[Federal Register Volume 68, Number 194 (Tuesday, October 7, 2003)]
[Rules and Regulations]
[Pages 57960-57989]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-24860]



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Part II





Small Business Administration





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13 CFR Part 120



Development Company Loan (504) Program Changes; Final Rule

  Federal Register / Vol. 68, No. 194 / Tuesday, October 7, 2003 / 
Rules and Regulations  

[[Page 57960]]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

RIN 3245-AE41


Development Company Loan (504) Program Changes

AGENCY: U.S. Small Business Administration (SBA).

ACTION: Final rule.

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SUMMARY: The U.S. Small Business Administration (``SBA'' or ``the 
Agency'') is amending the Certified Development Company (``CDC'') Loan 
Program (the ``CDC Program'' or the ``504 Program'') in order to 
improve delivery of the 504 Program to small businesses. The most 
significant regulations changed are those governing a CDC's area of 
operations; a CDC's organizational structure; the requirements for a 
new CDC or a CDC requesting to expand its territory; the ``adequately 
served'' standard; and whether a CDC may participate in other SBA loan 
programs. Also, to allow for greater delegation of authority to CDCs, 
the rule includes expanded sections on the Accredited Lender Program 
(``ALP''), the Premier Certified Lender Program (``PCLP'') and a 
simplification and clarification of the enforcement provisions for 
CDCs. The amendments also clarify the regulations governing fees that a 
small business may and may not be charged.

DATES: This rule is effective November 6, 2003.

FOR FURTHER INFORMATION CONTACT: Gail H. Hepler, Chief, 504 Loan Policy 
Branch, (202) 205-7530 or, by email, at [email protected].

SUPPLEMENTARY INFORMATION:

Rulemaking History

    On July 8, 2003, SBA published in the Federal Register a proposed 
rule (68 FR 40553). The proposed rule took into consideration and was 
based in part on over 1,900 comments SBA received in response to an 
Advanced Notice of Proposed Rulemaking (``ANPRM'') published in the 
Federal Register by SBA on December 6, 2002. SBA received over 70 
comments in response to the proposed rule.

Statutory Basis of the 504 Program

    The 504 Program, Title V of the Small Business Investment Act 
(``Act''), 15 U.S.C. 695, was established by Public Law 85-699 on 
August 21, 1958. A ``development company'' was defined as an enterprise 
formed for the purpose 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. The law further stated that a local development 
company is a corporation chartered under any applicable State 
corporation law to operate in a specified area within a State and be 
composed of, and controlled by, persons residing or doing business in 
the locality. The program was amended in 1980 due to changing business 
conditions for small businesses. During the late 1970s and early 1980s, 
the prime interest rate and unemployment rate reached historically high 
levels. It was generally believed that long-term, fixed-rate money was 
not available at a reasonable cost to small businesses because of these 
high prevailing rates and that this was hindering job creation. 
Congress enacted section 503 of the Act in 1980. The 503 and 504 
Programs were intended to provide long-term, fixed-rate financing to 
small businesses at favorable terms that were unavailable in the 
commercial marketplace. Congress specified in the Act that this program 
``foster economic development and create or preserve job opportunities 
in both urban and rural areas by providing long-term financing for 
small business concerns * * *'' The statute authorizes SBA to guarantee 
debentures backing long-term, fixed-asset loans (``504 Loans'') made by 
CDCs. It also authorizes SBA to pool the guarantees and sell interests 
in the pools to investors.

Overview of the Changes to the 504 Regulations

    SBA believes the regulatory changes will improve 504 Program 
delivery to small business customers by increasing customer choice of 
service; increase third-party lender choice of CDCs; facilitate the 
formation of new CDCs; facilitate the expansion of existing CDCs; and 
increase the number of CDCs able to take advantage of special 
initiatives for rural areas. By allowing market-driven forces to 
determine availability of 504 Program service, small businesses will 
have greater opportunity to negotiate the best total financing package 
including fees, as well as receive increased service by CDCs. In 
addition, the 504 Program will be more responsive to changes in market 
conditions.
    To allow for greater delegation of authority to CDCs, this final 
rule includes expanded sections on the ALP and the PCLP. This final 
rule also simplifies and clarifies the enforcement provisions for CDCs. 
In addition, SBA is amending the regulations governing ``job 
opportunity average'' to permit more flexibility to adjust the average 
in response to increased costs as reflected by such measures as the 
consumer price index. This change will permit CDCs to approve more 
projects that do not meet the job creation criteria but do meet other 
statutory goals such as increasing manufacturers' productivity and 
competitiveness through re-tooling, robotics or modernization. The 
final rule also clarifies the regulations governing fees that a small 
business may and may not be charged. The regulations covered by the 
final rule are 13 CFR, Subpart A, Sec.  120.102 and Sec.  120.140, and 
Subpart H, Sec. Sec.  120.800 through 120.984.
    The 504 Program from 1986 to 2002 has created or retained more than 
1.5 million jobs, averaging approximately $13,600 of debenture per job. 
However, the 504 Program has not used all of its available budgetary 
authority for many years. The 504 Program's authorization level for 
fiscal year 2002, for example, was $4.5 billion compared to the total 
approval level of $2.5 billion.
    SBA has decided to take steps to increase the availability of the 
long-term, fixed-rate financing offered by the 504 Program that is 
vital for our nation's small business community. This final rule begins 
this process by establishing the State in which a CDC is incorporated 
as the CDC's minimum area of operations. Currently, each CDC is 
assigned a specific, local area, typically several counties. Only one 
CDC per State is permitted to be a statewide CDC. In some cases, there 
are geographic areas that do not have CDC coverage. Although CDCs' 
areas of operations often overlap, SBA believes that establishing 
statewide areas of operations for all CDCs will increase the 
availability of 504 Program assistance to small businesses. SBA also 
believes that it is empowering the CDCs' boards to determine what is 
the optimal area of operations within the State for the CDC to market 
and service effectively.
    Next, SBA is eliminating the ``adequately served'' standard. 
Currently, a county meets the standard of ``adequately served'' when 
the CDC that includes the county in its area of operations averages at 
least one 504 loan approval in that county per 100,000 population per 
year averaged over two years. In such cases, the county is unavailable 
both to an existing CDC applying to expand its operations to include 
that county and to a new CDC applying to include that county in its 
proposed area of operations. In addition, the regulations currently do 
not permit a new CDC, or a CDC applying to expand its area of 
operations, to apply for a particular county if that county has become 
part of another CDC's area of

[[Page 57961]]

operations within the previous 24 months. Eliminating this standard 
will encourage new CDC applications and existing CDCs to expand their 
operations within their state of incorporation without first having to 
go through a lengthy expansion application process. SBA is allowing the 
marketplace to determine the maximum number of CDCs that can co-exist 
within a State. With these changes SBA anticipates that small 
businesses, as well as lenders, will have greater choice in, and access 
to, capital.
    To facilitate these changes, SBA is streamlining CDC organizational 
structure by modifying the CDCs' general membership requirements. 
Currently, a CDC is required to have a general membership that covers 
the CDC's entire area of operations. In the final rule, SBA will no 
longer require that a CDC's membership cover the entire area of 
operations, but rather will require that the CDC's members each 
actively support economic development within all or some portion of the 
CDC's area of operations. The CDC's board of directors would make the 
decision on how widely disbursed the CDC's general membership needs to 
be to meet the objective of local economic development. The result of 
this change and others will be that CDCs will be empowered to determine 
in which areas within their state of incorporation they wish to engage 
in 504 Program activities; they will not be required to serve the 
entire state but may do so if they choose. SBA also is modifying the 
regulations governing contracting for staff to facilitate a CDC's 
contracting for ``back office'' work with a contractor located outside 
of the CDC's area of operations. SBA believes that this will permit 
certain economies of scale by providing additional sources of expertise 
in 504 packaging, processing, servicing and liquidation.
    For CDCs that apply to cross State lines as a multi-state CDC, the 
CDC also will be able to determine the geographic coverage of its 
general membership in the new State. Also for multi-state CDCs, SBA is 
relaxing the requirements for board representation from the new State 
by eliminating the current requirement that at least three of the CDC's 
board members must come from the new State. In addition, SBA is 
allowing a CDC that currently has ALP or PCLP authority in its State of 
incorporation to use that authority in its expanded area. To ensure 
that only those CDCs with demonstrated proficiency in the 504 Program 
are permitted to expand beyond their State of incorporation, SBA is 
requiring applicants for multi-state CDC and local economic area 
expansion to be ALP-qualified, among other things. Taken together, SBA 
believes that these changes in a CDC's area of operations, elimination 
of the concept of ``adequately served,'' elimination of the requirement 
that a CDC's membership cover the entire area of operations, the 
clarification of contracting requirements, and the changes in the 
expansion requirements for CDCs will result in the 504 Program becoming 
more relevant in today's dynamic financial services marketplace.
    The final rule prohibits a CDC from investing in or being 
affiliated with a 7(a) lender. This rule was developed after reviewing 
the comments on this issue received in response to the ANPRM. The 
majority of those commenting on this issue, as well as those that 
commented on the proposed rule, stated that the 504 Program should 
remain separate from the 7(a) Program.
    The concept of permitting a CDC to invest in a Small Business 
Investment Company (``SBIC'') generally was supported by the commenters 
to the ANPRM. Many writers viewed such an investment as economic 
development as long as the SBIC and the CDC were not affiliates. 
However, SBA's current regulations prohibit a CDC from owning an equity 
interest in a business that has received or is applying to receive SBA 
financing (Sec.  120.140). Since SBICs typically have an ownership 
interest in the businesses that they assist, a CDC that has invested in 
an SBIC also would have an ownership interest in the small business 
receiving financing from the SBIC and could potentially violate this 
regulation by providing financing directly to that small business. In 
addition, SBA's regulations state that a CDC must operate in its area 
of operations. SBA interprets this requirement to apply to all CDC 
activities that use funds generated from the 504 Program. In light of 
these concerns, at this time, SBA is prohibiting a CDC from investing 
in an SBIC.

Section-by-Section Analysis

    SBA is adding a definition of ``SOP'' to Sec.  120.102, the 
definitions section applicable to the entire part 120. SBA's SOPs are 
available at any SBA office (see 13 CFR 102.2 and are generally 
available in SBA's reading room on its Web site (http://www.SBA.GOV).
    SBA is amending Sec.  120.140 to delete references to Associate 
Development Companies (``ADC'') (see discussion of Sec.  120.850).
    SBA is changing the headings for Sec.  120.800 and Sec.  120.801 to 
make them consistent with the other section headings in Subpart H.
    In Sec.  120.802 the definition of ``Area of Operations'' is 
modified to define the minimum area of operations for a CDC as the 
State in which the CDC is incorporated. As stated in the proposed rule, 
SBA has decided to take steps to increase the availability of the long-
term, fixed-rate financing offered by the 504 Program that is vital for 
our nation's small business community. Currently, each CDC is assigned 
a specific, local area, typically several counties. Only one CDC per 
State is permitted to be a statewide CDC. In some cases, there are 
geographic areas that do not have CDC coverage. Although CDCs' areas of 
operations often overlap, SBA believes that establishing statewide 
areas of operations for all CDCs will increase the availability of 504 
Program assistance to small businesses. Most of the comments SBA 
received concerned the proposed change to the CDC's minimum area of 
operations. Several comments were opposed to the proposed change based 
on concerns that the changes would dilute a CDC's role in community and 
economic development as well as a concern that rural areas would be 
neglected. Some commenters also were concerned that a CDC could not 
provide adequate servicing to much larger geographic areas. SBA also 
received several comments supporting the change as proposed. One such 
comment explained that it would eliminate monopolies that some CDCs 
currently have. Another stated that competition will result in the CDC 
working harder to distinguish itself by attempting to provide better 
service at the lowest possible cost. Other commenters supported 
expansion of a CDC's minimum area of operations but wanted the SBA 
district offices' geographic jurisdiction to define the minimum area, 
not the State.
    With regard to the concern about whether CDCs will be able to 
adequately provide 504 Program service to the much larger geographic 
area of the State in which it is incorporated, SBA did not propose to 
require that a CDC must serve the entire State in which it is 
incorporated when it proposed to change the ``area of operations'' 
definition to provide for a minimum of the State in which the CDC is 
incorporated. A CDC will continue to be free to concentrate its 504 
Program activities in whatever portions of its State it believes it can 
operate effectively as a CDC.
    As to the issue of the specific geographic limit of the area of 
operations (i.e., Statewide, as proposed; district-wide, as favored by 
several

[[Page 57962]]

commenters; or some even smaller geographic area), SBA is implementing 
the Statewide minimum. First, SBA does not believe that this 
necessarily will result in rural areas being neglected, as several 
commenters suggested. Under the current regulations many such areas are 
being neglected now, and SBA believes that increased competition among 
CDCs within a State may result in bringing additional access to capital 
to those areas, as CDCs focus their efforts on places where they have a 
competitive advantage.
    SBA also does not believe that changing the minimum area of 
operations to statewide necessarily will result in a dilution of a 
CDC's role in community and economic development. A CDC will have the 
discretion to determine over what geographic areas within its State it 
has the ability, based on its membership, board, and staff, to provide 
economic development. Local economic development remains one of the 
goals of projects financed by 504 loans, pursuant to section 502(d)(2) 
of the Act and Sec.  120.862(a). However, SBA does not believe that a 
CDC necessarily must operate only in a small geographic area in order 
to meet the local economic development needs of that area. In addition, 
the purpose of the 504 Program is not only to foster local economic 
development, but to meet other goals, such as the public policy goals 
listed in section 501(d)(3) of the Act and Sec.  120.862(b) which are 
not dependent on a CDC having a local presence, are even less dependent 
on a CDC having a local presence.
    While SBA agrees that the Agency could introduce competition to the 
504 Program within smaller geographic areas than a State, the Statewide 
minimum will allow SBA to administer the 504 Program more efficiently, 
given its increasingly limited staff resources. A district-wide minimum 
area of operations standard would produce a double standard between the 
43 States in which all CDCs would be Statewide, by virtue of the fact 
that there is only one district office in each of those States, and the 
remaining seven States with multiple districts, which would require 
additional monitoring by SBA. An even smaller geographic area of 
operations standard would require an even greater expenditure of SBA's 
resources to oversee and administer. For these reasons, the final rule 
publishes the area of operations definition in Sec.  120.802 as 
proposed.
    The definition of ``Local Economic Area'' also is revised slightly 
to make it consistent with the revised, statewide ``Area of 
Operations'' definition. SBA received several comments that suggested 
confusion on the part of the commenters in interpreting what was being 
changed in the definition. SBA had proposed changes only to the first 
sentence of the definition. Specifically, SBA did not propose to delete 
the reference to a ``metropolitan statistical area'' as an example of a 
local economic area and, therefore, that reference will continue to be 
part of the regulation.
    SBA received several comments that suggested that SBA did not 
adequately address whether the revised definition of area of operations 
would mean that local economic areas adjacent to a CDC's State of 
incorporation would be included in a CDC's minimum area of operations. 
SBA did not propose a change to the concept of a local economic area, 
and the proposed rule expressly states that a CDC must apply to SBA to 
expand its area of operations into a local economic area (see Sec.  
120.835). Some comments were in favor of revising the definition of 
local economic area or area of operations in ways that would remove or 
create exceptions to the requirement that a CDC apply to SBA to serve a 
local economic area; one comment proposed that a CDC's minimum area of 
operations include all local economic areas adjacent to a CDC's state 
of incorporation. SBA did not propose to change the definition of local 
economic area in this way and considers to be beyond the scope of this 
rulemaking the requirement that a CDC apply to SBA to cover such areas.
    The definition for ``Associate Development Company'' is deleted. 
This change is discussed in the analysis of revisions for Sec.  
120.850. SBA received several comments in support of the proposed 
change.
    Other regulations in Subpart H of part 120 use the terms 
``Designated Attorney,'' ``Lead SBA Office'' and ``Priority CDC.'' For 
clarification, SBA is adding definitions for those terms. Comments 
received supported these additional definitions. SBA did not receive 
any comments objecting to these new definitions.
    In Sec.  120.810, application for certification as a CDC, SBA is 
changing the policies governing new CDC applications to reflect the 
change in the definition of a CDC's ``Area of Operations'' to a minimum 
of statewide. Additionally, it deletes the current restrictions that 
permit existing CDCs to exclude geographic areas from being considered 
for a new CDC. SBA is permitting the marketplace to determine the 
optimum number of CDCs that may be supported. In this section and in 
several others (for example, Sec.  120.812(d) and Sec.  120.837), SBA 
proposed to add the phrase ``The procedures of Sec. Sec.  120.855 
through 120.857 do not apply'' to the specific action described in the 
proposed regulation section. Several commenters expressed confusion as 
to whether SBA was proposing to change existing rights or add new 
rights to reconsideration or appeal from the SBA action addressed in 
that regulation. Several commenters also requested that SBA expand 
these sections further to specifically provide CDCs a right of 
administrative appeal to SBA's Office of Hearings and Appeals (OHA), 
under part 134 of SBA's regulations, for each such action.
    By adding this phrase to this section and others, SBA did not 
intend and did not propose to add any new administrative appeal rights 
to these sections. On the contrary, SBA was attempting to clarify that 
the expanded SBA enforcement and CDC administrative appeal rights 
proposed in Sec. Sec.  120.855 through 120.857 for actions described in 
Sec.  120.854 specifically would not apply to the sections in which the 
phrase would appear. Because this appears to have caused confusion 
rather than provide clarification, SBA's final rule deletes the phrase 
beginning with ``The procedures of Sec. Sec.  120.855 through 120.857* 
* *'' wherever it appeared in the proposed rule. This results in the 
preservation of the procedures that currently exist under SBA 
regulations in subpart H of this part and in Sec. Sec.  134.102(d) and 
(f) of this chapter, namely that only in cases in which a right of 
administrative appeal to OHA is specifically set forth by regulation 
does such a right exist. As discussed below regarding Sec.  120.856, 
SBA has added Sec.  120.856(f) clarifying that the procedures in Sec.  
120.856 only apply to actions taken by SBA pursuant to Sec.  120.855.
    Also, SBA is adding a clarification that an applicant CDC must 
demonstrate financial capability to meet the upfront costs of the 
program until the CDC's operations meet the breakeven point. This is to 
ensure that the CDC will be staffed sufficiently to meet the 
requirements of marketing, processing, closing, and servicing 504 
loans. The added requirement that an applicant must demonstrate 
financial capability to meet the upfront costs of the 504 Program until 
the CDC's operations meet the breakeven point should assist in 
attracting only those applicants committed to devoting adequate 
resources (refer to Sec.  120.802 discussion on the comments regarding 
changes to CDC area of operations). Several commenters objected to the 
proposed rule on the basis that the current ``adequately served'' 
concept applicable

[[Page 57963]]

to new applicants, which limits the geographic areas that are available 
for new CDCs, assists in minimizing the number of processing and 
closing problems from inexperienced CDCs. SBA considered these concerns 
but continues to believe that the marketplace should determine the 
maximum number of CDCs that may be supported by 504 loan activity 
within a State.
    SBA received several comments about the proposed deletion of the 
requirement in Sec.  120.811 for public notice as well as direct notice 
to existing CDCs for new CDC applications (as well as in Sec.  120.836 
for CDC expansion requests). Several commenters were concerned that the 
deletion of the requirement for notice to the public and to existing 
CDCs would not give existing CDCs with knowledge of the community an 
opportunity to express their opinion about a new CDC application 
request or a CDC expansion request. SBA considered this concern but 
decided not to modify the proposed rule.
    In SBA's experience, most of the comments received in response to 
such notice to CDCs and the public have been from existing CDCs 
concerned about ``ruinous competition'' that would result from CDC 
expansion; SBA has received very few comments concerning new CDC 
applications that have resulted in information that SBA had not already 
discovered in its own review process. With the new emphasis on 
competition in the 504 Program as a result of this final rule, the 
issue of competition resulting from a CDC's expansion will no longer be 
relevant to SBA's decision.
    With regard to decisions on new CDC applications, SBA has an 
established, effective process for screening and conducting appropriate 
due diligence and character determinations on the officers, directors, 
and key staff of an applicant for certification as a CDC. SBA's current 
process addresses all comments SBA may receive concerning such 
applicant or any individual associated with the applicant. Eliminating 
the public notice requirement will not change that process or eliminate 
SBA's consideration of any comments it may receive. In addition, all 
new CDCs are subject to a two year probationary period (pursuant to 
Sec.  120.812), during which time significant, adverse character or 
other issues relating to the new CDC may come to light (through 
comments by members of the public or otherwise).
    Finally, SBA believes that elimination of the notice requirement 
will streamline the application process for both new CDCs and for CDC 
expansions and decrease the cost and time necessary for a CDC to pursue 
either type of application. For all of these reasons, the final rule 
deletes Sec.  120.811.
    Section 120.812, probationary period for newly certified CDCs, is 
revised to clarify how SBA will process a CDC's petition for permanent 
CDC status, and that the probationary period commences on the date of 
certification. Also SBA is deleting all references to ADCs in 
connection with the elimination of the ADC program (see discussion 
under Sec.  120.850). In this final rule, SBA also eliminates the last 
sentence in this regulation that the procedures in Sec. Sec.  120.855 
through 120.857 do not apply, for the same reasons discussed above for 
Sec.  120.810.
    In Sec.  120.820, CDC non-profit status, SBA describes what the 
Agency means by the term ``good standing.'' While this is a term that 
has been used over the years in administering the 504 Program, SBA has 
not fully defined it previously. Several comments expressed concern 
about SBA's ability to analyze a CDC's compliance with laws, including 
taxation requirements. The comments seem to suggest that SBA should not 
have the right to consider a CDC's compliance with other laws that 
govern the CDC when considering whether the CDC is in good standing. 
SBA disagrees and continues to believe that a CDC's compliance with all 
laws governing a CDC should be a part of SBA's analysis, as the 
regulator overseeing CDCs, of whether a CDC is in good standing. SBA 
has no intention of ensuring that CDCs comply with all laws, but it has 
the means (through publicly available information, for example) to 
ascertain when a CDC is not in compliance with tax and other legal 
requirements. Therefore, SBA adopts Sec.  120.820 as it was published 
in the proposed rule.
    Section 120.821, CDC Area of Operations, is revised to delete the 
limitation of one statewide CDC since all CDCs' areas of operations 
will be at least statewide (see discussion of definition of the ``Area 
of Operations'' under Sec.  120.802).
    Section 120.822, CDC membership, is revised to streamline CDC 
membership qualifications by deleting the requirement that a CDC's 
membership must be representative of its entire area of operations. 
Currently, a CDC must have representation from each of the four groups 
(i.e., government organizations, financial institutions, community 
organizations, and businesses) for its entire area of operations. With 
this change, SBA will still require that each of the four groups be 
represented in the membership, but will no longer require that such 
members represent the entire area of operations. SBA also is 
eliminating the requirement that SBA pre-approve the CDC's members 
representing government organizations, and is adding small business 
development companies (``SBDCs'') and other types of community 
organizations that may be a source of members for a CDC. It will be up 
to the CDC's board to determine how broadly-based geographically the 
membership needs to be to meet the CDC's economic development 
objectives. The CDC's board may choose to have a membership that 
represents only a county, or some counties, while another CDC's board 
may choose to have a membership that represents the entire State.
    Several comments suggested that the regulation may need some 
clarifying language by stating specifically that the membership groups 
need not have members that do not represent the entire area of 
operations. SBA considered these comments but disagrees that further 
clarification is required. Section 120.822(b) as proposed specifically 
states that ``Members must be responsible for actively supporting 
economic development in the Area of Operations,'' and the preamble to 
the proposed rule SBA clarified that ``With this change, SBA still 
would require that each of the four groups be represented in the 
membership, but would no longer require that such members represent the 
entire area of operations.'' SBA is publishing Sec.  120.822 as 
proposed.
    Other comments suggested that a CDC should be able to use CDC 
employees in meeting the membership requirements. SBA considered these 
comments but disagrees. The membership requirement is designed to be 
filled by local community leaders volunteering to assist in providing 
economic development in their communities through the formation of a 
CDC. The membership elects the CDC's board from among its members. The 
board, in turn, hires paid professional staff to operate the CDC on a 
daily basis. SBA believes that this will preserve objectivity between 
the CDC's membership, its board, and its staff. Therefore, SBA is 
publishing in the final rule Sec.  120.822 as it was published in the 
proposed rule.
    Section 120.823, CDC board of directors, is revised to delete the 
requirement that a CDC that is approved as a multi-state CDC meet the 
CDC board requirements for each State. SBA did not propose this 
specific change to Sec.  120.823(b) in the proposed rule. However, SBA 
did discuss in the preamble to the proposed rule SBA's

