds necessary for safety in air commerce. This regulation is within the scope of that authority because it addresses an unsafe condition that is likely to exist or develop on products identified in this rulemaking action.

We determined that this AD will not have federalism implications under Executive Order 13132. This AD will not have a substantial direct effect on the States, on the relationship between the national government and the States, or on the distribution of power and responsibilities among the various levels of government.

For the reasons discussed above, I certify this AD:

(1) Is not a “significant regulatory action” under Executive Order 12866,

(2) Is not a “significant rule” under the DOT Regulatory Policies and Procedures (44 FR 11034, February 26, 1979),

(3) Will not affect intrastate aviation in Alaska to the extent that it justifies making a regulatory distinction, and

(4) Will not have a significant economic impact, positive or negative, on a substantial number of small entities under the criteria of the Regulatory Flexibility Act.

We prepared a regulatory evaluation of the estimated costs to comply with this AD and placed it in the AD docket.

Accordingly, under the authority delegated to me by the Administrator, the FAA amends 14 CFR part 39 as follows:

The Commission is adopting amendments to rule 5b-3 [17 CFR 270.5b-3] under the Investment Company Act. 1 The Commission is also adopting amendments to Forms N-1A [17 CFR 239.15A and 17 CFR 274.11A], N-2 [17 CFR 239.14 and 17 CFR 274.11a-1], and N-3 [17 CFR 239.17a and 17 CFR 274.11b] under the Investment Company Act and the Securities Act. 2

The first use of a reference to ratings or rating agencies in Commission rules was in 1975, when the Commission adopted the term “nationally recognized statistical rating organization” (“NRSRO”) as part of amendments to the net capital rule for broker-dealers, rule 15c3-1 under the Securities Exchange Act of 1934 (“Exchange Act”) (the “Net Capital Rule”). 3 The Commission eventually included references to credit ratings issued by NRSROs in other rules under the securities laws, including the Investment Company Act. 4 In addition, credit ratings by NRSROs have been used as benchmarks in federal and state legislation, rules administered by other federal agencies, and foreign regulatory schemes. 5 Even prior to the enactment of the Dodd-Frank Act, 6 concerns about the wide-spread use of NRSRO credit ratings in statutes and regulations prompted the Commission to explore whether to eliminate references to credit ratings in Commission rules because of the potential overreliance by investors and, investment advisers and other financial professionals on these ratings, and whether there are practical alternatives to NRSRO credit ratings that could be used as benchmarks in regulations. 7

Section 939A of the Dodd-Frank Act requires each Federal agency, including the Commission, to “review any regulation issued by such agency that requires the use of an assessment of the credit-worthiness of a security or money market instrument and any references to or requirements in such regulations regarding credit ratings.”  8 That section further provides that each such agency shall “modify any such regulations identified by the review . . . to remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standard of credit-worthiness as each respective agency shall determine as appropriate for such regulations.”  9

As a step toward implementing these mandates, in March 2011 the Commission proposed to replace references to ratings issued by NRSROs in two Commission rules and four Commission forms under the Investment Company Act, including rule 5b-3 and Forms N-1A, N-2, and N-3. 10 We received 26 comment letters on the proposed rule and form amendments. 11 Several commenters addressed specific provisions of the proposal to amend rule 5b-3 and Forms N-1A, N-2, and N-3, which we discuss in more detail below.

We are adopting, largely as proposed, amendments to rule 5b-3 and Forms N-1A, N-2, and N-3 to implement section 939A of the Dodd-Frank Act and effectuate Congressional intent to reduce reliance on NRSRO credit ratings. 12 As discussed below, the amendments replace a reference to required NRSRO credit ratings in rule 5b-3 for certain securities held by funds as collateral for repurchase agreements with an alternative standard that is designed to retain a similar degree of credit quality. We are also amending Forms N-1A, N-2, and N-3 to eliminate the required use of NRSRO credit ratings by funds that choose to use credit quality categorizations in the required table, chart, or graph of portfolio holdings. Under the amendments, funds that choose to use credit quality to depict portfolio holdings must include a description of how the credit quality of the holding was determined. If a fund chooses to use credit ratings issued by a credit rating agency to depict the credit quality of portfolio holdings, the fund must include a description of how the credit ratings were identified and selected.

In a separate release, the Commission is adopting final amendments to remove references to credit ratings from rules on broker-dealer financial responsibility and confirmations of transactions. These amendments follow the Commission's April 2011 proposed rules in which we proposed to amend rules and one form under the Exchange Act applicable to broker-dealer financial responsibility, distributions of securities, and confirmations of transactions in order to remove references to credit ratings pursuant to section 939A of the Dodd-Frank Act. 13

As part of our implementation of section 939A, we have reviewed our prior actions and those of other regulators. As discussed below, both the Commission and other regulators have proposed and issued several final rules towards implementation of the mandate under section 939A of the Dodd-Frank Act. In some cases, the references to credit ratings were replaced with an alternative standard of credit quality designed to retain the same degree of credit quality and liquidity as reflected by the use of credit ratings.

The Commission has long been concerned with the use of credit ratings and has taken a variety of actions even before the enactment of the Dodd-Frank Act regarding the use of NRSRO credit ratings in its rules. For example, in 1994, the Commission published a concept release soliciting comment on, among other things, whether the Commission should eliminate references to NRSRO credit ratings from certain rules. 14 The Commission continued to consider the use of credit ratings in its rules, when in 2003, we sought comment on alternative benchmarks that could be used to meet the Commission's regulatory objectives. 15 Finally, in 2008, the Commission proposed amendments to remove references to NRSRO credit ratings from certain of its rules under the Securities Act, Exchange Act, and Investment Company Act. 16 As previously noted, after the enactment of the Dodd-Frank Act, in 2011, the Commission proposed to remove credit ratings references from certain rules and forms under the Investment Company Act. 17 Also in 2011, the Commission separately proposed and adopted amendments removing references to credit ratings in rules and forms under the Securities Act and the Exchange Act related to offerings of securities or issuer disclosure. 18 Generally, in these prior actions, the Commission has proposed or adopted amendments to its rules that seek to retain a similar degree of credit quality to that in the rule being amended by replacing credit ratings references with a two-part standard that includes an assessment of the credit quality and the liquidity of the security, the details of which vary according to the requirements of the particular rule or form.

A number of other federal agencies have also taken action to implement section 939A of the Dodd-Frank Act, including regulations proposed or adopted by the Commodity Futures Trading Commission (“CFTC”), 19 the Office of the Comptroller of the Currency (“OCC”), 20 the National Credit Union Administration (“NCUA”), 21 the Federal Housing Finance Agency (“FHFA”), 22 the Department of Labor (“DOL”), 23 and jointly by the OCC and Federal Reserve Board (“FRB”). 24 The actions taken by these other regulators were considered in adopting today's amendments.

Rule 5b-3 allows funds to treat the acquisition of a repurchase agreement as an acquisition of securities collateralizing the repurchase agreement for certain diversification and broker-dealer counterparty limit purposes under the Investment Company Act  25 if the obligation of the seller to repurchase the securities from the fund is “collateralized fully.”  26 In a typical investment company repurchase agreement, a fund enters into a contract with a broker, dealer, or bank (the “counterparty” to the transaction) to purchase securities. The counterparty agrees to repurchase the securities at a specified future date, or on demand, for a price that is sufficient to return to the fund its original purchase price, plus an additional amount representing a return to the fund on its investment. Economically, a repurchase agreement functions as a loan from the fund to the counterparty, in which the securities purchased by the fund serve as collateral for the loan. 27

Under current requirements, a repurchase agreement is collateralized fully if, among other things, the collateral for the repurchase agreement consists entirely of (i) cash items, (ii) government securities, 28 (iii) securities that at the time the repurchase agreement is entered into are rated in the highest rating category by the “requisite NRSROs”  29 or (iv) unrated securities that are of a comparable quality to securities that are rated in the highest rating category by the requisite NRSROs, as determined by the fund's board of directors or its delegate. 30 When the Commission proposed rule 5b-3, we explained that the highest rating category requirement in the definition of fully collateralized was designed to help ensure that the market value of the collateral would remain stable and that the fund could liquidate the collateral quickly in the event of a default by the counterparty. The high quality requirement was also designed to limit a fund's exposure to the ability of the counterparty to maintain sufficient collateral, and reflected the understanding that securities of lower quality may be subject to greater price fluctuation. 31

