504 and 7(a) Loan Programs Updates, 15641-15651 [2014-06237]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 79, Number 55 (Friday, March 21, 2014)]
[Rules and Regulations]
[Pages 15641-15651]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-06237]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

RIN 3245-AG04


504 and 7(a) Loan Programs Updates

AGENCY: U.S. Small Business Administration.

ACTION: Final rule.

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SUMMARY: This rule finalizes the proposed rule that the U.S. Small 
Business Administration (``SBA'') issued to improve access to its two 
flagship business lending programs: the 504 Loan Program and the 7(a) 
Loan Program. This rule will enhance job creation through increasing 
eligibility for loans under SBA's business loan programs and by 
modifying certain program participant requirements applicable to the 
504 Loan Program. In addition, SBA is revising Certified Development 
Company (CDC) operations requirements to clarify certain existing 
regulations. SBA has decided to further study the issue of how to 
redefine affiliation for the business loan programs and is not 
including any changes to the affiliation standards in this final rule.

DATES: This rule is effective April 21, 2014, except for the amendment 
to 13 CFR 120.823, which is effective April 21, 2015.

FOR FURTHER INFORMATION CONTACT: Linda Rusche, Director, of Financial 
Assistance; ATTN: Linda Reilly, Chief, 504 Program Branch, Office of 
Financial Assistance, Small Business Administration, 409 3rd Street 
SW., Washington, DC 20416; telephone 202-205-9949.

SUPPLEMENTARY INFORMATION:

I. Background

    The 504 Loan Program and 7(a) Loan Program are SBA's two primary 
business loan programs authorized under the Small Business Investment 
Act of 1958 and the Small Business Act, respectively. On February 25, 
2013, SBA published a proposed rule with request for comments in the 
Federal Register to implement several changes intended to reinvigorate 
the business loan programs by eliminating unnecessary compliance 
burdens and loan eligibility restrictions. 78 FR 12633. The major 
changes proposed by SBA related to affiliation principles, the personal 
resources test, the 9-month rule for the 504 Loan Program, and 
operational and organizational requirements for Certified Development 
Companies (``CDCs''). The comment period was open until April 26, 2013. 
SBA received

[[Page 15642]]

99 written comments during the comment period. These comments were 
received from 62 separate entities or individuals, including 32 CDCs, 
16 financial institutions, 11 trade associations, one business, one 
United States Senator, and one individual. (The number of separate 
commenters does not total 99 because, in many cases, SBA received more 
than one submission from representatives of the same entity). The 
comments are summarized and addressed below.

II. Summary of Comments Received

A. Affiliation as Applied to the Business Loan Programs--Section 
121.302

    SBA received 56 comments related to the proposed affiliation 
standards for small businesses. SBA received many comments that were 
generally supportive of the proposed standards and also received 
several comments that opposed or suggested modifications to certain 
provisions. Several commenters opposed the ``totality of the 
circumstances'' standard set forth in proposed section 121.302(a). 
Among the comments were that this standard would leave too much gray 
area and might not be consistently applied, and that it would be 
preferable to have a black and white test; that this standard is vague 
and open-ended; and that it would subject lender decisions to more 
scrutiny and second-guessing than currently occurs. In addition, many 
commenters expressed concern that the proposed six-page Applicant 
Affidavit on Affiliation was far too complicated for the typical 
applicant to complete without the extensive assistance of an attorney, 
a certified public accountant, and/or the CDC. Some expressed concern 
that the proposed Affidavit would likely add to the applicant's cost 
and would increase the time needed to prepare applications, and would 
not, contrary to SBA's intention, result in streamlining the process 
and reducing costs. Another commenter stated that the CDC would not be 
able to rely exclusively on the Affidavit, and would still be required 
by prudent lending to evaluate the validity of the Affidavit by 
comparing it to the applicant's financial and organizational documents. 
In light of the comments, and upon further consideration, SBA has 
decided to further study the issue of redefining affiliation for the 
business loan programs and is not finalizing any changes to the 
affiliation standards at this time.

B. Elimination of Personal Resources Test in Business Loan Programs--
Section 120.102

    SBA proposed to eliminate section 120.102, commonly known as ``the 
personal resources test.'' Commenters expressed overwhelming support 
for the elimination of this regulation, which requires certain owners 
of a Borrower to inject personal liquid assets into the business to 
reduce the amount of SBA guaranteed funds that would otherwise be 
needed. Those opposed to eliminating the regulation were concerned that 
it would lead to increased scrutiny by SBA of lenders' determinations 
that credit was ``not available elsewhere'', which is a requirement of 
Section 120.101. While there may be some connection between Section 
120.101 and 120.102, the findings for each are distinct. The present 
regulation at Section 120.102 concerns the effect of personal resources 
available to the applicant, while the regulation at Section 120.101 
addresses the availability of financing from non-federal sources. 
Others opposed felt that more Borrowers with significant assets would 
receive loans and that personal liquid assets would not be required to 
be converted to collateral for the loan, and that this practice would 
not be consistent with prudent lending. Although SBA will no longer 
require that the personal resources of owners be used to reduce the SBA 
funded portion of the total financing package, a lender that believes 
that prudent lending requires that assets either be injected or pledged 
as collateral for a particular loan would not be prohibited from so 
requiring. See, e.g., 13 CFR 120.150.
    One commenter suggested that SBA raise the level of exempted 
personal resources rather than eliminate the rule entirely. SBA 
considered that option but determined that elimination of the personal 
resources test would enable more robust Borrowers to participate in 
SBA's loan programs, thus mitigating risk to SBA's loan portfolio while 
facilitating job growth. SBA is adopting this regulation as proposed by 
removing this provision from the regulations.

C. CDC Operational and Organizational Requirements

1. Section 120.816 CDC Non-Profit Status and Good Standing
    SBA proposed to redesignate section 120.820 as section 120.816. 
There were no comments regarding this change, and SBA is redesignating 
this section as proposed.
2. Section 120.818 Applicability to Existing for-Profit CDCS
    SBA proposed to add this section to clarify that, unless expressly 
provided otherwise in the regulations, any Loan Program Requirement (as 
defined in section 120.10) that applies to non-profit CDCs also applies 
to for-profit CDCs. This regulation reflects current practice. All 
commenters supported this regulation, but one commenter suggested that 
the rule be modified to permit for-profit CDCs to pay dividends. 
However, under current section 120.825, CDCs are prohibited from paying 
dividends out of funds generated from loan activity in the 504 Loan 
Program. This regulation requires that any funds generated from 504 
loan activity by a CDC that remain after payment of staff and overhead 
expenses be retained by the CDC as a reserve for future operations or 
for investment in other local economic development activity in its Area 
of Operations. This requirement serves the interests of the 504 Loan 
Program, and SBA will not modify the rule to permit dividends.
    The commenter also suggested that the rule be modified to allow 
shareholders to serve as officers, directors and employees. However, 
under current section 120.823, a shareholder may be an employee or 
staff of a CDC, but may not at the same time serve as a voting member 
of the Board. SBA is continuing this prohibition in the final rule.
    SBA has required that CDCs be non-profit corporations since 1987 
(see current 13 CFR 120.820). There are five for-profit CDCs that were 
established and certified by SBA prior to that date, and these CDCs 
have been allowed to continue to operate in the 504 Loan Program. As 
noted above, this section is expressly stating the existing practice, 
which SBA believes is appropriate, and SBA is adopting this regulation 
as proposed.
3. Section 120.820 CDC Affiliation
    In section 120.820(a), SBA proposed to require that a CDC be 
independent and not affiliated with any Person (the definition of which 
under Sec.  120.10 includes a 7(a) Lender), except as permitted under 
this section. No comments were received with respect to paragraph (a), 
and SBA is adopting this provision as proposed.
    In section 120.820(b), SBA proposed to permit CDCs to be affiliated 
with an entity whose function is economic development in the same Area 
of Operations and that is either a non-profit entity or a State or 
local government political subdivision. SBA