[[Page 57964]]

intent to change the requirement currently in Sec.  120.823(b) that a 
multi-state CDC must meet the board requirements set forth in Sec.  
120.823 for each State in which it is authorized to operate (see 
preamble discussion, ``Overview of Proposed Changes to the 504 
Regulations,'' last full paragraph, column one, 68 FR 40556). In 
addition, this change is consistent with the changes SBA did 
specifically propose to Sec.  120.835(c) concerning a CDC requesting a 
multi-state expansion. SBA also received several comments in support of 
this change. Because this change is consistent with SBA's intent as 
expressed in the proposed rule and with other changes specifically 
proposed and is supported by the public, SBA revises Sec.  120.823(b) 
in this final rule. With this change and the change to Sec.  120.835, a 
multi-state CDC will be required to meet the loan committee (Sec.  
120.823(b)) and membership (Sec.  120.822(b)) requirements for each 
State in which it operates as a CDC, and the CDC's board would need to 
establish a loan committee in each such State, but would not need to 
meet the other board requirements (Sec.  120.823) for each such State.
    Section 120.824, professional management and staff, is revised to 
modify the requirements for when and under what circumstances a CDC can 
contract for management services. The change clarifies the requirements 
regarding CDC staff provided under contract including deleting the 
requirement that a contractor must live or do business in the CDC's 
area of operations. SBA believes that a CDC may wish to contract for 
certain services, such as ``back office'' staff support, with 
individuals or organizations that are outside of the CDC's area of 
operations.
    The comments were generally supportive of this change but several 
expressed concerns regarding SBA's current requirement that a CDC's 
manager must be employed directly unless contributed by a non-profit 
affiliate of that CDC that has the economic development of the CDC's 
area of operations as one of its principal activities. This is a 
requirement currently in Sec.  120.824(a)(2) and SBA did not propose to 
change this requirement; therefore, these comments are beyond the scope 
of this rulemaking.
    Several commenters also objected to SBA's proposed deletion of the 
exception in the current Sec.  120.824(a)(1) concerning the 
circumstances under which a rural CDC may contract with another CDC for 
management services, on the basis that the exception for small rural 
CDCs is specified by the Act. SBA recognizes that section 503(e)(2) of 
the Act allows a rural CDC a waiver if it contracts with another CDC 
covering the same area. In SBA's experience this waiver provision has 
never been used. However, SBA will process all rural CDC waivers in 
accordance with the Act. Therefore, SBA added back to Sec.  120.824 as 
proposed, a paragraph (a)(2) specifically addressing rural CDCs, to 
clarify that there is no change to the status quo regarding such 
waivers for rural CDCs.
    SBA also received some comments on the changes to the proposed 
clarified options of the CDC board's role in hiring and terminating the 
CDC's manager, either as a direct employee or through a contract when 
provided by a non-profit affiliate. The comments suggested that there 
may be other ways that a CDC's manager may be hired or terminated. 
However, the board of a CDC bears the ultimate responsibility for the 
CDC and its management and SBA believes it is appropriate to expect the 
CDC's board to control these decisions. Except for the change 
discussed, SBA is publishing in the final rule Sec.  120.824 as 
proposed.
    As set forth in the proposed rule, Sec.  120.826, basic 
requirements for operating a CDC, is slightly reworded for clarity. As 
also proposed, the responsibilities currently described in Sec.  
120.827(a) are moved to this section because SBA considers them to be 
basic requirements for operating a CDC. In addition, SBA is clarifying 
that all CDCs must comply with all of the 504 Program requirements 
imposed by statute, regulation, SOP, policy and procedural notice, loan 
authorization, debenture, or any agreement between SBA and the CDC. 
Comments generally were supportive of the changes. Therefore, SBA is 
adopting Sec.  120.826, basic requirements for operating a CDC, as it 
was proposed.
    Section 120.827, other services a CDC may provide to small 
businesses, is revised to focus this section only on, and clarify what 
is meant by, ``other services'' that a CDC may provide to a small 
business, as well as describe the regulations to which the CDC will be 
subject if it does provide such other services. Comments generally were 
supportive of the changes although a few expressed concern regarding 
the deletion of the current regulation Sec.  120.827(c) which provides 
that a CDC may lend to a borrower the amount of the required borrower 
contribution. SBA had proposed to delete Sec.  120.827(c) because that 
provision is already included in Sec.  120.912, which is not being 
amended in this rule and, therefore, is redundant in this section. 
Therefore, SBA is adopting the final rule Sec.  120.827 as proposed.
    Section 120.828, minimum level of 504 loan activity and 
restrictions on portfolio concentrations, is reworded to clarify the 
minimum level of 504 loan activity a CDC must maintain. In addition, 
this section covers the requirement concerning portfolio concentrations 
currently contained in Sec.  120.827(a) and the heading to the section 
is revised accordingly. Comments were generally supportive of the 
proposed changes, although some expressed concern that CDCs with small 
portfolios may not be able to meet the portfolio concentration 
requirements. SBA considered this concern but was not persuaded since 
this requirement already exists in Sec.  120.827(a) and SBA knows of no 
CDC that has not met this requirement. Therefore, SBA is adopting the 
final rule Sec.  120.828 as proposed.
    Section 120.829, job opportunity average a CDC must maintain, 
modifies the job opportunity average a CDC must currently maintain by 
changing it to an amount specified by SBA by means of a notice 
published in the Federal Register. Currently, the average stated in 
Sec.  120.829(a) is preventing many CDCs from accepting 504 loan 
applications from small businesses for loans that would not create jobs 
but would meet other statutory 504 Program objectives, such as loans to 
increase business efficiency through technology. In addition, the 
present ratio has been in effect since 1990 and does not take into 
account the inflationary factors in the cost of land, real estate 
acquisition, construction, and machinery and equipment since that time. 
Finally, SBA is clarifying that a new CDC is permitted two years from 
the date it is certified to meet the job portfolio requirement. Several 
commenters were concerned that the change would not give SBA enough 
flexibility and would eliminate the special circumstances under which a 
CDC's portfolio could average a higher job per dollar ratio. SBA 
considered these comments but believes that the rule as proposed does 
permit flexibility. In addition, the rule has not eliminated the 
special exceptions. The only thing that will change is the means by 
which SBA changes the job opportunity average. SBA will revise the 
average periodically, based on appropriate economic factors, and will 
publish the revised average in the Federal Register as a notice, rather 
than as a regulatory change. Therefore, SBA has adopted Sec.  120.829 
in the final rule as proposed.
    Section 120.830, reports a CDC must submit, is revised to change 
the submission requirement for CDC annual reports to 180 days after the 
end of the

[[Page 57965]]

CDC's fiscal year to permit CDCs more time to provide financial 
statements with the required level of review. The final rule also 
clarifies the requirement by adding that the annual report must include 
financial statements of any affiliate or subsidiary of the CDC. In 
addition, it adds some clarifying language regarding the submission 
requirements for changes to directors or staff. Several comments 
requested that the submission requirement be increased further than the 
120 days SBA had proposed, to 180 days, due to the complicated nature 
of some audits. SBA considered these concerns and agrees that a longer 
timeframe may be necessary. Part of the reason to increase the 
timeframe is that SBA is requiring the financial statements of any 
affiliates of the CDC. Therefore, to accommodate the more complicated 
audits, the final rule provides for 180 days.
    Several commenters also expressed concern about SBA's proposed 
change that the financial statement submission includes any affiliates 
of the CDC. The current regulations define concerns as affiliates of 
each other when one concern controls or has the power to control the 
other, or a third party or parties controls or has the power to control 
both (see Sec.  121.103(a) of this chapter). SBA is the agency that 
certifies CDCs and is their sole regulatory oversight agency. As part 
of its oversight responsibilities, SBA believes that it should review 
the financial statements of those affiliates that the CDC controls or 
that may control the CDC, because such affiliates may have some control 
over the CDC's 504 Program activities even though they may not be 
involved directly in conducting those activities, or because such 
affiliates may present issues of potential conflicts of interest with 
or financial harm to the CDC. Therefore, the final rule concerning 
financial statement submission requirements adopts the rule as 
proposed.
    Several commenters also expressed concern about SBA's proposed 
requirements for a statement of personal history and other information 
to be submitted for new associates. The commenters appeared to 
suggest--incorrectly--that this is a new requirement. Section 120.830 
currently requires CDCs to submit to SBA for review and approval the 
``resumes for all new Associates and staff.'' SBA's longstanding 
procedure has been to require statements of personal history, 
fingerprint cards, and resumes for all such individuals, just as SBA 
requires for all individuals identified in the CDC's initial 
application for certification. (See SBA standard operating procedures 
50-10(4), subpart H, chapter 4, paragraph 5(d)(1).) As the sole 
regulatory oversight agency for CDCs, SBA is responsible for performing 
the necessary due diligence to assure that new associates and staff 
meet certain ethical and experience standards. Therefore, in order to 
make the rule reflective of SBA's longstanding practice, SBA is 
publishing in the final rule Sec.  120.830 as proposed.
    Section 120.835, application to expand an area of operations, is 
revised. Currently, most of the applications SBA receives are for 
expansions of a CDC's area of operations within its State of 
incorporation. The expansion request usually is for several counties in 
which there currently are one or more CDCs that include those counties 
in their areas of operations. Because the final rule establishes the 
State of incorporation as the minimum area of operations for all CDCs 
and because SBA is allowing the marketplace to determine the optimum 
number of CDCs, these types of expansion requests no longer will be 
necessary and much of the current regulatory language is no longer 
required (refer to discussion of changes to Sec.  120.802 and Sec.  
120.810). Therefore, SBA has modified the regulation to limit SBA's 
consideration of applications for expansion to only those requests by a 
CDC to expand beyond the CDC's State of incorporation either to a local 
economic area contiguous to the State in which the CDC is incorporated, 
or to an entire State contiguous to such State.
    SBA also has added the requirement that CDCs must be ALP-qualified 
before they can request either type of expansion. Several commenters 
expressed concern that this new requirement will make it more difficult 
for a CDC to expand beyond its area of operations. SBA reiterates that 
with the minimum area of operations being Statewide, there will be far 
less need for CDCs to request the right to expand because SBA believes 
that the majority of CDCs will not wish to expand beyond their own 
State. For a CDC that wishes to expand into local economic areas or 
entire States outside its State of incorporation, however, it is 
important that such CDC be of a sufficient size and at a sufficient 
level of proficiency in the 504 Program to be able to adequately cover 
territory beyond its State. SBA is concerned about, among other things, 
the CDC's portfolio size and currency, performance as a CDC, and 
whether the CDC has sufficient proficiency with loan closing (i.e., has 
a designated attorney and the necessary insurance coverage to be able 
to participate in SBA's expedited loan closing process) and that the 
CDC is knowledgeable of applicable law in other States, to be able to 
handle the additional territory without presenting an undue risk to 
SBA's overall 504 loan portfolio. For these reasons, the final rule 
requires a CDC requesting expansion of its territory beyond its State 
of incorporation to be ALP-qualified, as proposed.
    To further streamline the application process for multi-state 
expansion, SBA is deleting the requirement that a multi-state CDC have 
at least three members from each State on its board. SBA believes that 
the general membership requirements (see Sec.  120.822) and loan 
committee requirements (see Sec.  120.823) for the State into which it 
is expanding are sufficient to demonstrate the CDC's commitment to 
local economic development in that State. (To be consistent with this 
deletion in Sec.  120.835 regarding the board requirements, SBA also is 
modifying Sec.  120.823(b).) A discussion of the comments received 
regarding the minimum area of operations and local economic areas may 
be found under Sec.  120.802. SBA also received comments regarding 
multi-state CDC requirements that were not proposed for change, 
including membership and loan committee requirements, and were, 
therefore, beyond the scope of this rulemaking. They may be considered 
as part of a proposed rule at some future date. Therefore, SBA is 
publishing in the final rule Sec.  120.835 as proposed.
    Section 120.836, public notice, and opportunity for response, is 
deleted. SBA believes that the requirement is no longer needed for the 
same reasons discussed regarding Sec.  120.811. The final rule deletes 
Sec.  120.836 as proposed.
    Section 120.837, SBA decision on application for a new CDC or for 
an existing CDC to expand an area of operations, streamlines the 
process by changing the paragraph on a multi-state CDC to permit any 
unilateral authority that a CDC has in its State of incorporation to be 
carried over into the additional State in which it is approved to 
operate as a multi-state CDC and clarifying SBA's decision process. 
Comments received generally were in support of the proposed changes. 
However, several commenters suggested that the proposed changes seemed 
to have deleted the decision process for new CDCs and CDCs expanding 
into local economic areas. After reviewing the proposed rule, including 
the summary which stated that the regulation was to continue to cover 
both new CDCs and expanding CDCs, SBA agreed with the commenters and 
has modified the rule. SBA reviewed the proposed rule and determined 
that

[[Page 57966]]

while SBA had stated in the preamble that the regulation was to 
continue to cover SBA's decision with respect to new CDCs, CDCs 
expanding into local economic areas, and CDCs becoming multi-state 
CDCs, the proposed revision to the heading of the section was 
misleading. SBA therefore makes clarifying changes to both the heading 
and to Sec.  120.837(b). Also the commenters found the reference to the 
enforcement regulations not applying in these cases to be confusing. 
SBA has deleted the reference to the enforcement regulations, 
Sec. Sec.  120.855 through 120.857, for the same reasons discussed 
regarding Sec.  120.810.
    Section 120.838, expiration of existing, temporary expansions, was 
a short-term regulation to manage the conversion of existing temporary 
expansions into permanent expansions by March 1, 1996, and is no longer 
required. Comments received generally supported the proposed deletion 
of this regulation. Therefore, the final rule adopts the deletion of 
the regulation as was proposed.
    Section 120.839, case-by-case extensions, gives a district office 
the authority to make all decisions concerning whether SBA will allow a 
CDC to make a 504 Loan outside of its area of operations (other than 
multi-state or local economic area expansions), and adds, as a new 
basis for such decision, the situation in which a State may not have a 
CDC. (For example, currently Alaska has no CDC.) In addition, SBA is 
deleting as a basis for such decision, the situation in which specific 
circumstances exist that prevent an existing CDC serving that area from 
adequately assisting the business (see Sec.  120.839(a)(2)), because 
the exception has never been used and SBA's experience indicates that 
it is unnecessary. Comments received by SBA generally supported the 
proposed changes. Some commenters wanted the regulation to emphasize 
that the applicant CDC must demonstrate that it can properly service 
the 504 loan it wishes to make outside its area of operations, in 
addition to fulfilling its other 504 Program responsibilities for the 
504 loan. Section 120.839(b) currently has this specific requirement, 
although SBA had proposed to expand this beyond just servicing. SBA 
agrees with this concern and is adding language back to the final rule 
that emphasizes a CDC's servicing responsibilities regarding the loan. 
Other commenters expressed concern that a small business may be 
prevented from receiving a 504 loan if CDCs covering the area are not 
willing to consider an application from such a business and, therefore, 
urged SBA to preserve existing Sec.  120.839(a)(2). However, as SBA 
explained in the proposed rule, SBA's experience indicates that this 
provision is unnecessary since it has never been used. In addition, the 
change in the minimum area of operations will vastly increase many 
CDC's area of operations, resulting in less need for case-by-case 
exceptions in general since small businesses will have expanded access 
to and choices among CDCs. Therefore, Sec.  120.839 is adopted as 
proposed except for the modifications discussed.
    SBA substantially revises Sec.  120.840, accredited lenders program 
to describe the ALP, the benefits a CDC will receive through the ALP, 
how to apply for the ALP, and how SBA will process the application. 
Comments received generally were supportive of the proposed change, 
although several expressed concern that the section does not 
specifically state that a CDC may seek renewal of its ALP status every 
two years. Even though in SBA's experience CDCs have routinely been 
renewed for consecutive two-year periods, SBA is modifying the 
regulation to state ``periods'' rather than the singular ``period''. In 
addition, SBA has deleted the reference to the enforcement regulations, 
Sec. Sec.  120.855 through 120.857, for the same reasons discussed 
regarding Sec.  120.810. This rule adopts Sec.  120.840 as proposed 
except for the modifications discussed.
    In Sec.  120.841, SBA is establishing more detailed qualifications 
for the ALP. The standards are consistent with section 507 of the Act 
and coordinate with eligibility requirements for CDC participation in 
the PCLP (see Sec.  120.845 discussion below). These changes will make 
it easier for SBA to provide consistent and objective evaluation of a 
CDC application to participate in the ALP.
    Several commenters asked for additional clarity regarding the 
qualification requirements of the CDC's staff. In light of those 
comments, SBA reviewed the proposed rule and agreed there should not be 
two sections on CDC staff qualification requirements. Accordingly, SBA 
has consolidated the two paragraphs regarding staff experience into one 
paragraph as well as added some clarifying language.
    SBA received several comments pointing out that the PCLP 
regulations permit some flexibility in SBA's determination of whether a 
CDC is in compliance with 504 Program requirements by introducing the 
concept of ``substantially,'' whereas the ALP regulations do not. Since 
one of the requirements to be a PCLP CDC is to qualify as an ALP CDC, 
it would be inconsistent to not permit the same flexibility in the ALP 
regulations. Therefore, SBA has modified this section to apply the 
concept of ``substantially'' to compliance with ALP requirements as 
well.
    SBA received several comments regarding proposed Sec.  120.841(d) 
which indicated that a CDC must meet SBA's CDC portfolio benchmarks. 
The comments raised concerns regarding the accuracy of the benchmarks 
and alleged that the benchmarks were not developed through a public 
comment process. Several comments also stated that use of the 
benchmarks would not be fair, to the extent that a CDC's default rate 
was derived from loans that are approved by SBA or to the extent that a 
CDC's loss rate was derived from liquidation and debt-collection 
litigation that was handled by SBA or the Department of Justice. Since 
these actions were not subject to the control of the CDC, the comments 
contended, it would be unfair for SBA to consider the CDC to be not in 
compliance with 504 Program requirements based on the relevant 
benchmark score. These comments recommended that SBA either delete or 
modify the language regarding the portfolio benchmarks in Sec.  
120.841(d). Several commenters questioned SBA's authority to establish 
portfolio performance benchmarks in the first instance.
    SBA strongly disagrees with those comments. SBA has responsibility, 
as 100% guarantor of each debenture issued by CDCs and as the sole 
regulatory oversight agency for CDCs, to protect the safety and 
soundness of the 504 Program. CDCs are established by SBA, with the 
responsibility to identify and approve only those 504 loans that are 
eligible, creditworthy, sufficiently collateralized, and have a 
reasonable expectation, based on the CDC's thorough financial analysis, 
of timely repayment. CDCs also are required to close 504 loans in 
compliance with SBA's loan authorization and other requirements. CDCs 
also must adequately service loans. While SBA may retain the right to 
review some aspects of the CDC's approval, closing, and servicing 
activities (depending on the status of the CDC), this review does not 
negate the CDC's responsibility to comply with 504 Program requirements 
and act in a prudent, commercially reasonable manner with respect to 
these activities. SBA may have a greater degree of control over 504 
loan liquidation activities, depending on the status of the CDC, but 
the amount of loan recoveries during liquidation depends to a great 
degree on the initial