Today we are amending rule 5b-3 to eliminate the requirement that collateral other than cash or government securities be rated in the highest category by the requisite NRSROs or be of comparable quality. In place of this requirement, the amended rule requires that collateral other than cash or government securities consist of securities that the fund's board of directors (or its delegate) determines at the time the repurchase agreement is entered into are: (i) Issued by an issuer that has an exceptionally strong capacity to meet its financial obligations on the securities collateralizing the repurchase agreement; and (ii) sufficiently liquid that they can be sold at approximately their carrying value in the ordinary course of business within seven calendar days. 32

The new credit quality standard we are adopting is designed to retain a degree of credit quality that is similar to the existing standard under rule 5b-3 and consistent with the two-part approach we have taken in establishing credit quality standards to replace credit rating references in other rules under the federal securities laws. 33 We note that our amendment to rule 5b-3 does not affect a money market fund that seeks special treatment of its repurchase agreement holdings under the diversification provisions of rule 2a-7 because in order to obtain such treatment, a money market fund is limited to investing in repurchase agreements collateralized by cash items or government securities (which remain unaffected by our amendments today). 34 We are adopting the liquidity component of the new standard as proposed, but we have revised the credit quality component from what was proposed to address certain commenters' concerns.

We proposed that collateral issuers be required to have the “highest capacity” to meet their financial obligations on the collateral securities. 35 Three of the five commenters who addressed the proposed amendments to rule 5b-3 argued that this standard is not consistent with the standard established by the ratings reference in the current rule because the proposed standard does not contemplate any variation in creditworthiness among issuers that meet the highest rating standard. 36 Commenters suggested that short-term collateral securities rated “A-1+” or “A-1” by Standard & Poor's both would satisfy the rating condition under the current rule, but that only those rated “A-1+” would likely have satisfied the credit standard under our proposal. 37 Accordingly, as these commenters recommended, the amended rule requires an issuer to have an “exceptionally strong” capacity to meet its financial obligations on the collateral securities. 38 We are adopting this standard, as revised from our proposal, because we believe that, like the current rule, it permits some variation in creditworthiness among issuers while being designed to retain a degree of risk limitation similar to the current rule. 39 In the case of asset-backed securities that serve as collateral, an evaluation of the capacity of the issuer to meet its financial commitment on the security should include an assessment of the quality of the underlying assets and the structure of the asset-backed security. 40

As discussed above, we are adopting the liquidity component of the new standard as proposed. The liquidity standard in the amended rule is similar to the standard used in rule 2a-7 governing money market funds, and is also used in other rules under the Investment Company Act. 41 No commenters addressed the proposed liquidity standard.

We expect that securities that actively trade in a secondary market at the time of the acquisition of the repurchase agreement will satisfy the liquidity component of the standard. We also understand that most securities used to collateralize repurchase agreements generally actively trade in a secondary market. 42 Securities that do not actively trade in a secondary market would likely require a more in-depth evaluation by the board or its delegate to determine whether they meet the liquidity standard.

The final amendments do not, as one commenter suggested, include specific factors or tests that the board or its delegate must apply in performing its credit analysis. 43 This commenter acknowledged that a reliable and objective shorthand measure of credit risk that could be incorporated into Commission regulations is currently unavailable. 44 The Commission considered including specific factors for funds to consider in performing credit analysis under rule 5b-3. On balance, we believe that, in the context of rule 5b-3, the new credit quality standards provide sufficiently clear criteria under which a fund board or its delegate can make determinations regarding credit quality and liquidity for this particular purpose. Fund boards should also be familiar with applying similar credit quality standards used in other Commission rules. 45 Fund boards may also consult external resources and Commission staff guidance (if applicable) for additional guidance on making credit quality determinations in certain circumstances. 46

The new credit quality standard is intended to achieve the same objectives that the credit rating requirement was designed to achieve, i.e., to limit collateral securities to those that are likely to retain a sufficiently stable market value and that, under ordinary circumstances, the fund would be able to liquidate quickly, at or near their carrying value in the event of a counterparty default. 47 Amended rule 5b-3 would not, however, prohibit a fund board from establishing its own additional criteria for what the fund may accept as collateral for repurchase agreements under the amended rule.

Under the final rule, as was proposed, the fund's board will be required to make credit quality determinations for all collateral securities that are not cash items or government securities, rather than just for unrated securities. In addition, as in the current rule, the amended rule continues to permit the board to delegate these credit quality and liquidity determinations. 48 We do not agree with the concerns of one commenter that this determination will impose undue burdens on the board because the determination is similar to what rule 5b-3 currently requires a fund board (or its delegate) to make with respect to unrated collateral securities. 49 In addition, the amended rule will continue to permit the board of directors to delegate credit quality and liquidity determinations that the board believes are within the delegate's expertise if the board retains sufficient oversight. 50

Under the amended rule, when determining credit quality and liquidity, the board (or its delegate) may incorporate into its analysis ratings, reports, opinions and other assessments issued by third parties, including NRSROs. A board should evaluate the basis for using any third-party assessment, including an NRSRO rating, in determining whether collateral meets the new standard and would not rely on the use of an NRSRO rating as a standard by itself without evaluating the quality of each NRSRO's assessment. In this way, the board could determine which third-party providers are credible and reliable and provide assessments that would be most appropriate to incorporate in making determinations under the amended rule. Delegation of these functions, as well as the use of third-party providers, may help to limit the potential increase in burdens on the board. One commenter suggested that we not allow a fund board to consider credit ratings in determining if a repurchase agreement is fully collateralized, stating that this would conflict with section 939A of the Dodd-Frank Act. 51 We believe, however, that credit ratings can serve as a useful data point for evaluating credit quality, and as noted above, a fund's board (or its delegate) may not rely solely on the credit ratings of an NRSRO without performing additional due diligence.

A fund that enters into repurchase agreements and relies on rule 5b-3 must maintain written policies and procedures that are reasonably designed to comply with the conditions of the rule, including the credit quality and liquidity requirements we are adopting today, and funds may therefore have to amend their policies and procedures. 52 We also understand that credit quality standards for securities collateralizing repurchase agreements are typically negotiated in the agreements between funds and counterparties. 53 We understand that those standards currently include a rating (for rated collateral securities) and any additional criteria that a fund manager considers necessary to ensure that the credit quality of collateral securities meets the fund's requirements, or, for unrated securities, a comparable credit quality standard. The amended rule does not prohibit fund boards (or their delegates) from considering the credit quality standards in current repurchase agreements and policies and procedures adopted to comply with the current rule as part of their analysis, provided that fund boards (or their delegates) determine that the ratings specified in the repurchase agreements and policies and procedures meet the standards we are adopting today, and that the agencies providing the ratings used in the policies and procedures are credible and reliable for that use. A fund could also revise its repurchase agreements and policies and procedures to change or eliminate the consideration of specific credit ratings or to incorporate other third-party evaluations of credit quality. 54

As discussed above, amended rule 5b-3 replaces the requirement that collateral for repurchase agreements consist of securities rated in the highest category by the requisite NRSROs (other than cash and government securities) with a requirement that the collateral other than cash and government securities consist of securities issued by an issuer that has an exceptionally strong capacity to meet its financial obligations and that are sufficiently liquid. Consistent with the protection of investors and as necessary and appropriate in the public interest, we are also amending rule 5b-3 to define an issuer to include an issuer of an unconditional guarantee of the security. 55 We proposed this amendment to preserve a fund's ability to use the same types of collateral securities as it currently uses to satisfy the conditions of rule 5b-3. We received no comments on this aspect of the proposal and are adopting it as proposed. Thus, under amended rule 5b-3, a collateral security with an unconditional guarantee, the issuer of which meets the new credit quality test, satisfies that element of the standard.