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received several comments in support of this provision. However, one 
commenter expressed concern that the affiliated entity could charge the 
CDC excessive fees. SBA also received two comments in opposition from 
CDCs that currently each have a for-profit affiliate. These commenters 
stated that the for-profit affiliate needed to associate with a 
community development or economic development partner in order to 
secure other federal financial assistance, such as through the New 
Market Tax Credits Program. One of the commenters stated that, through 
its for-profit affiliate, the CDC derived additional income that it was 
able to use to invest in economic development activities in its 
community, including to provide financial and professional technical 
assistance to disadvantaged small businesses. Both commenters also 
requested that SBA consider revising the rule to include a 
``grandfather provision'', arguing that it would be unfair to apply 
this prohibition to existing for-profit affiliates.
    SBA has considered these comments and is revising the final rule to 
add a new paragraph (e) to allow a CDC to continue to have for-profit 
affiliates (other than a 7(a) Lender) if such for-profit entities were 
affiliated with the CDC prior to the date of publication of this final 
rule in the Federal Register. In addition, SBA recognizes that, after 
the effective date of this final rule, there may be unique 
circumstances, such as those described by the commenters, where a CDC's 
affiliation with a for-profit entity may serve the best interests of 
the 504 Loan Program. Accordingly, SBA is revising the rule to provide 
that, with the prior written approval of the D/FA or designee in his or 
her discretion, a CDC may be affiliated with a for-profit entity (other 
than a 7(a) Lender) whose function is economic development in the same 
Area of Operations if such affiliation is in the best interests of the 
504 Loan Program.
    With respect to section 120.820(c), a few commenters generally 
supported this provision which, as proposed, would permit a CDC to 
continue its affiliation with a 7(a) Lender that is either a state or 
local development company approved by SBA as of November 6, 2003, or a 
credit union, so long as the affiliation was in effect as of the 
effective date for this final rule. For the final rule, SBA is 
simplifying this provision to state that ``[a] CDC that was affiliated 
with a 7(a) Lender as of November 6, 2003, may continue such 
affiliation.'' This change retains the timeframe for grandfathering 
affiliations with state development companies that is contained in 
section 120.852(a)--which allows for such affiliations if they existed 
as of November 6, 2003--instead of extending the grandfather period for 
these affiliations to the effective date of this final rule. This 
change would also allow a CDC to continue to be affiliated with any 
other 7(a) Lender (including credit unions) if the affiliation was in 
effect as of November 6, 2003. SBA does not expect that changing the 
grandfather period for these 7(a) Lenders from the effective date of 
this final rule to November 6, 2003 will affect any CDCs. The limited 
grandfathering of pre-existing affiliations between CDCs and 7(a) 
Lenders set forth in this provision is the only exception to the 
prohibition on these affiliations that is authorized under SBA's rules.
    In addition, SBA is including in section 120.820(c) the prohibition 
against a CDC affiliating with or investing, directly or indirectly, in 
a 7(a) Lender. This prohibition is currently set forth in Sec.  
120.852(a) and, to avoid confusion, SBA is consolidating all of the 
provisions related to CDC affiliation in section 120.820. SBA has long 
interpreted the prohibition against a CDC investing in a 7(a) Lender to 
mean investing ``directly or indirectly'' and is including this phrase 
in the rule. With this change, and the change discussed below regarding 
SBICs in section 120.852(b), SBA is removing and reserving Sec.  
120.852.
    Several commenters were opposed to proposed section 120.820(d), in 
which SBA proposed to prohibit CDCs from being affiliated with, or 
directly or indirectly investing in or financing, another CDC. The 
commenters stated that the program has benefitted from more experienced 
CDCs being able to offer financial or managerial assistance to new 
CDCs. One commenter expressed concern that this provision would 
prohibit a CDC from contracting with another CDC for ``back-office 
packaging, processing or liquidation services''. SBA recognizes that 
the program may benefit from such assistance and, under current section 
120.824(b), a CDC may continue to request SBA's approval of a 
professional services contract with another CDC. However, SBA does 
intend for section 120.820(d) to prohibit a CDC from being affiliated 
with another CDC. To clarify how affiliation would be determined, SBA 
is adding the phrase ``as determined in accordance with 121.103'' to 
this provision. SBA would not expect that contracts between CDCs that 
are for limited services would give rise to affiliation under section 
121.103 and be prohibited by this provision. The question of whether a 
contract for more extensive services would give rise to affiliation 
would depend on the specific facts presented by that contract and would 
need to be determined by SBA on a case-by-case basis.
    With respect to this provision's prohibition on a CDC directly or 
indirectly investing in or financing another CDC, some commenters 
suggested that SBA allow a CDC to so invest in or finance another CDC 
with SBA's prior written approval. SBA agrees with this recommendation 
and is amending this provision to so provide.
    As discussed above, to complete the consolidation of the provisions 
related to CDC affiliation in Sec.  120.820, SBA is moving the 
provision set forth in Sec.  120.852(b), which prohibits a CDC from 
investing directly or indirectly in an SBIC, to Sec.  120.820 as 
paragraph (f). Finally, SBA has made additional edits throughout the 
section for clarification purposes.
4. Section 120.822 CDC Membership
    SBA proposed eliminating the membership requirement for CDCs. Most 
commenters who submitted comments on this provision expressed support 
for this change because they believe that maintaining membership is 
unproductive for the CDC. Several commenters who opposed the change did 
so on three bases, including that members were a valuable resource to 
CDCs providing them with insight into local communities, that 501(c)(6) 
organizations, such as some CDCs, were required by the IRS to be 
membership based, and that not requiring membership in each state where 
a CDC is located may encourage the expansion of more CDCs into a state, 
resulting in a dilution of the pool of small business applicants within 
the state.
    SBA notes that there is nothing in the regulations as proposed that 
would preclude CDCs from deciding to have a membership. If the 
organization is required by the IRS to have members, or if for some 
other reason it chooses to have members, the CDC may do so. SBA is 
simply removing the requirement that a CDC have a membership. SBA also 
notes that the same concern about the pool of small business applicants 
being diluted was raised when SBA allowed CDCs to expand their Area of 
Operations within an entire State, and this concern has not been 
realized. In addition, the concern regarding the need for a connection 
to the local community will continue to be addressed by the 
requirements that a multi-state CDC create loan committees in each 
State in which the CDC operates and that loan committee members must 
live or work in the Area of Operations of the State where the 504 
project they are voting on is located unless the project falls under