[[Page 57967]]

underwriting and subsequent servicing decisions made by the CDC.
    In order to more effectively fulfill SBA's responsibility to 
monitor and oversee CDCs' activities, several years ago SBA established 
a means of collecting 504 loan performance information for each CDC, in 
five areas: Currency, delinquency, default, liquidation, and loss. SBA 
then used this information to determine the level (benchmark) of 
performance that SBA considers to present an acceptable level of risk 
to SBA's overall 504 loan portfolio for each of the five areas. 
Beginning in 1999, SBA issued a series of notices informing CDCs about 
this CDC performance information system, identified where the 
information regarding each CDC's performance was available, and 
advising CDCs that SBA would be using the system to evaluate each CDC. 
In addition to the notices, SBA explained to the CDC community the 
system and the sources of information used in the system, at several 
national conferences as well as by providing information on SBA's 
internet website. Thus, the proposed rule was not the first time CDCs 
received notice about the benchmarks. SBA believes that evaluating the 
performance of each CDC is an essential part of SBA's overall 
responsibility to manage the 504 Program so as to minimize the 
financial risk to the taxpayers.
    Several comments attempted to show that the benchmarks were not 
accurate, relying on the argument that SBA has altered its measure of 
the 504 Program subsidy rate over the past decade (although the 
comments did not clarify how this measure has any direct application to 
the benchmark scores). However, SBA finds it highly significant that 
not one comment identified a specific case where the portfolio 
performance scores for a particular CDC were found to be inaccurate. 
SBA provides CDCs with their benchmark scores on a monthly basis (the 
scores soon will be available to CDCs directly through the Internet 
rather than through their district offices), and in those few cases 
where CDCs have brought to SBA's attention concerns about the accuracy 
of a particular benchmark score SBA has consistently worked with the 
CDC to understand the basis for the concern and make any necessary 
corrections. Thus, SBA believes the benchmarks overall are accurate and 
are a reliable means of measuring a CDC's performance, particularly 
because all CDCs are subject to the same criteria and because 
individual CDCs are measured against other CDCs in their tier with 
similar portfolio sizes.
    In the context of a specific finding by SBA, relying on a CDC's 
portfolio benchmark score as evidence that the CDC was not in 
compliance with 504 Program requirements, the CDC, having access to its 
score and having its own information about the performance of its loan 
portfolio, would be able to present to SBA its arguments that the 
benchmark score was inaccurate and SBA would carefully consider those 
comments before proceeding to take any action using the score as 
evidence in support of such action.
    SBA has considered the comments concerning the portfolio benchmarks 
in Sec.  120.841(d) in the proposed rule, and in the final rule 
modifies this section so it will be consistent with Sec.  120.854(d), 
which addresses a CDC's failure to meet one or more portfolio 
benchmarks as evidence of its failure to perform underwriting, closing, 
servicing, liquidation, litigation, or other actions with respect to 
504 loans in a commercially unreasonable or imprudent manner. As a 
result of this change, SBA will consider a CDC's performance on the 
portfolio benchmarks to be a measure, indicator, or evidence of how the 
CDC is complying with various 504 Program requirements.
    This final rule adopts Sec.  120.841 as proposed except as 
discussed.
    Section 120.845, premier certified lenders program, is implemented 
as proposed except for one change. SBA added the word ``substantially'' 
to Sec.  120.845(c)(1) for the reasons discussed for Sec.  120.841.
    The PCLP is now a permanent program pursuant to section 508 of the 
Act. SBA is adding considerably more detail to Sec.  120.845 and moving 
some of its revised and expanded provisions to new Sec. Sec.  120.846-
120.848. Since CDCs participating in the PCLP must be approved to 
participate under the ALP or be ``ALP qualified,'' SBA is adding some 
of the PCLP requirements to Sec.  120.841.
    The PCLP is designed to take advantage of the proven loan 
processing and servicing skills of SBA's most proficient and most 
active CDCs. It is a relatively new program (started in 1994 as a pilot 
program) with a somewhat limited operating history. Because SBA 
transfers substantial additional authority to CDCs, the PCLP carries 
potentially significant risk to SBA and the 504 Program. Therefore, SBA 
intends to closely monitor and control program implementation and 
expansion. With respect to SBA's prior review of a 504 Loan at the loan 
approval stage, SBA is interested in limiting/minimizing its 
involvement in reviewing 504 Loans made by PCLP CDCs. While, initially, 
SBA expects to continue to review loan eligibility while delegating 
virtually all credit decisions to PCLP CDCs, SBA will consider 
expanding or reducing that authority as warranted by the results of the 
program.
    Participation in the PCLP, pursuant to section 508(b) of the Act, 
is limited to those CDCs that are active in the 504 Program; are in 
good standing with SBA; have demonstrated the ability to properly 
analyze, close and service 504 Loans; and have been active as ALP CDCs. 
Section 508(b)(2)(A) of the Act allows SBA to waive the requirement for 
those non-ALP CDCs that meet the ALP participation criteria. However, 
rather than developing a waiver process, SBA is incorporating the ALP 
participation criteria into the PCLP participation criteria (see Sec.  
120.845(c)(1)).
    Based on the guidance in the statute, and following extensive 
discussion with the CDC industry, SBA developed more specific factors 
to be used in evaluating a CDC's level of activity; ability to properly 
analyze, close, service and liquidate 504 Loans; and good standing. 
Each factor represents a major and essential CDC function, and each 
carries significant risk to SBA and the 504 Program. Because SBA 
delegates substantial authority and autonomy to PCLP CDCs, it considers 
each factor important, and a substantive deficiency in any one may 
preclude participation in the PCLP. SBA will use information from 
onsite compliance reviews, operational reviews and other program 
management and oversight activities to make the determination regarding 
eligibility for PCLP status.
    Congress, SBA and the CDC industry recognize that the success of 
the PCLP is highly dependent on the extent to which PCLP CDCs are 
familiar with SBA's credit and eligibility standards and its loan 
processing, closing, servicing and liquidation policies and procedures. 
These policies and procedures are highly complex and require processing 
a substantial volume of 504 Loans over an extended period of time to 
remain proficient. Also, SBA needs access to a significant number of a 
CDC's loans to evaluate its proficiency. SBA notes that ALP its 
participants must have processed at least twenty 504 Loans in the most 
recent three years (see Sec.  120.841(b)). When considering the minimum 
504 Loan volume requirement for participation in the PCLP, SBA 
considered the concern of smaller and rural CDCs that a high minimum 
504 Loan volume requirement could exclude them from being a PCLP CDC. 
SBA discussed those concerns with the CDC

[[Page 57968]]

industry and concluded that proficiency in 504 Loan policies and 
procedures can only be developed and maintained from regularly 
processing a significant number of 504 Loans. In addition, one of the 
main purposes of the PCLP was to improve the efficiency and expedite 
the loan processing of higher volume CDCs, which were being 
disproportionately impacted by the longer turn-around time in SBA's 
district offices. Also, for low volume CDCs, any potential efficiency 
benefits from participating in the PCLP would more than likely be 
offset by the cost and effort required to develop and maintain the high 
level of 504 Loan proficiency required in a staff that rarely processes 
an SBA 504 Loan. (About half of all CDCs process less than six 504 Loan 
applications per year.) After considering these issues, SBA proposes to 
require that ALP and PCLP applicants must have received approval for at 
least 20 504 loans in the most recent three years and have a portfolio 
of at least 30 active 504 loans. (SBA defines an ``active'' 504 Loan as 
a loan that was approved and closed by the CDC and has a status of 
either current, delinquent, or in liquidation.)
    To assist in determining the proficiency of a PCLP applicant to 
effectively process and administer 504 Loans, SBA is requiring that 
SBA-conducted oversight reviews of a PCLP applicant must have found the 
applicant to be substantially in compliance with SBA's regulations, 
policies and procedures. In addition, SBA will need to assess the 
applicant's current proficiency, so these reviews must be relatively 
recent (within the past 12 months). While SBA has policy and procedural 
guidance in place generally requiring annual SBA oversight review, CDCs 
may occasionally request a postponement of those reviews. Applicants to 
the PCLP must recognize the need for current SBA review data and 
coordinate with their Lead SBA Office to ensure that the CDC is 
available and prepared for any required oversight reviews.
    SBA has developed comprehensive management information systems to 
timely track and analyze the performance of a CDC's 504 Loan portfolio. 
As a result of an extensive examination and analysis of these 
performance data, SBA has determined that portfolio currency, 
delinquency, default, liquidation and loss rates are important measures 
of the quality of a CDC's portfolio and the effectiveness and diligence 
of its loan analysis, closing and servicing. Therefore, SBA has 
established benchmarks for each of these measures and SBA will use such 
portfolio benchmarks as an indication or measure of the CDC's 
compliance with 504 program requirements.
    SBA and the CDC industry recognize that the training and experience 
of the PCLP applicant's staff are critical determinants of the quality 
and effectiveness of its 504 Loan program administration as well as its 
diligence in applying SBA's 504 Loan credit and eligibility standards. 
As a result, the CDC industry has developed appropriate credit, 
packaging, loan closing and loan servicing training programs, which the 
staff of many CDCs attend. As a result, SBA is requiring that the 
principal staff of PCLP applicants possess adequate 504 Loan training 
and experience.
    Under the PCLP, SBA delegates authority and a certain level of 
autonomy to PCLP CDCs to process, close and service 504 Loans with only 
limited prior SBA review. As a result, SBA is requiring that applicants 
to the PCLP must demonstrate a particularly thorough understanding of 
and an applied diligence to SBA's 504 Loan credit and eligibility 
standards and its 504 Loan processing, closing and servicing policies 
and procedures. A failure to consistently apply appropriate credit 
analyses and standards and loan processing, closing and servicing 
policies or procedures exposes SBA and the taxpayer to excessive risk 
of loss and negatively impacts the availability of SBA financing to the 
small business community. A CDC's failure to adequately apply SBA's 504 
Loan eligibility standards could result in 504 Loan approvals to small 
businesses that are expressly prohibited by statute or regulation from 
receiving SBA loans.
    Section 508(b)(2)(A) requires that PCLP CDCs be in good standing 
with SBA. SBA interprets that requirement to mean both in good standing 
with the State in which the CDC is incorporated (as discussed in Sec.  
120.820), and in substantial compliance with the 504 Program 
requirements imposed by statute, regulation, SOP, policy and procedural 
notice, loan authorization, debenture, or any agreement between SBA and 
the CDC. Under the PCLP, due to the higher level of authority delegated 
to the PCLP CDCs and the potential risk to the Agency, SBA expects a 
significantly higher level of compliance with both of these 
requirements by PCLP CDCs.
    The Lead SBA Office will consider the CDC's initial application to 
the PCLP, and will forward the application package, including a 
recommendation regarding the applicant's qualifications, to SBA's PCLP 
Processing Center, which then will forward the package with its 
recommendation to the AA/FA for final action. PCLP applicants are 
expected to coordinate with their Lead SBA Office early in their 
consideration of the PCLP to realistically assess its program 
requirements and their prospects for admission. When officially 
applying for the PCLP, an applicant will need to provide certain 
essential information and documentation to assist SBA in ascertaining 
its qualifications, including a resolution from its Boards of 
Directors; resumes on key staff for 504 Loan processing, servicing, 
liquidation, and litigation; documentation of any required insurance; 
and information about the qualifications of its closing attorney. While 
SBA will generally confer PCLP status for a period of two years, under 
appropriate conditions SBA may approve a lesser period.
    Section 120.846, requirements for maintaining and renewing PCLP 
status, is added. Pursuant to section 508(b)(3) of the Act, in order to 
retain its PCLP status, a PCLP CDC must continue to meet the 
eligibility requirements of the PCLP, as described in Sec.  120.845. 
While level of activity is one of those criteria, section 508(i) of the 
Act requires that PCLP CDCs establish a goal of processing a minimum of 
50 percent of their 504 Loan applications using PCLP procedures. SBA 
considered establishing a requirement that PCLP CDCs process at least 
30 percent of their 504 Loans using PCLP procedures immediately after 
becoming a PCLP CDC and gradually increasing that requirement as the 
PCLP CDC matures. However, following discussions with the CDC industry, 
SBA determined that immediately establishing such an absolute minimum 
could discourage participation in what is a developing program with a 
variety of relatively new concepts and procedures. Nevertheless, SBA 
recognizes that the legislation authorizing PCLP mandates that PCLP 
CDCs be active CDC lenders and establish a goal of processing a minimum 
of 50 percent of their 504 Loans using PCLP procedures. As a result, 
while SBA still expects PCLP CDCs to process a substantial proportion 
of their 504 Loans using PCLP procedures and strive to reach their 50 
percent goal as mandated by statute, SBA is not immediately requiring 
an absolute minimum. Thus, as the PCLP matures, SBA intends to publish 
procedural guidance gradually incorporating and increasing the minimum 
number and percent of 504 Loans that PCLP CDCs must process using PCLP 
procedures.
    Due to the delegation of authority under the PCLP, and the 
associated risk of loss, SBA expects PCLP CDCs to

[[Page 57969]]

develop, implement and actively monitor effective internal control 
systems and processes that will ensure continued conformance with the 
requirements of the PCLP. These systems should provide PCLP CDCs with 
early information on their performance. SBA also has developed 
management control systems to monitor individual PCLP CDCs, 
specifically the portfolio benchmark data and the management oversight 
reviews, and SBA provides this information to PCLP CDCs. With these 
internal and external control systems, SBA expects PCLP CDCs to 
constantly monitor their performance as a CDC and as a PCLP CDC and to 
be in a position to take appropriate and timely corrective action when 
necessary. Due to the risk inherent in the delegation of authority 
under the PCLP, SBA will move to timely suspend, terminate or decline 
to renew the PCLP status of PCLP CDCs that do not comply with the 
requirements of the PCLP. Significant problems with respect to 
liquidation and litigation activities by either a PCLP CDC or its 
contractor may, at SBA's option, also lead to the non-renewal of PCLP 
status.
    Section 120.847, requirements for the loan loss reserve fund, is 
implemented as proposed, except for one change as discussed below.
    To mitigate some of the potential risk of delegating additional 
authority to PCLP CDCs, pursuant to section 508(c)(1) of the Act, PCLP 
CDCs must establish and make deposits to a Loan Loss Reserve Fund 
(``LLRF''). The LLRF is a restricted account established for the 
purpose of accumulating deposits and limiting withdrawals to those SBA 
specifically authorizes. The PCLP CDC may use the deposits to reimburse 
SBA for 10 percent of any loss sustained by SBA as a result of a 
default in the payment of principal or interest on a debenture issued 
by the PCLP CDC using PCLP procedures (``PCLP debenture''). Pursuant to 
section 508(c)(3) of the Act, the LLRF must be composed of: (1) 
Segregated deposit accounts at one or more federally insured depository 
institutions subject to a collateral assignment to SBA; (2) irrevocable 
letters of credit in favor of SBA; or (3) some combination of the 
above. Due to the characteristics and cost of letters of credit, and in 
consultation with the CDC industry, SBA has determined that letters of 
credit do not currently represent a feasible option for PCLP CDCs. 
Consequently, SBA is not addressing letters of credit in this rule. 
However, SBA will continue to explore this option with the CDC 
industry, and will promulgate regulations addressing letters of credit 
to the extent this becomes a feasible option.
    Pursuant to section 508(b)(2)(c) of the Act, PCLP CDCs must 
reimburse SBA for 10 percent of any loss SBA incurs in connection with 
a default on a PCLP debenture and the regulation proposes how to 
measure SBA's loss. The statute and proposed rule also require that the 
LLRF maintain a deposit equal to one percent of the original principal 
amount of each PCLP debenture.
    The LLRF must be a deposit account with a federally insured 
depository institution selected by the PCLP CDC. Following discussions 
with the CDC industry, SBA is aware that alternative accounts and 
financial instruments may offer greater returns on the LLRF. However, 
the Act restricts LLRFs to federally insured depository institutions 
and that language as well as other applicable law greatly limit the 
investment alternatives. This rule elaborates on what constitutes a 
deposit account acceptable to SBA. Also, to simplify the administration 
of the LLRF, this rule allows PCLP CDCs to pool loss reserves in a 
single segregated account. SBA generally does not anticipate that PCLP 
CDCs will incur significant fees in connection with their LLRFs, 
although PCLP CDCs will need to be mindful of breakage fees, should 
they place funds into certificates of deposit (``CDs''). This final 
rule goes on to make clear that the PCLP CDC will be responsible for 
any fees, costs and expenses incurred in connection with the LLRF.
    Pursuant to section 508(c)(3) of the Act, any LLRF established by a 
PCLP CDC must be subject to a collateral assignment in favor of, and in 
a format acceptable to, SBA. Accordingly, a PCLP CDC must give SBA a 
first priority perfected security interest in each LLRF. The PCLP CDC 
must grant the security interest pursuant to a security agreement 
between the PCLP CDC and SBA, and the security interest must be subject 
to a control agreement between SBA, the PCLP CDC, and the applicable 
depository institution. The control agreement will include provisions 
requiring a depository institution to follow instructions from SBA 
regarding withdrawals without further consent from the PCLP CDC. The 
laws governing security interests in deposit accounts are complex, vary 
by jurisdiction, and are undergoing change. Therefore, when 
establishing an LLRF, a PCLP CDC must coordinate with the Lead SBA 
Office to develop, execute and deliver the required documentation. SBA 
field counsel will have a model control agreement, which they may need 
to modify to meet local legal requirements. This final rule provides 
that the CDC must provide to the Lead SBA office a fully executed 
original copy of the security and control agreements which the Lead SBA 
Office will retain in its files. All associated documents must meet SBA 
requirements and occasional changes may be necessary. If a depository 
institution will not enter into or modify a control agreement or 
violates the terms of any such agreement, the PCLP CDC cannot maintain 
an LLRF with that institution.
    Pursuant to section 508(c)(4) of the Act, PCLP CDCs are allowed to 
make required deposits to the LLRF associated with each loan in as many 
as three deposits, but specifies the minimum amount and timing of those 
deposits. This final rule sets forth the amount and timing of those 
deposits.
    Due to its management control and oversight responsibilities, SBA 
must ensure that LLRFs: (1) Are properly established; (2) contain the 
required reserve amounts; and (3) are appropriately administered and 
controlled. Periodic reporting by PCLP CDCs to SBA on the amount of 
funds maintained in LLRFs is critical to ensuring that LLRFs are 
properly established and maintained. However, while LLRFs must contain 
deposits equal to one percent of each PCLP debenture, the deposits 
associated with each PCLP debenture may be made in as many as three 
installments. Also, during the normal course of a PCLP CDC's 
operations, LLRFs will be subject to a variety of other deposits and 
withdrawals (e.g., withdrawals associated with loans paid in full and 
defaults). As a result, reporting and reconciling LLRFs might become 
quite complex. SBA is concerned with the potential burden such 
reporting could represent to PCLP CDCs. SBA continues to work with the 
CDC industry to develop and test efficient and effective reporting 
procedures, and will publish appropriate procedural guidance as those 
procedures are finalized.
    SBA will allow PCLP CDCs to withdraw any funds from the LLRFs that 
exceed required minimums, at SBA's discretion. Section 120.847(g) 
provides that requests for withdrawals must be forwarded to the Lead 
SBA Office, which will check the balances to ensure the required 
minimums are maintained and authorize withdrawals as appropriate.
    Section 120.847(h) provides that when a PCLP CDC has submitted a 
liquidation wrap-up report to SBA, or SBA otherwise has determined that 
all reasonable collection efforts have been exhausted, the Lead SBA 
Office will calculate the SBA's loss and notify the

[[Page 57970]]

PCLP CDC of the amount of any reimbursement obligation and provide 
appropriate supporting documentation. The final rule sets forth 
procedures so that PCLP CDCs may appeal any problems or disagreements 
regarding the calculation of SBA's loss.
    Section 120.847(i) requires PCLP CDCs to reimburse SBA for 10 
percent of any loss and states that the reimbursement may come from the 
LLRF or from other funds provided by the PCLP CDC. There could also be 
instances where a PCLP CDC would not have sufficient funds in its LLRF 
to reimburse SBA for 10 percent of SBA's loss, and the regulation 
describes the period of time by which the CDC must reimburse the 
Agency.
    Pursuant to section 508(c)(5) of the Act, the final rule requires 
that should a PCLP CDC's LLRF drop below the required minimum, the PCLP 
CDC must replenish the LLRF within 30 days of the time that it realizes 
this deficiency or of a notice from SBA that the LLRF is deficient. 
Thus, if a depository institution offsets from any LLRFs maintained 
with the institution any amounts owing by the PCLP CDC to it, the PCLP 
CDC must replenish the LLRF to the full amount then required within 30 
days. Comments received regarding these changes concerned a perceived 
inconsistency in the source of reimbursement to SBA for losses. SBA 
considered this concern and is revising Sec.  120.847 to clarify that a 
PCLP CDC may reimburse SBA for losses either from the LLRF or other 
funds.
    Section 120.848, requirements of PCLP loan processing, closing, 
servicing, liquidating and litigating, is added.
    Pursuant to section 508(e)(1) of the Act, PCLP CDCs are permitted 
to approve, authorize, close, service, and liquidate 504 Loans, subject 
to terms and conditions established by SBA. SBA's authority to 
establish such terms and conditions is limited by section 508(e)(2) of 
the Act, which states that the CDC's approval of a 504 Loan using its 
PCLP authority is subject to SBA's final approval of the PCLP debenture 
as to eligibility but that SBA as part of its approval may not review 
the creditworthiness, loan closing, and legal compliance (except with 
respect to eligibility) of the underlying 504 loan.
    Several comments objected to the proposed Sec.  120.848, including 
SBA's authority to require a PLCP CDC to process 504 Loans involving 
complex or problematic eligibility issues through SBA using standard 
loan processing procedures (Sec.  120.848(c)), or to require a PCLP CDC 
to turn over to SBA the handling of a particular PLCP loan (Sec.  
120.848(f)). These commenters suggested that SBA does not have the 
authority, under section 503(e)(2) of the Act, to require that PCLP 
CDCs take these actions. However, SBA believes that these commenters 
misinterpret the Act. SBA has specific authority under section 
508(e)(1) to establish the terms and conditions under which PCLP CDCs 
are permitted to approve, authorize, close, service, and liquidate 504 
Loans, which authority encompasses all of the terms and conditions SBA 
proposed in the proposed rule.
    Section 120.848 provides guidance on PCLP CDCs' approving, 
authorizing, closing, servicing, and liquidating 504 Loans and notes 
that all 504 Program requirements apply to 504 Loans processed by PCLP 
CDCs. Under Sec.  120.848(c), PCLP CDCs are specifically authorized to 
determine a 504 Loan applicant's credit-worthiness; to establish the 
terms and conditions under which the loan will be made; and to take 
other processing actions as may be delegated by SBA to PCLP CDCs. SBA 
believes that the PCLP can be most prudently administered if SBA 
focuses, at least initially, on expediting the processing of routine 
CDC loan applications under the PCLP and handling complex or 
problematic eligibility issues using standard 504 Loan procedures. 
However, SBA will continue to study and analyze this issue and develop 
further guidance as the PCLP progresses.
    Several comments suggested that SBA revise the requirement in Sec.  
120.848(c) that complex loan applications be processed through the Lead 
SBA Office, because SBA currently is expanding its centralized 504 loan 
processing activity. SBA considered this suggestion and agreed that 
this section should be modified. Therefore, in Sec.  120.848(c) in the 
final rule, SBA deleted ``Lead SBA Office'' and added ``SBA,'' in order 
to accommodate ongoing Agency changes.
    Several comments also suggested that SBA consider permitting PCLP 
CDCs to close their own 504 loans without SBA review. SBA notes that 
under Sec.  120.848(e), a PLCP CDC is required to close PCLP loans and 
debentures under SBA's expedited loan closing procedures, which 
provides for a limited review of documents relating to the debenture, 
but does not include an entire review of the CDC's closing of the 504 
Loan underlying that debenture. This is entirely consistent with the 
Act and with the comments. SBA did not propose to modify SBA's current 
practice, in which SBA shares with the PCLP CDC joint responsibility 
for closing the PLCP debenture. Refer to the discussion of Sec.  
120.960, responsibility for closing, for further discussion of SBA's 
reasons for not changing this current practice.
    Several commenters also suggested that PLCP CDCs be permitted to 
make eligibility determinations which involve franchise issues and 
issues of potential environmental hazards and liability with respect to 
the project property collateral, independently and without SBA's 
review. SBA considered these suggestions but implements the proposed 
rule without change on this issue. These are important issues that 
relate to the eligibility for 504 loan financing of the borrower and of 
the project itself, and SBA has the authority under section 508(e)(2) 
of the Act to review and approve eligibility issues. Accordingly, SBA 
implements Sec.  120.484 as proposed except as discussed.
    With respect to Sec.  120.848(b), SBA's management control and 
oversight responsibilities require a systematic review of a PCLP CDC's 
504 loan processing proficiency. As a result, SBA must periodically 
review the processing actions of PCLP CDCs to ensure the PCLP CDC is 
using appropriate and reasonable procedures. PCLP CDCs are thus 
expected to retain in their loan files copies of all documents 
associated with their processing actions. SBA may occasionally review 
these documents on site or request that they be forwarded to SBA for 
review. If SBA identifies significant problems or deviations from SBA's 
504 Program requirements, SBA will take appropriate corrective action, 
including possible removal from the PCLP.
    SBA is deleting Sec. Sec.  120.850-120.852, concerning ADCs, to 
eliminate the ADC designation. The reasons are twofold. First, SBA is 
seeking to eliminate redundancy in the regulations. One aspect of the 
ADC program was that it established requirements for organizations to 
qualify to contract with CDCs for 504-related services. However, Sec.  
120.824 permits CDCs to contract for 504-related services and governs 
such contracts. Second, these regulations established one of the 
grounds (not meeting the minimum required level of 504 Loan approval 
activity) for removing a CDC from the 504 Program discussed under Sec.  
120.854. In the final rule, all grounds for taking enforcement action 
against a CDC are combined under one regulation, Sec.  120.854.
    Section 120.855, CDC ethical requirements, is redesignated as Sec.  
120.851, and reworded to clarify its meaning and to remove the 
reference to ADCs (see Sec.  120.850 discussion). SBA received several 
comments on this regulation. SBA proposed to delete the ``good cause'' 
exception to the general