We are also adopting amendments to Forms N-1A, N-2, and N-3 to remove the required use of credit ratings assigned by an NRSRO. Forms N-1A, N-2, and N-3, among other things, contain the requirements for shareholder reports of mutual funds, closed-end funds, and certain insurance company separate accounts that offer variable annuities. 56

Currently, Forms N-1A, N-2, and N-3 require shareholder reports to include a table, chart, or graph depicting portfolio holdings by reasonably identifiable categories ( e.g., type of security, industry sector, geographic region, credit quality, or maturity). 57 The forms require the categories to be selected in a manner reasonably designed to depict clearly the types of investments made by the fund, given its investment objectives. If credit quality is used to present portfolio holdings, the forms currently require that credit quality be depicted using the credit ratings assigned by a single NRSRO. We are amending Forms N-1A, N-2, and N-3, as proposed, to no longer require the use of NRSRO credit ratings by funds that choose to use credit quality categorizations in the required table, chart, or graph of portfolio holdings. Accordingly, funds that choose to show credit quality categorizations in the required table, chart, or graph may use alternative categorizations that are not based on NRSRO credit ratings.

In a change from the 2011 Proposing Release, however, under the amended forms, funds that choose to continue to use credit ratings will no longer be restricted to using the credit ratings assigned by a single NRSRO. Accordingly, funds that choose to depict credit quality using credit ratings assigned by a credit rating agency may use different credit rating agencies for split-rated securities ( i.e., securities that have received different ratings from multiple credit rating agencies) and they may use ratings provided by credit rating agencies that are not NRSROs. 58 Funds will also be required to describe how the credit quality of the holdings was determined, and if credit ratings are used, a description of how they were identified and selected. 59

Four of the five substantive comments we received on the proposed amendments to Forms N-1A, N-2, and N-3, supported eliminating the required use of NRSRO credit ratings to depict credit quality. 60 Two of these commenters noted that shareholders would benefit from information about the credit quality of a fund's portfolio securities, whether determined by an NRSRO or internally. 61

Although most commenters supported eliminating the required use of credit ratings to depict credit quality, four commenters opposed the proposed requirement that a fund that chooses to use NRSRO credit ratings must use the credit ratings of a single NRSRO. Instead, these commenters recommended that when a security is split-rated, the fund be permitted to choose which NRSRO rating to use, provided the choice is made consistently pursuant to a disclosed policy. 62 These commenters argued that this approach would benefit funds and investors by allowing funds to disclose credit quality information in shareholder reports in a manner consistent with marketing materials and internal investment policies. 63

We agree with commenters and have revised the final form amendments to provide this additional degree of flexibility. Accordingly, the amended forms permit funds to consider alternative approaches to presenting credit quality that accurately and effectively describe the credit quality of the fund's portfolio. For example, under the amended forms, a fund could have a policy of disclosing the median credit quality rating for split-rated securities instead of only using the ratings of a single credit rating agency (when more than two rating agencies rate the security). 64 In the 2011 Proposing Release, we proposed to maintain the general requirement that ratings be selected from a single NRSRO because we were concerned about the possibility that a fund may select the most favorable credit ratings among credit ratings assigned by multiple NRSROs. On balance, we are persuaded by commenters that the benefits of this additional flexibility outweigh the potential “cherry picking” concern. We believe that the risks associated with cherry picking ratings are mitigated by the disclosure requirements discussed below. 65 For example, if a fund discloses that, with respect to split-rated securities, it is the fund's policy to select the highest credit rating provided by a credit rating agency, investors will be on notice that the fund has made a decision not to include potentially lower and more conservative measures of credit quality. In addition, we believe that in some circumstances selecting credit ratings from more than one credit rating agency may reflect a more comprehensive approach to credit quality analysis that results in information about credit quality that may be more accurate or complete. For example, a fund that reviews credit ratings from three rating agencies, discards the outliers ( i.e., the highest and lowest ratings), and selects the middle rating, 66 has evaluated credit quality from a broader set of market participants that may lead to a more complete evaluation of credit quality.

Under the amended forms, funds that choose to depict portfolio holdings according to credit quality must include a description of how the credit quality of the holdings was determined. 67 This description should include a discussion of the credit quality evaluation process, the rationale for its selection, and an overview of the factors considered, such as the terms of the security ( e.g., interest rate, and time to maturity), the obligor's capacity to repay the debt, and the quality of any collateral. If the fund uses credit ratings issued by a credit rating agency to depict credit quality, the fund should explain how the credit ratings were identified and selected, and include this description near, or as part of, the graphical representation. 68 This description should include, if applicable, a discussion of: (i) The criteria considered or process used in selecting the credit ratings ( e.g., the fund might use the median credit rating from among three rating agencies  69 ); (ii) how the fund evaluated those criteria ( i.e., the due diligence performed); (iii) how the fund reports credit ratings for any security that is not rated by the credit rating agency selected if the fund has a policy of using the ratings of a single rating agency ( e.g., has the fund selected a designated alternate rating agency); (iv) how the fund reports credit ratings for any security that is not rated by any credit rating agency ( i.e., the process for self-rating); or (v) other fund policies on selecting credit ratings for purposes of disclosure. We expect that this discussion, modified and expanded upon by funds as appropriate, will provide investors with insight into how the fund identified and selected the credit ratings used in depicting the fund's portfolio by credit quality.

We recognize that under the final form amendments, a fund has a variety of options when depicting its portfolio holdings using credit quality. For example, a fund might choose not to use credit ratings and could rely instead on internal credit assessments. If a fund does not use credit ratings, we note that it might be misleading for a fund to describe its portfolio holdings quality with similar descriptions as the ratings nomenclature used by rating agencies ( e.g., AAA, Aa), or to characterize the securities as “rated.” If a fund chooses to depict its portfolio using credit ratings issued by a credit rating agency, a fund could choose to use the median credit rating from among multiple credit rating agencies (discarding the highest and lowest ratings) when a security is split-rated. 70 We note, however, that it might be misleading for a fund to disclose an average credit quality rating that is based on ratings from multiple credit rating agencies because credit rating agencies may use different criteria to evaluate the credit quality of an issuer. A fund might also choose other methods for evaluating credit quality of portfolio securities, such as a policy of selecting the highest or lowest credit rating for split-rated securities among the ratings issued by certain specified rating agencies. 71 As discussed above, a fund must include in its disclosure a description of how the credit quality of the holdings was determined, no matter the method used.

The amended forms are intended to provide funds with the flexibility to present credit ratings in a manner that more clearly explains the credit quality of the fund's portfolio and the method by which the fund determined that quality.

Certain provisions of the amendments we are adopting contain “collections of information” within the meaning of the Paperwork Reduction Act of 1995 (“PRA”). 72 The titles for the existing collections of information we are amending are: (i) “Rule 30e-1 under the Investment Company Act of 1940, Reports to Stockholders of Management Companies”;  73 and (ii) “Rule 38a-1 under the Investment Company Act of 1940, Compliance procedures and practices of registered investment companies.” We adopted those rules pursuant to the Investment Company Act. There is currently no approved collection of information for rule 5b-3, and the amendments do not create any new collections under that rule. The amendments to rule 5b-3 do, however, affect the collection of information burden for rule 38a-1.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. We published notice soliciting comments on the collection of information requirements in the 2011 Proposing Release and submitted the proposed collections of information to the Office of Management and Budget (“OMB”) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11 under the control numbers 3235-0025 (rule 30e-1) and 3235-0586 (rule 38a-1). We received no comments on the PRA estimates contained in the 2011 Proposing Release.

