[Federal Register Volume 75, Number 198 (Thursday, October 14, 2010)]
[Proposed Rules]
[Pages 63110-63113]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-25729]


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

SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

RIN 3245-AF56


Small Business Investment Companies--Conflicts of Interest and 
Investment of Idle Funds

AGENCY: U.S. Small Business Administration.

ACTION: Proposed rule.

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

SUMMARY: The U.S. Small Business Administration proposes to revise a 
rule which prohibits a small business investment company (SBIC) from 
providing financing to an Associate, as defined in the rules, unless it 
first obtains a conflict of interest exemption from SBA. The revision 
would eliminate the requirement for an exemption in the case of a 
follow-on investment in a small business concern by an SBIC and an 
Associate investment fund, where both parties invested previously on 
the same terms and conditions and where the follow-on investment would 
also be on the same terms and conditions as well as in the same 
proportions. In addition, this rule would implement two provisions of 
the Small Business Investment Act. First, it would bring the public 
notice requirement for conflict of interest transactions into 
conformity with statutory requirements. Second, it would expand the 
types of investments an SBIC is permitted to make with its ``idle 
funds'' (cash that is not immediately needed for fund operations or 
investments in small business concerns). Finally, the rule would remove 
an outdated cross-reference and eliminate a section that exactly

[[Page 63111]]

duplicates a provision found elsewhere in part 107.

DATES: Comments on the proposed rule must be received on or before 
November 15, 2010.

ADDRESSES: You may submit comments, identified by RIN 3245-AF56, by any 
of the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Mail, Hand Delivery/Courier: Harry E. Haskins, Deputy 
Associate Administrator for Investment, U.S. Small Business 
Administration, 409 Third Street, SW., Washington, DC 20416.

SBA will post comments on http://www.regulations.gov. If you wish to 
submit confidential business information (CBI) as defined in the User 
Notice at http://www.regulations.gov, please submit the information to 
Carol Fendler, Investment Division, 409 Third Street, SW., Washington, 
DC 20416. Highlight the information that you consider to be CBI and 
explain why you believe this information should be held confidential. 
SBA will review the information and make the final determination of 
whether it will publish the information or not.

FOR FURTHER INFORMATION CONTACT: Carol Fendler, Investment Division, 
Office of Capital Access, (202) 205-7559 or [email protected].