[[Page 57971]]

rule, that an associate of a CDC may not be an officer, director, or 
manager of more than one CDC, and the commenters requested that such an 
exception remain. SBA has considered these comments but believes that, 
in every case, a CDC should be independently managed and operated to 
pursue its own economic development mission. Further, SBA believes that 
with the new requirement that each CDC's area of operations be 
statewide, a potential for a conflict of interest exists if the same 
individual is an officer of or on the board of two CDCs. Therefore, SBA 
is adopting Sec.  120.851 as proposed.
    Section 120.852 prohibits a CDC from investing in or being 
affiliated with a 7(a) lender or an SBIC, which SBA believes will help 
to avoid apparent conflicts of interest and serve the economic 
development mission of the CDC. However, the final rule does not 
require a CDC with an existing investment in an SBIC to liquidate such 
investment. In response to the ANPRM, commenters overwhelmingly stated 
that SBA should not permit a CDC to establish a 7(a) lender or permit a 
7(a) lender to establish a CDC and that the two programs should remain 
separate. Comments in response to the proposed rule also were generally 
supportive of the separation of 7(a) lenders and CDCs. Several 
commenters suggested that there be an exception for CDCs that already 
are affiliated with State development companies that were authorized 
under section 501 of the Act that could continue to be so affiliated, 
even if the state development company is a 7(a) lender. SBA considered 
these comments and agrees to permit this exception.
    SBA also received comments regarding the proposed prohibition on a 
CDC investing in an SBIC. A typical comment opposed the prohibition on 
the basis that it would eliminate a CDC's use of the SBIC program as an 
economic development tool (without explaining why it was believed this 
would occur). SBA believes the concern is unfounded. In general, if a 
CDC has an investment in an SBIC, then the CDC would be prohibited from 
referring a 504 borrower to that SBIC for that borrower's venture 
capital requirements. By contrast, by prohibiting a CDC itself from 
having an investment in an SBIC, the CDC will be free to refer its 
borrowers to the SBIC for venture capital, thus increasing the 
borrowers's access to capital. Other comments requested that the 
regulation be modified to be consistent with the preamble to the 
proposed rule, which SBA stated that the Agency would not require a CDC 
with an existing investment in an SBIC to liquidate such investment. 
SBA has considered this comment and agrees that the final rule should 
be modified to reflect this exception. This rule adopts Sec.  120.882 
as it was published in the proposed rule except as discussed.
    Section 120.853 is identical to existing Sec.  120.973 except that 
it would eliminate references to ADCs.
    New Sec.  120.854, grounds for taking enforcement action against a 
CDC, Sec.  120.855, types of enforcement actions, and Sec.  120.856, 
enforcement procedures, consolidate existing Sec.  120.852 and 
Sec. Sec.  120.982-120.984. These provisions also clarify and expand 
the grounds required for SBA enforcement actions against CDCs as well 
as SBA's and CDCs' rights and responsibilities in such actions. Section 
120.981, voluntary transfer and surrender of CDC certification, is 
redesignated as Sec.  120.857 to move it under the new heading entitled 
Enforcement Actions.
    SBA received numerous comments regarding SBA's proposed changes to 
its enforcement procedures. Several comments expressed concern that SBA 
officials would abuse the authority provided by the enforcement 
regulations to unfairly penalize or control CDCs. Thus, one comment 
expressed concern that the regulations ``can be open to wide 
interpretation by any SBA official at either the local or national 
level.'' Another comment stated that the enforcement provisions are 
``an attempt to give SBA personnel effective operating control of all 
CDCs'' and that ``[t]hrough the guise of oversight and evaluation SBA 
officials are attempting to create a web of regulations, which would 
enable a vindictive official to manipulate every action of a CDC under 
threat of suspension or termination.''
    These comments reflect considerable misunderstanding of the 
regulations and how SBA typically conducts enforcement actions. SBA's 
actions reflect numerous layers of careful review and various controls 
in order to ensure that all facts and relevant issues are considered. 
Notably, the regulations only authorize the AA/FA (or his or her 
authorized delegate) to undertake enforcement actions, not numerous 
agency officials. Moreover, an enforcement action usually begins with a 
recommendation from the district office, which is signed and approved 
by various officials. When the recommendation reaches SBA's 
Headquarters, it is reviewed by a number of officials, as well as 
attorneys in SBA's Office of General Counsel prior to the initiation of 
any proposed action. After a notice of proposed action is sent to the 
program participant, any response from the participant is given 
considerable analysis by numerous SBA officials and attorneys and a 
consensus is attained as to whether to proceed with a final enforcement 
action. This carefully considered process should allay any concerns. 
Nevertheless, SBA's responsibility for managing the 504 Program 
requires that the Agency have a wide range of enforcement options 
available and considerable flexibility in implementing these actions. 
Moreover, SBA's revision of the enforcement regulations is a direct 
response to problems that SBA has encountered under the current 
regulations in dealing with CDCs that have repeatedly failed to comply 
with SBA rules and regulations or which have willfully failed to comply 
with SBA efforts to require compliance with regulations and other 
requirements. Thus, SBA disagrees with those comments that sought to 
retain the current enforcement regulations without change.
    Several comments noted that the Act already prescribes the grounds 
for enforcement actions to suspend or revoke an ALP CDC or a PCLP CDC's 
ability to participate in these programs, and, therefore, that the 
proposed enforcement provisions as they relate to an ALP CDC or PCLP 
CDC were inconsistent with the statute.
    SBA inadvertently consolidated the grounds for such enforcement 
actions with the general enforcement provisions in the proposed rule, 
and agrees that the Act sets forth grounds (but not procedures) for the 
suspension or termination (which the statute refers to as a revocation) 
of a CDC's authority to act as an ALP CDC or PCLP CDC. Consequently, 
SBA has made minor revisions to Sec. Sec.  120.854 to include, verbatim 
as set forth in the Act, the grounds for such enforcement actions in 
new paragraphs (b) and (c), and has made conforming technical changes 
to Sec.  120.855. Although these grounds for enforcement were not 
included in the proposed rule, the final rule simply incorporates 
statutory language, which SBA does not have discretion to modify, and 
makes conforming technical changes to the proposed rule.
    In the final rule, all grounds for taking enforcement action 
against a CDC are combined under one regulation, Sec.  120.854. SBA 
received some comments that asked whether Sec.  120.854(b) would be 
applied retroactively. Section 120.180, however, currently provides for 
prospective application of any new regulations under Part 120, and this 
regulation has not been amended by this final rule.
    Some comments suggested that the word ``knowingly'' be inserted 
into Sec.  120.854(c) to establish intent. SBA considered this concern 
but has

[[Page 57972]]

declined to adopt it because it is based on a faulty legal premise, and 
because it would unduly burden the Agency's enforcement authority. 
Contrary to the assertion that misrepresentation is ``tantamount to 
civil fraud or deceit'', as several comments contended, the concept of 
negligent misrepresentation is well established in the law. See, e.g., 
First National Bank, Henrietta v. SBA, 429 F.2d 280 (5th Cir. 1970).
    SBA emphasizes that the regulation authorizes enforcement action 
only if a CDC misrepresents or fails to disclose ``material'' 
information, which would include important information that the CDC 
would have reason to know the Agency was relying upon in making a 
decision about a loan or the CDC's participation in the Program. An 
example of such information would include a CDC's misrepresentation of 
or failure to disclose information in its annual report to SBA that, if 
accurately disclosed, would show that the CDC was in violation of SBA 
rules or regulations. Similarly, a CDC that was seeking authority from 
SBA to issue a 504 debenture and failed to disclose a significant 
adverse change in the borrower's financial condition that was known to 
the CDC would have failed to disclose a material fact.
    As to such critical facts, the Agency believes that CDCs have an 
obligation to exercise diligence to ensure that they provide accurate 
information to SBA that the CDC knows, or should know, that the Agency 
is relying upon. Under egregious circumstances, enforcement action may 
be appropriate if a CDC negligently fails to do so, and SBA needs the 
flexibility to be able to undertake enforcement action without the 
unwarranted burden of having to prove that the CDC intended to deceive 
the Agency. If a CDC's misrepresentation or failure to disclose 
material was a result of inadvertence, the CDC will have the 
opportunity to explain this in responding to any proposed enforcement 
action. In doing so, however, SBA expects that the CDC would discuss 
the quality control measures it had implemented to prevent transmission 
of inaccurate or less than thorough information to the Agency. SBA 
will, thus, consider the ``intent'' of the CDC as part of its 
determination of whether to proceed with a proposed enforcement action.
    A concern was raised regarding the use of the word ``material'' in 
Sec.  120.854(c) because this term was considered to be too subjective 
and would ``open the likelihood for abuse and retaliation by the 
Agency.'' SBA has considered this comment but believes that the term 
should be retained in the final rule for several reasons. First, use of 
the word ``material'' is important in that SBA is making it clear that 
trivial infractions will not trigger an enforcement action under Sec.  
120.854(c). Thus, contrary to the comment's suggestion that the word 
``material'' could increase the risk of unfounded enforcement actions 
against a CDC, the intent of the Agency in using this word is just the 
opposite. At the same time, SBA believes that needed flexibility in 
applying its 504 Program enforcement procedures is retained through the 
word ``material''. SBA notes that this term has been employed as 
longstanding policy with respect to denials of loan guarantees under 
the 7(a) Program under Sec.  120.524. Thus, SBA believes it is 
appropriate to retain this word in the final rule.
    Several comments were received regarding language in proposed Sec.  
120.854(d) that evidence of CDC improper actions could include the 
CDC's failure to meet one or more of the portfolio benchmarks 
established by SBA to measure a CDC's portfolio performance. Many of 
these comments raised similar concerns regarding the accuracy or lack 
of public adoption of the benchmarks that were discussed above, which 
SBA has considered and rejected.
    Moreover, these comments appear to be based on the erroneous belief 
that an SBA enforcement action could proceed solely upon a CDC's 
failure to meet a portfolio benchmark. The regulation provides that 
benchmark performance is merely supporting evidence that a ``CDC is not 
performing underwriting, closing, servicing, liquidation, litigation, 
or other actions with respect to 504 loans in a commercially 
unreasonable or imprudent manner.'' SBA has made a minor revision to 
the second sentence of Sec.  120.854(d) to emphasize this regulatory 
interpretation.
    The need to show that a CDC's actions were imprudent or 
commercially unreasonable would also preclude SBA from being able to 
bring an enforcement action using the CDC's benchmark performance if 
the CDC could show that the performance score was directly related to 
SBA's approval or liquidation of 504 loans, and not the CDC's actions. 
Thus, SBA disagrees with those comments which asserted that the 
provision could be used to bring an enforcement action against a CDC 
for actions that were beyond its control.
    In the context of a specific enforcement action that was relying on 
a CDC's benchmark score as evidence of that CDC's imprudence or 
commercial unreasonableness, the CDC, having access to the score, as 
discussed above, and having its own information about the performance 
of its loan portfolio, would be able to present SBA with arguments that 
the benchmark score was inaccurate in its opposition to the enforcement 
action. SBA would carefully consider those comments before proceeding 
with any enforcement action.
    Other comments requested that SBA modify Sec.  120.854(e) to 
clarify that an agency notification of deficiency to a CDC include a 
request to take corrective action if appropriate. SBA considered this 
concern, agrees with the comments, and is modifying the rule 
accordingly so that an agency notice of deficiency also include a 
request for corrective action if appropriate. SBA also agrees with, and 
has modified Sec.  120.854(e) to address, those comments that stated 
that it would be fair to provide the CDC with a reasonable period of 
time to cure the deficiency. The Agency disagrees, however, with 
comments that a specified time for a cure should be provided because 
SBA needs flexibility in determining the appropriate cure period 
depending upon the facts of each situation. SBA further disagrees with 
comments suggesting that a notice of deficiency must describe with 
specificity the corrective action that is needed rather than simply 
requiring it to be corrected. Although SBA may suggest the type of 
corrective action that is needed, it will generally be the CDC, with 
the knowledge of its own operations and portfolio, that will be in the 
best position to make the judgment as to how best to correct a 
deficiency.
    Comments objected to proposed language in Sec.  120.854(f) that 
would permit SBA to initiate enforcement action based upon a CDC's 
``pattern of uncooperative behavior or an action that SBA determines is 
``deleterious to the 504 program'' or that ``undermines SBA's 
administration of the 504 program'' or that was ``not consistent with 
standards of good conduct.'' Generally, the comments expressed concern 
that these provisions were ambiguous and subject to subjective 
interpretation. The terms are so broad, one comment opined, so ``as to 
render it useless in determining what the SBA means and what is 
expected of the CDC'' and allows SBA ``to decertify a CDC simply for 
convenience,'' and without just cause or due process.
    SBA has considered these comments but believes that the provisions 
should be retained in order to preserve needed and justifiable 
flexibility in administering the 504 program, as discussed above. It 
has been the Agency's experience in dealing with enforcement actions in 
the past that it

[[Page 57973]]

is imperative to have the type of catchall provision embodied by Sec.  
120.854(f) in order to have effective management tools available in the 
event that a program participant is engaging in ``a pattern of 
uncooperative behavior'' or has taken other action that warrants some 
enforcement action, but which does not squarely fit within the specific 
grounds identified in a regulation as a basis for enforcement.
    Although SBA retained these provisions, the Agency is sensitive to 
those comments that CDCs would not be on notice of what behavior was 
expected by these regulations. SBA believes that the appropriate 
resolution of these concerns is to provide additional procedural 
protection to CDCs. Therefore, SBA has added language to Sec.  
120.854(f) that would ensure that SBA could only propose enforcement 
action based on Sec.  120.854(f) after the Agency had: (1) Provided 
written notice to the CDC explaining why the CDC's actions were 
uncooperative, not good conduct, or undermined SBA's management of the 
program and that the CDC's actions could give rise to an enforcement 
action; and (2) providing the CDC with a reasonable time to cure the 
deficiency. This change reasonably addresses all of the comments that 
objected to these provisions.
    Several comments objected to the enforcement actions authorized 
under Sec.  120.855. Thus, concerns were expressed about the language 
in Sec.  120.855(a) that the AA/FA or his or her delegate's decision to 
undertake enforcement actions ``in SBA's sole discretion'' would result 
in enforcement actions that were subjective or selective. SBA disagrees 
with the suggestion to delete this language because each enforcement 
case is different and the Agency believes that effective program 
administration requires maximum flexibility to determine the 
appropriate enforcement action appropriate for each particular action. 
SBA also believes that the due process rights that are provided by the 
regulations, including the review by the SBA OHA (which is discussed 
further below regarding Sec.  120.856) protects CDCs from arbitrary 
enforcement actions.
    Several comments objected to Sec.  120.855(a)(3) which authorizes 
SBA to direct a CDC to transfer some or all of its portfolio to another 
entity. The comments asserted that SBA should provide the CDC with a 
right to cure any deficiency prior to such a transfer. Directing a CDC 
to transfer some or all of its portfolio to another entity is an 
extreme action that would generally only be considered in egregious 
circumstances. Typically, SBA would provide a CDC with an opportunity 
to cure a deficiency before the initiation of such an action. SBA, 
however, disagrees with the proposals to mandate a cure before 
initiating such an enforcement action because there may be 
circumstances where the opportunity to cure would not be possible, and 
SBA's administration of the program would be unnecessarily restricted 
by a mandatory cure opportunity prior to enforcement. For example, if a 
CDC was terminated from the program due to regulatory violations, a 
cure of these violations may not be possible. In such a case, SBA needs 
the authority to be able to direct the transfer of that CDC's portfolio 
to another entity without the requirement of providing the CDC with a 
cure opportunity.
    SBA also disagrees with the comments which objected to the Agency's 
authority to direct the transfer of 504 loans to entities other than 
SBA or a CDC on the ground that transfer to banks and other for-profit 
entities was contrary to the public or program's interest. Although it 
would be SBA's clear preference that 504 loans be transferred to a CDC, 
there may be occasions where no other responsible CDC exists for such a 
transfer. SBA requires the flexibility to direct a portfolio transfer 
in the manner that the Agency believes is in the best interests of the 
program. Generally, however, it is anticipated that a transfer to an 
entity other than a CDC would be temporary until another responsible 
CDC was available.
    Many comments objected to Sec.  120.855(a)(4), which allows SBA to 
direct the Central Servicing Agent (CSA) to suspend payment of fees to 
a CDC and to direct the CSA to submit those fees to SBA to pay for any 
financial loss resulting from a CDC's imprudence, commercial 
unreasonableness or failure to comply with an SBA requirement. SBA has 
agreed to eliminate the provisions allowing for payment of the fees to 
the Agency to compensate for financial loss because it would like to 
study this issue further. SBA, however, has retained in the final rule 
the language allowing the suspension of fee payments to the CDC as an 
enforcement tool in the absence of any significant comments on this 
proposal.
    A number of concerns were raised regarding Sec.  120.856, which 
sets forth procedures for proposing and undertaking enforcement 
actions, and the affected CDC's due process and appellate rights. As 
discussed below, SBA has revised this section to address several of the 
comments the Agency received. These changes have also necessitated a 
renumbering of the subsections in Sec.  120.856.
    Several comments contended that Sec.  120.856(a) should require SBA 
to provide details of the reasons behind a proposed enforcement action. 
SBA agrees with this proposal and has added language to make clear that 
the underlying facts and reasons for the proposed action should be 
reasonably detailed.
    SBA received a number of comments regarding Sec.  120.856(c) [now 
renumbered as Sec.  120.856(b)], which sets forth the CDC's right to 
respond to a notice of proposed enforcement action or to a notice of 
immediate suspension. Several comments requested that the provision 
should specify that the period for the CDC to respond to a notice 
should be fixed at 30 days; others felt that the CDC should be given 60 
days to respond. SBA disagrees with these comments because the Agency 
believes that 30 days is a sufficient amount of time, and that the 
Agency must retain the flexibility to permit a greater or lesser amount 
of time for a response to accommodate the unique circumstances of each 
enforcement action. SBA has, however, added language that a CDC may 
request additional time if it can show that there are compelling 
reasons why it is not able to respond within the 30-day timeframe.
    SBA does, however, agree with those comments that urged that a 
CDC's 30-day response period should begin to run when a CDC receives 
the notice of proposed action or immediate suspension. For purposes of 
determining whether a CDC has timely responded to a notice of a 
proposed action or immediate suspension, the regulations will make 
clear that it is presumed that the notice has been received within 5 
days of the date of the notice, absent compelling evidence from the CDC 
to the contrary.
    Several comments contended that the regulations should make some or 
all of the following discovery procedures available to a CDC that 
receives a notice of a proposed action or immediate suspension: (1) The 
ability to undertake discovery; (2) the ability to review SBA's 
complete file; (3) the ability to request and review additional 
documents; (4) the ability to question SBA's employees; (5) the ability 
to obtain copies of any documentation that SBA has obtained during the 
course of its investigation before or after the CDC files its 
objection; and (6) the ability to obtain information from third 
parties. Absent these discovery procedures, the comments contended, the 
CDC would be deprived of the ability to respond meaningfully to the 
notice. In addition,