Rule 5b-3 under the Investment Company Act allows funds to treat the acquisition of a repurchase agreement as an acquisition of securities collateralizing the repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3) of the Investment Company Act under certain conditions. Rule 5b-3, as amended, requires that the securities collateralizing a repurchase agreement consist of securities that the fund's board of directors, or its delegate, determines are issued (or have unconditional guarantees that are issued) by an issuer that has an exceptionally strong capacity to meet its financial obligations and are highly liquid. 74 To that end, the fund's board of directors, pursuant to rule 38a-1 under the Investment Company Act, must have procedures that are reasonably designed to ensure that the fund is able to comply with the conditions of amended rule 5b-3, including the credit quality and liquidity requirements outlined in the amended rule. 75 As discussed above, these procedures should be designed to limit collateral securities to those that are likely to retain a stable market value and that, in ordinary circumstances, the fund would be able to liquidate quickly in the event of a default. This rule 38a-1 collection of information will be mandatory for funds that rely on rule 5b-3. Records of information made in connection with this requirement will be required to be maintained for inspection by Commission staff, but the collection will not otherwise be submitted to the Commission. To the extent that the Commission receives confidential information pursuant to this collection of information, such information would be kept confidential, subject to the provisions of applicable law. 76

We do not anticipate that the amendments to rule 5b-3 will significantly change collection of information burdens under rule 38a-1 because we believe funds would likely rely significantly on their current policies and procedures to determine the credit quality of collateral securities and comply with amended rule 5b-3. As we indicated above, we understand that credit quality standards for securities collateralizing repurchase agreements typically are contained in the repurchase agreements between funds and counterparties. 77 We understand that those standards currently include a rating (for rated collateral securities) and any additional criteria a fund manager considers necessary to ensure that the credit quality of the collateral securities meets the fund's requirements, or, for unrated securities, a comparable credit quality standard. Counterparties provide collateral securities to conform to these standards and funds confirm that the securities are conforming. As we have noted above, funds can continue to consider evaluations of outside sources, including credit ratings that the board determines are credible and reliable in making their credit quality determinations under the amended rule. We expect that funds will likely continue to rely on their current policies and procedures ( i.e., using credit quality standards that include ratings currently set forth in their repurchase agreements with counterparties). Thus, we do not expect that the amendments to rule 5b-3 will significantly change the current collection of information burden estimates for rule 38a-1. 78 Nevertheless, funds may review their repurchase agreements and policies and procedures that address rule 5b-3 compliance and make technical changes to those documents in response to the amendments. Staff estimated in the proposal and continues to believe that it will take, on average, 1.5 hours of a senior business analyst's time to perform this review and make any technical changes for an individual fund portfolio, for an estimated one-time additional burden of 15,176 hours for all fund portfolios (other than money market fund portfolios). 79 Amortized over three years, the staff estimates that the estimated annual aggregate burden will be 5,059 burden hours. 80

We anticipate that the fund's board will review the fund manager's recommendation, but that the cost of this review will be incorporated in the fund's overall annual board costs and would not result in any particular additional cost. We received no comments on these estimates and therefore have not modified them. 81

The amendments to Forms N-1A, N-2, and N-3 eliminate the required use of NRSRO credit ratings by funds that choose to use credit quality categorizations in the table, chart, or graph of portfolio holdings provided in shareholder reports. The collection of information is mandatory for those funds that choose to use credit quality categorizations in these forms. If a fund chooses to depict portfolio holdings according to credit quality, the fund must include a description of how the credit quality of the holdings was determined. If credit ratings assigned by a credit rating agency are used, the fund must disclose how it identified and selected the credit ratings. Responses to the disclosure requirements will not be kept confidential.

Although funds would remain obligated to provide a table, chart, or graph of portfolio holdings by reasonably identifiable categories, the amendments require that certain funds must make new disclosures. Under our proposed amendment, we estimated that there would be no additional collection of information burden as a result of proposing to remove the required use of credit ratings from the forms. 82 Under our amended rule, however, funds that choose to use credit quality categorizations must disclose how the fund made the credit quality determinations, and if the fund uses credit ratings issued by a credit rating agency, the fund must disclose how it identified and selected the credit ratings. 83

Accordingly, based on staff experience, the staff estimates that it will take, on average, 3 hours of an attorney's time to perform this review and make any technical changes to an individual fund's disclosures, for an estimated burden of 32,049 hours for all funds. 84 Amortized over three years, the staff estimates that the estimated annual aggregate burden will be 10,683 burden hours and that there will be approximately 10,683 respondents. 85

As discussed above, we are adopting rule and form amendments to implement section 939A of the Dodd-Frank Act. The amendments to rule 5b-3 replace a NRSRO credit rating standard with alternative credit quality and liquidity criteria that are designed to achieve the same purposes as the NRSRO credit rating standard without imposing unnecessarily burdensome costs. The amendments to Forms N-1A, N-2, and N-3 remove the required use of credit ratings when portraying credit quality in shareholder reports, but require that those funds include a description of how the credit quality of the holdings were determined, and if credit ratings assigned by a credit rating agency are used, how the credit ratings were identified and selected. The regulatory changes adopted today will directly affect investment companies registered under the Investment Company Act and could affect the demand for rating agencies' services by eliminating the required use of NRSRO credit ratings in rule 5b-3 and Forms N-1A, N-2, and N-3. The amendments to rule 5b-3 may also affect other parties such as repurchase agreement counterparties ( e.g., broker-dealers and banks), investors, and issuers of collateral securities. Finally, we recognize that the elimination of the required use of NRSRO credit ratings in rule 5b-3 and Forms N-1A, N-2, and N-3 may reduce the incentive for credit rating agencies to register as NRSROs and thereby be subject to the Commission's oversight and statutory and regulatory requirements applicable to NRSROs. We received no comments on the cost-benefit analysis contained the 2011 Proposing Release.

At the outset, the Commission notes that, where possible, we have attempted to quantify the costs and benefits expected to result from adopting the amendments to rule 5b-3 and Forms N-1A, N-2, and N-3. However, wherever the discussion of costs or benefits is not quantified in this section it is because the Commission is unable to quantify the economic effects because it lacks the information necessary to provide a reasonable estimate. For example, as discussed below, the Commission does not have available to it comprehensive information on the exposure of funds to different repurchase agreement market segments, the nature and type of collateral used in repurchase agreements, or the extent to which funds rely on rule 5b-3. Because of this lack of data, including the extent to which funds may rely on rule 5b-3, we are unable to quantify the costs to comply with the amended rule and note that the costs could vary from our estimates. We discuss below the economic baseline, costs and benefits of our final rule and form amendments, alternatives considered, as well as the impact on efficiency, competition, and capital formation.

Rule 5b-3, as amended, permits a fund to treat the acquisition of a repurchase agreement as an acquisition of securities collateralizing the repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3) of the Investment Company Act if the collateral other than cash or government securities consists of securities that the fund's board of directors, or its delegate, determines at the time the repurchase agreement is entered into are: (i) Issued by an issuer that has an exceptionally strong capacity to meet its financial obligations; and (ii) sufficiently liquid that they can be sold at approximately their carrying value in the ordinary course of business within seven calendar days.

The economic baseline against which we measure the economic effects of these amendments is the regulatory framework as it exists immediately before the adoption of today's amendments. Currently, rule 5b-3 allows funds to treat the acquisition of a repurchase agreement as an acquisition of securities collateralizing the repurchase agreement for certain diversification and broker-dealer counterparty limit purposes under the Investment Company Act if the obligation of the seller to repurchase the securities from the fund is “collateralized fully.” In general, under rule 5b-3, a fund investing in a repurchase agreement looks to the value and liquidity of the securities collateralizing the repurchase agreement rather than the creditworthiness of the counterparty for satisfaction of the repurchase agreement. Under current requirements, a repurchase agreement is collateralized fully if, among other things, the collateral for the repurchase agreement consists entirely of (i) cash items, (ii) government securities, (iii) securities that at the time the repurchase agreement is entered into are rated in the highest rating category by the “Requisite NRSROs” or (iv) unrated securities that are of a comparable quality to securities that are rated in the highest rating category by the Requisite NRSROs, as determined by the fund's board of directors or its delegate.

