[Federal Register Volume 64, Number 215 (Monday, November 8, 1999)]
[Proposed Rules]
[Pages 60735-60742]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-29090]


=======================================================================
-----------------------------------------------------------------------

SMALL BUSINESS ADMINISTRATION

13 CFR Part 120


Business Loan Program

AGENCY: Small Business Administration (SBA).

ACTION: Proposed rule.

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

SUMMARY: SBA proposes to amend the regulations governing Certified 
Development Companies (``CDCs''). This proposed rule would amend the 
rules governing CDC Area of Operations (the geographic area where SBA 
authorizes a CDC to make loans under SBA's Development Company Loan 
Program (``504 loan'')). The proposed rule would cover an applicant 
requesting to become a CDC; an existing CDC applying to expand its Area 
of Operations within the State in which it is chartered; an existing 
CDC applying to expand its Area of Operations beyond the State in which 
it is chartered into a contiguous bi-sected local economic area 
(``Local Economic Area''); and an existing CDC applying to expand its 
Area of Operations outside the State in which it is chartered into 
another State beyond a Local Economic Area.
    The proposed rule also revises when SBA considers a county 
``adequately served'' (when the 504 loan activity within a county 
precludes the county from being available for inclusion in a new CDC's 
Area of Operations or an existing CDC's expansion request). In some 
cases, counties would be available for inclusion in a new CDC's Area of 
Operations or an existing CDC's expansion request under the proposed 
rule that are not available under the current regulations.
    The proposed rule would clarify under what circumstances and 
conditions a CDC may contract out its management and staff functions. 
It also would address the purposes for which a CDC may use its net 
income generated in different States. The proposed rule would eliminate 
a limited liability company from the types of organizations that may 
apply to become a CDC. Finally, the proposed rule would expressly 
authorize CDCs to establish Loan Committees and set forth conditions 
under which they may be used.

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

ADDRESSES: Comments should be mailed to Jane Palsgrove Butler, 
Associate Administrator for Financial Assistance, Small Business 
Administration, 409 Third Street, SW., Washington, DC 20416.

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

SUPPLEMENTARY INFORMATION: When Title V of the Small Business 
Investment Act of 1958--Loans to State and Local Development 
Companies--was enacted by Public Law 85-699 on August 21, 1958, it 
defined a Development Company as ``an enterprise * * * formed for the 
purpose

[[Page 60736]]