SUPPLEMENTARY INFORMATION:
    Section 107.730--Financings which constitute conflicts of interest. 
The Small Business Investment Act of 1958, as amended (SBI Act), 
authorizes SBA to adopt regulations to govern transactions that may 
constitute a conflict of interest and which may be detrimental to small 
business concerns, small business investment companies, their 
investors, or SBA. Accordingly, SBA promulgated 13 CFR 107.730, which 
generally prohibits financing transactions that involve a conflict of 
interest, unless the SBIC obtains a prior written exemption from SBA. 
The most common type of transaction requiring an exemption is 
``financing an Associate.'' Associates of an SBIC, as defined in Sec.  
107.50, encompass a broad range of related parties based on business, 
economic and family ties, both direct and indirect.
    In addition to identifying transactions requiring a conflict of 
interest exemption, Sec.  107.730 sets forth the circumstances under 
which an SBIC is permitted to co-invest with its Associates. The 
primary purpose of these provisions is to ensure that the terms of such 
co-investments are ``fair and equitable'' to the SBIC, i.e. that the 
SBIC is not being disadvantaged relative to an Associate. The co-
investment rules include a number of ``safe harbor'' provisions under 
which the transaction is presumed to be fair and equitable to the SBIC; 
one of these safe harbors covers financings where the SBIC and its 
Associate invest at the same time and on the same terms and conditions. 
SBIC managers frequently seek to rely on this provision because they 
are involved in the management of more than one fund and would like to 
have the funds co-invest in a small business. SBA generally considers 
such co-investments to be beneficial because risk is spread across more 
than one entity. The small business may also benefit from having access 
to multiple investors.
    It became apparent after adoption of the current Sec.  107.730 that 
certain types of transactions could be characterized as both ``co-
investment with an Associate'' and ``financing an Associate.'' As with 
all other transactions that involve the financing of an Associate, SBA 
has required the SBIC to obtain a prior written exemption even if the 
financing would fall under the safe harbor for co-investments with 
Associates.
    However, SBA believes the exemption requirement is unnecessarily 
burdensome for one particular type of transaction: The SBIC and an 
Associate investment fund (most typically a fund under common 
management) make an initial investment in a small business under the 
same terms and conditions, which include the acquisition by each fund 
of at least a 10% equity interest in the small business. This initial 
round of financing is a ``co-investment with an Associate'' and does 
not require a conflict of interest exemption. However, when the same 
two parties want to make a follow-on investment in the same small 
business, again under the same terms and conditions, the second and 
subsequent round(s) of financing are considered to be ``financing an 
Associate'' and do require a prior written exemption. This is because 
the Associate fund's 10% or greater equity interest causes the small 
business itself to be defined as an Associate of the SBIC under 
paragraph (8)(ii) of the definition in Sec.  107.50. While SBA would 
approve a conflict of interest exemption for a follow-on financing 
transaction on the same terms and conditions by an SBIC and its 
Associate fund, the Agency is concerned that the exemption requirement 
may cause unnecessary delays in making financing available to the small 
business, and imposes a significant administrative burden on both the 
SBIC and SBA.
    To address this concern, this proposed rule adds an exception to 13 
CFR 107.730(a)(1). Currently, this paragraph prohibits the financing of 
an Associate without a prior written conflict of interest exemption. 
Under the new exception, a prior written exemption would not be 
required for an Associate financing that satisfies all of the following 
conditions:
    1. The small business that will receive the financing is an 
Associate of the SBIC, pursuant to paragraph (8)(ii) of the Associate 
definition, only because an Associate investment fund already holds a 
10% or greater equity interest in the small business.
    2. The SBIC and the Associate fund previously invested in the small 
business at the same time and on the same terms and conditions.
    3. The SBIC and the Associate fund will provide follow-on financing 
to the small business at the same time and on the same terms and 
conditions.
    4. The SBIC and the Associate fund will provide follow-on financing 
to the small business in the same proportionate dollar amounts as their 
respective investments in the previous round of financing (e.g., if the 
SBIC invested $2 million and the Associate invested $1 million in the 
previous round, their follow-on investments would be in the same 2:1 
ratio).
    The revision will allow transactions meeting these specific 
conditions to be governed only by the co-investment provisions of Sec.  
107.730(d) rather than by the ``Associate financing'' provisions of the 
current Sec.  107.730(a), thereby returning to SBA's original intent 
when it promulgated the co-investment rules. SBA expects that this 
change will help to eliminate delays in making follow-on financing 
available to small businesses while providing appropriate protection 
for small business concerns, investors in SBICs and the Federal 
government.
    SBA is also proposing a change to Sec.  107.730(g), which requires 
public notice of all requests by SBICs for conflict of interest 
exemptions. The current language requires public notice by both SBA 
(via publication in the Federal Register) and the requesting SBIC (via 
publication in a newspaper in the locality most directly affected by 
the transaction). These disclosure requirements are more extensive than 
those required by section 312 of the SBI Act, from which the local 
publication requirement was removed by section 3 of Public Law 107-100 
(December 21, 2001). This rule would bring the regulation into 
conformity with the statute by eliminating the requirement for public 
notice in the affected locality; the requirement for public notice in 
the Federal Register would not be affected.

[[Page 63112]]

    Section 107.530--Restrictions on investments of idle funds by 
leveraged Licensees. An SBIC holding idle funds may invest those funds 
only as permitted by Sec.  107.530(b). The permitted investments are 
all relatively short term and bear minimal or no risk of loss, such as 
direct obligations of the United States that mature within 15 months of 
the date of investment. The current regulation largely follows section 
308(b) of the SBI Act (15 U.S.C. 687(b)), but does not reflect an 
amendment made by Public Law 108-447, Division K, section 202 (December 
8, 2004) that allows an SBIC to invest ``in mutual funds, securities, 
or other instruments that consist of, or represent pooled assets of'' 
the various direct investment vehicles permitted by section 308(b). 15 
U.S.C. 687(b)(3). For example, this provision allows an SBIC to invest 
idle funds in a money market account, as long as the money market fund 
invests exclusively in permitted instruments. This proposed rule would 
bring the regulation into conformity with the statute.
    Section 107.855--Interest rate ceiling and limitations on fees 
charged to Small Businesses (``Cost of Money''). The proposed rule 
would correct an error by removing Sec.  107.855(g)(10). This paragraph 
provides an exclusion from the Cost of Money calculation in the form of 
a cross-reference to the non-existent Sec.  107.855(i).
    Section 107.505--Facsimile requirement. The proposed rule would 
eliminate duplication by removing Sec.  107.505, which requires an SBIC 
to have the capability to receive fax messages. This section repeats 
language already found in Sec.  107.504(b).

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

Executive Order 12866

    The Office of Management and Budget has determined that this rule 
is not a ``significant'' regulatory action under Executive Order 12866.

Executive Order 12988

    This action meets applicable standards set forth in section 3(a) 
and 3(b)(2) of Executive Order 12988, Civil Justice Reform, to minimize 
litigation, eliminate ambiguity, and reduce burden. The action does not 
have retroactive or presumptive effect.

Executive Order 13132

    The proposed rule would not have substantial direct effects on the 
States, or the distribution of power and responsibilities among the 
various levels of government. Therefore, for the purposes of Executive 
Order 13132, Federalism, SBA determines that this proposed rule has no 
federalism implications warranting the preparation of a federalism 
assessment.

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

    For purposes of the Paperwork Reduction Act, (PRA) 44 U.S.C. Ch. 
35, SBA has determined that this rule would not impose any new 
reporting or recordkeeping requirements. The requirement for SBICs to 
submit requests for conflict of interest exemptions is not an 
information collection as that term is defined by the PRA because the 
requests do not involve any standardized or identical reporting, 
recordkeeping or disclosure requirements. Rather, each request for 
exemption is unique to the circumstances of the particular SBIC. In any 
event, to the extent that SBICs are currently required to submit 
conflict of interest exemptions under the circumstances described in 
this proposed rule, that requirement would no longer exist.

Compliance With the Regulatory Flexibility Act, 5 U.S.C. 601-612

    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601, requires 
administrative agencies to consider the effect of their actions on 
small entities, small non-profit businesses, and small local 
governments. Pursuant to the RFA, when an agency issues a rule, the 
agency must prepare an Initial Regulatory Flexibility Act (IRFA) 
analysis which describes whether the impact of the rule will have a 
significant economic impact on a substantial number of small entities. 
However, Sec.  605 of the RFA allows an agency to certify a rule, in 
lieu of preparing an IRFA, if the rulemaking is not expected to have a 
significant economic impact on a substantial number of small entities. 
This proposed rule would affect all SBICs, of which there are currently 
309. SBA estimates that approximately 75% of these SBICs are small 
entities. Therefore, SBA has determined that this proposed rule would 
have an impact on a substantial number of small entities. However, SBA 
has determined that the impact on entities affected by the rule would 
not be significant. The conflict of interest provision would eliminate 
the current requirement for SBICs to obtain a conflict of interest 
exemption for a particular type of transaction. This change is expected 
to reduce the regulatory burden on SBICs and allow them to close such 
financing transactions with less delay.
    SBA asserts that the economic impact of the rule, if any, would be 
minimal and entirely beneficial to small SBICs. Accordingly, the 
Administrator of the SBA hereby certifies that this rule would not have 
a significant impact on a substantial number of small entities.

List of Subjects in 13 CFR Part 107

    Investment companies, Loan programs--business, Reporting and 
recordkeeping requirements, Small businesses.

    For the reasons stated in the preamble, the Small Business 
Administration proposes to amend part 107 of title 13 of the Code of 
Federal Regulations as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

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

    Authority: 15 U.S.C. 681 et seq., 683, 687(c), 687b, 687d, 687g, 
687m, Pub. L. 106-554, 114 Stat. 2763; and Pub. L. 111-5, 123 Stat. 
115.


Sec.  107.505  [Removed]

    2. Remove Sec.  107.505.
    3. Amend Sec.  107.530 by redesignating paragraphs (b)(3) through 
(b)(6) as (b)(4) through (b)(7) and adding a new paragraph (b)(3) to 
read as follows:


Sec.  107.530  Restrictions on investments of idle funds by leveraged 
Licensees.

* * * * *
    (b) Permitted investments of idle funds. * * *
    (3) Mutual funds, securities, or other instruments that exclusively 
consist of, or represent pooled assets of, investments described in 
paragraphs (b)(1) or (b)(2) of this section; or
* * * * *
    4. Amend Sec.  107.730 by revising paragraphs (a)(1) and (g) to 
read as follows:


Sec.  107.730   Financings which constitute conflicts of interest.

    (a) * * *
    (1) Provide Financing to any of your Associates, except for a 
Financing to an Associate that meets all of the following conditions:
    (i) The Small Business that receives the Financing is your 
Associate, pursuant to paragraph (8)(ii) of the Associate definition in 
Sec.  107.50, only because an investment fund that is your Associate 
holds a 10% or greater equity interest in the Small Business.
    (ii) You and the Associate investment fund previously invested in 
the Small

[[Page 63113]]

Business at the same time and on the same terms and conditions.
    (iii) You and the Associate investment fund are providing follow-on 
financing to the Small Business at the same time, on the same terms and 
conditions, and in the same proportionate dollar amounts as your 
respective investments in the previous round(s) of financing (for 
example, if you invested $2 million and your Associate invested $1 
million in the previous round, your respective follow-on investments 
would be in the same 2:1 ratio).
* * * * *
    (g) Public notice. Before granting an exemption under this Sec.  
107.730, SBA will publish notice of the transaction in the Federal 
Register.


Sec.  107.855   [Amended]

    5. Amend Sec.  107.855 by removing paragraph (g)(10) and 
redesignating current paragraphs (g)(11) through (g)(13) as (g)(10) 
through (g)(12).

    Dated: October 6, 2010.
Karen G. Mills,
Administrator.
[FR Doc. 2010-25729 Filed 10-13-10; 8:45 am]
BILLING CODE 8025-01-P