As of the end of 2012, the total repurchase agreement market approximated $3 trillion. 86 The repurchase agreement market has two primary segments, bilateral and tri-party. 87 The bilateral segment comprises cash-driven transactions against specific collateral while the tri-party segment comprises cash-driven transactions against general collateral. We believe that investment companies' primary exposure to repurchase agreements is through the tri-party market, but the Commission does not have available to it comprehensive information on the exposure in either market segment. The collateral used in the approximately $2 trillion tri-party market is dominated by government securities: Approximately 35% consists of Treasury securities and approximately 50% consists of agency mortgage-backed securities, agency debentures, and agency collateralized mortgage obligations. 88

While we believe that many funds invest in tri-party repurchase agreements, comprehensive information about the extent to which funds invest in these agreements is not available to us. Nor are we able to estimate how often funds rely on rule 5b-3 when entering into repurchase agreements, or the extent to which fund repurchase agreements are collateralized with securities other than cash or government securities. However, we are able to estimate the extent of money market fund participation in the tri-party repurchase market using Form N-MFP data, which shows that money market funds held approximately $591 billion in tri-party repurchase agreements as of the end of 2012. While we understand almost all funds rely on rule 5b-3 on occasion (for example when approaching diversification limits or avoiding restrictions on investments in certain entities), we do not have the information necessary to determine how frequently those funds rely on rule 5b-3 in their daily transactions in repurchase agreements. Accordingly, we are largely unable to quantify the benefits and costs discussed below.

Amended rule 5b-3 is intended to establish a similar credit quality standard to the NRSRO credit rating standard we are replacing in order to achieve the same objectives that the NRSRO credit rating reference requirement was designed to achieve in the existing rule, i.e., limit collateral securities to those that are likely to retain a stable market value and that, under ordinary circumstances, the fund would be able to liquidate quickly at or near its carrying value in the event of a counterparty default. Although amended rule 5b-3 seeks to maintain a similar degree of credit quality as the standard it replaces, the Dodd-Frank Act mandate is designed to reduce reliance on NRSRO credit ratings. 89

Some fund boards or their delegates, after independent analysis, might make a determination of credit quality that comports with the analysis of the NRSRO credit ratings and, accordingly, make no substantive changes to the funds' investments in repurchase agreements. Other fund boards might turn to non-NRSRO sources (“third-party providers”) to satisfy the new requirements, which may result in a different pool of assets from which the funds may select for collateralizing repurchase agreements. We believe that this flexibility of allowing for a broader range of credit quality models will increase competition for such models, whether from internal assessments made by the fund or from external assessments made by third-party providers such as credit rating agencies. As a result, credit assessments, and the repurchase agreement market in general, may become more efficient and may promote capital formation through a more accurate assessment of credit risk that may increase investment in repurchase agreements.

We recognize, as discussed above, that funds typically establish standards for the credit quality of collateral securities (that include credit ratings and additional credit quality criteria required by the fund) in repurchase agreements with counterparties. 90 Funds could change their policies and procedures to reflect changes made to the rule by the amendments, but the rule would not prohibit funds from considering the standards in current repurchase agreements and policies and procedures provided that the fund's board or its delegate made the determination that those standards satisfy the standards in amended rule 5b-3. As a result, amended rule 5b-3 may not significantly change the types of collateral securities held by funds relying on rule 5b-3.

Amended rule 5b-3 requires the fund's board or its delegate to make a determination about the collateral of each repurchase agreement. This will increase the regulatory burden on the fund's board, 91 but we believe that the burden is significantly reduced by the fund board's ability to incorporate ratings, reports, analyses, and other assessments issued by third parties, including NRSRO ratings that the fund's board concludes are credible and reliable for purposes of making the evaluation. Moreover, fund boards that find these increased regulatory burdens to be excessive can mitigate them by restricting the fund to repurchase agreement collateral that consists of cash and government securities.

If the fund's board decides to rely primarily on NRSRO ratings as part of the process of evaluating credit quality, the fund may incur some additional costs from today's amendments. 92 However, some fund boards may decide not to rely primarily on NRSRO ratings, perhaps because of a more cost efficient way of making the required determinations or because they believe NRSRO ratings are not helpful or sufficient in evaluating credit quality. Reducing the emphasis on NRSRO ratings could also adversely affect the quality of NRSRO ratings. Currently, the importance attached to NRSRO ratings may impart franchise value to the NRSRO's ratings business. By eliminating references to NRSRO ratings in Federal regulations, section 939A of the Dodd-Frank Act could reduce these franchise values and mitigate NRSROs' incentives to produce credible and reliable ratings. Moreover, the Commission recognizes that the elimination of the required use of credit ratings in Commission rules and forms may reduce the incentive for credit rating agencies to register as NRSROs with the Commission and thereby be subject to the Commission's oversight and the statutory and regulatory requirements applicable to NRSROs. To the extent that the quality and accuracy of NRSRO ratings is adversely affected, negative impacts on the capital allocation process and economic efficiency would result.

The new methodologies that the fund's board employs may result in a pool of assets from which the fund may select for collateralizing repurchase agreements that is different from a pool based on NRSRO ratings. This may affect the fund relative to the baseline of NRSRO ratings by including or excluding as collateral assets that are different from the collateral permitted under the current rule. In turn, this could increase the credit risk in the pool of collateral assets or decrease the return earned by investing in repurchase agreements. Both of these effects may lead to a less efficient market for repurchase agreement collateral. Issuers' ability to raise capital may also be adversely affected to the extent that issuers of collateral securities lose the regulatory preference that currently exists because of the required use of NRSRO ratings within rule 5b-3. We do not, however, believe that the amended rule is likely to lead to the acceptance of riskier collateral in practice because the standard we are adopting is very similar to the standard articulated by the NRSROs for securities that have received the highest ratings. In addition, we anticipate that fund boards and advisers will retain the credit quality standards in their current repurchase agreements and their existing policies and procedures that address compliance with current rule 5b-3 and include ratings that they believe are credible and reliable.

Although we believe that boards of funds relying on rule 5b-3 have established policies and procedures for complying with the rule, 93 funds may incur costs to revise existing policies and procedures for investing in repurchase agreements to comply with amended rule 5b-3. We recognize that increased compliance costs are a necessary result of our amendments to rule 5b-3 and may disproportionately impact smaller funds to the extent these funds do not today have policies and procedures for assessing creditworthiness. As noted above, we are not able to quantify many of the costs (and benefits) discussed above. However, we estimate that each fund will incur, at a minimum, the collection of information costs discussed in the Paperwork Reduction Act section for a total average one-time cost of approximately $368 per fund. 94 Funds may also incur additional costs in complying with the amendments which we are unable to quantify, for the reasons discussed above.

In adopting today's amendments to rule 5b-3, the Commission considered, as noted by one commenter, including specific factors or tests that a fund board must apply in performing its credit analysis under the rule. 95 As noted above, the number and scope of factors that may be appropriate to making a credit quality determination with respect to a security may vary significantly depending on the particular security and through time. Accordingly, we are not adopting specific factors or tests that a fund board must apply in performing credit analysis, but may provide guidance in the future. 96

We also considered different standards to replace credit ratings that would help ensure that funds can liquidate collateral quickly in the event of a default. These alternatives included, for example, omitting an explicit liquidity requirement because securities in the “highest rating category” generally are more liquid than lower quality securities. Other liquidity alternatives we considered included limiting collateral securities only to cash and government securities because liquidity may decline between the time of acquisition and the time of default, or prohibiting a fund from relying on rule 5b-3 if, at any point after the time a fund enters into a repurchase agreement, the collateral could no longer be liquidated within seven calendar days. After considering the alternatives, we believe that amended rule 5b-3 strikes a better balance than the alternatives by imposing a liquidity requirement that is similar to the liquidity standard inherent to the credit quality rating required under the current rule, while not unduly restricting funds' flexibility to utilize a larger pool of assets for collateralizing repurchase agreements.

Forms N-1A, N-2, and N-3, as amended, eliminate the required use of NRSRO credit ratings by funds that choose to use credit quality categorizations in the required table, chart, or graph of portfolio holdings. If a fund chooses to depict portfolio holdings according to credit quality, the fund must include a description of how the credit quality of the holdings was determined. If a fund uses credit ratings assigned by a credit rating agency to depict credit quality, the fund must disclose how it identified and selected the credit ratings.

As noted above, the economic baseline against which we measure the economic effects is the regulatory framework as it exists immediately before the adoption of today's amendments. Currently, Forms N-1A, N-2, and N-3 require shareholder reports to include a table, chart, or graph depicting portfolio holdings by reasonably identifiable categories ( e.g., type of security, industry sector, geographic region, credit quality, or maturity). The forms require the categories to be selected in a manner reasonably designed to depict clearly the types of investments made by the fund, given its investment objectives. If credit quality is used to present portfolio holdings, the forms currently require that credit quality be depicted using the credit ratings assigned by a single NRSRO.