of furthering economic development of its community and environs, and 
with authority to promote and assist the growth and development of 
small-business concerns in the areas covered by their operations * * * 
A local development company is a corporation chartered under any 
applicable State corporation law to operate in a specified area within 
a State * * * A local development company shall be principally composed 
of and controlled by persons residing or doing business in the locality 
* * *'' (13 CFR part 108, section 2, as of January 1, 1967).
    When the Sec. 503 Development Company Loan Program was authorized 
in 1980, its purpose was to provide financing through corporations 
``formed by local citizens whose primary purpose is to improve their 
community's economy. They assist in the planned economic growth of the 
community by promoting and assisting the development of small business 
concerns in their area.'' (Legislative History, Pub. L. 100-590, p.22. 
It continues ``to qualify for this program, a development company must 
be chartered in the State where it intends to operate * * *'' (id, 
p.23))
    Since the inception of the Certified Development Company Program 
(``504 Program''), no CDC has been certified to operate permanently in 
more than one State, except for relatively few circumstances when a 
CDC's operations are in a Local Economic Area. Regulations published on 
August 10, 1982, permitted a CDC to operate within two States if ``(i) 
a State line bisects a city, in which case the 503 company may operate 
city-wide or (ii) the 503 company has obtained prior written approval 
to operate within a contiguous economic area, as determined by SBA, 
which crosses a State line.'' Since this regulation was published, of 
the 270 active CDCs, only nine have applied for and received approval 
by SBA to have their permanent Areas of Operations cross State lines to 
include a contiguous bi-sected local economic area. The permanent Area 
of Operations of the other 261 CDCs are within their State of 
incorporation.
    Prior to the regulations published on March 1, 1996, all counties 
within a CDC's Area of Operations had to be contiguous. The only 
exception was Statewide CDCs that were intended to cover those counties 
not covered by local CDCs. Many States did not (and continue to not) 
have Statewide CDCs. Therefore, many of those States had counties that 
were not covered by any CDC resulting in the small businesses in those 
counties not having access to the CDC Program. To accommodate these 
small businesses, the regulations for the program were modified on July 
23, 1987, to permit the temporary expansion of a CDC's Area of 
Operations for up to 1 year, to include an area underserved by the 504 
Program. In such cases, the CDC needed prior SBA approval of each loan. 
The temporary expansion could be renewed by the district office. The 
CDC was exempt from a CDC's membership and Board requirements in the 
temporary area. (The regulation permitting temporary expansions was 
replaced as of March 1, 1996, by Sec. 120.839, case-by-case extension, 
which permitted a CDC to apply to make an individual loan for a 504 
project outside of its Area of Operations to the SBA district office 
serving the area under certain circumstances.)
    The district offices were authorized to approve temporary 
expansions for up to 1 year so that small businesses could have access 
to the program where there were no existing CDCs. Under this 
regulation, CDCs received temporary authority to operate in other 
contiguous counties in their States or in a Local Economic Area in an 
adjoining State. If the CDC wanted to expand its permanent Area of 
Operations to include the temporary area, it had to comply with the 
regulations governing the eligibility requirements for CDCs including 
membership and board representation. Often, CDCs were better able to 
assess whether or not they wanted a particular geographic area 
permanently by temporarily marketing and doing projects in it. Some 
decided not to include the area permanently and withdrew; others 
permanently expanded into the areas. In other cases, new CDCs or other 
local CDCs were approved by SBA to include these areas in their 
permanent Areas of Operations.
    During the mid-1990s, three CDCs temporarily expanded beyond their 
State of incorporation and beyond a Local Economic Area. In each case, 
local CDCs covering these areas were inactive or did not exist and the 
SBA district offices wanted their small businesses to have access to 
the 504 Program. When the temporary authority expired, one CDC 
sponsored a new CDC incorporated in the State to service the area with 
the required membership and board representation. The application was 
approved. However, the other two CDCs submitted applications to expand 
to include their temporary areas in their permanent Areas of 
Operations. Since, in each case, the areas were beyond the CDC's State 
of incorporation and beyond a Local Economic Area, SBA could not 
consider these requests under its existing regulations.
    However, given the low 504 lending volume in several parts of the 
country, SBA believes that it is in the best interests of underserved 
communities to permit active CDCs in good standing to permanently 
expand their Areas of Operations beyond their State of incorporation 
and beyond a Local Economic Area. SBA proposes to call such a CDC a 
``Multi-State CDC'' (a CDC that is operating as a foreign corporation 
in another State and is permitted by SBA under certain circumstances to 
include in the CDC's permanent Area of Operations counties in that 
State that are located beyond a Local Economic Area). At the same time, 
SBA wants to ensure that the congressional intent for CDCs is followed 
and that they are formed by local citizens whose primary purpose is to 
improve their community's economy. Therefore, the proposed regulations 
would require the following:
    1. The requirements in Sec. 120.822, Membership, must be met 
separately for the Area of Operations within the State in which the CDC 
is incorporated and each additional State in which it operates as a 
Multi-State CDC.
    2. The requirements in Sec. 120.823, CDC Board of Directors, must 
be met separately for the State in which the CDC is incorporated and 
for each additional State in which it operates as a Multi-State CDC. In 
addition, in order for the Board of Directors (``Board'') to maintain 
the appearance of independence and objectivity regarding the loan 
decisions, CDC staff or management must not be voting members of the 
Board. This will eliminate any appearance of a conflict of interest.
    3. Each State must have a separate Loan Committee comprised of 
members residing or working in that State, and representing at least 
three of the four membership groups (government organizations 
responsible for economic development in the Area of Operations in the 
State; financial institutions that provide commercial long-term fixed 
asset financing in the Area of Operations in the State; community 
organizations dedicated to economic development in the Area of 
Operations in the State; and businesses in the Area of Operations in 
the State) including at least one member with commercial loan 
experience acceptable to SBA. In order for the Loan Committee to 
maintain the appearance of independence and objectivity regarding loan 
decisions, CDC staff or management must not be voting members of the 
Loan Committee. Again, this will eliminate any appearance of a conflict 
of interest.

[[Page 60737]]