[[Page 15644]]

one of the exceptions listed in Sec.  120.839. The final rule, 
therefore, removes section 120.822, as proposed.
5. Section 120.823 CDC Board of Directors
    SBA received many comments on Section 120.823, in which SBA 
proposed several changes with respect to the requirements that apply to 
the CDC Board of Directors.
    Section 120.823(a) primarily addresses the size of the Board and 
areas of expertise for directors. SBA proposed to require that the size 
of the CDC Board of Directors be no fewer than 11 and no more than 25 
members; that the Board have directors with background and expertise in 
internal controls, risk management, commercial lending, legal issues 
related to commercial lending and corporate governance; and that the 
CDC Board have at least one director from the economic, community or 
workforce development field and two directors that are representatives 
from the commercial lending field. In addition, the rule proposed to 
permit the directors to be either active in or retired from their 
fields.
    Many commenters opposed the limitation of the Board size from 11-25 
both on the basis that the lower limitation was too high and that the 
higher limitation was too low. After considering the comments, SBA has 
determined that it will amend this provision to lower the minimum 
number from 11 to 9, and will also allow CDCs to request SBA's approval 
to have fewer than 9 directors. Some commenters expressed a legitimate 
concern that CDCs in rural or isolated communities may have difficulty 
in finding people to serve and may have other valid reasons that would 
justify having fewer directors. SBA will also give CDCs the flexibility 
to create a Board with more than 25 directors by revising the rule to 
reflect that the upper number of 25 is not a requirement but a 
recommendation.
    A majority of the commenters who submitted comments on this 
provision supported the rule's minimum requirements regarding the 
background and expertise of directors, but some requested clarification 
as to whether one director could have more than one area of expertise. 
Certainly, a director may have a background in more than one area and, 
thus, be qualified as an expert in more than one area. Commenters 
opposed to the rule argued that CDCs may obtain any expertise needed 
through professional services contracts. SBA believes, however, that it 
is important that these areas of expertise be represented on the Board. 
All commenters supported allowing retired individuals to represent the 
fields from which they are retired. SBA is adopting this provision as 
proposed with the exception of changing the Board size requirements as 
described above.
    With respect to section 120.823(b), many commenters supported the 
requirement proposed by SBA to increase the number of Board members 
with commercial lending experience (other than the CDC manager) from 
one to two. Commenters opposed to this requirement expressed concern 
that it would be difficult to find more than one commercial lender to 
sit on the Board. However, SBA believes that Board members with 
commercial lending experience add the necessary expertise for approving 
loans.
    Other commenters opposed to this requirement stated that two 
members with such expertise would be insufficient for the Board. 
However, a CDC is not restricted to having only two members with 
commercial lending experience. A CDC may have more such members, so 
long as the number is less than 50% of the representation on the Board. 
Indeed, in order to comply with the voting requirements, a CDC may need 
to have more than two such directors if one of the directors must 
recuse him or herself from the vote. SBA is adopting this provision as 
proposed.
    With respect to section 120.823(c), most commenters supported the 
proposed requirement that the CDC Board of Directors meet at least 
quarterly and be responsible for any actions of the CDC and any 
committees established by the Board. One CDC commenter opposed the 
language because its Board meets monthly. However, there is nothing in 
the regulation to prohibit the Boards of Directors from meeting more 
frequently, and SBA is adopting the introductory clause of section 
120.823(c) as proposed.
    In section 120.823(c)(1), SBA proposed that no CDC staff member 
except the CDC manager could be a voting member of the CDC Board. SBA 
received no comments regarding paragraph (c)(1), and is adopting the 
paragraph as proposed.
    With respect to section 120.823(c)(2), SBA proposed to require that 
a CDC set a quorum of not less than 50% of the Board of Directors. The 
majority of the commenters supported the changes to this provision, but 
there was a single request for modifying the requirement for a quorum 
to 40%. However, SBA believes that a 50% quorum is standard business 
practice, and is adopting this paragraph as proposed.
    With respect to section 120.823(c)(3), all of the comments 
supported the proposed change, which would permit the attendance at 
meetings through any format permitted by state law. This provision 
recognizes that there are now methods for meeting other than being 
physically present, and SBA is adopting this paragraph as proposed.
    With respect to section 120.823(c)(4), most of the comments 
received in response to this provision supported SBA's proposal to 
limit the number of directors in the commercial lending field to less 
than 50% of the Board of Directors. Some requested that SBA raise the 
percentage to 60 or 67%. One commenter opposing the change stated that 
commercial lenders are especially well-qualified to serve on a CDC 
Board and should comprise a larger percentage of the Board. While SBA 
understands the commenters' points of view, SBA believes that CDCs will 
be better served by having a more diverse Board not dominated by 
commercial lenders and is adopting this paragraph as proposed.
    With respect to section 120.823(c)(5), SBA proposed to limit the 
ability of an outside entity to control a CDC's Board by restricting a 
single entity's representation on the Board to one member. The majority 
of the commenters was opposed to or requested modification of this 
paragraph based primarily upon their mistaken interpretation that this 
provision would prohibit any member of the CDC's Board of Directors 
from serving on the Board of any other entity. SBA does not intend for 
this provision to have that effect, but to only prohibit more than one 
member of the CDC's Board of Directors to be employed by or serve on 
the Board of Directors of any other single entity (including the 
entity's affiliates). SBA is revising this provision to clarify this 
intent.
    In addition, one commenter expressed concern that paragraph (c)(5) 
would prohibit more than one board member of a CDC from serving on the 
board of the same civic organization, such as a Rotary Club. However, 
SBA has no objection to more than one board member serving on the same 
board of a civic, charitable, or comparable entity, provided the entity 
is not involved in financial services or economic development 
activities. SBA is amending the rule to clarify this intention. SBA is 
also making a technical change to clarify that no CDC Board member may 
serve on the Board of another CDC, in accordance with current Sec.  
120.851(b).
    With respect to section 120.823(d), SBA proposed to require that 
the Board be responsible for ensuring that the

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structure and operation of the CDC comply with SBA's Loan Program 
Requirements. In paragraphs (d)(1) and (2), SBA proposed to require 
that the Board be responsible for setting the mission and hiring, 
firing, supervising and evaluating the CDC manager. To emphasize the 
fiscal responsibility of the Board as it relates to salaries, paragraph 
(d)(3) explicitly outlines the duties of the Board to set salaries for 
the CDC manager and to review all other salaries to provide greater 
transparency and accountability. SBA would require that a Report on 
Compensation be included in the Annual Report (see proposed Sec.  
120.830). SBA also proposed in paragraph (d)(4) to provide the CDC with 
flexibility in determining whether to have committees, but addressed 
the requirements for Executive and Loan Committees, if established.
    Many commenters expressed overall support for paragraphs (d)(1)-
(4). A few commenters requested modification or clarification and 
expressed concern that these paragraphs, generally, placed too much 
responsibility on the Board of Directors. For example, section 
120.823(d)(3) requires that the Board set the CDC manager's salary and 
review all other salaries, and one commenter suggested that this 
regulation would require the Board to set all salaries. However, this 
provision only requires that the Board set the salary for the CDC 
manager and review the salaries set by that manager. Moreover, the 
Board of Directors of an organization is generally responsible for all 
actions of that organization.
    In addition, in response to the comments that expressed concern 
about the need for CDCs to maintain a connection to the local 
community, SBA is revising section 120.823(d)(4)(ii) to include a new 
paragraph (E) that retains the current requirement that the Loan 
Committee consist of members who live or work in the Area of Operations 
of the State where the 504 project they are voting on is located unless 
the project falls under one of the exceptions listed in Sec.  120.839.
    No specific comments were submitted as to paragraphs 120.823(d)(5)-
(9). With respect to section 120.823(d)(5), SBA proposed to require 
that the Board ensure that the CDC's expenses are reasonable and 
customary, and in section 120.823(d)(6), SBA proposed to require the 
Board to hire an independent auditor to provide financial statements in 
accordance with the Loan Program Requirements.
    The proposed provisions in paragraphs (d)(7) and (8) emphasize the 
requirement that the Board monitor the portfolio and review the 
semiannual status report from the CDC to ensure that the Board provides 
appropriate oversight of the CDC's portfolio. SBA proposed to add 
requirements in paragraph (d)(9) that the Board ensure that the CDC 
establish and maintain adequate reserves to enable the CDC to operate.
    SBA is adopting paragraphs 120.823(d)(1)-(9) as proposed.
    With respect to section 120.823(d)(10), SBA proposed to require the 
Board to approve all investments over $2,500. Most commenters opposed 
or requested modification to this paragraph. The commenters expressed 
concern that the amount was too low and suggested that when the Board 
approves the budget, it approves each investment. Other CDCs commented 
that they have other loan programs where they manage loan funds in 
which almost every action would involve funds of over $2,500. After 
review, SBA agrees with the suggestion and is amending the regulation 
to provide that the Board must approve each CDC investment; however, if 
the investment is included in the CDC's budget, the Board's approval of 
the budget may be deemed approval of the investment. If the investment 
is not included in the budget, the Board must separately approve the 
investment.
    With respect to section 120.823(d)(11), SBA proposed to require 
that the Board establish a policy in the Bylaws of the CDC prohibiting 
an actual or apparent conflict of interest, and enforce such policy. 
Most commenters supported the policy, but one was opposed based upon 
the fact that the CDC did not want to be mandated to use a federal 
definition of ``conflict of interest.'' Several other CDCs recommended 
that SBA not require the policy to be placed in the Bylaws. SBA did not 
specifically define ``conflict of interest'' in this section, but at a 
minimum the CDC's Bylaws must meet the standards of 13 CFR 120.140. The 
Bylaws of a corporation are drawn to regulate its management and 
internal affairs, and it is the Agency's belief that a conflict of 
interest policy is properly included in the Bylaws. SBA is adopting 
this paragraph as proposed.
    With respect to 120.823(d)(12) and (13), SBA proposed to require 
the Board to retain accountability for the actions of the CDC, and 
establish internal control policies in accordance with 13 CFR 120.826. 
A majority of the commenters supported these policies. One commenter 
expressed concern that the requirement to establish internal controls 
required the CDC to hire an outside consultant to monitor internal 
controls of the CDC. It does not. The regulation requires that the 
Board establish the policy. This is not a new requirement as the 
requirement is fully described in the current regulation at 13 CFR 
120.826(b), but is added here to consolidate all of the Board 
requirements in one section. SBA is adopting paragraphs (12) and (13) 
as proposed.
    With respect to section 120.823(d)(14), SBA proposed to require 
that the Board establish commercially reasonable loan approval 
policies, procedures and standards, and include in its Bylaws a credit 
approval process and any delegations to an Executive Committee or Loan 
Committee. The majority of commenters opposed the requirement that the 
credit approval process be set forth in the CDC's Bylaws. SBA has 
considered these comments and agrees that it would be sufficient to 
allow the CDC to set forth the credit approval process in a loan policy 
manual. SBA is amending the proposed rule to reflect these changes.
    Two of those opposed also objected to the requirement contained in 
(d)(14) that the Board ratify or approve loans over a certain dollar 
amount. SBA believes that it is the Board's responsibility to do so and 
that the requirement is reasonable and appropriate; therefore, SBA is 
not changing the approval requirement.
    With respect to section 120.823(d)(15), SBA proposed to require 
that Board members certify annually that they have read and understand 
Section 120.823 of this regulation. Many commenters supported the 
paragraph, and some requested modification to either permit a separate 
governance committee to make the certification or to permit Board 
members to take training instead. Several commenters opposed the 
requirement as being too onerous. SBA does not agree with the 
commenters. Training would be more expensive and time-consuming for the 
Board members than reading this section of the regulation and signing a 
certification that they have done so. SBA believes that the annual 
certification by all Board members that they have read and understand 
section 120.823 is important and is adopting paragraph (d)(15) as 
proposed.
    With respect to section 120.823(e), SBA proposed to require that 
CDCs maintain Directors' and Officers' Liability and Errors and 
Omission insurance in the amount of at least $5,500,000 (in the 
aggregate and for each occurrence) with a deductible of not more than 
$50,000. SBA invited comments on the amounts of both the insurance and 
the deductible. No commenters fully supported the

[[Page 15646]]

requirement. Twenty-eight CDCs (or 11% of all CDCs), submitted comments 
on this issue and expressed a concern that this proposed provision 
would increase the cost of insurance. Some commenters felt that the 
financial burden on the CDCs was too great because increasing the 
insurance coverage as required would triple their premiums. One 
commenter indicated that, while he supported the requirement for 
insurance, he would recommend that a fee be added to the debenture to 
cover the cost. Others suggested that there be flexibility as to the 
deductible, that the amount be left to the Board, or that the amount be 
based upon portfolio size.
    In proposing this insurance requirement that would apply to all 
CDCs, SBA's intent is to address the higher risks associated with the 
statutory increases in the 504 loan amounts of up to $5 million for 
each small business concern and $5.5 million for certain projects. As a 
result of these higher amounts, a CDC's loan volume may increase, which 
is expected to result in an increase in the processing and servicing 
fees collected by CDCs that will offset any new costs associated with 
this new insurance requirement. However, after considering all of the 
comments, SBA has determined that not all CDCs may need to have 
insurance coverage of $5.5 million per occurrence and in the aggregate 
per year SBA agrees that the amount of insurance should generally 
correspond to the size of a CDC's portfolio. SBA intends to consult 
with CDCs and their representatives, as well as insurance underwriters, 
in developing the appropriate amounts of insurance required. These 
amounts will not exceed the amount of insurance proposed by SBA in the 
proposed rule and will not be less than $1 million. Further guidance on 
CDC insurance requirements will be in the next update to SOP 50 10 
after the final rule is effective.
    Finally, several commenters expressed concern regarding the 
effective date of the changes in section 120.823 and that CDCs would 
need time to implement the changes. SBA agrees and is delaying the 
effective date of the changes made to section 120.823 until 12 months 
after the date of publication in the Federal Register, at which time 
CDCs must be in compliance with this section. In the interim, CDCs must 
continue to comply with the requirements set forth in current section 
120.823.
6. Section 120.830 Reports a CDC Must Submit
    SBA proposed to revise the requirements with respect to the reports 
that a CDC must submit to SBA. In section 120.830(a), SBA proposed to 
require that a CDC submit with its Annual Report its most recent 
Federal tax return; audited or reviewed financial statements, as 
appropriate; a report on compensation of any current or former officer, 
director, employee or independent contractor who received compensation 
during the covered period of more than $100,000; written certification 
from each of its Directors that each has read and understands the 
requirements of 13 CFR Section 120.823; and a report on investments in 
economic development activities in each state in which it has a loan.
    Commenters generally supported the requirements. One commenter 
noted that the IRS Form 990 includes information on compensation for 
employees earning more than $100,000 year. SBA agrees that the 
submission of the IRS Form 990 would satisfy this reporting 
requirement. Non-profit CDCs that have not yet completed the IRS Form 
990 for their last tax year, or for-profit CDCs that are not required 
by the IRS to file the IRS Form 990, may submit the information in any 
format as long as it includes all of the information with respect to 
employee compensation that would be found on the IRS Form 990. One 
commenter indicated SBA could obtain the requested information by 
searching for the IRS Form 990 on-line, but the on-line version is 
often one to two years old and is not acceptable. Another recommended 
that SBA modify the report on compensation to require the CDC to report 
any compensation that CDC employees earning more than $100,000 per year 
receive not only from the CDC, but also from any outside source. 
However, even if a CDC had sufficient information to report on the 
outside compensation received by its employees, SBA is primarily 
interested in the compensation that CDC employees receive from the CDC, 
not outside sources. SBA would expect, however, the CDC to provide 
information on the compensation that CDC directors, officers or 
employees receive from ``related organizations'' to the CDC, as 
required to be reported on the IRS Form 990.
    In addition, one commenter suggested that any reimbursement for 
expenses that the employee receives that the IRS does not include as 
compensation (``accountable expenses'') should not be reported as 
income for SBA purposes. The commenter observed that the IRS Form 990 
would not include any accountable expenses. SBA agrees that expenses 
not reportable as compensation to the IRS may be excluded from the 
CDC's report on compensation.
    Finally, with respect to section 120.830(a)(4), several commenters 
supported the proposed requirement that the report include the economic 
development investments made in each state in which the CDC has an 
outstanding loan, but requested clarification with respect to what 
would constitute economic development. SBA notes that economic 
development investment in the community could take many forms 
including, but not limited to, investment in a foundation established 
for economic development, direct investment through other loan programs 
in the community, or investment in other economic development entities. 
SBA would expect the investment report to include each investment by 
type and amount. SBA is adopting section 120.830 as proposed.
7. Section 120.835 Application To Expand an Area of Operation
    SBA proposed eliminating the requirement that a CDC have membership 
in each state in a Multi-State expansion since the proposed revisions 
to Section 120.822 make membership optional. A majority of the 
commenters supported this change. Those opposed expressed the opinion 
that membership in an area the CDC serves gives it a stronger 
relationship with each state in a CDC's Area of Operations. In 
addition, some of the commenters opposed felt that eliminating the 
requirement for membership in each state would make it easier for a CDC 
to move into a contiguous state which would dilute the pool of 
potential projects within each state. As discussed above under section 
120.822, similar arguments were made when CDCs were allowed to operate 
statewide for projects, and that has not proven to be the case. 
Further, SBA is retaining the requirements in current sections 
120.835(c)(3) and 120.823(a) and (b), which together require a multi-
state CDC to have a loan committee in each State into which it expands 
that meets local membership requirements. SBA is adopting this section 
as proposed.

[[Page 15647]]

8. Section 120.852 Restrictions Regarding CDC Participation in the 
Small Business Investment Company (SBIC) Program and the 7(a) Loan 
Program
    As discussed above, SBA is removing and reserving section 120.852, 
and moving its content to section 120.820.
9. Section 120.920 Required Participation by the Third Party Lender, 
and Section 120.925 Preferences
    SBA proposed to revise section 120.920 to provide that if a Third 
Party Lender requires a lien on collateral in addition to the Project 
Property, the Third Party Lender, in the event of liquidation, must 
first apply the proceeds from the sale of such additional collateral to 
the balance on the Third Party Lender's loan. SBA believes that this 
change could increase recoveries on the 504 loan. Commenters were 
generally supportive of this change. Some commenters requested that SBA 
clarify that the Third Party Lender does not have to liquidate 
collateral that either no longer exists or has no recoverable value. 
However, this language is in the Third Party Lender Agreement signed by 
the Third Party Lender, and so there is no need to amend the 
regulation.
    Commenters were also generally supportive of SBA's proposal to 
eliminate section 120.925 regarding Preferences. However, one commenter 
was opposed to the elimination of this provision, arguing that the 
Lender should not be permitted to have any type of Preference. A 
Preference is defined as ``any arrangement giving a Lender or a CDC a 
preferred position compared to SBA relating to the making, servicing, 
or liquidation of a business loan with respect to such things as 
repayment, collateral, guarantees, control, maintenance of a 
compensating balance, purchase of a Certificate of deposit or 
acceptance of a separate or companion loan, without SBA's consent.'' 
See Sec.  120.10 (Definition of ``Preference''). SBA recognizes that 
there are other types of security that the Third Party Lender could 
obtain for its loan in addition to a lien on additional collateral, 
such as a guaranty or other arrangements for repayment, and that the 
Third Party Lender should be required to comply with proposed section 
120.920 for this collateral or security as well. Accordingly, SBA is 
revising section 120.920 to apply the requirements of section 120.920 
to any type of collateral or security that the Third Party Lender 
obtains.
    In addition, one commenter requested clarification as to the timing 
of the sale of the collateral by the Third Party Lender. Under the 
proposed regulation, the proceeds of any collateral held in addition to 
the Project Property must be applied to the Third Party Lender's debt 
prior to the proceeds of the Project Property. SBA agrees that 
clarification would be helpful and is amending the final rule to 
require that, unless otherwise approved in writing by SBA, the Third 
Party Lender liquidate, or otherwise exhaust all reasonable avenues of 
collection with respect to, the additional collateral or other security 
no later than the disposition of the Project Property, and to apply any 
proceeds received as a result of such Additional Collateral to the 
balance outstanding on the Third Party Loan prior to the application of 
proceeds from the disposition of the Project Property to the Third 
Party Loan.

D. Section 120.882(a)--The ``9-Month Rule'' (Applies to 504 Loan 
Program Only)

    With respect to section 120.882(a), SBA proposed to eliminate 
paragraph (a)(2) of this section which limits Project expenses eligible 
for 504 Loan Program financing to those incurred within 9 months prior 
to receipt by SBA of a complete loan application. As explained in the 
proposed rule, SBA intends for this change to permit financings of 
expenses toward a Project regardless of when they were incurred, so 
long as they are directly attributable to the Project. SBA also 
observed that there may be circumstances when an applicant might incur 
short term debt to cover expenses directly attributable to a Project 
that is eligible for financing under the 504 Loan Program. As stated in 
the proposed rule, SBA believes that determining whether an expense has 
been incurred by an applicant for a 504 project requires a fact 
specific analysis which appropriate agency personnel need to make 
regardless of when the expense was incurred.
    All commenters expressed support for this change with one comment 
seeking clarification as to whether long-term debt could be included in 
a 504 project. Historically, the 504 Loan Program did not include debt 
refinancing except in the limited circumstance where the debt was 
``directly attributable'' to the Project and incurred within certain 
time limitations. For example, under current SBA policy, the 504 loan 
may refinance short term debt (known as ``bridge financing'') on the 
Project land as long as the financing is for a term of 3 years or less. 
See SOP 50 10 5(F), Subpart C, Chapter 2, Paragraph III.H.4.(a)(2)(b). 
More recently, the 504 Loan Program was authorized to also permit 
refinancing of debt unrelated to the Project so long as the Project 
involved expansion of a small business concern (120.882(e)) and, on a 
temporary basis, the refinancing of certain debt with no business 
expansion required (120.882(g), the authority for which has expired). 
Accordingly, the only type of debt that SBA permits to be financed 
other than under Sec.  120.882(e) is ``bridge financing'' that is 
directly attributable to the Project, and the elimination of the 9-
month rule is not intended to change this policy. SBA will continue to 
determine whether expenses incurred prior to application were in fact 
incurred for a 504 Project. SBA is adopting this provision as proposed.

Compliance With Executive Orders 13563, 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 13563 and Executive Order 12866

    The Office of Management and Budget (OMB) has determined that this 
final rule is a ``significant'' regulatory action for the purposes of 
Executive Order 12866. Accordingly, the next section contains SBA's 
Regulatory Impact Analysis. However, this is not a major rule under the 
Congressional Review Act, 5 U.S.C. 800.
Regulatory Impact Analysis
    SBA provided a detailed Regulatory Impact Analysis in the Proposed 
Rule. No 7(a) lenders commented on costs, though several CDCs submitted 
comments on increased program costs. SBA anticipates the 504 program 
changes will have minimal impacts on costs to CDCs, including increased 
costs in the program for corporate governance, reporting or increased 
insurance, but may also result in an increase in the CDC's processing 
and servicing fee income. SBA anticipates no impact on small entities 
as a result of grandfather clauses in the final rule. Twenty-eight (28) 
or 11% of CDCs expressed a concern under 120.823(e) about the increased 
cost of insurance as proposed. SBA concurs with the CDC comments that 
portfolio size should be considered and SBA should develop a sliding 
scale for insurance costs. SBA will coordinate with CDCs and their 
representatives and insurance underwriters when establishing the 
insurance scale, which will be presented in the next update to SOP 50 
10 after the Final Rule is effective. Due to the increase in the 504 
debenture size to $5.5 million for energy public policy and 
manufacturing projects, SBA

[[Page 15648]]

proposed increasing the insurance requirements for all CDCs. A large 
CDC did not anticipate an increase in cost, due to its current 
insurance level. Currently, only those CDCs that are in the Accredited 
Lenders Program (ALP) have been required to have insurance of up to $1 
million. For FY 12, there were an estimated 85 ALP CDCs, or 33%, that 
are insured and 175 non-ALP CDCs, or 67%, which are not currently 
required to have insurance by SBA. SBA estimates that the changes to 
the eligibility requirements may increase the number of 504 loans a CDC 
processes and, therefore, may increase processing and servicing fee 
income by potentially 5-10% per CDC in the first year after the Final 
Rule is effective, with an overall average of a 8% rate for the 
national portfolio overall in the first year. As a sample, SBA reviewed 
the insurance and fees of a large, medium and small CDC that commented 
on increased insurance costs in comparison to anticipated fee income. 
The proportional costs of insurance as compared to the expected 
increase in processing and servicing fees appears to further justify a 
sliding scale of insurance costs based on a CDC's portfolio size.
    Five, or 2% of, CDCs expressed concerns under section 120.823(d)(6) 
that there would be increased cost to a CDC for independent loan 
reviews. SBA provided clarification language to address these concern. 
CDCs are not required to hire independent loan reviewers, and may 
comply by using independent loan reviewers who are internal to the CDC 
as long as they are independent of the loan approval process.
    Two CDCs commented that anticipated CDC costs would increase by 
requiring the board to oversee investments over $2,500. SBA addressed 
this concern by clarifying that this oversight is part of the CDC's 
budget and financial review process.
    SBA received two cost comments under section 120.102, both of which 
referenced potential cost impacts to the SBA as a result of the 
elimination of the personal resources test. One comment stated this 
change would lower the costs to SBA. The other comment expressed a 
concern that costs would increase for SBA. SBA estimates this rule 
change will not impact the cost of program administration.
    SBA received comments under sections 121.103 and 121.302 expressing 
concern that the proposed affidavit as to affiliation was too 
complicated and could result in increased costs to the borrower. As 
indicated above, SBA has decided to further study the affiliation issue 
and is not finalizing any changes to the affiliation standards at this 
time.
    One CDC expressed a concern about increased travel expenses due to 
an increase in frequency of CDC board meetings. SBA has also proposed 
to allow CDCs to meet via conference call and web conference to the 
extent permitted by State law, which should minimize compliance costs 
for CDCs.
    One CDC expressed concern under sections 120.823(d)(12) and (d)(13) 
that the CDC would need to hire a consultant to develop and oversee 
internal controls for their CDC. One CDC expressed concern under 
section 120.823(d)(5) that it is cost prohibitive for smaller CDCs to 
provide audited financial statements. Smaller CDCs are only required to 
provide reviewed financial statements, not audited financial 
statements.

Executive Order 13563

    A description of the need for this regulatory action and benefits 
and costs associated with this action, including possible 
distributional impacts that relate to Executive Order 13563, were 
included in the Regulatory Impact Analysis under Executive Order 12866 
that was published with the proposed rule. 78 FR 12633.
    SBA's two primary business loan programs operate through the 
agency's lending partners, which are 7(a) Lenders and CDCs. The agency 
has held public forums and meetings which allowed it to reach hundreds 
of its lending partners and gain valuable insight, guidance, and 
suggestions from many of them and the trade associations which 
represent many of them. The agency's outreach efforts to engage 
stakeholders before proposing this rule were extensive.

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 preemptive effect.

Executive Order 13132

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

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

    The SBA has determined that this final rule imposes additional 
reporting and recordkeeping requirements, which will result in 
amendments to the existing information collections identified below. 
SBA solicited public comments on these amendments when the proposed 
rule was published. SBA proposed to amend the currently approved CDC 
Annual Report to require CDCs to report on executive compensation and 
economic development projects, and to submit a copy of the CDC's tax 
return. The rule also proposed to require each CDC director to certify, 
as part of the CDC Annual Report, that he or she has read and 
understands the requirements set forth in 13 CFR Sec.  120.823. 
Finally, SBA proposed to make changes to the governance of CDC 
membership; composition of CDC board of directors and to increase 
insurance coverage.
    As a result of these new requirements, SBA has amended the 
following information collections:
    1. Title and Description of Information Collection: The Certified 
Development Company (CDC) Annual Report Guide (SBA Form 1253) provides 
instructions to assist the CDC in preparing and submitting its Annual 
Report, which provides information to SBA on economic development, and 
the CDC's financial condition, operations and employment impact. OMB 
Control Number: 3245-0074.
    Description of and Estimated Number of Respondents: All CDCs must 
provide an annual report. Currently there are approximately 260 CDCs. 
There is 1 report per respondent. The burden estimate takes into 
consideration the fact that respondents keep the information requested 
in the ordinary course of business.
    Estimated Number of Responses: 260.
    Estimated Time per Response: SBA estimates the time needed to 
complete this collection will average 28 hours per report.
    Total Estimated Hour Burden: 260 x 28 hours = 7,280 total annual 
burden hours. This is 168 hours less than the current OMB inventory 
(7,488) as there are fewer CDCs than the last burden hour estimate for 
this collection.
    Since proposing changes to these information collections, SBA has 
revised SOP 50 10, one of the Standard Operating Procedures (SOP) 
governing the 7(a) and 504 loan programs. Some of the amendments to the 
SOP will result in additional changes to SBA Forms 1919 and 1920, SBA 
Form 1244, and SBA Form 1253 and will result in the

[[Page 15649]]

elimination of SBA Forms 4, 4-I and Form 4 Schedule A . The SOP changes 
do not affect SBA Forms 2233 and 2234. SBA published notice in the 
Federal Register soliciting public comments on these SOP-related 
changes. See, 78 FR 53816 (August 30, 2013) and 78 FR 54362 (September 
3, 2013); no comments were received from the public on the changes 
brought about by the revised SOP. SBA has submitted the forms, as 
revised to reflect the SOP changes, to OMB for review and approval, and 
will make them available on the Agency's Web site at www.sba.gov soon 
after obtaining OMB's approval. After this final rule becomes 
effective, SBA will repost the forms as revised to conform to changes 
made by this final rule.

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

    When an agency issues a rulemaking, the Regulatory Flexibility Act 
(RFA), 5 U.S.C. 601-612, requires the agency to ``prepare and make 
available for public comment a final regulatory analysis'' which will 
``describe the impact of the final rule on small entities.'' Section 
605 of the RFA allows an agency to certify a rule, in lieu of preparing 
an analysis, if the rulemaking is not expected to have a significant 
economic impact on a substantial number of small entities. Although the 
rulemaking will impact all of the approximately 4,500 7(a) Lenders 
(some of which are small) and all of the approximately 260 CDCs (all of 
which are small), SBA does not believe the impact will be significant. 
The grandfathering clauses in the final rule will not have an impact on 
small entities. As provided previously in the cost analysis in the 
Regulatory Impact Analysis (RIA), CDCs provided comments on the concern 
on increased costs in insurance, board travel for meetings and 
independent loan reviews. No 7(a) lenders comments on increased costs. 
Information about the economic impact of this rulemaking can be found 
in the RIA. As stated above, the final rule will expand access to the 
business loan program but this will not increase the burden of the 
agency's lending partners because they choose their own level of 
program participation (i.e., 7(a) Lenders and CDCs are not required to 
process more loan applications simply because more small businesses are 
eligible to apply for a business loan). For those CDCs and lenders that 
process more businesses loans, the benefit of the increase in revenue 
will far exceed any increased burden. In addition, the elimination of 
certain program participation requirements would not have a substantial 
economic impact or cost on the small business borrower, lender or CDC.
    In addition, in response to the comments that expressed concerns 
about increased costs in insurance, SBA will develop a sliding scale 
for insurance coverage to address CDC concerns of increased insurance 
coverage to mitigate the potential of increased costs. To address the 
concerns about the increased costs of board travel for meetings and 
independent loan reviews, SBA's final rule has provisions for web-
conference and teleconference meetings that would mitigate CDCs costs 
of board meeting traveling to meetings. CDCs are not required to hire 
independent loan reviewers outside the CDC, as the independent loan 
review may be internal to the CDC as long as the reviewer is 
independent of the loan approval process. These changes should mitigate 
any increase in costs that may be associated with this rulemaking.
    SBA believes that this final rule is SBA's best available means for 
facilitating American job preservation and creation by removing 
unnecessary regulatory requirements. Since the main purpose of this 
final rule is to reduce unnecessary regulatory burdens and program 
eligibility criteria, a review of the preamble sections above will 
provide additional detailed explanations regarding how and why this 
final rule reduces regulatory burdens and responsibly increase program 
participation flexibility. For these reasons, SBA has determined that 
there is no significant impact on a substantial number of small 
entities.

List of Subjects in 13 CFR part 120

    Community development, Equal employment opportunity, Loan 
programs--business, Reporting and recordkeeping requirements, Small 
business.

    For the reasons stated in the preamble, SBA amends 13 CFR part 120 
as follows:

PART 120--BUSINESS LOANS

0
1. The authority for 13 CFR part 120 continues to read as follows:

    Authority:  15 U.S.C. 634(b)(6), (b)(7), (b)(14), (h) and note, 
636(a), (h) and (m), 650, 687(f), 696(3) and 697(a) and (e); Pub. L. 
111-5, 123 Stat. 115, Pub. L. 111-240, 124 Stat. 2504.


Sec.  120.102  [Removed]

0
2. Remove Sec.  120.102.


Sec.  120.820  [Redesignated as Sec.  120.816]

0
3. Redesignate Sec.  120.820 as Sec.  120.816.

0
4. Add Sec.  120.818 to read as follows:


Sec.  120.818  Applicability to existing for-profit CDCs.

    Unless expressly provided otherwise in the regulations, any Loan 
Program Requirement that applies to non-profit CDCs also applies to 
for-profit CDCs.

0
5. Add new Sec.  120.820 to read as follows:


Sec.  120.820  CDC Affiliation.

    (a) A CDC must be independent and must not be affiliated (as 
determined in accordance with Sec.  121.103 of this chapter) with any 
Person (as defined in Sec.  120.10) except as permitted under this 
section.
    (b) A CDC may be affiliated with an entity (other than a 7(a) 
Lender or another CDC) whose function is economic development in the 
same Area of Operations and that is either a non-profit entity or a 
State or local government or political subdivision (e.g., council of 
governments).
    (c) A CDC must not be affiliated (as determined in accordance with 
Sec.  121.103) with or invest, directly or indirectly, in a 7(a) 
Lender. A CDC that was affiliated with a 7(a) Lender as of November 6, 
2003 may continue such affiliation.
    (d) A CDC must not be affiliated (as determined in accordance with 
Sec.  121.103 of this chapter) with another CDC. In addition, a CDC 
must not directly or indirectly invest in or finance another CDC, 
except with the prior written approval of D/FA or designee and D/OCRM 
or designee if they determine in their discretion that such approval is 
in the best interests of the 504 Loan Program.
    (e) A CDC may remain affiliated with a for-profit entity (other 
than a 7(a) Lender) if such affiliation existed prior to March 21, 
2014. A CDC may also be affiliated with a for-profit entity (other than 
a 7(a) Lender) whose function is economic development in the same Area 
of Operations with the prior written approval of the D/FA or designee 
if he or she determines in his or her discretion that such approval is 
in the best interests of the 504 Loan Program.
    (f) 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.


Sec.  120.822  [Removed]

0
6. Remove Sec.  120.822.

0
7. Revise Sec.  120.823 to read as follows:

[[Page 15650]]

Sec.  120.823  CDC Board of Directors.

    (a) The CDC, whether for-profit or nonprofit, must have a Board of 
Directors with at least nine (9) voting directors. A CDC may request 
the approval of the D/FA or designee to have a Board with fewer 
directors than 9 for good cause. SBA recommends that the CDC create a 
Board with no more than 25 voting directors. The Board must be actively 
involved in encouraging economic development in the Area of Operations. 
The initial Board may be created by any method permitted by applicable 
State law. At a minimum, the Board must have directors with background 
and expertise in internal controls, financial risk management, 
commercial lending, legal issues relating to commercial lending, and 
corporate governance. Directors may be either currently employed or 
retired. A CDC must have at least one voting director that represents 
the economic, community or workforce development fields, and at least 
two voting directors that represent the commercial lending field.
    (b) At least two voting members of the Board of Directors, other 
than the CDC manager, must possess commercial lending experience 
satisfactory to SBA. When the Board votes on SBA loan approval or 
servicing actions, at least two voting Board members, with such 
commercial lending experience, other than the CDC manager, must be 
present and vote.
    (c) The Board of Directors must meet at least quarterly and shall 
be responsible for the actions of the CDC and any committees 
established by the Board of Directors. In addition, the Board of 
Directors is subject to the following requirements:
    (1) Except for the CDC manager, no person on the CDC's staff may be 
a voting director of the Board;
    (2) A quorum must be present to transact business. The quorum shall 
be set by the CDC but shall be no less than 50% of the voting members 
of the Board of Directors;
    (3) Attendance at meetings may be through any format permitted by 
State law;
    (4) Directors from the commercial lending fields must comprise less 
than 50% of the representation on the Board; and
    (5) A CDC may not permit more than one of its Directors to be 
employed by or serve on the Board of Directors of any other single 
entity (including the entity's affiliates), unless that entity is a 
civic, charitable, or comparable organization that is not involved in 
financial services or economic development activities. No CDC Board 
member may serve on the Board of another CDC in accordance with Sec.  
120.851(b).
    (d) The Board shall have and exercise all corporate powers and 
authority and be responsible for all corporate actions and business. 
There must be no actual or appearance of a conflict of interest with 
respect to any actions of the Board. The Board is responsible for 
ensuring that the structure and operation of the CDC, as set forth in 
the Bylaws, comply with SBA's Loan Program Requirements. The 
responsibilities of the Board include, but are not limited, to the 
following:
    (1) Approving the mission and the policies for the CDC;
    (2) Hiring, firing, supervising and annually evaluating the CDC 
manager;
    (3) Setting the salary for the CDC manager and reviewing all 
salaries;
    (4) Establishing committees, at its discretion, including the 
following:
    (i) Executive Committee. To the extent authorized in the Bylaws, 
the Board of Directors may establish an Executive Committee. The 
Executive Committee may exercise the authority of the Board; however, 
the delegation of its authority does not relieve the Board of its 
responsibility imposed by law or Loan Program Requirements. No further 
delegation or redelegation of this authority is permitted. If the Board 
establishes an Executive Committee and delegates any of its authority 
to the Executive Committee as set forth in the Bylaws of the CDC, the 
Executive Committee must:
    (A) Be chosen by and from the Board of Directors from the Board; 
and
    (B) Meet the same organizational and representational requirements 
as the Board of Directors, except that the Executive Committee must 
have a minimum of five voting members who must be present to conduct 
business.
    (ii) Loan Committee. The Board of Directors may establish a Loan 
Committee. The Loan Committee may exercise the authority of the Board 
only as set forth below; however, the delegation of its authority does 
not relieve the Board of its responsibility imposed by law or Loan 
Program Requirements. If the Board of Directors chooses to establish a 
Loan Committee, no CDC staff or manager may serve on the Loan 
Committee. The Loan Committee must:
    (A) Be chosen by the Board of Directors from the membership (if 
any), shareholders or the Board;
    (B) Have a quorum of at least five (5) committee members authorized 
to vote;
    (C) Have at least two members with commercial lending experience 
satisfactory to SBA; and
    (D) Have no actual or appearance of a conflict of interest, 
including for example, a Loan Committee member participating in 
deliberations on a loan for which the Third Party Lender is the 
member's employer or the member is otherwise associated with the Third 
Party Lender; and
    (E) Consist of members who live or work in the Area of Operations 
of the State where the 504 project they are voting on is located unless 
the project falls under one of the exceptions listed in Sec.  120.839.
    (5) Ensuring that the CDC's expenses are reasonable and customary;
    (6) Hiring directly an independent auditor to provide the financial 
statements in accordance with Loan Program Requirements;
    (7) Monitoring the CDC's portfolio performance on a regular basis;
    (8) Reviewing a semiannual report on portfolio performance from the 
CDC manager, which would include, but not be limited to, asset quality 
and industry concentration;
    (9) Ensuring that the CDC establishes and maintains adequate 
reserves for operations;
    (10) Ensuring that the CDC invests in economic development in each 
of the States in its Area of Operations in which it has a portfolio, 
and approving each investment. If the investment is included in the 
CDC's budget, the Board's approval of the budget may be deemed approval 
of the investment. If the investment is not included in the budget, the 
Board must separately approve the investment;
    (11) Establishing a policy in the Bylaws of the CDC prohibiting an 
actual conflict of interest or the appearance of same, and enforcing 
such policy (see Sec.  120.140 and Sec.  120.851);
    (12) Retaining accountability for all of the actions of the CDC;
    (13) Establishing written internal control policies, in accordance 
with Sec.  120.826;
    (14) Establishing commercially reasonable loan approval policies, 
procedures, and standards. The Bylaws must include any delegations of 
authority to the Loan Committee and Executive Committee, if either 
Committee has been established. In addition, the CDC must establish and 
set forth in detail in a policy manual its credit approval process. All 
504 loan applications must have credit approval prior to submission to 
the Agency. The Loan Committee, if established, may be delegated the 
authority to provide credit approval for loans up to $2,000,000 but, 
for loans of $1,000,000 to $2,000,000, the Loan Committee's action must 
be ratified by the Board or Executive

[[Page 15651]]

Committee prior to Debenture closing. Only the Board or Executive 
Committee, if authorized by the Board, may provide credit approval for 
loans greater than $2,000,000.
    (15) All members of the Board of Directors must annually certify in 
writing that they have read and understand this section, and copies of 
the certification must be included in the Annual Report to SBA.
    (e) The Board of Directors shall maintain Directors' and Officers' 
Liability and Errors and Omissions insurance in amounts established by 
SBA that are based on the size of the CDC's portfolio and other 
relevant factors.

0
8. Amend Sec.  120.830 by revising paragraph (a) to read as follows:


Sec.  120.830  Reports a CDC must submit.

* * * * *
    (a) An Annual Report within one hundred-eighty days after the end 
of the CDC's fiscal year (to include Federal tax returns for that 
year). A CDC that is certified by SBA within 6 months of the CDC's 
fiscal year-end is not required to submit an Annual Report for that 
year. The Annual Report must include, but is not limited to, the 
following:
    (1) Audited or Reviewed Financial Statements as required in Sec.  
120.826(c) and (d) for the CDC and any affiliates or subsidiaries of 
the CDC.
    (i) Audited financial statements must, at a minimum, include the 
following:
    (A) Audited balance sheet;
    (B) Audited statement of income (or receipts) and expenses;
    (C) Audited statement of source and application of funds;
    (D) Such footnotes as are necessary to an understanding of the 
financial statements;
    (E) Auditor's letter to management on internal control weaknesses; 
and
    (F) The auditor's report; and
    (ii) Reviewed financial statements must, at a minimum, include the 
following:
    (A) Balance sheet;
    (B) Statement of income (or receipts) and expenses;
    (C) Statement of source and application of funds;
    (D) Such footnotes as are necessary to an understanding of the 
financial statements;
    (E) The accountant's review report; and
    (2) Report on compensation: CDCs are required to provide detailed 
information on total compensation (including salary, bonuses and 
expenses) paid within the CDC's most recent tax year for current and 
former officers and directors, and for current and former employees and 
independent contractors with total compensation of more than $100,000 
during that period.
    (3) Certification of members of the Board of Directors. Written 
annual certification by each Board member that he or she has read and 
understands the requirements set forth in Sec.  120.823.
    (4) Report on investment in economic development. Written report on 
investments in economic development in each State in which the CDC has 
an outstanding 504 loan.
* * * * *

0
9. Amend Sec.  120.835 by revising paragraph (c) to read as follows:


Sec.  120.835  Application to expand an Area of Operations.

* * * * *
    (c) 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 the State the CDC seeks to expand into 
is contiguous to the State of the CDC's incorporation and the CDC 
establishes a loan committee in that State meeting the requirements of 
Sec.  120.823.


Sec.  120.852  [Removed and Reserved]

0
10. Remove and reserve Sec.  120.852.

0
11. Amend Sec.  120.882 by revising paragraph (a) to read as follows:


Sec.  120.882  Eligible Project costs for 504 loans.

* * * * *
    (a) Costs directly attributable to the Project including 
expenditures incurred by the Borrower (with its own funds or from a 
loan) to acquire land used in the Project, or for any other expense 
directly attributable to the Project, prior to applying to SBA for the 
504 loan;
* * * * *
0
12. Amend Sec.  120.920 by revising paragraph (b) to read as follows:


Sec.  120.920  Required participation by Third Party Lender.

* * * * *
    (b) Third party loan collateral. The 504 loan is usually 
collateralized by a second lien on Project Property. The Third Party 
Lender may obtain additional collateral or other security for the Third 
Party Loan (``Additional Collateral'') only if in the event of 
liquidation and unless otherwise approved in writing by SBA:
    (1) The Third Party Lender liquidates or otherwise exhausts all 
reasonable avenues of collection with respect to the Additional 
Collateral no later than the disposition of the Project Property, and
    (2) The Third Party Lender applies any proceeds received as a 
result of the Additional Collateral to the balance outstanding on the 
Third Party Loan prior to the application of proceeds from the 
disposition of the Project Property to the Third Party Loan.


Sec.  120.925  [Removed and Reserved]

0
13. Remove and reserve Sec.  120.925.

Marianne O'Brien Markowitz,
Acting Administrator.
[FR Doc. 2014-06237 Filed 3-20-14; 8:45 am]
BILLING CODE 8025-01-P