We believe, based on staff experience, that the majority of funds choose to depict their portfolios using credit quality, and accordingly, report credit ratings from a single NRSRO. As discussed above, we conservatively estimate that 10,683 funds collectively file reports on Forms N-1A, N-2, and N-3 each year and will be affected by the amendments. 97

The Dodd-Frank Act mandate is designed to reduce potential reliance on NRSRO credit ratings. Under the amendments, funds have greater flexibility to assess and depict credit quality, which may lead to better-informed investors who can, in turn, make better capital allocation decisions. Accordingly, better-informed investors may make more effective investment decisions based on their risk tolerance and may promote increased competition among funds. We note, however, that funds might choose to report credit quality in a more positive light than is possible under the prior requirement to use the credit ratings from a single NRSRO. However, as discussed above, the disclosure requirements we are adopting today should mitigate many of the potential adverse consequences. As a result, today's amendments may have a varied effect on investors' ability to make effective capital allocation choices.

Because we do not anticipate that these amendments will result in large changes in the portfolios held by funds or their investors, we do not believe the amendments would have more than a marginal effect on efficiency or capital formation. A potential benefit may arise by allowing funds to use different credit rating agencies for split-rated securities because that may promote competition between credit rating agencies to provide ratings that are more accurate if funds use the most accurate ratings for each part of their portfolios even if those ratings come from different credit rating agencies. This may foster innovation in the industry, and it may foster the growth of niche credit rating agencies. Although some funds may eliminate the specific use of credit ratings in their depiction of portfolio credit quality, we anticipate that many of those funds are likely to consider some outside analyses in evaluating the credit quality of portfolio securities. 98 A fund's consideration of external analyses by third-party sources determined to be credible and reliable may contribute to the accuracy of funds' determinations and thus help funds arrive at consistent and more accurate depictions of credit quality.

Under the amended forms, funds may continue to depict portfolio holdings as they do today: Funds can continue to depict portfolio holdings without making reference to credit quality, and funds can continue to depict portfolio holdings using credit ratings from one NRSRO. Today's amendments impose no new costs on funds that depict portfolio holdings based on criteria other than credit quality, but they do impose small additional costs on funds that choose to portray portfolio holdings using credit ratings from one NRSRO because they must make new disclosures about how the ratings were identified and selected. We believe that the majority of costs related to today's amendments to Forms N-1A, N-2, and N-3 are the costs described above related to the collections of information under the Paperwork Reduction Act. Accordingly, we estimate that funds on average will incur costs of approximately $1,137 per fund in complying with the amendments. 99 In addition, funds may voluntarily incur additional costs if they choose to develop and apply new methodologies to depict credit quality. Funds that choose to do so will incur a cost not only to determine the credit quality of portfolio holdings but also a cost to include in the registration statement a description of how the credit quality of portfolio holdings was determined, and if credit ratings are used, how the ratings were identified and selected.

In adopting the amendments to the forms, the Commission considered replacing the required use of credit ratings with an option to depict a fund's portfolio by credit quality using the credit ratings of only a single credit rating agency. This approach, proposed in 2011, was intended to eliminate the possibility that a fund could choose to use NRSRO credit ratings and then select the most favorable ratings among the credit ratings assigned by multiple NRSROs. As discussed above, a number of commenters suggested that funds be permitted to use the credit ratings assigned by more than one NRSRO for split-rated securities, provided the choice is made consistently, pursuant to a disclosed policy. On balance, we believe that the benefits of this additional flexibility outweigh the potential costs associated with the possibility that funds cherry pick the highest credit rating available. We note that the risks associated with cherry picking ratings are mitigated by the fact that the forms, as amended, require that funds disclose how they identified and selected the credit ratings, which would include, for example, a fund policy that selects the highest credit rating available.

The Commission has prepared the following Final Regulatory Flexibility Analysis (“FRFA”) in accordance with section 4(a) of the Regulatory Flexibility Act regarding the rule and form amendments we are adopting today to give effect to provisions of the Dodd-Frank Act. 100 The FRFA relates to amendments to rule 5b-3 under the Investment Company Act and Forms N-1A, N-2, and N-3 under the Investment Company Act and Securities Act. We prepared an Initial Regulatory Flexibility Analysis (“IRFA”) in conjunction with the 2011 Proposing Release in March 2011. 101

As described more fully in sections I and III of this Release, to implement section 939A of the Dodd-Frank Act, the Commission is adopting amendments to (i) rule 5b-3 to eliminate references to the credit rating and replace it with an alternative standard of creditworthiness that is intended to achieve the same objectives that the credit rating requirement was designed to achieve and (ii) Forms N-1A, N-2, and N-3 to eliminate the required use of NRSRO credit ratings by funds that choose to use credit quality categorizations in the required table, chart, or graph of portfolio holdings in their shareholder reports, and to permit funds that choose to depict credit quality using credit ratings assigned by a credit rating agency to use different credit rating agencies for split-rated securities.

In the 2011 Proposing Release, we requested comment on the IRFA. In particular, we sought comment on how many small entities would be subject to the proposed rule and form amendments and whether the effect of the proposed rule and form amendments on small entities subject to them would be economically significant. None of the comment letters we received addressed the IRFA. None of the comment letters made comments about the effect of the rule and form amendments on small investment companies.

The amendments to rule 5b-3 and Forms N-1A, N-2, and N-3 under the Investment Company Act would affect funds, including entities that are considered to be a small business or small organization (collectively, “small entity”) for purposes of the Regulatory Flexibility Act.

Investment Companies. Under Commission rules, for purposes of the Investment Company Act and the Regulatory Flexibility Act, an investment company is a small entity if it, together with other investment companies in the same group of related investment companies, has net assets of $50 million or less as of the end of its most recent fiscal year. 102 Based on a current review of filings submitted to the Commission, we estimate that 171 investment companies may be considered small entities and that all of these investment companies may potentially rely on rule 5b-3. 103 As discussed above, we recognize that increased compliance costs are a necessary result of the amendments to rule 5b-3 and may disproportionately impact smaller funds to the extent these funds do not have policies and procedures for assessing creditworthiness. Based on a current review of filings submitted to the Commission, we estimate that approximately 131 investment companies that meet the definition of small entity would be subject to the amendments to Forms N-1A, N-2, and N-3.

Rule 5b-3. The amendments to rule 5b-3 allow a fund to treat the acquisition of a repurchase agreement as an acquisition of securities collateralizing the repurchase agreement for purposes of sections 5(b)(1) and 12(d)(3) of the Investment Company Act if the collateral other than cash or government securities consists of securities that the fund's board of directors (or its delegate) determines at the time the repurchase agreement is entered into are: (i) Issued by an issuer that has an exceptionally strong capacity to meet its financial obligations; and (ii) sufficiently liquid that they can be sold at approximately their carrying value in the ordinary course of business within seven calendar days. A fund that acquires repurchase agreements and intends the acquisition to be treated as an acquisition of the collateral securities must determine whether it must change its policies for evaluating collateral securities under the amended rule and must adopt and implement written policies and procedures reasonably designed to comply with the conditions of amended rule 5b-3, including these credit quality and liquidity requirements that we are adopting. 104 The costs associated with the amendments to rule 5b-3 are those discussed in section IV.A and V.B above.

Forms N-1A, N-2, and N-3. The amendments to Forms N-1A, N-2, and N-3 apply to open-end management investment companies, closed-end management investment companies, and separate accounts organized as management investment companies that offer variable annuity contracts, including those that are small entities. The amendments to Forms N-1A, N-2, and N-3 eliminate the required use of NRSRO credit ratings by funds that choose to use credit quality categorizations in the required table, chart, or graph of portfolio holdings in their shareholder reports. If a fund chooses to depict portfolio holdings according to credit quality, it must include a description of how the credit quality of the holdings was determined, and if credit ratings assigned by a credit rating agency are used to depict credit quality, the fund must disclose how it identified and selected the credit ratings. The amended forms also permit funds that choose to depict credit quality using credit ratings assigned by a credit rating agency to use different credit rating agencies for split-rated securities. The costs associated with the amendments to the forms are those discussed in section IV.B and V.C above.