    4. The CDC's Board must ratify, at least quarterly, the actions of 
its Loan Committees. As well as meeting the general regulatory 
requirements of a CDC's Board, the Board must have equal voting 
representation from the State in which the CDC is incorporated and each 
of the States the CDC operates in as a Multi-State CDC.
    5. The CDC may apply to expand only in those counties that meet the 
criteria of Sec. 120.835(a) as proposed in this regulation.
    6. The CDC, upon the request of SBA, must provide evidence that the 
net income generated in any State where the CDC is operating as a 
Multi-State CDC is being invested in that State.
    7. Any loans approved by SBA for a Multi-State CDC will not be 
considered in the calculations under Secs. 120.810(a) and 120.835(a). 
In other words, in determining whether a county is ``adequately 
served'' for purposes of a new CDC's Area of Operations or an existing 
CDC's expansion request, the 504 loans approved for a Multi-State CDC 
will not be used as part of the calculation if the new CDC or expanding 
CDC is incorporated within the State.
    The proposed regulations require board and membership 
representation from each State in which a Multi-State CDC proposes to 
operate to ensure that the CDC's community economic development efforts 
will be properly tailored to meet the needs of the communities it 
serves and that the CDC does not evolve primarily into a loan packager. 
Local membership, Board, and Loan Committee representation are more 
likely to identify businesses with the greatest potential for 
increasing or retaining local employment and helping the community's 
economy. For example, a local Loan Committee would more likely know if 
the approval of an application from a new business, such as a hotel, 
would help other nearby businesses or, instead, would risk the 
business's failure, or cause other, established hotels to fail, due to 
a surplus of hotels in the area.
    The proposed regulations also re-introduce the concept of a Local 
Economic Area previously Stated in Sec. 108.503-1(c)(i) prior to March 
1, 1996. It would permit a CDC to apply for an Area of Operations that 
crosses State lines without meeting the above requirements when the 
contiguous areas that lie in different States are part of the same 
``local economic area.'' The same Local Economic Area would mean that 
the employees and customers of the businesses in that area work and 
live in that economic area as if there is no State line dividing it. 
Re-introducing the concept in the regulations will help differentiate 
this type of expansion from the proposed one in which a CDC 
incorporated in one State is applying to expand as a Multi-State CDC 
into another State.
    The proposed rule revises the definition for ``Area of Operations'' 
and adds definitions for ``Multi-State CDC'' and ``Local Economic 
Area'' to Sec. 120.802.
    Under the proposed rule, for a 24-month period after a new CDC has 
been approved to operate in a county in its State of incorporation or 
an existing CDC has been approved to expand into an area within its 
State of incorporation, SBA will not accept an application to include 
the county in the Area of Operations of a new CDC or an application 
from an existing CDC to expand into that county. This would give the 
CDC that received permission to operate in the counties an opportunity 
to recoup up-front costs of establishing itself in the new area.
    The proposed regulations would also change Secs. 120.810 and 
120.835 to permit a new CDC or an existing CDC incorporated in a State 
to apply to operate in a county within that State with a population of 
100,000 or more, even if the county is being ``adequately served'' by 
an existing CDC incorporated in that State. Currently, if a CDC is 
doing one 504 loan per year per 100,000 population averaged over 24 
months in a particular county, another CDC may not apply to include 
that county in its Area of Operations. Under the current regulations, 
the county is ``adequately served.'' The proposed regulations would 
permit SBA to consider an application for that county from another CDC 
incorporated in that State if the county has a population of 100,000 or 
more and there is only one CDC incorporated in that State that includes 
that county in its permanent Area of Operations. This will give small 
businesses more choices.
    The proposed rule further amends Secs. 120.810 and 120.835 to 
direct an applicant for certification as a new CDC and for expansion 
within its State of incorporation or into a Local Economic Area to 
apply to the SBA district office serving the area where the CDC's 
headquarters is located. The current regulation requires an applicant 
to apply to the district office serving a proposed area of operations. 
If a CDC is applying to expand into another State as a Multi-State CDC, 
it must apply to the SBA district office serving the area where the CDC 
will headquarter its Multi-State CDC operations in that State. A new 
CDC may not apply to cover an area as a Multi-State CDC during the 
first 24 months after SBA approves it to be a CDC. SBA believes that a 
CDC should demonstrate that it has actively serviced an Area of 
Operations within its State of incorporation (including any Local 
Economic Areas) before it applies to cover an area as a Multi-State 
CDC. SBA will review a CDC's 504 performance history when it considers 
an application to serve an area as a Multi-State CDC.
    Proposed regulation Sec. 120.837 would be retitled ``SBA decision 
on application for certification or expansion.'' Current Sec. 120.837 
applies only to decisions on requests for expansion. Under the proposed 
rule, the provisions of Sec. 120.837 would apply to applicants applying 
to become CDCs and CDCs wishing to expand. In either case, the proposed 
regulation would require the processing district office to solicit 
comments from all other district offices serving the CDC's existing and 
proposed area of operations to determine if the applicant is in 
compliance with all of SBA's regulations, policies, and performance 
benchmarks, including pre-approval and annual review of any management 
or staff contracts, and the timely submission of all annual reports.
    The proposed rule further amends Sec. 120.837 to delete the 
examples of the types of information a district office might consider 
in reviewing an application for expansion. The amended rule would 
clarify that the district office, in making its recommendation, and the 
Associate Administrator for Financial Assistance (AA/FA), in making the 
decision on the application, may consider any available information 
regarding the proposed area of operations, the requesting CDC, and the 
existing CDCs serving the area. Some CDCs and district offices have 
treated the examples in the current regulation as a prescribed list 
that could not be supplemented.
    The proposed regulations would delete the requirement in 
Sec. 120.837 that the AA/FA must make his or her final decision within 
30 days of receipt of the district office's recommendation. Because of 
staffing limitations, SBA has not been able to meet this deadline. 
However, SBA will continue to place a priority on these requests.
    The proposed regulation Sec. 120.837(c) also would establish that 
any unilateral authority that a CDC has in its State of incorporation 
(such as Accredited Lenders Program (ALP), Premier Certified Lenders 
Program (PCLP), or Priority CDC) does not carry over into a State in 
which it is operating as a Multi-State CDC. The CDC must earn any such 
status in each State based solely on the activity in that State. SBA's 
grant of any special unilateral authority in an Area of

[[Page 60738]]