[[Page 57974]]

the comments urged, a CDC that avails itself of one or more of these 
discovery procedures should have additional time to respond to the 
notice of proposed enforcement action or immediate suspension or be 
able to make additional submissions to SBA beyond the initial objection 
in opposition to the enforcement action.
    The SBA does not believe that these discovery procedures are 
necessary to provide the CDC with meaningful review or appropriate for 
the enforcement action set forth in Sec. Sec.  120.854-120.857. The 
existing procedures already provide for a meaningful review, in that 
the CDC will receive a written notice setting forth the proposed 
enforcement action or immediate suspension and a reasonably detailed 
description of the underlying facts and reasons for SBA's proposed 
action or immediate suspension, and will have the opportunity to submit 
its objections and opposition to that notice. A second review is then 
undertaken by the Agency prior to the final decision, and the CDC has 
further relief in seeking review from the OHA and ultimately the 
courts. The requested discovery procedures will likely serve to delay 
and frustrate SBA efforts to undertake enforcement necessary for 
effective program management, and result in considerable additional 
burden on limited Agency resources in responding to the requested 
discovery. Indeed, it has been the Agency's experience in attempting 
enforcement actions in the past that certain CDCs have attempted to 
repeatedly delay those efforts.
    Further, it is SBA's experience that enforcement actions are 
typically based on documentation and information that is already 
available or known to the CDC, e.g., loan documentation, the CDC's 
annual report, or correspondence between the CDC and SBA. Thus, the 
requested discovery procedures are generally not necessary. 
Nevertheless, SBA does recognize that if an enforcement action is based 
on information derived from a third party, i.e. a party other than SBA 
or a CDC, such as a borrower, principles of fairness suggest that that 
the CDC should be provided with a copy of the relevant documentation or 
name of the third party in the event the information was oral. SBA 
recognizes also, however, that there may be occasions where there may 
be compelling reasons for not disclosing the identity of the third 
party or copies of the actual documentation, such as privilege or 
significant impairment of SBA's ability to manage the 504 Program. 
Therefore, SBA has added a new section Sec.  120.856(g) providing that 
if an enforcement action is based upon information derived from a third 
party, SBA's notice of proposed action or immediate suspension will 
provide copies of documentation received from such third party or the 
name of the third party in case of oral information unless SBA 
determines that there are compelling reasons not to provide such 
information. If compelling reasons exist, SBA will provide a summary of 
the information it received to the CDC. Finally, SBA disagrees that a 
regulation is required to allow the CDC to obtain information from 
these or other third parties because the CDC can pursue such 
information without the need for a regulation.
    Several comments asserted that Sec.  120.856(c) [now renumbered as 
Sec.  120.856(b)] should provide that a CDC which has received a notice 
of a proposed action or immediate suspension has the right to request a 
more definite statement if SBA's reasons for the proposed action were 
unclear. Inasmuch as SBA would, as a matter of course, respond to any 
legitimate request for clarification, SBA agrees to amend the 
regulation to make clear that a CDC may request clarification of a 
notice. SBA does not, however, agree with those comments that suggested 
that the regulation should be revised so that such a request for 
clarification would automatically delay the time for a CDC to respond 
to the notice. Allowing a CDC the right to postpone its response time 
based on an alleged inability to understand a notice could allow the 
CDC to improperly delay the enforcement action by seeking clarification 
where none was actually needed (and potentially filing repeated 
requests for clarification), and by waiting until the last possible 
moment to respond before seeking clarification. In addition, imposing 
an automatic delay of the CDC's response time would add considerable 
confusion to the enforcement procedures by creating uncertainty as to 
the deadline for the CDC's response. Thus, SBA has added language that 
the Agency ``may'' consider delaying the period for the CDC's response 
in the event the CDC legitimately seeks clarification or has a 
compelling basis for needing additional time to respond. The new 
language would likely preclude a CDC from delaying a request for 
clarification or additional time or improperly making such requests. If 
SBA disregarded a legitimate request for clarification or an extension 
of time and proceeded with a termination action, the CDC would have a 
right to appeal that decision before the OHA or a federal court.
    Several comments requested that section 120.856(d) [now renumbered 
as Sec.  120.856(c)] should include a deadline for SBA to issue a final 
decision on a proposed termination action. The offered rationale for 
this request was that without a deadline, the CDC would be ``in limbo'' 
for an indefinite period of time and could not pursue its rights before 
the OHA and the courts. SBA disagrees with these comments, for the most 
part. If SBA proposes an enforcement action, the CDC would not lose any 
right or authority until a final decision is made, and, therefore, 
would not experience any prejudice in the event that SBA did not 
immediately issue a final decision. Similarly, there is nothing for a 
CDC to appeal to OHA or the courts until a final decision is rendered. 
In the case of an immediate suspension under Sec.  120.855(b) [now 
renumbered as Sec.  120.856(a)(2)], however, the CDC's rights and 
authority would be affected. Therefore, for those actions, SBA agrees 
that a deadline should be imposed on the issuance of a final decision 
to avoid any undue prejudice to the CDC. Therefore, SBA has revised 
Sec.  120.856(c) to require the Agency to issue a final decision on an 
immediate suspension within 90 days of receiving the CDC's objection. 
Procedures have also been added to address this deadline in the event a 
CDC seeks clarification or additional time. In addition, SBA has 
clarified that Agency decisions must be in writing in Sec.  120.856(c).
    Although SBA did not receive any comments pertaining to Sec.  
120.856(e) [now renumbered as Sec.  120.856(d)], the Agency has 
determined through its own initiative that there is a conflict between 
this section and Sec.  120.856(f) [now renumbered as Sec.  120.856(e)]. 
Although proposed Sec.  120.856(e) provided that a decision under that 
section constitutes the final agency decision, which signifies that 
there is no further appeal within the agency, proposed Sec.  120.856(f) 
allowed for an appeal from that section to the OHA. To address this 
inconsistency, Sec.  120.856(e) has been revised to clarify that it 
only sets forth a right of appeal and appellate procedures for an 
appeal from Sec.  120.856(c).
    SBA also received a comment from the SBA OHA regarding Sec.  
120.856(f) [now renumbered as Sec.  120.856(e)] requiring the OHA 
review of the appeal of an enforcement action to be consistent with 
legal precedent developed under the arbitrary or capricious standard of 
5 U.S.C. 706 because under OHA regulations this could be construed as 
requiring that only the SBA Administrative Law Judge would hear such 
appeals. The Agency intends that Administrative Judges and

[[Page 57975]]

the Administrative Law Judge be able to hear appeals and, therefore, 
has deleted the reference to the statute. Nonetheless, SBA expects that 
OHA judges will look to legal precedent developed under the arbitrary 
and capricious standard of the APA in deciding appeals from these 
enforcement provisions.
    Many comments were received that the regulations should allow the 
SBA Office of Hearings and Appeals to have a de novo review of 
enforcement actions in Sec.  120.856(e). Several comments contended 
this review was provided under current regulation (SBA does not 
interpret the regulation as providing such review, but acknowledges 
that the current regulation is unclear). One comment stated that the 
arbitrary and capricious standard imposes such an ``excessive'' burden 
upon the CDC that ``the decision of the program office would 
necessarily be affirmed by OHA even if it was obviously wrong.''
    SBA has considered but disagrees with these contentions and has 
retained the original proposed regulations provision that the OHA 
review is limited to the arbitrary and capricious standard, a standard 
of review which is well established under the law. As previously noted, 
the fact that SBA enforcement actions are undertaken with considerable 
review and deliberation, and that numerous agency officials are 
involved in the decision, should allay those concerned about arbitrary 
decisionmaking. However, the decision to take an enforcement action 
necessarily involves policy judgments about what action is in the best 
interests of the Agency and the 504 Program. Therefore, SBA does not 
believe that it is appropriate or in the best interests of the 504 
Program for the OHA, which is not a policymaking office and which does 
not have the familiarity and experience with the 504 Program, to be 
able to undertake a de novo review and to make policy for the 504 
Program.
    Further, the arbitrary and capricious standard, although a 
deferential review, requires that the Agency have a rational and 
reasonable basis for its decision. If such a basis is lacking, the 
matter should be remanded back to the Agency for further consideration. 
A review of the numerous cases which have applied this standard and 
remanded agency decisions refutes any assertion that the arbitrary and 
capricious review is merely a rubber stamp of an agency's decision.
    Several comments took the position that de novo review by the OHA 
was required based upon the assertion that procedural due process under 
the Constitution requires that the decision be made by a ``fair, 
neutral decision maker.'' These comments, however, did not argue or 
show a basis for any suggestion that the AA/FA was not a fair, neutral 
decision maker. Moreover, to the extent these comments assert that an 
appeal of an agency decision to an independent office of the agency is 
required by constitutional due process, those comments are simply 
mistaken. SBA could, and, indeed, has in numerous regulations, provided 
that the decision by the relevant agency official is the final agency 
action, without providing any right of appeal to the OHA. OHA review of 
enforcement actions is not a right, but an accommodation that SBA has 
chosen to provide to CDCs in order to improve the fairness of the 
enforcement procedures.
    Several comments contended that the regulations should allow a CDC 
to raise arguments with the OHA that it had not made to the Agency in 
responding to a proposed enforcement action, and that CDCs should have 
a right of discovery or to subpoena third parties in the OHA to add 
information to the record of the agency's decision. One comment's 
justification for allowing new arguments to be raised before the OHA 
was that ``the CDC may easily forget an important matter and not raise 
it or make a submission * * * without relying on counsel.''
    SBA also considered but is not persuaded by these comments. If the 
CDC provided the OHA with arguments or information obtained through 
discovery in the OHA that were not considered by the Agency, the OHA's 
review would not merely evaluate whether the Agency's decision was 
supported by the administrative record, but would necessarily entail a 
de novo review of the underlying matter. As stated above, SBA believes 
such review is inappropriate. Additionally, a CDC that is faced with a 
proposed enforcement action or immediate suspension would be best 
advised to make sure that it diligently provides all relevant 
information to the Agency and consults with counsel to the extent it 
deems such consultation to be appropriate.
    Nevertheless, SBA does agree that a CDC that can show that it was 
unable to present facts or an argument to the AA/FA due to compelling 
reasons beyond its control, and that it has been prejudiced by this 
inability, can request that the OHA remand the matter back to the AA/FA 
for further consideration. This procedure is set forth in new language 
that has been added to Sec.  120.856(e). Similar language has been 
added to newly renumbered Sec.  120.856(b) with respect to a CDC's 
objection to a notice of a proposed action or immediate suspension, 
with conforming language added to Sec.  120.856(e)(3).
    SBA also has added language to Sec.  120.856(e) that if the OHA 
decides that SBA's decision was arbitrary, capricious or contrary to 
law, the OHA must remand the matter to the AA/FA or the deciding 
official for further consideration. Although this was clearly implied 
in the proposed rule, it was not explicitly stated and so SBA has added 
this language to the final rule for clarification.
    As discussed above with respect to Sec.  120.810 and elsewhere, SBA 
has deleted language from the proposed regulations to the effect that 
the procedures in Sec. Sec.  120.854 to 120.856 do not apply to those 
sections. SBA has added a new paragraph 120.856(f) which incorporates 
the concept of the deleted language to specify that the procedures in 
Sec.  120.856 only apply to actions undertaken pursuant to Sec.  
120.855.
    Section 120.861, job creation or retention, is revised (see 
discussion of revisions to Sec.  120.829 for a description of the 
changes to the job requirement criteria and the comments received). The 
change in the criteria will be published in a Federal Register notice 
from time to time.
    Section 120.862, other economic development objective, includes two 
technical changes. The first is the Agency-wide replacement of ``SIC'' 
codes with ``NAICS'' codes when identifying the types of small 
businesses eligible to receive SBA assistance. The second is to correct 
the cross-reference to the regulation that describes a minority for 
purposes of the public policy goal of assisting minority-owned 
businesses. The changes also reflect the statutory changes to section 
501(d) of the Act, which added women-owned and veteran-owned businesses 
to the public policy goals.
    Section 120.870, leasing project property, eliminates references to 
504 project property being leased by the CDC to the borrower. Comments 
received suggested revising SBA's rules regarding leasing to be more 
flexible. SBA considered these comments to be beyond the scope of the 
proposed rule. Therefore, SBA is adopting Sec.  120.870 as proposed.
    SBA is changing the heading of Sec.  120.871 to make the form 
consistent with other section headings.
    Section 120.880, basic eligibility requirements, simplifies the 
regulation by replacing the actual size standards with a cross-
reference to the size standard regulation. As the size standard 
regulations change, so will this

[[Page 57976]]

regulation without requiring it to be re-written. Comments received 
were supportive of this change. Therefore, SBA is adopting Sec.  
120.880 as proposed.
    Section 120.882, eligible project costs for 504 loans, clarifies 
eligible costs that may be included in 504 project costs. SBA received 
some comments on this regulation requesting clarification. For example, 
previously the regulation included accounting fees as a professional 
fee, but the proposed rule does not. SBA deliberately proposed to 
remove accounting fees because even though the regulation stated that 
only fees attributable to the project were to be included, borrowers 
were submitting as accounting costs fees charged by their accountant to 
prepare financial statements, which are a cost of doing business, not a 
project-related cost. The final rule retains this charge. Commenters 
were also concerned that certain items in the proposed rule were not 
project-related fees, such as hazard and flood insurance. SBA 
considered these concerns and agreed. Therefore, SBA is deleting hazard 
and flood insurance from the list of eligible project costs in Sec.  
120.822. Recording fees are eligible project costs, and are already 
covered in Sec.  120.882(a), and therefore do not appear in Sec.  
120.882(c) in the final rule. Other comments were concerned that such 
fees as permit fees and utility hook-up fees were not included. SBA 
believes such fees are already covered by Sec.  120.882(a), (b), and 
(d), which SBA did not propose to change. As a result of comments, SBA 
also deleted the reference to Sec.  120.971(a)(2) which limits legal 
fees associated with a 504 loan and debenture closing. SBA was 
concerned that the limitation might be construed as also applying to 
legal fees that are part of eligible project costs. This rule adopts 
section Sec.  120.882 as proposed except as discussed.
    Section 120.883, eligible administrative costs for 504 loans, 
clarifies eligible administrative costs that may be paid from the 
proceeds of the 504 Loan and debenture. SBA received some comments on 
this proposed regulation that sought clarification. The comments 
objected to what was perceived as a stricter interpretation of eligible 
administrative costs for 504 loans than previously permitted. SBA 
intends this result, because administrative costs must be very limited 
in order to protect the government's lien position in the collateral. 
SBA's lien generally is in a second lien position behind a larger first 
lien securing the third party loan. The Act requires the borrower to 
contribute at least 10 percent towards the project costs (see section 
502(3)(c) of the Act) . The calculation of the amount of SBA's share of 
the financing (up to a maximum of 40 percent) as well as the borrower's 
contribution is based on the total amount of project costs. 
Administrative costs were designed to permit the borrower to finance a 
limited number of specific fees above the project costs as part of the 
debenture financing that receives SBA's 100 percent guarantee. Every 
dollar of administrative cost that is included in the debenture 
increases SBA's exposure on the debenture and erodes the equity cushion 
provided by the borrower in the collateral. Therefore, it is SBA's 
intention that only the specific fees listed in the regulation be 
financed by the debenture and receive SBA's guaranty protection. Fees 
that are not eligible project costs or eligible administrative costs 
must be treated separately as a cost of doing business by the borrower. 
Accordingly, Sec.  120.883 in the final rule refers to all of Sec.  
120.882, not just to Sec.  120.882(c), to clarify that none of the fees 
that qualify as eligible project costs under Sec.  120.882 may be 
included as administrative costs included in the debenture. This rule 
adopts Sec.  120.883 as it was published in the proposed rule except as 
discussed.
    Section 120.892 is revised to require a 504 loan borrower to 
provide to the CDC current financial statements within 120 days of 504 
loan closing, instead of within 90 days. Comments received were 
supportive of this change. This rule adopts Sec.  120.892 as proposed.
    SBA is changing the headings of Sec. Sec.  120.900 and 120.910 to 
make their form consistent with the other section headings in Subpart 
H.
    Section 120.911, land contributions, makes a technical correction 
to the regulation by deleting the reference to CDCs. CDCs do not 
contribute land for a 504 loan.
    Section 120.913, limitations on any SBIC contributions, clarifies 
the heading, and adds a cross-reference and clarifies the section.
    Section 120.923, policies on subordination, changes the section 
heading and consolidates the current Sec. Sec.  120.923 and 120.924.
    Section 120.925, preferences, adds a cross-reference to another SBA 
regulation governing preferences.
    Section 120.926, referral fee, modifies the current language by 
adding ``reasonable'' in describing the referral fee that a CDC may 
charge a third party lender. The changes also emphasize that neither 
the lender nor the CDC can charge this fee to the borrower. SBA 
received one comment that suggested that a CDC be permitted to charge a 
referral fee to a borrower. The commenter believes that it is in the 
best interest of a potential borrower that requires additional help in 
accessing capital to charge this fee directly to the borrowers. The 
commenter also stated that the inability to charge the fee to a 
borrower would be a disincentive to the CDC to find a lender for 
difficult or rural-based loans. SBA considered this comment but was not 
persuaded. SBA has observed that the fees permitted to be charged by a 
CDC to a borrower have generally been sufficient to reimburse a CDC for 
its services related to all aspects of a 504 financing. With the 
increase in choice among CDCs for a potential 504 borrower as a result 
of this rule, SBA believes the fees permitted to be charged to a 
borrower are sufficient incentive to CDCs to make financing available 
to all eligible and credit-worthy 504 borrowers.
    Section 120.930, amount, eliminates the requirement that SBA must 
approve 504 loans between $25,000 and $50,000 on an exception basis. 
SBA does not believe that it ever has declined such a request. Comments 
received on Sec. Sec.  120.900-120.930 were generally supportive. SBA 
is adopting Sec.  120.900, Sec.  120.910, Sec.  120.911, Sec.  120.913, 
Sec.  120.923, Sec.  120.925, Sec.  120.926, and Sec.  120.930 as they 
were proposed.
    Section 120.931, 504 lending limits, increases the dollar amounts 
to reflect the changes to section 502(2) of the Act that became 
effective December 21, 2000. Comments received suggested that this 
section be adjusted automatically to reflect any changes established by 
Congress. SBA considered these comments but believes the suggestions 
are beyond the scope of the proposed rule. SBA is adopting Sec.  
120.931 as proposed.
    Section 120.933, maturity, creates flexibility in debenture 
maturities. This will permit SBA to consider other maturities besides 
10 and 20 years at some future date. SBA received comments regarding 
the proposed change that expressed concern regarding SBA's proposal to 
permit additional maturities. The comments suggested that this would 
``cause chaos in the funding markets'' or ``wreak havoc.'' SBA 
considered these comments and strongly disagrees. SBA notes that the 
home mortgage industry has expanded the number of maturities offered 
substantially to better serve the needs of home loan borrowers. While 
SBA has no immediate plans to make changes to the 10 and 20-year 
maturities now used, SBA believes it is important that the Agency has 
this flexibility in order to serve the changing needs of the small 
business community. Therefore, SBA is publishing the regulation as 
proposed to

[[Page 57977]]

permit SBA greater flexibility in meeting the needs of the marketplace.
    Section 120.934, collateral, clarifies the paragraph by rearranging 
and re-wording the sentences.
    Section 120.935, changes the heading.
    Section 120.936, subordination to CDC, is deleted. SBA believes 
that this regulation is a holdover from the former 501 and 502 
programs. SBA knows of no instance when a CDC has requested a 
subordination on its 504 loans. Comments received were supportive of 
the changes to Sec. Sec.  120.934-120.936. SBA adopts Sec. Sec.  
120.934, 120.935, and 120.936 as they were published in the proposed 
rule.
    Section 120.960, responsibility for closing, describes the 
circumstances under which SBA can decline to close a debenture or 
cancel its guarantee of the debenture prior to sale. Several comments 
received suggested that the regulation gives too much unilateral 
authority to SBA. While the commenters did not suggest that SBA 
eliminate its right to review the debenture closing before the 
debenture sale, they did suggest that SBA would have too much 
discretion under this regulation as proposed, to decline to approve a 
debenture for sale. SBA considered these concerns and agrees that 
several changes are needed, which will make this section more 
consistent with SBA's long-standing practice in place for SBA-
guaranteed 7(a) loans but without eliminating SBA's review of 504 loan 
and debenture closing prior to debenture sale. SBA has not proposed to, 
and does not in the final rule eliminate, this prior review by SBA, 
because of the significant differences between the 504 Program and the 
7(a) program with regard to SBA's practice for determining SBA's 
liability under its guaranty. SBA believes it must have the discretion 
to take the actions set forth in Sec.  120.960(c) in order to 
adequately protect SBA's guaranty of the debenture and minimize the 
credit risk to the entire 504 loan portfolio.
    Section 120.524 describes the bases upon which SBA may be released 
from liability on its guaranty for 7(a) loans. SBA reviews the 7(a) 
lender's documentation after the 7(a) loan is closed and disbursed and 
usually only after a default. The purpose of the review is to determine 
whether SBA should honor its guaranty by granting a purchase request, 
seek a reduction in SBA's guaranty liability, deny liability in full or 
in part on SBA's guaranty, or seek recovery from the lender if the SBA 
has already purchased the loan from the secondary market holder or from 
the lender itself. The purchase review is a process that serves to 
minimize an erroneous payment by SBA, by ensuring that SBA purchases 
only those loans which were originated, closed, serviced and liquidated 
in accordance with the loan authorization, prudent lending standards, 
and SBA regulations and other requirements.
    As discussed under Sec.  120.848, currently there is no such 
purchase review process for 504 loans; SBA simply honors its guaranty 
to the debenture holder and generally does not seek recovery against 
the CDC for SBA's loss under the guaranty (although SBA has such 
regulatory authority). If a CDC were to close a 504 loan and debenture 
without SBA review, then SBA likely would need to create a new review 
process, to take place after SBA's purchase of the debenture upon 
default on the 504 loan, to ensure that the CDC had closed the 504 loan 
in accordance with the loan authorization, prudent lending standards 
and SBA regulations and other requirements, and if a deficiency were 
discovered, SBA would need to determine the extent to which SBA should 
seek recovery from the CDC for SBA's loss under its guaranty. SBA does 
not intend to implement such a process in the 504 Program at this time. 
For these reasons and based on recommendations from commenters, in the 
final rule SBA added the word ``materially'' to Sec.  120.960(c)(1), to 
make it consistent with Sec.  120.524(a)(1); and changed the phrase ``a 
material adverse change'' to ``an unremedied material adverse change'' 
to Sec.  120.960(c)(7), to make it consistent with the terms of the 504 
loan authorization. Other than these changes, Sec.  120.960 is 
implemented as proposed.
    Section 120.970, servicing of 504 loans and debentures, clarifies 
the regulation regarding a CDC's responsibility in servicing a 504 
loan. Comments received on this regulation suggested that SBA establish 
a new borrower fee identified as a ``default servicing fee.'' According 
to the commenters, the borrower would incur the fee if the borrower 
failed to comply with certain requirements such as submitting financial 
statements. Since the proposed rule did not propose this new fee to a 
borrower, this suggestion is beyond the scope of the proposed rule. 
Comments also suggested that Sec.  120.970(c) was confusing because it 
seemed to suggest that the borrower, not the CDC, was responsible for 
filing renewals and extensions of security interests. SBA considered 
these comments and concurs. SBA has modified the rule to clarify that 
the CDC is responsible for filing renewals and extensions. This rule 
adopts Sec.  120.970 as it was published in the proposed rule except as 
discussed.
    Section 120.971, allowable fees paid by borrower, clarifies the 
language describing the loan closing fees that a CDC may charge. 
Comments received suggested a change to permit CDCs the ability to 
increase the servicing fee charged to an uncooperative borrower for 
issues such as not providing required statements of proof of insurance, 
evidence of tax payments or financial statements. SBA considered these 
comments but believe they are beyond the scope of this rulemaking. This 
rule adopts Sec.  120.971 as proposed.
    Section 120.972, third-party lender participation fee and CDC fee, 
revises the heading, deletes the language ``from the Third Party 
Lender'' from paragraph (a), and slightly clarifies paragraph (b). SBA 
may accept the third party lender participation fee from the third 
party lender, the 504 borrower, or the CDC. This final rule implements 
Sec.  120.972 as proposed.
    SBA is removing Sec. Sec.  120.980-120.984. Comments received were 
supportive of these changes. This rule removes Sec. Sec.  120.980-
120.984.