The Regulatory Flexibility Act directs us to consider significant alternatives that would accomplish our stated objectives, while minimizing any significant adverse effect on small entities. In connection with the rule and form amendments, the Commission considered the following alternatives: (i) Establishing different compliance standards or timetables that take into account the resources available to small entities; (ii) clarifying, consolidating, or simplifying compliance and reporting requirements under the rule for small entities; (iii) use of performance rather than design standards; and (iv) exempting small entities from all or part of the requirements.

We believe that special compliance or reporting requirements for small entities, or an exemption from coverage for small entities, is not appropriate or consistent with investor protection or the Dodd-Frank Act. We believe that, with respect to rule 5b-3, different credit quality standards, special compliance requirements or timetables for small entities, or an exemption from coverage for small entities, may create a risk that those entities could acquire repurchase agreements with collateral that is less likely to retain its market value or liquidity in the event of a counterparty default. Further consolidation or simplification of the rule and form amendments for funds that are small entities is inconsistent with the Commission's goals of fostering investor protection.

The form amendments apply to all investment companies that use Forms N-1A, N-2, and N-3 to register under the Investment Company Act and to offer their securities under the Securities Act. If the Commission had excluded small entities from the form amendments, small entities would have been required to use NRSRO credit ratings if they chose to depict credit quality, while other entities would not have been subject to that requirement. We believe that special compliance or reporting requirements, or an exemption, for small entities would not be appropriate because the amended requirement—eliminating the required use of credit ratings where a fund chooses to depict the fund's portfolio based on credit quality—is intended to eliminate potential reliance on NRSRO credit ratings resulting from the perception that the Commission endorses the ratings because of their required use in Commission forms.

We have endeavored through the form amendments to minimize regulatory burdens on investment companies, including small entities, while meeting our regulatory objectives. We have endeavored to clarify, consolidate, and simplify the requirements applicable to investment companies, including those that are small entities. Finally, the amendments will use performance rather than design standards for determining the credit quality of specific securities. For these reasons, we have not adopted alternatives to rule 5b-3 and Forms N-1A, N-2, and N-3.

The Commission is adopting amendments to rule 5b-3 under the authority set forth in sections 6(c) and 38(a) of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-37(a)] and section 939A of the Dodd-Frank Act. The Commission is adopting amendments to Form N-1A, Form N-2, and Form N-3 under the authority set forth in sections 5, 6, 7, 10 and 19(a) of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77j, and 77s(a)]; sections 8, 24(a), 30 and 38 of the Investment Company Act [15 U.S.C. 80a-8, 80a-24(a), 80a-29, and 80a-37]; and section 939A of the Dodd-Frank Act.

For reasons set out in the preamble, Title 17, Chapter II of the Code of Federal Regulations is amended as follows:

In an interim final rule published in the Federal Register on May 29, 2013, at 78 FR 32124, VA amended 38 CFR 17.65, which contains VA's regulations governing approvals and provisional approvals of CRC facilities. The interim final rule allowed VA to waive one or more of the standards in 38 CFR 17.63 for the approval of a particular CRC facility, provided that a VA safety expert certifies that the deficiency does not endanger the life or safety of the residents; the deficiency cannot be corrected; and granting the waiver is in the best interests of the veteran in the facility and VA's CRC program. The rulemaking also made a certain necessary technical amendment to § 17.66. The interim final rule was effective immediately upon publication and provided a 60-day comment period, which ended on July 29, 2013. VA received no public comments and therefore makes no changes to the regulation.

Based on the rationale set forth in the interim final rule, VA is adopting the interim final rule as a final rule with no changes.

In accordance with 5 U.S.C. 553(b)(B) and (d)(3), the Secretary of Veterans Affairs concluded that there was good cause to publish the interim final rule without prior opportunity for public comment and to publish the rule with an immediate effective date. The Secretary found that it was contrary to the public interest to delay this rule for the purpose of soliciting advance public comment or to have a delayed effective date. The interim final rule was necessary to address an immediate need to provide a mechanism that will allow VA to grant a waiver to a CRC facility that cannot obtain full approval because of a minor deviation from regulatory standards that cannot be corrected and does not endanger the lives or safety of the veteran residents. Although approval would be rescinded because of a minor and uncorrectable deviation from standards unrelated to health or safety, veterans may be dissuaded from maintaining their residence in such a facility. Providing a waiver in that circumstance will preclude the need to terminate a CRC facility's approval based on an uncorrectable minor deviation from non-safety related standards. This eliminates the potential that resident veterans will needlessly choose to leave an otherwise healthy, safe, and suitable living arrangement. Regulations in place prior to the effective date of the interim final rule did not provide for any waiver of standards. It is in the public interest for a veteran not to be removed from a stable living situation based solely on a minor deviation from standards that does not threaten life or safety.

To prevent veterans from needlessly choosing to leave affected CRC facilities because the facilities are no longer on the approved list, and in order to ensure timely implementation of the program established by this rule, and for the reasons stated above, the Secretary also found, in accordance with 5 U.S.C. 553(d)(3), good cause for the interim final rule to be effective on the date of publication.

Title 38 of the Code of Federal Regulations, as revised by this final rulemaking, represents VA's implementation of its legal authority on this subject. Other than future amendments to this regulation or governing statutes, no contrary guidance or procedures are authorized. All existing or subsequent VA guidance must be read to conform with this rulemaking if possible or, if not possible, such guidance is superseded by this rulemaking.

This final rule contains no provisions constituting a collection of information under the Paperwork Reduction Act of 1995 (PRA) (44 U.S.C. 3501-3521). Documentation that a VA safety expert may request from a CRC facility to support a waiver determination, as provided under 38 CFR 17.65(d)(1), would not qualify as “information” under the PRA because collection of this information would be conducted on an individual case-by-case basis and would require individualized information pertaining to the specific deficiency identified by the VA safety expert. We believe that this collection is therefore exempt from the PRA requirements, as provided under 5 CFR 1320.3(h)(6) (excluding from PRA requirements a “request for facts or opinions addressed to a single person).”

The Secretary hereby certifies that this final rule will not have a significant economic impact on a substantial number of small entities as they are defined in the Regulatory Flexibility Act, 5 U.S.C. 601-612. This final rule will have little, if any, economic impact on a few small entities. VA may waive a standard under this rulemaking provided a VA safety expert certifies that the deficiency does not endanger the life or safety of the residents, the deficiency cannot be corrected, and granting the waiver is in the best interests of the veteran in the facility and VA's CRC program.

In order to reach the above determinations, the VA safety expert may request supporting documentation from the CRC facility. VA believes supplying this information will constitute an inconsequential amount of the operational cost for those CRC facilities. VA believes that, at most, only a few CRC facilities would qualify for a waiver. On this basis, the Secretary certifies that the adoption of this final rule will not have a significant economic impact on a substantial number of small entities as they are defined in the Regulatory Flexibility Act. Therefore, pursuant to 5 U.S.C. 605(b), this rulemaking is exempt from the initial and final regulatory flexibility analysis requirements of sections 603 and 604.

Executive Orders 12866 and 13563 direct agencies to assess the costs and benefits of available regulatory alternatives and, when regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, and other advantages; distributive impacts; and equity). Executive Order 13563 (Improving Regulation and Regulatory Review) emphasizes the importance of quantifying both costs and benefits, reducing costs, harmonizing rules, and promoting flexibility. Executive Order 12866 (Regulatory Planning and Review) defines a “significant regulatory action,” requiring review by the Office of Management and Budget (OMB) unless OMB waives such review, as “any regulatory action that is likely to result in a rule that may: (1) Have an annual effect on the economy of $100 million or more or adversely affect in a material way the economy, a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local, or tribal governments or communities; (2) Create a serious inconsistency or otherwise interfere with an action taken or planned by another agency; (3) Materially alter the budgetary impact of entitlements, grants, user fees, or loan programs or the rights and obligations of recipients thereof; or (4) Raise novel legal or policy issues arising out of legal mandates, the President's priorities, or the principles set forth in this Executive Order.”