Operations depends on the quality of a CDC's performance history, 
relationship with its SBA district office(s), and its processing, 
closing, servicing, and liquidation abilities in that Area of 
Operation. There is no guarantee that the quality of a CDC's operations 
in one State will be duplicated in another State with a separate 
membership, Board, Loan Committee, management, and staff.
    The proposed rule would amend Sec. 120.820 to delete a limited 
liability company from the types of organizations that may apply to be 
certified as a CDC. SBA believes that since a limited liability company 
structure only benefits its members when it is a for-profit entity 
providing its members certain tax advantages over a C Corporation while 
still offering its members some of the liability protection enjoyed by 
C Corporation shareholders, a limited liability company structure would 
not be appropriate to be used to fulfill the non-profit, local economic 
development role intended for CDCs. (SBA has never received an 
application from a limited liability company to become a CDC.) Section 
120.822 sets forth a CDC's membership requirements. The proposed rule 
adds to Sec. 120.822 the requirement that the membership must meet at 
least annually. It emphasizes that a CDC must meet the membership 
requirements separately for its State of incorporation and for each 
State in which it proposes to and is operating as a Multi-State CDC.
    Section 120.823 sets forth the requirements regarding a CDC's Board 
of Directors. The proposed regulation clarifies that a quorum 
represents at least five Directors authorized to vote. There may be no 
conflict of interest or self-dealing, or any appearance of a conflict 
of interest or self-dealing in regards to any action of a CDC Board. 
Board members often must recuse themselves from voting on a project. 
The proposed regulation clarifies that it is the number of Board 
members voting, not present, that determines whether there is a quorum.
    A CDC Board must be independent, objective, and composed of 
qualified representatives of the required community groups with a nexus 
to the mission and activities of the CDC. For example, an individual is 
not a qualified representative of the business community merely because 
he or she works for a business located in the community. A board member 
must be a responsible official of the represented organization. An 
example of a responsible official of a business would be the owner of 
the business. An example of a responsible official of a bank would be a 
commercial loan officer.
    The Board is responsible for hiring and providing oversight of the 
CDC's management and staff, which in turn is responsible for the day-
to-day marketing, processing, closing, and servicing of the loans. In 
order to maintain the appearance of objectivity on the part of the 
Board, the proposed regulation prohibits any member of a CDC's staff or 
management from being a voting member of the Board. If a member of a 
CDC's staff or management is present as a non-voting member of the 
Board, his or her presence does not count toward a quorum.
    Many CDC Boards designate a Loan Committee to review and decide on 
loan approvals and servicing actions on an interim basis between Board 
meetings. SBA's current regulations do not address Loan Committees. The 
proposed regulation clarifies that a Board may establish a Loan 
Committee. The Loan Committee must meet the same organizational 
requirements as the full Board. It must be independent and objective, 
providing objective analysis of the actions recommended by the CDC 
management and staff. It must represent at least three of the four 
membership groups; and include at least one person with commercial 
lending experience acceptable to SBA. Like the Board, the Loan 
Committee must have at least five voting members to establish a quorum 
and the Loan Committee must not include any CDC staff or management as 
a voting member. Members must be responsible members of the represented 
organizations with a nexus to the missions and activities of the CDC. 
All members must live or work in the Area of Operations of the State in 
which the 504 project on which they are voting is located, unless the 
project qualifies under one of the exceptions in Sec. 120.839, Case-by-
case Extensions. For example, a representative Loan Committee might 
include three bankers (lenders), a CPA (business), a commercial real 
estate agent (business), a representative of the local economic 
development authority (government), and a member of the Board of 
Directors who represents the community (community). If there is a Loan 
Committee, the Board must still meet at least quarterly and ratify the 
actions of the Loan Committee.
    The proposed rule makes it clear that a CDC must meet the Board and 
Loan Committee requirements for its State of incorporation and for each 
State in which it proposes to and is operating as a Multi-State CDC. 
Also, there can be no conflict of interest or self-dealing, or any 
appearance of a conflict of interest or self-dealing, on the part of 
any Board or Loan Committee member in regard to any action of the Board 
or Loan Committee. If there is a potential for an appearance of a 
conflict of interest, the Board or Loan Committee member must recuse 
him or herself from voting on the action. For example, if a Loan 
Committee member is an officer of the bank that will have the first 
mortgage on the 504 project being reviewed for approval, he or she 
should not vote on the project. At least one other member of the Loan 
Committee with commercial lending experience will have to be present to 
vote on the project. Also, the language allowing an alternative, 
approved by SBA, to a voting Board member with lending experience has 
been deleted because SBA believes that a CDC should have several Board 
or Loan Committee members with commercial lending experience available 
to vote on loans, rather than needing an exception to the requirement 
because its member is unavailable.
    In Sec. 120.824, the proposed rule clarifies under what 
circumstances a CDC may contract out its management and staffing. 
Section 503(e) of the Small Business Investment Act of 1958 states that 
a qualified State or local development company must have: (1) A full-
time professional staff; and (2) professional management ability 
(including adequate accounting, legal, and business-servicing 
abilities). Public Law 100-590, approved November 3, 1988, permitted an 
exception to these requirements for a CDC in a rural area. It states 
that the rural CDC ``shall be deemed to have satisfied the requirements 
of a full-time professional staff and professional management ability 
if it contracts with another certified development company which has 
such staff and management ability and which is located in the same 
general area to provide such services.'' The Congressional Record dated 
October 3, 1988, states that this would allow ``a certified development 
company in a rural area to contract out for professional staff and 
professional management ability rather than hiring the employees in-
house. This will help development companies in rural areas which do not 
do a sufficient loan volume to justify a full time staff.'' 
(Congressional Record--H9279). This is the only exception Congress made 
to the requirement that a CDC must have in-house full-time professional 
management and staff.
    In recent years, many CDCs have entered into contracts with outside 
parties for CDC staffing and management. Questions have arisen

[[Page 60739]]

regarding the extent and propriety of such contracts.
    In Sec. 120.824, the proposed rule requires a CDC to have a full-
time professional, including an Executive Director (or the equivalent) 
managing daily operations. At a minimum, this means a CDC must have at 
least one full-time salaried professional employee that is employed 
directly to manage the CDC. A CDC may petition the AA/FA to waive this 
requirement in only two circumstances: (1) When the management of a 
rural CDC with insufficient loan volume to justify its own management 
employee is to be contributed by another CDC located in the same 
general area; or (2) when the management of a CDC is to be contributed 
by a non-profit affiliate of the CDC that is financially subsidizing 
the CDC's operation and has the economic development of the CDC's Area 
of Operations as one of its principal activities. In the latter case, 
the management contributed by the affiliate may work on and operate 
other economic development programs of the affiliate, but must be 
available to 504 customers during regular business hours. The first 
exception is authorized by statute. SBA proposes to permit the second 
exception because it considers the CDC and the affiliate to be 
sufficiently related to have the same or similar mission and objectives 
for the Area of Operations.
    A CDC must possess a full-time professional staff that is capable 
of packaging, processing, closing, and servicing loans. The staff 
capacity of the CDC may be procured from salaried employees or, under 
certain circumstances, on a contractual basis that is acceptable to 
SBA, as long as at least one full-time professional manager in charge 
of the day-to-day operations of the CDC is a salaried employee of the 
CDC. The purpose of permitting a CDC to contract for staff functions, 
in certain cases, is to allow those CDCs that do not have sufficient 
503/504 project-related income to provide the cash flow to support a 
full-time staff for each of the functions to be able to contract for a 
qualified individual on a part-time basis. If a CDC contracts for some 
of the staff functions, the services must be billed at rates that are 
reasonable and customary for the service and the geographic area.
    The proposed regulation eliminates the reference in the current 
Sec. 120.824 to Lender Service Providers, as defined in 13 CFR 103.1. 
This reference has been confusing to CDCs, and SBA believes it is not 
necessary. The proposed rule clarifies that the contractors must either 
live or work in the CDC's Area of Operations.
    In contracting out for management and staff services, there must be 
no evidence of a conflict of interest or self-dealing, or any 
appearance of a conflict of interest or self-dealing on the part of the 
CDC's Board, management, or staff that could result in increased costs 
to a small business borrower or the CDC, or which would adversely 
affect the financial condition of the CDC including its ability to 
become self-sustaining. Any contracted staff must be qualified for the 
function that he or she is providing and live or do business in the 
CDC's Area of Operations.
    SBA believes that Congress intended a CDC to sustain its operations 
continuously with reliable sources of funds, including income from 
services rendered from the Development Company Loan Program. A CDC's 
Board is not acting in the best interests of the CDC, SBA, or small 
business borrowers if it is permitting fee income generated from the 
Development Company Loan Program to be diverted to another organization 
through a contractual relationship rather than retained in the CDC to 
support its operations and economic development mission. The reason for 
the present clarification to the regulations is to ensure that the 
congressional intent is followed and that CDCs are not doing indirectly 
what they are not permitted to do directly, such as becoming 
effectively a shell for a for-profit organization through a contractual 
relationship. This would be in direct conflict with the intent of the 
Development Company Loan Program. Except for a few for-profit CDCs 
certified before January 1, 1987, and grandfathered in 1986, when the 
eligibility requirements for a CDC were changed, a CDC must be non-
profit. The preamble to the 1986 regulations stated that ``The purpose 
of a 503 company shall be to foster economic development in its area of 
operations; any benefit flowing to shareholders, members or other 
related parties shall be merely incidental to such purpose.'' The 
preamble went on to say that the reason for the change was ``the desire 
to emphasize the pro bono publico character of the industry over the 
profit incentive. The nature of the 503 company is to be a catalyst in 
fostering economic development, and not a profit center for owners or 
members * * *'' (64 FR 20765).
    Conflict of interest and self dealing, or any appearance of a 
conflict of interest or self dealing by related parties (which includes 
the CDC's professional management, staff, and Board of Directors) to 
the detriment of a small business borrower, the CDC, or SBA is 
prohibited.
    If a CDC Board proposes to contract for staff rather than hire that 
staff directly, SBA must preapprove and annually review each contract 
to ensure that the contracts are reasonable and customary for the area 
and that there is no self-dealing or conflict of interest, or any 
appearance of self-dealing or conflict of interest. If the CDC's Board 
believes that it is in the best interest of the CDC to contract for a 
function, the CDC's Board must justify to SBA why SBA should favorably 
consider the contract for the services. SBA-approved contractors must 
not be compensated directly from the small business and must be 
compensated only by the CDC from the eligible 504 project-related fees 
that the CDC receives. No contractor or Associate of a contractor may 
be a voting or non-voting member of the CDC's Board or Loan Committee.
    Finally, the proposed rule amends Sec. 120.825 to clarify and 
emphasize that any funds generated from 503 and 504 loan activity by a 
CDC remaining after the payment of staff and overhead expenses must be 
retained in the CDC as a reserve for future operations or to be 
invested in other local economic activity in its Area of Operations. 
One of the primary missions of the CDC's Board must be to ensure that 
the CDC is, or is becoming, self-sufficient through the fee income 
generated while maintaining its local economic focus. If the CDC's 
Board approves a contract that benefits the contractor at the expense 
of the CDC, then the CDC's Board is failing its mission.
    SBA invites comment on all aspects of this proposed rule, including 
the underlying policies. SBA may rely on its own expertise in 
promulgating the final rule. Submitted comments will be available to 
any person or entity upon request.

Compliance With Executive Orders 13132, 12988, and 12866, the 
Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the 
Paperwork Reduction Act (44 U.S.C., Ch. 35)

    For the purposes of Executive Order 13132, SBA certifies that this 
proposed rule has no federalism implications warranting preparation of 
a federalism assessment.
    This proposed rule does not constitute a significant rule within 
the meaning of Executive Order 12866, since it is not likely to have an 
annual effect on the economy of $100 million or more, result in a major 
increase in costs or prices, or have a significant adverse effect on 
competition or the U.S. economy.

[[Page 60740]]

    SBA certifies that this proposed rule will not have a significant 
economic impact on a substantial number of small entities within the 
meaning of the Regulatory Flexibility Act, 5 U.S.C. 601-612. Currently, 
out of approximately 24 million small businesses in the United States, 
about 4000 receive 504 loans annually. As described in the preamble, 
through this regulation, SBA hopes to increase the number of loans made 
to small businesses. Even if SBA were to assume a generous result of a 
20 percent increase in loans, it would only result in an annual 
increase of 800 loans per year. SBA does not consider this a 
significant economic impact on a substantial number of small entities. 
Other aspects of this rule clarify management and structural 
requirements for CDCs. These aspects would have no economic impact on 
small entities, as they merely alter CDC requirements.
    SBA certifies that this proposed rule does not impose any 
additional reporting or recordkeeping requirements under the Paperwork 
Reduction Act, 44 U.S.C., chapter 35.
    For purposes of Executive Order 12988, SBA certifies that this 
proposed rule is drafted, to the extent practicable, to accord with the 
standards set forth in paragraph 3 of that Order.

List of Subjects in 13 CFR Part 120

    Loan programs--business, Small business.

    For the reasons stated in the preamble, SBA proposes to amend 13 
CFR part 120 as follows:

PART 120--BUSINESS LOANS

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

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

    2. Amend Sec. 120.802, to revise the definition of ``Area of 
Operations'' and add definitions of Local Economic Area and Multi-State 
CDC in alphabetical order to read as follows:
    Area of Operations is the geographic area where SBA has approved a 
CDC's request to provide 504 program services to small businesses on a 
permanent basis.
* * * * *
    Local Economic Area is an area, as determined by SBA, that is in a 
State other than the State in which an existing CDC (or an applicant 
applying to become a CDC) is incorporated, shares a border with the 
CDC's existing Area of Operations (or applicant's proposed Area of 
Operations) in its State of incorporation, and is a part of a local 
trade area that is contiguous to the CDC's Area of Operations (or 
applicant's proposed Area of Operations) within its State of 
incorporation. Examples would be a city that is bi-sected by a State 
line or a metropolitan statistical area that is bi-sected by a State 
line.
    Multi-State CDC is a CDC that is incorporated in one State and is 
authorized by SBA to operate as a CDC in another State beyond any 
contiguous Local Economic Areas.
* * * * *
    3. Revise Sec. 120.810 to read as follows:


Sec. 120.810  Applications for certification as a CDC.

    Applicants for certification as a CDC must apply to the SBA 
District Office serving the area in which the applicant proposes to 
locate its headquarters.
    (a) An SBA District Office may accept an application for a county 
only if:
    (1) The county is part of the Area of Operations of only one CDC 
that is incorporated in the State where the county is located; the 
county has a population of 100,000 or more; the county has not become 
part of an Area of Operations within the last 24 months of a CDC that 
is incorporated in the State where the county is located; and the 
applicant is incorporated in the State where the county is located.
    (2) For all counties other than those that qualify under paragraph 
(a)(1) of this section:
    (i) There is no CDC that includes the county in its Area of 
Operations; or
    (ii) The CDCs that include the county in their Areas of Operations 
have not averaged together at least one 504 loan approval per 100,000 
population per year averaged over the previous 24 months prior to SBA 
receiving a complete application from the applicant (loans that are 
approved by SBA for a Multi-State CDC outside of its State of 
incorporation are not to be used in the calculation if the applicant is 
incorporated in the State); and the county has not become part of an 
Area of Operations within the last 24 months of a CDC that is 
incorporated in the State where the county is located.
    (b) An applicant whose application has been accepted must 
demonstrate that it satisfies the certification and operating criteria 
in Secs. 120.820 through 120.829 and the need for 504 services in the 
Area of Operations (if there is already a CDC in the Area of 
Operations, the applicant must justify the need for another and present 
a plan to avoid duplication or overlap). Applications must also include 
an operating budget approved by the applicant's Board of Directors, and 
a plan to meet CDC operating requirements (without specializing in a 
particular industry). An applicant's proposed Area of Operations may 
include Local Economic Areas. An applicant may not apply to cover an 
area as a Multi-State CDC. The AA/FA shall make the certification 
decision.
    4. Revise Sec. 120.820 to read as follows:


Sec. 120.820  CDC non-profit status.

    A CDC must be a non-profit corporation in good standing. (For-
profit CDCs certified by SBA prior to January 1, 1987, may retain their 
certifications.) An SBIC may not be a CDC.
    5. Revise Sec. 120.822 as follows:


Sec. 120.822  CDC membership.

    (a) A CDC must have at least 25 members (or stockholders for for-
profit CDCs approved prior to January 1, 1987). The CDC membership must 
meet annually. No person or entity may own or control more than 10 
percent of the CDC's voting membership (or stock). Members must be 
representative of and provide evidence of active support in the Area of 
Operations. Members must be from each of the following groups:
    (1) Government organization responsible for economic development in 
the Area of Operations and acceptable to SBA;
    (2) Financial institutions that provide commercial long-term fixed 
asset financing in the Area of Operations;
    (3) Community organizations dedicated to economic development in 
the Area of Operations such as chambers of commerce, foundations, trade 
associations, colleges, or universities; and
    (4) Business in the Area of Operations.
    (b) A CDC that is incorporated in one State and is operating as a 
Multi-State CDC in another State must meet the membership requirements 
for each State.
    6. Revise Sec. 120.823 to read as follows:


Sec. 120.823  CDC Board of Directors and Loan Committee.

    The CDC must have a Board of Directors chosen from the membership 
by the members, and representing at least three of the four membership 
groups. No single group shall control. The Board members must be 
responsible officials of the organizations they represent, and at least 
one must possess commercial lending experience. The Board must meet at 
least quarterly and shall be responsible for CDC staff decisions and 
actions. A quorum shall require at least five Directors authorized to 
vote. No person who is a member of a CDC's staff or management may be a 
voting member of the Board. When the Board votes on loan approval or

[[Page 60741]]

servicing actions, at least one Board member with commercial lending 
experience acceptable to SBA must be present and vote. There must be no 
appearance of a conflict of interest with respect to any actions of the 
Board.
    (a) The Board may establish a Loan Committee that reports to the 
Board. The Loan Committee members must represent at least three of the 
four membership groups including at least one member with commercial 
lending experience acceptable to SBA. All members must live or work in 
the Area of Operations of the State where the 504 project they are 
voting on is located unless the project falls under one of the 
exceptions listed in Sec. 120.839, Case-by-case extensions. No CDC 
staff or management is permitted to be a voting member of any Loan 
Committee. A quorum shall require at least five voting members. The 
CDC's Board must ratify the actions of any Loan Committee on at least a 
quarterly basis. There must be no appearance of a conflict of interest 
with respect to any actions of the Loan Committee.
    (b) If the CDC is incorporated in one State and is approved as a 
Multi-State CDC to operate in another State, the CDC must meet the 
Board and Loan Committee requirements for each State.
    7. Revise Sec. 120.824 to read as follows:


Sec. 120.824  Professional management and staff.

    A CDC must have full-time professional management, including an 
Executive Director (or the equivalent), managing daily operations. It 
must also have a full-time professional staff qualified by training and 
experience to market the 504 Program, package and process 504 loan 
applications, close 504 loans, service, and, if authorized by SBA, 
liquidate the loan portfolio, and sustain a sufficient level of service 
and activity in the Area of Operations. CDCs may obtain, under written 
contract, marketing, packaging, processing, closing, or liquidation 
services provided by qualified individuals and entities who live or do 
business in the CDC's Area of Operations under the following 
circumstances:
    (a) The CDC has at least one salaried professional employee that is 
employed directly (not contracted ) full-time to manage the CDC. A CDC 
may petition SBA to waive the requirement of at least one full-time 
manager if the CDC is rural and has insufficient loan volume to justify 
its own management, and another CDC located in the same general area 
will provide the management; or the management of a CDC is to be 
contributed by a non-profit affiliate of the CDC that is financially 
subsidizing the CDC's operations and has the economic development of 
the CDC's Area of Operations as one of its principal activities. In the 
latter case, the management contributed by the affiliate may work on 
and operate other economic development programs of the affiliate, but 
must be available to 504 customers during regular business hours.
    (b) SBA must pre-approve all contracts. (CDCs may contract for 
legal and accounting services without SBA approval.)
    (c) If a CDC's Board believes that it is in the best interest of 
the CDC to contract for a marketing, packaging, processing, closing, 
servicing or liquidation function, the CDC's Board must justify to SBA 
why SBA should favorably consider the contract for the services. The 
CDC's Board must demonstrate to SBA that compensation under the 
contract is only from the CDC, is reasonable and customary for similar 
services in the Area of Operations, is only for actual services 
performed, and does not evidence any conflict of interest or self-
dealing, or an appearance of conflict of interest or self-dealing, on 
the part of any of the CDC's officers, management, and staff, including 
members of the Board and any Loan Committee.
    (d) Contracts must be for a period not to exceed 2 years (including 
options to renew) and must clearly identify procedures satisfactory to 
SBA that permit the CDC to terminate the contract prior to its 
expiration date. SBA must review all 2-year contracts after the first 
year to ensure that there is no conflict of interest or self-dealing, 
or an appearance of conflict of interest or self-dealing.
    (e) No contractor (under this section) or Associate of a contractor 
may be a voting member of the CDC's Board or Loan Committee.
    8. In Sec. 120.825 add the following two sentences to the end of 
the section as follows:


Sec. 120.825  Financial ability to operate.

    * * * Any funds generated from 503 and 504 loan activity by a CDC 
remaining after payment of staff and overhead expenses must be retained 
in the CDC as a reserve for future operations or to be invested in 
other local economic development activity in its Area of Operations. If 
a CDC is operating as a Multi-State CDC, it must maintain separate 
accounting for each State of all 504 fee income and expenses and 
provide, upon SBA's request, evidence that the funds resulting from its 
Multi-State CDC operations are being invested in economic development 
activities in each State in which it was generated.
    9. Revise Sec. 120.835 to read as follows:


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

    An existing, active CDC applying to expand its Area of Operations 
must be operating in conformance with all existing SBA regulations, 
policies, and performance benchmarks and be well-qualified to serve the 
proposed area. A CDC seeking to expand its Area of Operations must 
apply in writing to the SBA District Office where the CDC is 
headquartered, unless it is applying as a Multi-State CDC. In that 
case, the CDC must apply to the SBA District Office that services the 
area where the Multi-State CDC is locating its principal office in that 
State.
    (a) An SBA District Office may accept a CDC's application to expand 
its Area of Operations into a county within its State of incorporation, 
in a Local Economic Area or in another State beyond a Local Economic 
Area that it would service as a Multi-State CDC only if:
    (1) The county is part of the Area of Operations of only one CDC 
that is incorporated in the State where the county is located; the 
county has a population of 100,000 or more; the county has not become 
part of an Area of Operations within the last 24 months of a CDC that 
is incorporated in the State where the county is located; and the 
applicant CDC is incorporated in the State where the county is located.
    (2) For all counties other than those that qualify under paragraph 
(a)(1) of this section:
    (i) There is no CDC that includes the county in its Area of 
Operations; or (ii) The CDCs that include the county in their Areas of 
Operations have not averaged together at least one 504 loan approval 
per 100,000 population per year averaged over the previous 24 months 
prior to SBA receiving a complete application from the applicant CDC 
(loans that are approved by SBA for a Multi-State CDC outside of its 
State of incorporation are not to be used in the calculation if the 
requesting CDC is incorporated in the State); and the county has not 
become part of an Area of Operations within the last 24 months of a CDC 
that is incorporated in that State.
    (b) An applicant whose application for expansion has been accepted 
must demonstrate to the satisfaction of SBA that it satisfies all of 
the certification and operating criteria in Secs. 120.820 through 
120.829. It must demonstrate that it has the ability to provide full 
service to small businesses in the

[[Page 60742]]

requested area including processing, closing, servicing, and, if 
authorized, liquidating 504 loans. It must also demonstrate the need 
for 504 services in the Area of Operations and present a plan for 
servicing the area. If there is already one or more CDCs in the 
requested Area of Operations, the applicant must justify the need for 
another. In addition, an applicant to service an area as a Multi-State 
CDC must show that:
    (1) The requirements in Sec. 120.822, Membership, are met 
separately for the Area of Operation within the CDC's State of 
incorporation and for each additional State in which it operates or 
seeks to operate as a Multi-State CDC;
    (2) The requirements regarding Boards of Directors in Sec. 120.823, 
CDC Board of Directors and Loan Committees, are met separately for the 
State of incorporation and for each additional State in which it 
operates or seeks to operate as a Multi-State CDC;
    (3) The CDC Board of Directors must have the same number of members 
residing or working in the CDC's State of incorporation and each other 
State in which it operates or seeks to operate as a Multi-State CDC; 
and
    (4) The CDC must have separate Loan Committees in its State of 
incorporation and in each State in which the CDC operates or seeks to 
operate as a Multi-State CDC, comprised of members residing or working 
in that State.
    10. Revise Sec. 120.837 to read as follows:


Sec. 120.837  SBA decision on applications for a new CDC or for an 
existing CDC to expand Area of Operations.

    (a) The processing District Office must solicit the comments of any 
other District Office in which the CDC operates or proposes to operate. 
The processing District Office must determine that the CDC is in 
compliance with SBA's regulations, policies, and performance 
benchmarks, including pre-approval and annual review by SBA of any 
management or staff contracts, and the timely submission of all annual 
reports. In making its recommendation on the application, the District 
Office may consider any information presented to it regarding the 
requesting CDC, the existing CDC, or CDCs that may be affected by the 
application, and the proposed area of operation.
    (b) The District Office will submit the application, 
recommendation, and supporting materials within 60 days of receipt of a 
complete application from the CDC to the AA/FA, who will make the final 
decision. The AA/FA may consider any available information.
    (c) If a CDC is approved to operate as a Multi-State CDC, any 
unilateral authority that a CDC has in its State of incorporation under 
any SBA program (such as the Accredited Lenders Program (ALP), Premier 
Certified Lenders Program (PCLP), or Expedited Closing Process 
(Priority CDC)) does not carry over into a State in which it is 
operating or is approved to operate as a Multi-State CDC. The CDC must 
earn the status in each State based solely on its activity in that 
State.

    Dated: September 23, 1999.
Aida Alvarez,
Administrator.
[FR Doc. 99-29090 Filed 11-5-99; 8:45 am]
BILLING CODE 8025-01-U