Compliance With Executive Orders 13132, 12988, and 12866, the 
Regulatory Flexibility Act (5 U.S.C. 601-612), and the Paperwork 
Reduction Act (44 U.S.C., Ch. 35)

    Executive Order 13132: For the purposes of Executive Order 13132, 
the SBA determined that this rule has no federalism implications 
warranting preparation of a federalism assessment.
    Executive Order 12988: For purposes of Executive Order 12988, Civil 
Justice Reform, SBA determined that this rule is drafted, to the extent 
practicable, in accordance with the standards set forth in paragraph 3 
of that Order.
    Executive Order 12866: The Office of Management and Budget (OMB) 
has determined that this rule constitutes a significant regulatory 
action under Executive Order 12866, Regulatory Planning and Review. SBA 
received no comments regarding the Executive Order from the public. SBA 
believes there is a need for this regulatory action for the reasons 
stated in the preamble above. SBA believes these regulatory changes 
will improve 504 Program delivery to small business customers to 
increase customer choice of service; increase third party lender choice 
of CDCs; facilitate the formation of new CDCs; facilitate the expansion 
of existing CDCs; and increase the number of CDCs able to take 
advantage of special initiatives for rural areas. By allowing market-
driven forces to determine availability of 504 Program

[[Page 57978]]

service, small businesses will have greater opportunity to negotiate 
the best total financing package, including fees, as well as receive 
increased service by CDCs. In addition, the 504 Program will be more 
responsive to changes in market conditions. SBA believes that there are 
no viable alternatives to these changes that would produce similar 
positive results without imposing an additional burden on the SBA or 
the public.
    In Fiscal Year (FY) 2002, OMB developed the Program Assessment 
Rating Tool (PART) to establish a systematic, consistent process for 
rating the performance of programs across the Federal government. The 
504 Program was evaluated under the PART criteria in FY 2002. The PART 
review revealed that the SBA needs to increase the availability of CDCs 
within the 504 Program to improve customer access to loans. 
Additionally, increasing the availability of CDCs will enable borrowers 
to determine which of the SBA's loan programs best meet their needs. 
The SBA expects that this rule will address that recommendation from 
OMB. The OMB PART review on this program can be found at http://www.whitehouse.gov/omb/budget/fy2004/pma/certifieddevelopment.pdf pdf.
    The SBA does not have sufficient data to establish a baseline in 
order to measure the costs and benefits of this rule on the affected 
public. However, the SBA has data on the cost to SBA of the 504 
Program. In FY2002, the cost of the 504 Program to SBA was 
approximately $15 million. The majority of the cost of the Program, 82 
percent or $12.6 million, was for the cost of the field office staff 
support that reviewed and approved loan applications and conducted 
marketing and outreach to generate new loans. The cost of the 504 
Program to the SBA also includes the cost of reviewing and analyzing 
CDC requests to expand their areas of operations by SBA's field office 
and Headquarters staff. The SBA would expect this cost to decline 
substantially as a result of this final rule because it permits all 
CDCs to operate at least throughout their State of incorporation. Other 
data on costs of the program can be found at http://www.sba.gov/aboutsba/budgetplans.html html. Relevant information is provided on pages 
23-24 of SBA's Budget Request and Performance Plan: Congressional 
Submission Fiscal Year 2004 and on pages 69-71 of SBA's Performance and 
Accountability Report Fiscal Year 2002.
    Regulatory Flexibility Act: This rule directly affects all CDCs, of 
which there are approximately 270. SBA has determined that CDCs fall 
under the size standard for NAICS 522298, All Other Nondepository 
Credit Intermediaries. The size standard is $6 million in average 
annual receipts. SBA estimates that at least 95 percent of the CDCs do 
not exceed this size standard and are therefore considered small 
entities by this definition. Thus, SBA has determined that this rule 
will have an impact on a substantial number of small entities.
    Even though SBA has determined that this rule will have an impact 
on a substantial number of small entities, SBA has determined that the 
impact will not be significant. SBA understands the concerns raised by 
some comments received that suggested that this rule may have a 
significant impact on many small and rural CDCs. Some comments 
expressed the concern that increased competition and reliance on market 
forces could lead to more decertifications of small and rural CDCs. 
Other commenters stated that small CDCs will not be able to compete in 
the new competitive environment this rule would create. For example, 
one stated concern is that larger CDCs would have an unfair advantage, 
and that small CDCs would be hurt by the new competition because many 
small CDCs will not have the resources necessary to access more 
profitable markets beyond their current area of operations while larger 
CDCs will access the more profitable markets of small and rural CDCs.
    SBA considered these comments but continues to believe that the 
rule is not significant. SBA believes that the effect of this rule will 
be first to ``level the playing field'' by allowing CDCs more 
flexibility to choose the optimal area of operations within their State 
of incorporation. Currently, each CDC has a specific area of operations 
that is approved by SBA. The typical area of operations is several 
counties within the CDC's State of incorporation. If a CDC wishes to 
apply to expand into neighboring counties, it can only do so if those 
counties are available. A county is available to a new CDC or a CDC 
requesting to expand its area of operations if the CDC(s) that include 
that county in its area of operations is not meeting a threshold of one 
504 approval per year per 100,000 population averaged over two years. 
If the existing CDC is meeting this threshold of activity, both an 
applicant wishing to become a CDC and a CDC wishing to expand its area 
of operations is barred from including that county in their request. 
This rule eliminates that threshold and permits all CDCs the 
opportunity to operate anywhere in their State of incorporation. This 
would allow CDCs in less lucrative areas to have access to the greater 
opportunities available in the more lucrative areas.
    SBA believes that some CDCs will choose to continue to operate in 
those counties they presently operate in while others will choose to 
expand their market area into neighboring counties or throughout the 
State. It has been SBA's experience with CDCs that are permitted to 
compete with other CDCs in the same market area, that the market of 
eligible 504 projects itself expands, resulting in a benefit for the 
affected CDCs as well as a benefit to small business borrowers. A 
recent example was the approval of a large CDC into a small CDC's area 
of operations in the Midwest. As a consequence, a county in which there 
had been no 504 loan activity the prior year generated two 504 loans 
for the small CDC and three 504 loans for the large CDC.
    SBA also believes that smaller, rural CDCs will derive a similar 
benefit by having a greater opportunity to meet the required 504 loan 
activity level. Since 1993, SBA has had to revoke certifications from 
more than 100 CDCs and transfer their 504 loan portfolios and fees to 
other, active CDCs due to their failure to meet the required 504 
activity level of two 504 loan approvals per year averaged over two 
years. Most of these CDCs have been located in rural areas where there 
are a limited number of potential 504 projects. Competition with other, 
larger CDCs was not the reason why these rural CDCs could not meet the 
required loan volume. There was simply a lack of 504-eligible projects 
in the geographic area. This rule enables those small, rural CDCs the 
opportunity to expand their market area by doing projects in more 
populous areas, resulting in their more easily meeting the 504 loan 
activity level. The result will be that these CDCs will remain in the 
program and continue to be available locally to small businesses in the 
rural areas. At the same time, those CDCs that currently have exclusive 
areas that include populous urban areas resulting in substantial 504 
loan activity may seek to expand their market areas into the less 
lucrative rural areas which will increase awareness of the program 
overall which may in turn be beneficial to the small, rural CDCs.
    Finally, as stated previously, it has been SBA's experience that 
the more CDCs that market the 504 program in a particular area, the 
higher the 504 loan volume in that area. SBA believes that this is due 
to the additional marketing initiatives by the CDCs which creates an 
increased awareness of the 504 Program among the local lending 
community and improves their willingness to participate because they 
have a choice. SBA

[[Page 57979]]

believes this increased awareness in the 504 Program can benefit small 
and rural CDCs even if they do not have the resources to increase their 
own marketing and outreach efforts. SBA also believes having multiple 
CDCs in the area improves the service provided by the CDCs, which also 
makes the 504 Program more useful to the local lending communities. As 
more and more lenders successfully use the program, they discuss it and 
provide information about it to other lenders which increases the 
impact of the marketing efforts of all CDCs serving the area. A similar 
phenomenon occurred in the lending industry. Over the years, lenders 
participating in SBA's 7(a) program have always been willing to come to 
lenders' meetings to describe their activity with other lenders. They 
do this because they recognize that as more people are aware of the 
program, the size of the market will increase, resulting in more 
overall loan activity for the lender.
    This rule also permits new CDCs the opportunity to market in areas 
that may produce more 504 loans sooner. This in turn should permit the 
new CDC the ability to reach a breakeven point sooner in its operations 
and continue to meet the required 504 activity of two 504 approvals per 
year. Currently it is estimated that it takes a CDC at least two years 
at a cost of $200,000 or more to reach the 504 activity level where the 
504 fee income covers the CDC's expenses. Very few of the new CDCs that 
SBA has certified in recent years have been able to remain viable. 
Allowing CDCs to market in multiple areas increases their ability to 
obtain customers.
    To summarize, the expected results of this final rule are that CDCs 
(and existing and future 504 loan borrowers) will benefit because 
small, rural CDCs that currently struggle to meet the volume 
requirement will be retained, awareness of the 504 program among 
lenders will increase, new CDCs will have a greater opportunity to 
succeed, and borrowers will have more choice among CDCs.
    In addition, SBA expects this rule will result in a reduction in 
the overall paperwork burden for CDCs since CDCs will no longer have to 
apply to SBA to expand their area of operations within their State of 
incorporation. SBA received and approved approximately 11 expansion 
requests during 2002. All were for CDCs requesting expansions into 
neighboring counties within the CDC's State of incorporation. The 
burden hours for a new CDC or a CDC wishing to expand to complete an 
application is estimated to be 10 hours. None of the applications for 
an expansion would have been necessary under this rule. In addition, 
applicants requesting to become CDCs also will be permitted to 
establish their optimal area of operations within their State of 
incorporation without being excluded from areas that currently have one 
or more CDCs. The SBA receives one or two applications to become a CDC 
per year. The burden hours for an application will be reduced by 
approximately one hour due to the changes in the general membership 
requirements that will allow an applicant more flexibility in meeting 
this requirement. The SBA believes that the economic impact of the 
reduction in paperwork, if any, will be minimal to small entities.
    SBA also received comments expressing concern about the enforcement 
provisions and the perceived increased authority SBA would derive from 
the provisions. SBA disagrees that the new enforcement provisions will 
result in significant economic impact. Although SBA had proposed 
allowing the use of fees that CDCs receive to compensate SBA from 
financial losses resulting from improper CDC conduct, the final rule 
deletes this provision. SBA also has a history of fair and evenhanded 
use of enforcement authority in all of our lending, procurement, grant, 
and other assistance programs. CDCs are protected from unfair or biased 
enforcement of the rules through the notice and appeal procedures in 
the regulations.
    Accordingly, SBA determines that this 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.
    Paperwork Reduction Act: For the purposes of the Paperwork 
Reduction Act, 44 U.S.C. Chapter 35, SBA has submitted two different 
reporting requirements to OMB for review: (1) the PCLP application and 
(2) the PCLP Loan Loss Reserve Fund (LLRF) reporting requirements. SBA 
received no comments from the public regarding these two information 
collections. SBA makes no changes to either of these information 
collections in this rule.

A. Application

    The PCLP application form is for the use of the 26 PCLP CDCs as 
provided in Sec.  120.848(d). The application will allow SBA to collect 
the information it needs from the PCLP in order to extensively analyze 
the borrower's financing proposal, including information on the 
borrower's personal and business financial statements, cash flow 
projections, and related information to support an eligibility 
determination. Analysis of the application is activities are designed 
to control and limit the risk associated with the 504 Program and SBA's 
guaranty, but they do require significant SBA resources. SBA estimates 
the burden of this collection of information as follows: A PCLP CDC 
will complete these forms for each PCLP loan it processes. SBA 
estimates that the time needed to complete this collection is 45 
minutes. SBA estimates that the cost to complete this collection will 
be approximately $20 per hour due to the clerical nature of most of the 
completion. Total estimated aggregated burden per annum is estimated to 
be approximately 700 hours per annum costing an aggregated $14,000 per 
year.

B. LLRF Compliance Information

    The LLRF Compliance form is for the use of the 26 PCLP CDCs as 
provided in Sec.  120.847(f). The LLRF compliance information will 
document the PCLP CDC's meeting of the LLRF deposit requirements. This 
will require the PCLP CDC to keep track of the face amount of each PCLP 
debenture and then determine and record the amount that must be 
contributed into its LLRF. SBA estimates the burden of this collection 
of information one hour per PCLP debenture. PCLP debenture volume will 
vary significantly among participants. We expect that few PCLP CDCs 
will issue more than 50 PCLP debentures annually. That would mean an 
aggregate burden of no more than 50 hours per year. SBA estimates that 
the added cost would be minimal, because existing PCLP CDC support 
staff and ordinary bank records will cover the labor costs. At an 
estimate of $10 per hour, the reporting requirements would not likely 
exceed $500 per year for any PCLP CDC.
    SBA created these information collections with the goal of 
collecting only the necessary information needed to successfully and 
efficiently operate the CDC program with minimal burden to the public.

List of Subjects in 13 CFR Part 120

    Loan Programs--business, Reporting and recordkeeping requirements, 
Small business.

0
For the reasons discussed in the preamble, SBA is amending 13 CFR part 
120 as follows:

PART 120--BUSINESS LOANS

0
1. The authority citation for part 120 continues to read as follows:

    Authority: 15 U.S.C. 634(b)(6), 636(a) and (h), 696(3) and 
697(a)(2).


[[Page 57980]]


0
2. Amend Sec.  120.10 by adding a definition of ``SOP'' to read as 
follows:
* * * * *
    SOPs are SBA Standard Operating Procedures, as issued and revised 
by SBA from time to time.

Subpart A--Policies Applying to All Business Loans

0
3. Revise the first sentence of the introductory text of Sec.  120.140 
to read as follows:


Sec.  120.140  What ethical requirements apply to participants?

    Lenders, Intermediaries, and CDCs (in this section, collectively 
referred to as ``Participants''), must act ethically and exhibit good 
character. * * *
* * * * *

Subpart H--Development Company Loan Program (504)

0
4. Revise the heading of Sec.  120.800 to read as follows:


Sec.  120.800  The purpose of the 504 program.

* * * * *

0
5. Revise the heading of Sec.  120.801 to read as follows:


Sec.  120.801  How a 504 Project is financed.

* * * * *
0
6. Amend Sec.  120.802 by removing the definition of ``Associate 
Development Company''; revising the definition of ``Area of 
Operations''; adding definitions of ``Designated Attorney'', ``Lead SBA 
Office'', and ``Priority CDC''; and revising the first sentence of the 
definition of ``Local Economic Area'', to read as follows:


Sec.  120.802  Definitions.

* * * * *
    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. The minimum Area of Operations is the State in which 
the CDC is incorporated.
* * * * *
    Designated Attorney is the CDC closing attorney that SBA has 
approved to close loans under an expedited closing process for a 
Priority CDC.
* * * * *
    Lead SBA Office is the SBA District Office designated by SBA as the 
primary liaison between SBA and a CDC and with responsibility for 
managing SBA's relationship with that CDC.
    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, is contiguous to the CDC's 
existing Area of Operations (or the applicant's proposed Area of 
Operations) of 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) of its State of incorporation. 
* * *
* * * * *
    Priority CDC is a CDC certified to participate on a permanent basis 
in the 504 program (see Sec.  120.812) that SBA has approved to 
participate in an expedited 504 loan and Debenture closing process.
* * * * *

0
7. Revise Sec.  120.810 to read as follows:


Sec.  120.810  Applications for certification as a CDC.

    (a) An applicant for certification as a CDC must apply to the SBA 
District Office serving the jurisdiction in which the applicant has or 
proposes to locate its headquarters (see Sec.  101.103 of this 
chapter).
    (b) The applicant must apply for an Area of Operations. The 
applicant's proposed Area of Operations must include the entire State 
in which the applicant is incorporated, and may include Local Economic 
Areas. An applicant may not apply to cover an area as a Multi-State 
CDC.
    (c) The applicant must demonstrate that it satisfies the CDC 
certification and operational requirements in Sec. Sec.  120.820, and 
120.822 through 120.824. The applicant also must include an operating 
budget, approved by the applicant's Board of Directors, which 
demonstrates the required financial ability (as described in Sec.  
120.825), and a plan to meet CDC operational requirements (without 
specializing in a particular industry) in Sec. Sec.  120.821, and 
120.826 through 120.830.
    (d) The District Office will forward the application and its 
recommendation to the AA/FA, who will make the final decision. SBA will 
notify the CDC in writing of its decision, and, if the petition is 
declined, the reasons for the decision.


Sec.  120.811  [Removed]

0
8. Remove Sec.  120.811.

0
9. Revise Sec.  120.812 to read as follows:


Sec.  120.812  Probationary period for newly certified CDCs.

    (a) Newly certified CDCs will be on probation for a period of two 
years from the date of certification, at the end of which the CDC must 
petition the Lead SBA Office for:
    (1) Permanent CDC status; or
    (2) A single, one-year extension of probation.
    (b) SBA will consider the failure to file a petition before the end 
of the probationary period as a withdrawal from the 504 program. If the 
CDC elects withdrawal, SBA will direct the CDC to transfer all funded 
and/or approved loans to another CDC, SBA, or another servicer approved 
by SBA.
    (c) The Lead SBA Office will send the petition and its 
recommendation to the AA/FA, who will make the final decision. SBA will 
determine permanent CDC status or an extension of probation, in part, 
based upon the CDC's compliance with the certification and operational 
requirements in Sec. Sec.  120.820 through 120.830.
    (d) SBA will notify the CDC in writing of its decision, and, if the 
petition is declined, the reasons for the decision.

0
10. Revise Sec.  120.820 to read as follows:


Sec.  120.820  CDC non-profit status and good standing.

    A CDC must be a non-profit corporation, except that for-profit CDCs 
certified by SBA prior to January 1, 1987 may retain their 
certifications. An SBIC may not become a CDC. A CDC must be in good 
standing based upon the following criteria:
    (a) In good standing in the State in which the CDC is incorporated 
and any other State in which the CDC conducts business.
    (b) In compliance with all laws, including taxation requirements, 
in the State in which the CDC is incorporated and any other State in 
which the CDC conducts business.

0
11. Revise Sec.  120.821 to read as follows:


Sec.  120.821  CDC Area of Operations.

    A CDC must operate only within its designated Area of Operations 
approved by SBA except as provided in Sec.  120.839.

0
12. Revise Sec.  120.822 to read as follows:


Sec.  120.822  CDC membership.

    (a) CDC Membership. 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 can own or 
control more than 10 percent of the CDC's voting membership (or stock). 
No employee or staff of the CDC can qualify as a member of the CDC for 
the purpose of meeting the membership requirements. The CDC membership 
must include representatives from all the groups listed in paragraph 
(b) of this section.
    (b) Membership groups. Members must be responsible for actively 
supporting economic development in the Area of Operations and must be 
from one of the following groups:

[[Page 57981]]

    (1) Government organizations responsible for economic development 
in the Area of Operations;
    (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, universities, or small business development 
centers (as defined in section 21(a)(1) of the Act, 15 U.S.C. 
648(a)(1)); and
    (4) Businesses in the Area of Operations.
    (c) 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.

0
13. Amend Sec.  120.823 by revising paragraph (b) to read as follows:


Sec.  120.823  CDC Board of Directors.

* * * * *
    (b) If a CDC is incorporated in one State and is approved as a 
Multi-State CDC to operate in another State, the CDC must have a Loan 
Committee for each State.
0
14. Amend Sec.  120.824 by revising the third sentence in the 
introductory text and paragraph (a) to read as follows:


Sec.  120.824  Professional management and staff.

    * * * CDCs may obtain, under written contract, management, 
marketing, packaging, processing, closing, servicing or liquidation 
services provided by qualified individuals and entities under the 
following circumstances:
    (a) The CDC must have at least one salaried professional employee 
that is employed directly (not a contractor or an Associate of a 
contractor) full-time to manage the CDC. The CDC manager must be hired 
by the CDC's board of directors and subject to termination only by the 
board. A CDC may petition SBA to waive the requirement of the manager 
being employed directly if:
    (1) Another non-profit entity that has the economic development of 
the CDC's Area of Operations as one of its principal activities will 
contribute the management of the CDC, and the management contributed by 
the other entity also may work on and operate that entity's economic 
development programs, but must be available to small businesses 
interested in the 504 program and to 504 loan borrowers during regular 
business hours; or
    (2) The CDC petitioning SBA for such waiver is rural; has 
insufficient loan volume to justify having management employed directly 
by the CDC; and has contracted with another CDC located in the same 
general area to provide the management.
* * * * *

0
15. Revise Sec.  120.826 to read as follows:


Sec.  120.826  Basic requirements for operating a CDC.

    A CDC must operate in accordance with all 504 program requirements 
imposed by statute, regulation, SOPs, SBA policy and procedural 
notices, loan authorizations, Debentures, and agreements between the 
CDC and SBA. In its Area of Operations, a CDC must market the 504 
program, package and process 504 loan applications, close and service 
504 loans, and if authorized by SBA, liquidate and litigate 504 loans. 
It must supply to SBA current and accurate information about all 
certification and operational requirements, and maintain the records 
and submit the reports required by SBA.

0
16. Revise Sec.  120.827 to read as follows:


Sec.  120.827  Other services a CDC may provide to small businesses.

    A CDC may provide a small business with assistance unrelated to the 
504 loan program as long as the CDC does not make such assistance a 
condition of the CDC accepting from that small business an application 
for a 504 loan. An example of other services a CDC may provide is 
assisting a small business in applying for a 7(a) loan (as described in 
Sec.  120.2). A CDC is subject to part 103 of this chapter when 
providing such assistance.

0
17. Revise Sec.  120.828 to read as follows:


Sec.  120.828  Minimum level of 504 loan activity and restrictions on 
portfolio concentrations.

    (a) A CDC is required to receive SBA approval of at least four 504 
loan approvals during two consecutive fiscal years.
    (b) A CDC's 504 loan portfolio must be diversified by business 
sector.
0
18. Amend Sec.  120.829 by revising paragraph (a) to read as follows:


Sec.  120.829  Job Opportunity average a CDC must maintain.

    (a) A CDC's portfolio must maintain a minimum average of one Job 
Opportunity per an amount of 504 loan funding that will be specified by 
SBA from time to time in a Federal Register notice. Such Job 
Opportunity average remains in effect until changed by subsequent 
Federal Register publication. A CDC is permitted two years from its 
certification date to meet this average.
* * * * *

0
19. Revise paragraphs (a) and (b) of, and add a new paragraph (g) to 
Sec.  120.830 to read as follows:


Sec.  120.830  Reports a CDC must submit.

* * * * *
    (a) An annual report within 180 days after the end of the CDC's 
fiscal year (to include financial statements of the CDC and any 
affiliates or subsidiaries of the CDC), and such interim reports as SBA 
may require;
    (b) For each new associate and staff, a Statement of Personal 
History (for use by non-bank lenders and CDCs) and other information 
required by SBA;
* * * * *
    (g) Other reports as required by SBA.

0
20. Revise Sec.  120.835 to read as follows:


Sec.  120.835  Application to expand an Area of Operations.

    (a) General. A CDC that has been certified to participate in the 
504 program may apply to expand its Area of Operations if it meets all 
requirements to be an Accredited Lender Program (ALP) CDC, as set forth 
in Sec.  120.840(c), and demonstrates that it can competently fulfill 
its 504 program responsibilities in the proposed area.
    (b) Local Economic Area Expansion. A CDC seeking to expand its Area 
of Operations into a Local Economic Area must apply in writing to the 
Lead SBA Office.
    (c) Multi-State CDC Expansion. A CDC seeking to become a Multi-
State CDC must apply to the SBA District Office that services the area 
within each State where the CDC intends to locate its principal office 
for that State. A CDC may apply to be a Multi-State CDC only if:
    (1) The State the CDC seeks to expand into is contiguous to the 
State of the CDC's incorporation;
    (2) The CDC demonstrates that its membership meets the requirements 
in Sec.  120.822 separately for its State of incorporation and for each 
additional State in which it seeks to operate as a Multi-State CDC; and
    (3) The CDC has a loan committee meeting the requirements of Sec.  
120.823.