The economic, interagency, budgetary, legal, and policy implications of this regulatory action have been examined, and it has been determined not to be a significant regulatory action under Executive Order 12866. VA's impact analysis can be found as a supporting document at http://www.regulations.gov, usually within 48 hours after the rulemaking document is published. Additionally, a copy of the rulemaking and its impact analysis are available on VA's Web site at http://www1.va.gov/orpm/, by following the link for “VA Regulations Published.”

The Unfunded Mandates Reform Act of 1995 requires, at 2 U.S.C. 1532, that agencies prepare an assessment of anticipated costs and benefits before issuing any rule that may result in the expenditure by State, local, and tribal governments, in the aggregate, or by the private sector, of $100 million or more (adjusted annually for inflation) in any 1 year. This final rule will have no such effect on State, local, and tribal governments, or on the private sector.

The Catalog of Federal Domestic Assistance numbers and titles for the programs affected by this document are 64.007, Blind Rehabilitation Centers; 64.008, Veterans Domiciliary Care; 64.009, Veterans Medical Care Benefits; 64.010, Veterans Nursing Home Care; 64.011, Veterans Dental Care; 64.012, Veterans Prescription Service; and 64.022, Veterans Home Based Primary Care.

The Secretary of Veterans Affairs, or designee, approved this document and authorized the undersigned to sign and submit the document to the Office of the Federal Register for publication electronically as an official document of the Department of Veterans Affairs. Jose D. Riojas, Chief of Staff, Department of Veterans Affairs, approved this document on December 6, 2013, for publication.

Based on the rationale set forth in the Federal Register at 78 FR 32124 on May 29, 2013, VA is adopting the interim final rule as a final rule with no changes.

On April 15, 2013, VA published in the Federal Register (78 FR 22219) a proposed rule to amend VA regulations by removing § 17.100. This regulation stated that a veteran who misses two medical appointments without providing 24 hours' notice and a reasonable excuse is deemed to have refused VA medical care and no further treatment will be provided to that veteran, except in emergency situations, unless the veteran agrees to cooperate by keeping future appointments. We stated that this penalty is inconsistent with VA's goal of providing patient-centered care, may interfere with continuity and coordination of care, and could have a negative impact on the therapeutic relationship. In addition, refusing to provide further medical services to certain veterans, including homeless veterans and other veterans who lack reliable telephone access or dependable transportation to and from scheduled appointments is counterproductive and may discourage them from attempting to access care in the future. Lastly, providing treatment only in emergent circumstances does not provide an adequate safety net for our patients, especially those with chronic or poorly controlled medical conditions.

Interested persons were invited to submit comments to the proposed rule on or before June 14, 2013, and we received six comments. All of the comments were supportive of removing § 17.100, and did not suggest changes to the proposed removal of the rule. However, two commenters raised issues that we believe should be addressed.

One commenter expressed support for removing this regulation, but suggested a different approach to addressing the issue of broken appointments. The commenter suggested that, after two consecutive missed appointments, VA should follow a series of steps to contact the veteran and to place a limit (“moratorium”) on the care available to the veteran on the particular health issue.

VA appreciates the commenter's input. However, VA has determined that the appropriate course of action is to remove the penalty for breaking appointments. In practice, the problem of missed appointments has been adequately addressed through internal VA processes, as well as by using non-punitive measures and maintaining an open channel of communication between VA clinical/administrative staff and veterans. The penalty contemplated by § 17.100 is incompatible with regulatory changes implemented after that regulation was published, is not in line with current practice, and is inconsistent with VA's patient-centered approach to medical care. Even a short break in a course of treatment can interfere with continuity and coordination of care, and the punitive nature of the regulation could have a negative impact on the therapeutic relationship.

Another commenter supported removing the penalty for breaking medical appointments, but stated that the regulation should be removed because it violates due process protections. VA disagrees. The regulation we remove by this final rule did not terminate a benefit; it merely attempted to facilitate efficient delivery of limited health care resources. The veteran remained enrolled to receive health care, and could receive treatment for any emergent condition that may arise. To schedule a non-emergency medical appointment, the veteran merely had to agree to attend the appointment. In any event, this issue is moot because we are removing the penalty.

This commenter also suggested that VA should employ social workers to be responsible for tracking and contacting veterans who habitually miss medical appointments. VA does use various methods to follow up with those veterans in an effort to ensure they receive necessary medical care. Veterans are contacted via mail, phone, or electronic means after a missed appointment, and are encouraged to contact VA to reschedule.

We do not make any changes based on these comments.

Based on the rationale set forth in the proposed rule and in this final rule, VA is adopting the provisions of the proposed rule as final, and removes § 17.100.

Title 38 of the Code of Federal Regulations, as revised by this final rulemaking, represents VA's implementation of its legal authority on this subject. Other than future amendments to this regulation or governing statutes, no contrary guidance or procedures are authorized. All existing or subsequent VA guidance must be read to conform with this rulemaking if possible or, if not possible, such guidance is superseded by this rulemaking.

This final rule contains no provisions constituting a collection of information under the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3521).

The Secretary hereby certifies that this final rule will not have a significant economic impact on a substantial number of small entities as they are defined in the Regulatory Flexibility Act, 5 U.S.C. 601-612. This final rule will directly affect only individuals and will not directly affect small entities. Therefore, pursuant to 5 U.S.C. 605(b), this rulemaking is exempt from the initial and final regulatory flexibility analysis requirements of 5 U.S.C. 603 and 604.

Executive Orders 12866 and 13563 direct agencies to assess the costs and benefits of available regulatory alternatives and, when regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, and other advantages; distributive impacts; and equity). Executive Order 13563 (Improving Regulation and Regulatory Review) emphasizes the importance of quantifying both costs and benefits, reducing costs, harmonizing rules, and promoting flexibility. Executive Order 12866 (Regulatory Planning and Review) defines a “significant regulatory action” requiring review by the Office of Management and Budget (OMB), unless OMB waives such review, as “any regulatory action that is likely to result in a rule that may: (1) Have an annual effect on the economy of $100 million or more or adversely affect in a material way the economy, a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or State, local, or tribal governments or communities; (2) Create a serious inconsistency or otherwise interfere with an action taken or planned by another agency; (3) Materially alter the budgetary impact of entitlements, grants, user fees, or loan programs or the rights and obligations of recipients thereof; or (4) Raise novel legal or policy issues arising out of legal mandates, the President's priorities, or the principles set forth in this Executive Order.”

The economic, interagency, budgetary, legal, and policy implications of this final rule have been examined, and it has been determined not to be a significant regulatory action under Executive Order 12866. VA's impact analysis can be found as a supporting document at http://www.regulations.gov, usually within 48 hours after the rulemaking document is published. Additionally, a copy of the rulemaking and its impact analysis are available on VA's Web site at http://www1.va.gov/orpm/, by following the link for “VA Regulations Published.”

The Unfunded Mandates Reform Act of 1995 requires, at 2 U.S.C. 1532, that agencies prepare an assessment of anticipated costs and benefits before issuing any rule that may result in the expenditure by State, local, and tribal governments, in the aggregate, or by the private sector, of $100 million or more (adjusted annually for inflation) in any one year. This final rule will have no such effect on State, local, and tribal governments, or on the private sector.

The Catalog of Federal Domestic Assistance numbers and titles for the programs affected by this document are 64.007, Blind Rehabilitation Centers; 64.008, Veterans Domiciliary Care; 64.009, Veterans Medical Care Benefits; 64.010, Veterans Nursing Home Care; 64.011, Veterans Dental Care; 64.012, Veterans Prescription Service; and 64.022, Veterans Home Based Primary Care.

The Secretary of Veterans Affairs, or designee, approved this document and authorized the undersigned to sign and submit the document to the Office of the Federal Register for publication electronically as an official document of the Department of Veterans Affairs. Jose D. Riojas, Chief of Staff, Department of Veterans Affairs, approved this document on December 20, 2013, for publication.

For the reasons stated in the preamble, the Department of Veterans Affairs amends 38 CFR part 17 as follows: