[Federal Register Volume 77, Number 65 (Wednesday, April 4, 2012)]
[Rules and Regulations]
[Pages 20292-20294]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-8017]


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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: Final rule.

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SUMMARY: The U.S. Small Business Administration is revising 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 
eliminates 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 implements two provisions of the Small Business 
Investment Act of 1958, as amended. First, it brings the public notice 
requirement for conflict of interest transactions into conformity with 
statutory requirements. Second, it expands 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 makes two technical corrections: Removing 
an outdated cross-reference; and eliminating a section that exactly 
duplicates a provision found elsewhere in part 107.

DATES: This rule is effective May 4, 2012.

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

SUPPLEMENTARY INFORMATION: On October 14, 2010, SBA published a 
proposed rule (75 FR 63110) to: (1) Remove the requirement for an SBIC 
to obtain a conflict of interest exemption from SBA for certain follow-
on financings; (2) revise the public notice requirements for conflict 
of interest financings to conform with statutory requirements under the 
Small Business Investment Act of 1958, as amended (SBI Act); and (3) 
expand the types of investments an SBIC is permitted to make with its 
``idle funds'', in conformity with the SBI Act. The rule also included 
two non-substantive technical corrections.
    SBA received no relevant comments on the proposed rule, which is 
being finalized without change. SBA's section-by-section explanation of 
the proposed regulatory changes, all of which have been implemented in 
this final rule, is repeated here as a convenience to the reader.
    Section 107.730--Financings which constitute conflicts of interest. 
The 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

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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, the final rule adds an exception to 13 CFR 
107.730(a)(1). This paragraph previously prohibited any financing of an 
Associate without a prior written conflict of interest exemption. Under 
the new exception, a prior written exemption is not 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 has also revised Sec.  107.730(g), which requires public notice 
of all requests by SBICs for conflict of interest exemptions. The 
previous language required 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 exceeded 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). The final rule 
brings 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 is not affected.
    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 final rule revises this section to reflect 
an amendment to section 308(b) of the SBI Act (15 U.S.C. 687(b)) 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.
    Section 107.855--Interest rate ceiling and limitations on fees 
charged to Small Businesses (``Cost of Money''). The final rule 
corrects an error by removing Sec.  107.855(g)(10). This paragraph 
provided 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 final rule eliminates 
duplication by removing Sec.  107.505, which required an SBIC to have 
the capability to receive fax messages. This section repeated language 
already found in Sec.  107.504(b).

Compliance With Executive Orders 12866, 12988 and 13132, the Paperwork 
Reduction Act (44 U.S.C. Chapter 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. 
This rule also is not a major rule under the Congressional Review Act 
(CRA).

Executive Order 12988

    This action meets applicable standards set forth in Sections 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

    For the purposes of Executive Order 13132, SBA has determined that 
this final rule will not have substantial direct effects on the States, 
or the distribution of power and responsibilities among the various 
levels of government. Therefore, SBA has determined that this final 
rule has no federalism implications warranting the preparation of a 
federalism assessment.

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

    For purposes of the Paperwork Reduction Act (PRA), 44 U.S.C. 
chapter 35, SBA has determined that this rule

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will 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 have been 
required to submit conflict of interest exemptions under the 
circumstances described in this rule, that requirement no longer 
exists.

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

    When an agency promulgates a final rule following publication of 
the proposed rule, the Regulatory Flexibility Act (RFA) (5 U.S.C. 601-
612) requires the agency to prepare a final regulatory flexibility 
analysis (FRFA) which describes the potential economic impact of the 
rule on small entities and alternatives that may minimize that impact. 
Section 605 of the RFA allows an agency to certify a rule, in lieu of 
preparing a FRFA, if the rulemaking is not expected to have a 
significant economic impact on a substantial number of small entities. 
This final rule affects all SBICs, of which there are currently 294, 
most of which are small entities. Therefore, SBA has determined that 
this rule will have an impact on a substantial number of small 
entities. However, SBA has determined that the impact on entities 
affected by the rule will not be significant. The new conflict of 
interest exception eliminates the 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, will be 
minimal and entirely beneficial to small SBICs. Accordingly, the 
Administrator of the SBA hereby certifies that this rule will 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 amends part 107 of title 13 of the Code of Federal 
Regulations as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

0
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]

0
2. Remove Sec.  107.505.

0
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
* * * * *

0
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 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]

0
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).

Karen G. Mills,
Administrator.
[FR Doc. 2012-8017 Filed 4-3-12; 8:45 am]
BILLING CODE 8025-01-P