Sec.  120.836  [Removed]

0
21. Remove Sec.  120.836.

0
22. Amend Sec.  120.837 by revising paragraph (b) and adding a new 
paragraph (c) to read as follows:


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

* * * * *
    (b) SBA will notify the CDC of its decision in writing, and if the 
application is denied, the reasons for its decision.

[[Page 57982]]

    (c) If a CDC is approved to operate as a Multi-State CDC, the CDC's 
ALP, PCLP, or Priority CDC authority will carry over into every 
additional State in which it is approved to operate as a Multi-State 
CDC.


Sec.  120.838  [Removed]

0
23. Remove Sec.  120.838.

0
24. Revise Sec.  120.839 to read as follows:


Sec.  120.839  Case-by-case application to make a 504 loan outside of a 
CDC's Area of Operations.

    A CDC may apply to make a 504 loan for a Project outside its Area 
of Operations to the District Office serving the area in which the 
Project will be located. The applicant CDC must demonstrate that it can 
adequately fulfill its 504 program responsibilities for the 504 loan, 
including proper servicing. The District Office may approve the 
application if:
    (a) The applicant CDC has previously assisted the business to 
obtain a 504 loan; or
    (b) The existing CDC or CDCs serving the area agree to permit the 
applicant CDC to make the 504 loan; or
    (c) There is no CDC within the Area of Operations.

0
25. Revise Sec.  120.840 to read as follows:


Sec.  120.840  Accredited Lenders Program (ALP).

    (a) General. Under the ALP program, SBA designates qualified CDCs 
as ALP CDCs, gives them increased authority to process, close, and 
service 504 loans, and provides expedited processing of loan approval 
and servicing actions.
    (b) Application. A CDC must apply for ALP status to the Lead SBA 
Office. The Lead SBA Office will send its recommendation and the 
application to the AA/FA for final decision.
    (c) Eligibility. In order for a CDC to be eligible to receive ALP 
status, its application must show that it meets the criteria set forth 
in Sec.  120.841.
    (d) Additional application requirements. The CDC's application must 
include the following:
    (1) Certified copy of the CDC's Board of Directors' resolution 
authorizing the application for ALP status.
    (2) Summary of the experience of each of the CDC's loan processing, 
closing, and servicing staff members with significant authority.
    (3) Name, address, and summary of experience of Designated 
Attorney.
    (4) Documentation of any SBA required insurance.
    (5) Any other documentation required by SBA.
    (e) Term of ALP designation. SBA generally will designate a CDC as 
an ALP CDC for a two-year period. SBA may renew the designation for 
additional two-year periods if the CDC continues to meet the ALP 
program eligibility requirements.
    (f) SBA approval or decline decision. SBA will notify the CDC in 
writing of an approval or decline of either an ALP application or of an 
ALP renewal. If the SBA approves the CDC's application, the ALP CDC may 
exercise its ALP authority in its entire Area of Operations. If an 
application or renewal is declined, SBA will notify the CDC of the 
reasons for the decision.

0
26. Add a new Sec.  120.841 to read as follows:


Sec.  120.841  Qualifications for the ALP.

    An applicant for ALP status must show that it substantially meets 
the following criteria:
    (a) CDC staff experience. The CDC's staff must have well-trained, 
qualified loan officers who are knowledgeable concerning SBA's lending 
policies and procedures for the 504 program. The CDC must have at least 
one loan officer with three years of 504 loan processing experience and 
at least one loan officer with three years of 504 servicing experience 
or two years experience plus satisfactory completion of SBA-approved 
processing and servicing training. The same loan officer may meet these 
qualifications. In addition, the CDC's staff must have demonstrated 
satisfactorily to SBA the ability to process and service 504 loans.
    (b) Number of 504 loans approved and size of portfolio. SBA must 
have approved at least 20 504 loan applications by the CDC in the most 
recent three years, and the CDC must have a portfolio of at least 30 
active 504 loans. (An ``active'' 504 loan is a loan that was approved 
and closed by the CDC and has a status of either current, delinquent, 
or in liquidation.)
    (c) Current reviews in compliance. SBA-conducted oversight reviews 
must be current (within past 12 months) for applicants for ALP status, 
and these reviews must have found the CDC to be in compliance with 504 
program requirements imposed by statute, regulation, SOPs, policy and 
procedural notices, loan authorizations, Debentures, and agreements 
between the CDC and SBA.
    (d) Record of compliance with 504 program requirements. The CDC 
must have a record of conforming to SBA's policies and procedures and 
of satisfactorily underwriting, closing and servicing 504 loans. SBA 
will consider all relevant material information, which will include but 
is not limited to whether the CDC meets all SBA's CDC portfolio 
benchmarks, when determining the CDC's record of compliance, including:
    (1) Submission of satisfactory 504 loan analyses and applications, 
and all required, and properly completed, loan documents.
    (2) Careful and thorough analysis and screening of all 504 loan 
applications for conformance with SBA credit and eligibility standards;
    (3) Proper completion of required 504 loan closing documents and 
compliance with SBA 504 loan closing policies and procedures.
    (4) Compliance with SBA loan servicing policies and procedures.
    (5) Compliance with the certification and operational requirements 
as set forth in Sec. Sec.  120.820 through 120.830.
    (6) Submission of timely, complete and acceptable annual reports.
    (7) Compliance with CDC ethical requirements (see Sec.  120.851).
    (e) Priority CDC. The CDC must be a Priority CDC with a Designated 
Attorney and SBA required insurance.
    (f) Record of Cooperation. The CDC must have a record of effective 
communication and a cooperative relationship with all SBA offices 
including district offices and SBA's loan processing and servicing 
centers.

0
27. Revise Sec.  120.845 to read as follows:


Sec.  120.845  Premier Certified Lenders Program (PCLP).

    (a) General. Under the PCLP, SBA designates qualified CDCs as PCLP 
CDCs and delegates to them increased authority to process, close, 
service, and liquidate 504 loans. SBA also may give PCLP CDCs increased 
authority to litigate 504 loans.
    (b) Application. A CDC must apply for PCLP status to the Lead SBA 
Office. The Lead SBA Office will send its written recommendation and 
the application to SBA's PCLP Loan Processing Center, which will review 
these materials and forward them with a recommendation to the AA/FA for 
final decision.
    (c) Eligibility. In order for a CDC to be eligible to receive PCLP 
status, its application must show that it meets the following criteria:
    (1) The CDC must be an ALP CDC in substantial compliance with 504 
program requirements imposed by statute, regulation, SOP, policy and 
procedural notices, Debentures, loan authorizations, and any agreement 
between SBA and the CDC or meet the criteria to be an ALP CDC set forth 
in Sec.  120.841(a) through (h).
    (2) The CDC can adequately comply with SBA liquidation and 
litigation requirements.

[[Page 57983]]

    (d) Additional application requirements. The application must 
include the following:
    (1) Certified copy of the CDC's Board of Directors' resolution 
authorizing the application for PCLP status.
    (2) Summary of the experience of each of the CDC's loan processing, 
closing, servicing and liquidation staff members with significant 
authority.
    (3) Name, address and summary of experience of Designated Attorney.
    (4) Documentation of any SBA required insurance.
    (5) Any other documentation required by SBA.
    (e) Term of designation. If approved, SBA generally will confer 
PCLP status for a period of two years. However, if SBA deems it 
appropriate, it may confer PCLP status for a period of less than two 
years.
    (f) Area of Operations for PCLP CDCs. If the SBA approves the CDC's 
application, the PCLP CDC may exercise its PCLP authority in its entire 
Area of Operations.
    (g) SBA approval or decline decision. SBA will notify the CDC in 
writing of an approval or decline of a PCLP application. If an 
application is declined, SBA will notify the CDC of the reasons for the 
decision.

0
27a. Add Sec. Sec.  120.846 through 120.848 to read as follows:


Sec.  120.846  Requirements for maintaining and renewing PCLP status.

    (a) To maintain its status as a PCLP CDC, a CDC must continue to:
    (1) Meet the PCLP eligibility requirements in Sec.  120.845 .
    (2) Timely conform with all requirements and deadlines set forth in 
SBA's regulations and policy and procedural guidance concerning 
properly establishing, funding and reporting a PCLP Loan Loss Reserve 
Fund (LLRF).
    (3) Substantially comply with all 504 program requirements imposed 
by statute, regulation, SOPs, policy and procedural notices, loan 
authorizations, Debentures, and agreements between the CDC and SBA.
    (4) Remain an active CDC.
    (5) In accordance with statutory requirements set forth in section 
508(i) of Title V, 15 U.S.C. 697e(i), establish a goal of processing at 
least 50 percent of its 504 loans using PCLP procedures.
    (b) SBA will notify the PCLP CDC in writing of a renewal or non-
renewal of PCLP status. If PCLP status is not renewed, SBA will notify 
the CDC of the reasons for the decision.


Sec.  120.847  Requirements for the Loan Loss Reserve Fund (LLRF).

    (a) General. PCLP CDCs must establish and maintain a LLRF (or 
multiple accounts which together constitute one LLRF) which complies 
with paragraphs (b) through (g) of this section. A PCLP CDC must use 
the LLRF or other funds to reimburse the SBA for 10 percent of any loss 
sustained by SBA as a result of a default in the payment of principal 
or interest on a Debenture it issued under the PCLP (``PCLP 
Debenture''). A CDC that is participating in the PCLP as of January 1, 
2004, and a CDC that has participated in the PCLP in the past but which 
does not have PCLP status as of that date, must establish a LLRF within 
30 days of that date to cover potential losses for all 504 loans made 
in connection with PCLP Debentures that remain outstanding as of that 
date. A CDC that receives PCLP status after that date must establish 
and maintain a LLRF prior to closing any 504 loans processed under its 
PCLP status. The LLRF is the accumulation of deposits that a PCLP CDC 
must establish and maintain for each PCLP Debenture that it issues. 
PCLP CDCs must coordinate with their Lead SBA Office to ensure that the 
LLRF is properly established, that all necessary documentation is 
executed and delivered by all parties in a timely fashion, and that all 
required deposits are made.
    (b) PCLP CDC Exposure and LLRF deposit requirements. A PCLP CDC's 
``Exposure'' is defined as its reimbursement obligation to SBA with 
respect to default in the payment of any PCLP Debenture. The amount of 
a PCLP CDC's Exposure is 10 percent of any loss (including attorney's 
fees; litigation costs; and care of collateral, appraisal and other 
liquidation costs and expenses) sustained by SBA as a result of a 
default in the payment of principal or interest on a PCLP Debenture. 
For each PCLP Debenture a PCLP CDC issues, it must establish and 
maintain an LLRF equal to one percent of the original principal amount 
(the face amount) of the PCLP Debenture. The amount the PCLP CDC must 
maintain in the LLRF for each PCLP Debenture remains the same even as 
the principal balance of the PCLP Debenture is paid down over time.
    (c) Establishing a LLRF. The LLRF must be a deposit account (or 
accounts) with a federally insured depository institution selected by 
the PCLP CDC. A ``deposit account'' is a demand, time, savings, or 
passbook account, including a certificate of deposit (CD) which is 
either uncertificated or, if certificated, non-transferable. A 
``deposit account'' is not an investment account and must not contain 
securities or other investment properties. A deposit account may 
contain only cash and CDs credited to that account. A PCLP CDC may pool 
its deposits for multiple PCLP Debentures in a single account in one 
institution. The LLRF must be segregated from the PCLP CDC's other 
operating accounts. The PCLP CDC is responsible for all fees, costs and 
expenses incurred in connection with establishing, managing and 
maintaining the LLRF, including fees associated with transferring funds 
or early withdrawal of CDs, and related income tax expenses.
    (d) Creating and perfecting a security interest in a LLRF. A PCLP 
CDC must give SBA a first priority, perfected security interest in the 
LLRF to secure the PCLP CDC's obligation to reimburse SBA for the PCLP 
CDC's Exposure under all of its outstanding PCLP Debentures. (If a PCLP 
CDC's LLRF is comprised of multiple deposit accounts, it must give SBA 
this security interest with respect to each such account.) The PCLP CDC 
must grant to SBA the security interest in the LLRF pursuant to a 
security agreement between the PCLP CDC and SBA, and a control 
agreement between the PCLP CDC, SBA, and the applicable depository 
institution. The control agreement must include provisions requiring 
the depository institution to follow SBA instructions regarding 
withdrawal from the account without a requirement for obtaining further 
consent from the PCLP CDC, and must restrict the PCLP CDC's ability to 
make withdrawals from the account without SBA consent. When 
establishing the LLRF, a PCLP CDC must coordinate with its Lead SBA 
Office to execute and deliver the required documentation. The PCLP CDC 
must provide to the Lead SBA Office a fully executed original of the 
security and control agreements. All documents must be satisfactory to 
SBA in both form and substance.
    (e) Schedule for contributions to a LLRF. The PCLP CDC must 
contribute to the LLRF the required deposits for each PCLP Debenture in 
accordance with the following schedule:
    (1) At least 50 percent of the required deposits to the LLRF on or 
about the date that it issues the PCLP Debenture.
    (2) At least an additional 25 percent of the required deposits to 
the LLRF no later than one year after it issues the PCLP Debenture.
    (3) Any remainder of the required deposits to the LLRF no later 
than two years after it issues the PCLP Debenture.
    (f) LLRF reporting requirements. Each PCLP CDC must periodically 
report to SBA the amount in the LLRF in a form

[[Page 57984]]

that will readily facilitate reconciliation of the amount maintained in 
the LLRF with the amount required to meet a PCLP CDC's Exposure for its 
entire portfolio of PCLP Debentures.
    (g) Withdrawal of excess funds. Interest and other funds in the 
LLRF that exceed the required minimums as set forth in paragraph (b) of 
this section, within the time frames set forth in paragraph (e) of this 
section, accrue to the benefit of the PCLP CDC. PCLP CDCs are 
authorized to withdraw excess funds, including interest, from the LLRF 
if such funds exceed the required minimums set forth in paragraph (b) 
of this section. The PCLP CDC must forward requests for withdrawals to 
the Lead SBA Office, which will verify the existence and amount of 
excess funds and notify the financial institution to transfer the 
excess funds to the PCLP CDC.
    (h) Determining SBA loss. When a PCLP CDC has concluded the 
liquidation of a defaulted 504 loan made with the proceeds of a PCLP 
Debenture and has submitted a liquidation wrap-up report to SBA, or 
when SBA otherwise determines that the PCLP CDC has exhausted all 
reasonable collection efforts with respect to that 504 loan, SBA will 
determine the amount of the loss to SBA. SBA will notify the PCLP CDC 
of the amount of its reimbursement obligation to SBA (if any) and will 
explain how SBA calculated the loss.
    (1) If the PCLP CDC agrees with SBA's calculations of the loss, it 
must reimburse SBA for ten percent of the amount of that loss no later 
than 30 days after SBA's notification to the PCLP CDC of the CDC's 
reimbursement obligation.
    (2) If the PCLP CDC disputes SBA's calculations, it must reimburse 
SBA for ten percent of any loss amount that is not in dispute no later 
than 30 days after SBA's notification to the PCLP CDC of the CDC's 
reimbursement obligation. No later than 30 days after SBA's 
notification, the PCLP CDC may submit to the AA/FA or his or her 
delegate a written appeal of any disagreement regarding the calculation 
of SBA's loss. The PCLP CDC must include with that appeal an 
explanation of its reasons for the disagreement. Upon the AA/FA's final 
decision as to the disputed amount of the loss, the PCLP CDC must 
promptly reimburse SBA for ten percent of that amount.
    (i) Reimbursing SBA for loss. A PCLP CDC may use funds in the LLRF 
or other funds to reimburse SBA for the PCLP CDC's Exposure on a 
defaulted PCLP Debenture. If a PCLP CDC does not satisfy the entire 
reimbursement obligation within 30 days after SBA's notification to the 
PCLP CDC's of its reimbursement obligation, SBA may cause funds in the 
LLRF to be transferred to SBA in order to cover the PCLP CDC's 
Exposure, unless the PCLP CDC has filed an appeal under paragraph 
(h)(2) of this section. If the PCLP CDC has filed such an appeal, SBA 
may cause such a transfer of funds to SBA 30 days after the AA/FA's or 
his or her delegate's decision. If the LLRF does not contain sufficient 
funds to reimburse SBA for any unpaid Exposure with respect to any PCLP 
Debenture, the PCLP CDC must pay SBA the difference within 30 days 
after demand for payment by SBA.
    (j) Insufficient funding of LLRF. A PCLP CDC must diligently 
monitor the LLRF to ensure that it contains sufficient funds to cover 
its Exposure for its entire portfolio of PCLP Debentures. If, at any 
time, the LLRF does not contain sufficient funds, the PCLP CDC must, 
within 30 days of the earlier of the date it becomes aware of this 
deficiency or the date it receives notification from SBA of this 
deficiency, make additional contributions to the LLRF to make up this 
difference.


Sec.  120.848  Requirements for 504 loan processing, closing, 
servicing, liquidating, and litigating by PCLP CDCs.

    (a) General. In processing, closing, servicing, liquidating and 
litigating 504 loans under the PCLP (``PCLP Loans''), the PCLP CDC must 
comply with 504 program requirements imposed by statute, regulation, 
SOPs, policy and procedural notices, loan authorizations, Debentures, 
and agreements between the CDC and SBA and in accordance with prudent 
and commercially reasonable lending standards.
    (b) Documentation of decision making. For each PCLP Loan, the PCLP 
CDC must document in its files the basis for its decisions with respect 
to loan processing, closing, servicing, liquidating, and litigating.
    (c) Processing requirements. SBA expects PCLP CDCs to handle most 
504 loan processing situations, although SBA may require that the PCLP 
CDC process 504 loans involving complex or problematic eligibility 
issues through the SBA using standard 504 loan processing procedures. 
The PCLP CDC is responsible for properly determining borrower 
creditworthiness and establishing the terms and conditions under which 
the PCLP Loan will be made. The PCLP CDC also is responsible for 
properly undertaking such other processing actions as SBA may delegate 
to the PCLP CDC.
    (d) Submission of loan documents. A PCLP CDC must notify SBA of its 
approval of a 504 loan by submitting to SBA's PCLP Loan Processing 
Center all documentation required by SBA, including SBA's PCLP 
eligibility checklist, signed by an authorized representative of the 
PCLP CDC. The PCLP Loan Processing Center will review these documents 
to determine whether the PCLP CDC has identified any problems with the 
PCLP Loan approval, and whether SBA funds are available for the PCLP 
Loan. If appropriate, the PCLP Processing Center will notify the PCLP 
CDC of the loan number assigned to the loan.
    (e) Loan and Debenture closing. After receiving notification from 
SBA PCLP Loan Processing Center, the PCLP CDC is responsible for 
properly undertaking all actions necessary to close the PCLP Loan and 
Debenture in accordance with the expedited loan closing procedures 
applicable to a Priority CDC and with Sec.  120.960.
    (f) Servicing, liquidation and litigation responsibilities. The 
PCLP CDC generally must service, liquidate and litigate its entire 
portfolio of PCLP Loans, although SBA may in certain circumstances 
elect to handle such duties with respect to a particular PCLP Loan or 
Loans.
    (g) Making a 504 loan previously considered by another CDC. A PCLP 
CDC also may utilize its PCLP status to process a 504 loan application 
from an applicant whose application was declined or rejected by another 
CDC operating in that same Area of Operations, if the applicant is 
located within that area and as long as SBA has not previously declined 
that applicant's 504 loan application. This may include the processing 
of a 504 loan application from an applicant that has withdrawn its 
application from another CDC.

0
28. Revise Sec.  120.850 to read as follows:


Sec.  120.850  Expiration of Associate Development Company designation.

    The designation of Associate Development Company (ADC) will cease 
to exist on January 1, 2004. After that date, former ADCs may continue 
to contract with CDCs as Lender Service Providers (see part 103 of this 
chapter) or to perform other services.

0
29. Add a new undesignated center heading before Sec.  120.851 to read 
as follows:

Other CDC Requirements

0
30. Revise Sec.  120.851 to read as follows:


Sec.  120.851  CDC ethical requirements.

    CDCs and their Associates must act ethically and exhibit good 
character.

[[Page 57985]]

They must meet all of the ethical requirements of Sec.  120.140. In 
addition, they are subject to the following:
    (a) Any benefit flowing to a CDC's Associate or his or her employer 
from activities as an Associate must be merely incidental (this 
requirement does not prevent an Associate or an Associate's employer 
from providing interim financing as described in Sec.  120.890 or Third 
Party Loans as described in Sec.  120.920, as long as such activity 
does not violate Sec.  120.140); and
    (b) A CDC's Associate may not be an officer, director, or manager 
of more than one CDC.

0
31. Revise Sec.  120.852 to read as follows:


Sec.  120.852  Restrictions regarding CDC participation in the Small 
Business Investment Company (SBIC) program and the 7(a) loan program.

    (a) 7(a) loan program. A CDC must not invest in or be an Affiliate 
of a Lender participating in the 7(a) loan program described in Sec.  
120.2(a). (For a definition of Affiliation, refer to Sec.  121.103 of 
this chapter.) CDCs that already are affiliated with state development 
companies approved by SBA under section 501 of Title V, as of November 
6, 2003 may remain Affiliates.
    (b) SBIC program. A CDC must not directly or indirectly invest in a 
Licensee (as defined in Sec.  107.50 of this chapter) licensed by SBA 
under the SBIC program authorized in Part A of Title III of the Small 
Business Investment Act, 15 U.S.C. 681 et seq. A CDC that has an SBA-
approved investment in a Licensee as of November 6, 2003 may retain 
such investment.

0
32. Redesignate Sec.  120.973 as Sec.  120.853 and revise redesignated 
Sec.  120.853 to read as follows:


Sec.  120.853  Oversight and evaluation of CDCs.

    SBA may conduct an operational review of a CDC. The SBA Office of 
Inspector General may also conduct, supervise or coordinate audits 
pursuant to the Inspector General Act. The CDC must cooperate and make 
its staff, records, and facilities available.

0
33. Add a new undesignated center heading immediately preceding new 
Sec.  120.853 to read as follows:

SBA Oversight


Sec.  120.855  [Removed]

0
34. Remove Sec.  120.855.

0
35. Add Sec. Sec.  120.854 through 120.856 to read as follows:


Sec.  120.854  Grounds for taking enforcement action against a CDC.

    (a) General. The AA/FA or his or her authorized delegate may 
undertake one or more of the enforcement actions set forth in 
Sec. Sec.  120.855(a) and (b) with respect to a CDC, based upon a 
determination that one or more of the following grounds exist:
    (1) The CDC has failed to receive SBA approval for at least four 
504 loans during two consecutive fiscal years;
    (2) The CDC has failed to comply materially with any requirement 
imposed by statute, regulation, SOP, policy and procedural notice, any 
agreement the CDC has executed with SBA, or the terms of a Debenture or 
loan authorization.
    (3) The CDC has made a material false statement or has failed to 
disclose a material fact to SBA:
    (i) With respect to a 504 loan;
    (ii) In applying to SBA for authority to participate in the 504 
program or for any change in the CDC's participation in the 504 
program; or
    (iii) In any report or other disclosure of information that SBA 
requires.
    (4) The CDC is not performing underwriting, closing, servicing, 
liquidation, litigation, or other actions with respect to 504 loans in 
a commercially reasonable or prudent manner. Supporting evidence of a 
CDC's commercially unreasonable or imprudent action may include, but is 
not limited to, failure to meet one or more of the portfolio 
benchmarks.
    (5) The CDC fails to correct an underwriting, closing, servicing, 
liquidation, litigation, or reporting deficiency, or fails to take 
other corrective action, after receiving notice from SBA of a 
deficiency and the need to take corrective action, if any, within the 
time period specified in SBA's notice of deficiency. Such a notice must 
give the CDC a reasonable time, as determined by SBA in its sole 
discretion, to correct the deficiency.
    (6) The CDC has engaged in a pattern of uncooperative behavior or 
taken an action that SBA determines is deleterious to the 504 program, 
that undermines SBA's management and administration of the 504 program, 
or that is not consistent with standards of good conduct. Prior to 
issuing a notice of a proposed enforcement action or immediate 
suspension under Sec.  120.855(a) or Sec.  120.855(b) based upon this 
paragraph, SBA must send prior written notice to the CDC explaining why 
the CDC's actions were uncooperative, deleterious to the program, 
undermined SBA's management of the program, or were not consistent with 
standards of good conduct. The prior notice must also state that the 
CDC's actions could give rise to a specified enforcement action, and 
provide the CDC with a reasonable time to cure the deficiency before 
any further action is taken.
    (b) ALP CDCs. The AA/FA or his or her authorized delegate may 
undertake one of the enforcement actions set forth in Sec.  120.855(c) 
with respect to a CDC, based upon a determination that one or more of 
the following grounds exist:
    (1) The CDC has not continued to meet the criteria for eligibility 
under section 507(b) of Title V, 15 U.S.C. 697d.
    (2) The CDC has failed to adhere to the SBA's rules and regulations 
or is violating any other applicable provision of law.
    (c) PCLP CDCs. The AA/FA or his or her authorized delegate may 
undertake one of the enforcement actions set forth in Sec.  120.855(d) 
with respect to a CDC, based upon a determination that one or more of 
the following grounds exist:
    (1) The CDC has not continued to meet the criteria for eligibility 
under section 508(b) of Title V, 15 U.S.C. 697e.
    (2) The CDC has not established or maintained the loss reserve 
required under this paragraph (c).
    (3) The CDC has failed to adhere to the SBA's rules and 
regulations.
    (4) The CDC is violating any other applicable provision of law.


Sec.  120.855  Types of enforcement actions.

    (a) Enforcement. Upon a determination that one or more of the 
grounds set forth in Sec.  120.854(a) exist, the AA/FA or his or her 
authorized delegate may undertake, in SBA's sole discretion, one or 
more of the following enforcement actions:
    (1) Suspend or terminate the CDC's authority to participate in the 
504 program or in any pilot or program within the 504 program 
established by SBA other than a CDC's authority to participate as an 
ALP CDC or PCLP CDC, which are governed by paragraphs (c) and (d) of 
this section.
    (2) Suspend or terminate the CDC's authority to perform 
underwriting, closing, servicing, liquidation, or litigation on one or 
more 504 loans or to perform any other function in connection with the 
504 program.
    (3) Require the CDC to transfer some or all of its existing 504 
loan portfolio and/or some or all of its pending 504 loan applications 
to SBA, another CDC, or any other entity designated by SBA. Any such 
transfer may be on a temporary or permanent basis, in SBA's sole 
discretion.
    (4) Instruct the CSA to withhold payment of servicing, late and/or 
other fee(s) to the CDC.

[[Page 57986]]

    (b) Immediate suspension. If SBA determines that one or more 
grounds set forth in Sec.  120.854(a) exist and further determines that 
immediate action is necessary to prevent the risk of significant loss 
to SBA or to prevent significant impairment of the integrity of the 504 
program, the AA/FA may issue a written notice of immediate suspension 
to a CDC, suspending all or certain activities of a CDC pertaining to 
the 504 program, and such suspension will be effective as of the date 
of the notice. SBA may combine a notice of immediate suspension with 
any enforcement action set forth in paragraphs (a), (c) or (d) of this 
section.
    (c) Suspension or termination of ALP CDC. Upon a determination that 
one or more of the grounds set forth in Sec.  120.854(b) exist, the AA/
FA or his or her authorized delegate may, in SBA's sole discretion, 
suspend or terminate a CDC's authority to participate as an ALP CDC.
    (d) Suspension or termination of PCLP CDC. Upon a determination 
that one or more of the grounds set forth in Sec.  120.854(c) exist, 
the AA/FA or his or her authorized delegate may, in SBA's sole 
discretion, suspend or terminate a CDC's authority to participate as a 
PCLP CDC.
    (e) Term of suspension. Any suspension issued under this section 
will be for a term determined by SBA in its sole discretion.


Sec.  120.856  Enforcement procedures.

    (a) SBA's notice to CDC of enforcement action. (1) Prior to 
undertaking an enforcement action set forth in Sec.  120.855(a), (c) or 
(d) the AA/FA or his or her authorized delegate must issue a written 
notice to the affected CDC identifying the proposed enforcement action, 
setting forth in reasonable detail the underlying facts and reasons for 
the proposed action and, if a suspension also is proposed, stating the 
term of the proposed suspension.
    (2) If the AA/FA or his or her authorized delegate undertakes an 
immediate suspension pursuant to Sec.  120.855(b), he or she must issue 
a written notice to the affected CDC identifying the scope and term of 
the suspension, and setting forth in reasonable detail the underlying 
facts and reasons for the proposed action.
    (3) If a proposed enforcement action or immediate suspension is 
based upon information obtained from a party other than the CDC or SBA, 
SBA's notice of proposed action or immediate suspension will provide 
copies of documentation received from such third party, or the name of 
the third party in case of oral information, unless SBA determines that 
there are compelling reasons not to provide such information. If 
compelling reasons exist, SBA will provide a summary of the information 
it received to the CDC.
    (b) CDC's opportunity to object. (1) A CDC that desires to contest 
a proposed enforcement action or an immediate suspension must file, 
within 30 calendar days of its receipt of the notice or within some 
other term established by SBA in its notice, a written objection with 
the AA/FA or other SBA official identified in the notice. Notice will 
be presumed to have been received within five days of the date of the 
notice unless the CDC can provide compelling evidence to the contrary.
    (2) The objection must set forth in detail all grounds known to the 
CDC to contest the proposed action or immediate suspension and all 
mitigating factors, and must include documentation that the CDC 
believes is most supportive of its objection. A CDC must exhaust this 
administrative remedy in order to preserve its objection to a proposed 
enforcement action or an immediate suspension.
    (3) If a CDC can show legitimate reasons why it does not understand 
the reasons given by SBA in its notice of the action, the CDC may 
request clarification from the Agency. SBA will provide the requested 
clarification in writing to the CDC or notify the CDC in writing that 
such clarification is not necessary. SBA, in its sole discretion, will 
further advise in writing whether the CDC may have additional time to 
present its objection to the notice.
    (4) A CDC may request additional time to respond to SBA's notice if 
it can show that there are compelling reasons why it is not able to 
respond within the 30-day timeframe or timeframe given by the notice 
for response. If such a request is submitted to the Agency, SBA may, in 
its sole discretion, provide the CDC with additional time to respond to 
the notice of proposed action or immediate suspension.
    (5) Prior to the issuance of a final decision by SBA under Sec.  
120.856(c), if a CDC can show that there is newly discovered material 
evidence which, despite the CDC's exercise of due diligence, could not 
have been discovered within the timeframe given by SBA to respond to a 
notice, or that there are compelling reasons beyond the CDC's control 
why it was not able to present a material fact or argument to the AA/FA 
or other deciding SBA official in its objection, and that the CDC has 
been prejudiced by not being able to present such information, the CDC 
may submit such information to SBA and request that the Agency consider 
such information in its final decision.
    (c) SBA's decision on CDC's objection to proposed action. (1) If 
the affected CDC files a timely written objection to a proposed 
enforcement action, the AA/FA or his or her authorized delegate must 
issue a written notice of decision to the affected CDC advising whether 
SBA is undertaking the proposed enforcement action setting forth the 
grounds for the decision. SBA will issue such a notice of decision 
whenever it deems appropriate.
    (2) If the affected CDC files a timely written objection to a 
notice of immediate suspension, the AA/FA or his or her authorized 
delegate must issue a written notice of final decision to the affected 
CDC within 90 days of receiving the CDC's objection advising whether 
SBA is continuing with the immediate suspension. If the CDC submits 
additional information to SBA after submitting its objection pursuant 
to Sec.  120.856(b)(5), SBA must issue its final decision within 90 
days of receiving such information.
    (3) Prior to issuing a notice of decision, SBA in its sole 
discretion can request additional information from the affected CDC or 
other parties and conduct any other investigation it deems appropriate. 
If SBA determines, in its sole discretion, to consider an untimely 
objection, it must issue a notice of decision pursuant to this 
paragraph.
    (d) SBA's notice of final agency decision. If SBA chooses not to 
consider an untimely objection or if the affected CDC fails to file a 
written objection to a proposed enforcement action or an immediate 
suspension, and if SBA continues to believe that such proposed 
enforcement action or immediate suspension is appropriate, the AA/FA or 
his or her authorized delegate must issue a written notice of decision 
to the affected CDC that SBA is undertaking one or more of the proposed 
enforcement actions against the CDC or that SBA will continue to pursue 
an immediate suspension of the CDC. Such a notice of decision need not 
state any grounds for the action other than to reference the CDC's 
failure to file a timely objection, and represents the final agency 
decision. If the affected CDC fails to file a written objection to an 
immediate suspension, SBA need not issue any further notice to the CDC.
    (e) Appeal to OHA. (1) A CDC may appeal from an SBA notice of 
decision issued pursuant to paragraph (c) of this section to the SBA 
Office of Hearings and Appeals (OHA). The rules and procedures set 
forth in part 134 of this chapter will govern such appeals.

[[Page 57987]]

    (2) OHA must limit its review to a determination of whether SBA's 
decision was arbitrary, capricious or contrary to law, or without 
procedure required by law. OHA must limit its review to the record that 
the AA/FA or his or her authorized delegate, and any other SBA 
officials directly involved with the decision, considered in making the 
final decision. If the OHA decides that SBA's decision was arbitrary, 
capricious, contrary to law, or without procedure required by law, the 
OHA must remand the matter to the AA/FA or the original deciding 
official for further consideration. The CDC may appeal from a 
reconsidered SBA decision as set forth in this paragraph (e).
    (3) (i) OHA must not consider any argument, fact or other 
information presented by the affected CDC unless the CDC previously 
submitted that information to SBA:
    (A) In or with the affected CDC's objection;
    (B) In response to a request for information from SBA; or
    (C) Pursuant to paragraph (b)(5) of this section if such 
information was accepted by SBA.
    (ii) However, if a CDC can show that there is newly discovered 
material evidence which, despite the CDC's exercise of due diligence, 
could not have been discovered before the Agency's final decision, or 
that there are compelling reasons beyond the CDC's control why it was 
not able to present a material fact or argument to the AA/FA or other 
deciding SBA official prior to such decision, and that the CDC has been 
prejudiced by not being able to present such information to the 
official, the CDC may file a motion with the OHA for a remand of the 
matter.
    (4) A decision by OHA, other than a remand, is the final agency 
decision.
    (f) Limit on applicability. The procedures in this section shall 
only apply to an action taken by SBA pursuant to Sec.  120.855.

0
35b. Add a new undesignated center heading immediately preceding new 
Sec.  120.854 to read as follows:

SBA Enforcement Actions

0
35c. Redesignate Sec.  120.981 as Sec.  120.857.

0
36. Revise Sec.  120.861 to read as follows:


Sec.  120.861  Job creation or retention.

    A Project must create or retain one Job Opportunity per an amount 
of 504 loan funding that will be specified by SBA from time to time in 
a Federal Register notice. Such Job Opportunity average remains in 
effect until changed by subsequent Federal Register publication.

0
37. Amend Sec.  120.862 as follows:
0
a. By revising the parenthetical at the end of paragraph (a)(4);
0
b. By revising paragraph (b)(2);
0
c. By redesignating paragraphs (b)(3) through (b)(7) as (b)(5) through 
(b)(9);
0
d. By adding new paragraphs (b)(3) and (b)(4), and
0
e. By revising redesignated paragraph (b)(5). The revisions and 
additions read as follows:


Sec.  120.862  Other economic development objectives.

* * * * *
    (a) * * *
    (4) * * * (North American Industry Classification System (NAICS), 
Sectors 31 `` 33); or
* * * * *
    (b) * * *
    (2) Expansion of exports;
    (3) Expansion of small businesses owned and controlled by women as 
defined in section 29(a)(3) of the Act, 15 U.S.C. 656(a)(3);
    (4) Expansion of small businesses owned and controlled by veterans 
(especially service-disabled veterans) as defined in section 3(q) of 
the Act, 15 U.S.C. 632(q);
    (5) Expansion of minority enterprise development (see Sec.  
124.103(b) of this chapter for minority groups who qualify for this 
description);
* * * * *

0
38. Amend Sec.  120.870 as follows:
0
a. By removing paragraph (b);
0
b. By redesignating paragraph (c) as paragraph (b); and
0
c. By revising paragraph (a) introductory text to read as follows:


Sec.  120.870  Leasing Project Property.

    (a) A Borrower may use the proceeds of a 504 loan to acquire, 
construct, or modify buildings and improvements, and/or to purchase and 
install machinery and equipment located on land leased to the Borrower 
by an unrelated lessor if:
* * * * *

0
39. Revise the heading of Sec.  120.871 to read as follows:


Sec.  120.871  Leasing part of Project Property to another business.

* * * * *

0
40. Amend Sec.  120.880 by revising paragraph (b) to read as follows:


Sec.  120.880  Basic eligibility requirements.

* * * * *
    (b) Together with its Affiliates, meet one of the size standards 
set forth in Sec.  121.301(b) of this chapter.

0
41. Revise Sec.  120.882(c) to read as follows:


Sec.  120.882  Eligible Project costs for 504 loans.

* * * * *
    (c) Professional fees directly attributable and essential to the 
Project, such as title insurance, opinion of title, architectural and 
engineering costs, appraisals, environmental studies, and legal fees 
related to zoning, permits, or platting; and
* * * * *

0
42. Revise paragraph (d) of Sec.  120.883 to read as follows:


Sec.  120.883  Eligible administrative costs for 504 loans.

* * * * *
    (d) Borrower's out-of-pocket costs associated with 504 loan and 
Debenture closing other than legal fees (for example, certifications 
and the copying costs associated with them, overnight delivery, 
postage, and messenger services) but not to include fees and costs 
described in Sec.  120.882;
* * * * *

0
43. Amend Sec.  120.892(b) by removing the phrase ``90 days'' and 
adding in its place the phrase ``120 days''.

0
44. Revise the heading of Sec.  120.900 to read as follows:


Sec.  120.900  Sources of permanent financing.

* * * * *

0
45. Revise the heading of Sec.  120.910 to read as follows:


Sec.  120.910  Borrower contributions.

* * * * *

0
46. Revise Sec.  120.911 to read as follows:


Sec.  120.911  Land contributions.

    The Borrower's contribution may be land (including buildings, 
structures and other site improvements which will be part of the 
Project Property) previously acquired by the Borrower.

0
47. Revise Sec.  120.913 to read as follows:


Sec.  120.913  Limitations on any contributions by a Licensee.

    Subject to part 107 of this chapter, a Licensee may provide 
financing for all or part of the Borrower's contribution to the 
Project. SBA will consider Licensee funds to be derived from federal 
sources if the Licensee has Leverage (as defined in Sec.  107.50 of 
this chapter). If the Licensee does not have Leverage, SBA will 
consider the investment to be from private funds. Licensee financing 
must be subordinated to the 504 loan and must not be repaid at a faster 
rate than the Debenture. (Refer to Sec.  120.930(a) for additional 
limitations.)

[[Page 57988]]


0
48. Amend Sec.  120.923 by revising the heading to read as follows:


Sec.  120.923  Policies on subordination.

* * * * *

0
48a. Redesignate Sec.  120.924 as paragraph (c) of Sec.  120.923.

0
49. Amend Sec.  120.925 by adding a parenthetical at the end to read as 
follows:


Sec.  120.925  Preference.

    * * * (See Sec.  120.10 for a definition of Preference.)

0
50. Revise Sec.  120.926 to read as follows:


Sec.  120.926  Referral fee.

    The CDC can receive a reasonable referral fee from the Third Party 
Lender if the CDC secured the Third Party Lender for the Borrower under 
a written contract between the CDC and the Third Party Lender. Both the 
CDC and the Third Party Lender are prohibited from charging this fee to 
the Borrower. If a CDC charges a referral fee, the CDC will be 
construed as a Referral Agent under part 103 of this chapter.

0
51. Revise paragraph (b) of Sec.  120.930 to read as follows:


Sec.  120.930  Amount.

* * * * *
    (b) A 504 loan must not be less than $25,000.
* * * * *

0
52. Revise Sec.  120.931 to read as follows:


Sec.  120.931 504  Lending limits.

    The outstanding balance of all SBA financial assistance to a 
Borrower and its affiliates under the 504 program covered by this part 
must not exceed $1,000,000 (or $1,300,000 if one or more of the public 
policy goals enumerated in Sec.  120.862(b) applies to the Project).

0
53. Revise Sec.  120.933 to read as follows:


Sec.  120.933  Maturity.

    From time to time, SBA will publish in the Federal Register the 
available maturities for a 504 loan and the Debenture that funds it. 
Such available maturities remain in effect until changed by subsequent 
Federal Register publication.

0
54. Revise Sec.  120.934 to read as follows:


Sec.  120.934  Collateral.

    The CDC usually takes a second lien position on the Project 
Property to secure the 504 loan. Sometimes additional collateral is 
required. (In rare circumstances, SBA may permit other collateral 
substituted for Project Property.) All collateral must be insured 
against such hazards and risks as SBA may require, with provisions for 
notice to SBA and the CDC in the event of impending lapse of coverage.

0
55. Revise the heading of Sec.  120.935 to read as follows:


Sec.  120.935  Deposit from the Borrower that a CDC may require.

* * * * *


Sec.  120.936  [Removed]

0
56. Remove Sec.  120.936.

0
57. Revise Sec.  120.960 to read as follows:


Sec.  120.960  Responsibility for closing.

    (a) The CDC is responsible for the 504 loan closing.
    (b) The Debenture closing is the joint responsibility of the CDC 
and SBA.
    (c) SBA may, within its sole discretion, decline to close the 
Debenture; direct the transfer of the 504 loan to another CDC; or 
cancel its guarantee of the Debenture, prior to sale, if any of the 
following occur:
    (1) The CDC has failed to comply materially with any requirement 
imposed by statute, regulation, SOP, policy and procedural notice, any 
agreement the CDC has executed with SBA, or the terms of a Debenture or 
loan authorization;
    (2) The CDC has failed to make or close the 504 loan or prepare the 
Debenture closing in a prudent or commercially reasonable manner;
    (3) The CDC's improper action or inaction places SBA at risk;
    (4) The CDC has failed to use required SBA forms or electronic 
versions of those forms;
    (5) The CDC, Third Party Lender or Borrower has failed to timely 
disclose to SBA a material fact regarding the Project or 504 loan;
    (6) The CDC, Third Party Lender or Borrower has misrepresented a 
material fact to SBA regarding the Project or 504 loan; or
    (7) SBA determines that there has been an unremedied material 
adverse change, such as deterioration in the Borrower's financial 
condition, since the 504 loan was approved, or that approving the 
closing of the Debenture will put SBA at unacceptable financial risk.

0
58. Revise the undesignated center heading immediately preceding Sec.  
120.970 to read as follows:

Servicing

0
59. Revise Sec.  120.970 to read as follows:


Sec.  120.970  Servicing of 504 loans and Debentures.

    (a) In servicing 504 loans, CDCs must comply with 504 program 
requirements imposed by statute, regulation, SOPs, policy and 
procedural notices, loan authorizations, Debentures, and agreements 
between the CDC and SBA, and in accordance with prudent and 
commercially reasonable lending standards.
    (b) The CDC is responsible for routine servicing including receipt 
and review of the Borrower's or Operating Company's financial 
statements on an annual or more frequent basis and monitoring the 
status of the Borrower and 504 loan collateral.
    (c) The CDC is responsible for assuring that the Borrower makes all 
required insurance premium payments and has paid all taxes when due.
    (d) The CDC is responsible for filing renewals and extensions of 
security interests on collateral for the 504 loan, as required.
    (e) The CDC must timely respond to Borrower requests for loan 
modifications.
    (f) For any 504 loan that is more than three months past due, the 
CDC must promptly request that SBA purchase the Debenture unless the 
504 loan has an SBA-approved deferment or is in compliance with an SBA-
approved plan to allow the Borrower to catch up on delinquent loan 
payments.
    (g) The CDC must cooperate with SBA to cure defaults and initiate 
workouts.
    (h) SBA may negotiate agreements with CDCs to liquidate 504 loans.

0
60. Add a new undesignated center heading immediately preceding Sec.  
120.971 to read as follows:

Fees

0
61. Revise paragraphs (a) (introductory text) and (a)(2) of Sec.  
120.971 to read as follows:


Sec.  120.971  Allowable fees paid by Borrower.

    (a) CDC fees. The fees a CDC may charge the Borrower in connection 
with a 504 loan and Debenture are limited to the following:
* * * * *
    (2) Closing fee. The CDC may charge a reasonable closing fee 
sufficient to reimburse it for the expenses of its in-house or outside 
legal counsel, and other miscellaneous closing costs (CDC Closing Fee). 
Some closing costs may be funded out of the Debenture proceeds (see 
Sec.  120.883 for limitations);
* * * * *

0
62. Revise Sec.  120.972 to read as follows:


Sec.  120.972  Third Party Lender participation fee and CDC fee.

    (a) Participation fee. For loans approved by SBA after September 
30, 1996, SBA must collect a one-time fee equal to 50 basis points on 
the Third

[[Page 57989]]

Party Lender's participation in a Project when the Third Party Lender 
occupies a senior credit position to SBA in the Project.
    (b) CDC fee. For loans approved by SBA after September 30, 1996, 
SBA must collect an annual fee from the CDC equal to 0.125 percent of 
the outstanding principal balance of the Debenture. The fee must be 
paid from the servicing fees collected by the CDC and cannot be paid 
from any additional fees imposed on the Borrower.

0
63. Remove the undesignated center heading immediately preceding Sec.  
120.980.

0
64. Remove Sec. Sec.  120.980, 120.982, 120.983 and 120.984.

    Dated: September 25, 2003.
Hector V. Barreto,
Administrator.
[FR Doc. 03-24860 Filed 10-6-03; 8:45 am]
BILLING CODE 8025-01-P