Small Business Investment Companies: Passive Business Expansion and Technical Clarifications, 39335-39341 [2017-17456]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 82, Number 159 (Friday, August 18, 2017)]
[Rules and Regulations]
[Pages 39335-39341]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-17456]





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Federal Register / Vol. 82, No. 159 / Friday, August 18, 2017 / Rules 

and Regulations



[[Page 39335]]







SMALL BUSINESS ADMINISTRATION



13 CFR Part 107



RIN 3245-AG67




Small Business Investment Companies: Passive Business Expansion 

and Technical Clarifications



AGENCY: U.S. Small Business Administration.



ACTION: Final rule and withdrawal of final rule.



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



SUMMARY: The U.S. Small Business Administration (SBA) is withdrawing 

the final rule concerning Small Business Investment Company (SBIC) 

investments in passive businesses that was published on December 28, 

2016, and is replacing it with this final rule. This final rule expands 

SBIC permitted investments in passive businesses and includes new 

reporting and other requirements for passive investments. This rule 

also makes a few minor technical amendments.



DATES: As of August 18, 2017, the final rule published December 28, 

2016 (81 FR 95424), delayed until March 21, 2017, on January 26, 2017 

(82 FR 8499), further delayed until May 20, 2017, on March 21, 2017 (82 

FR 14428), and further delayed until August 18, 2017, on May 2, 2017 

(82 FR 20433), is withdrawn. The amendments in this rule are effective 

September 18, 2017.



FOR FURTHER INFORMATION CONTACT: Theresa Jamerson, Office of Investment 

and Innovation, (202) 205-7563 or sbic@sba.gov.



SUPPLEMENTARY INFORMATION:



I. Background Information



    The SBIC Program is an SBA financing program authorized under Title 

III of the Small Business Investment Act of 1958, 15 U.S.C. 681 et seq. 

Congress created the Small Business Investment Company (SBIC) program 

to ``stimulate and supplement the flow of private equity capital and 

long-term loan funds, which small-business concerns need for the sound 

financing of their business operations and for their growth, expansion, 

and modernization, and which are not available in adequate supply. . . 

.'' 15 U.S.C. 661. Congress intended that the program ``be carried out 

in such manner as to insure the maximum participation of private 

financing sources.'' Id. In accordance with that policy, SBA does not 

invest directly in small businesses. Rather, through the SBIC Program, 

SBA licenses and provides debenture leverage (Leverage) to SBICs. SBICs 

are privately-owned and professionally managed for-profit investment 

funds that make loans to, and investments in, qualified small 

businesses using a combination of privately raised capital and Leverage 

guaranteed by SBA. SBA will guarantee the repayment of debentures 

issued by an SBIC up to a maximum of $150 million or three times the 

amount of the SBIC's qualifying private capital, whichever is less 

(although pursuant to SBA's regulations and credit policies, SBA rarely 

approves an SBIC to have a maximum amount of Leverage outstanding in 

excess of two times the amount of the SBIC's qualifying private 

capital).

    SBICs are generally prohibited from investing in passive businesses 

under the Act. Prior to this final rule, the SBIC program regulations 

provided for the following two exceptions that allowed an SBIC to 

structure an investment utilizing a passive small business as a pass-

through:

    A. ``Holding company exception''--Sec.  107.720(b)(2): This 

exception provides conditions under which an SBIC may structure an 

investment through up to two levels of passive entities to make an 

investment in a non-passive business that is a subsidiary of the 

passive business directly financed by the SBIC. The regulation defines 

a subsidiary company as one in which the financed passive business 

directly or indirectly owns at least 50% of the outstanding voting 

securities. As an example, this exception allows an SBIC to finance ABC 

Holdings 1, a passive small business, with the proceeds flowing through 

ABC Holdings 2, another passive small business, and then to ABC 

Manufacturing, a non-passive small business in which ABC Holdings 1 

owns directly or indirectly at least 50% of the outstanding voting 

securities.

    B. ``Blocker corporation exception''--Sec.  107.720(b)(3): This 

exception enables a partnership SBIC, with SBA's prior approval, to 

provide financing to a small business through a passive, wholly-owned C 

corporation, but only if a direct financing would cause one or more of 

the SBIC's investors to incur Unrelated Business Taxable Income (UBTI). 

A passive C corporation formed under the second exception is commonly 

known as a blocker corporation.

    On October 5, 2015, SBA published a proposed rule, Small Business 

Investment Companies: Passive Business Expansion and Technical 

Clarifications (80 FR 60077), to further expand the permitted use of 

passive businesses, provide clarification with regard to investments in 

such businesses, and make minor technical clarifications. SBA received 

three comments on the proposed rule, not including one comment that 

generally questioned the fairness of the Act as a whole and did not 

provide any specific comments on the rule. The three comments pertinent 

to the rule are addressed in Section II.

    On December 28, 2016, SBA published a final rule regarding SBIC 

investments in passive businesses, 81 FR 95419, which had an effective 

date of January 27, 2017. On January 26, 2017, SBA published a notice 

in the Federal Register at 82 FR 8499, to delay the effective date of 

the final rule until March 21, 2017, and to re-open the rule for 

additional public comment in accordance with the memorandum dated 

January 20, 2017, from the Assistant to the President and Chief of 

Staff, entitled ``Regulatory Freeze Pending Review.'' SBA received one 

comment that supported the December 2016 final rule. On March 21, 2017, 

SBA published another notice to delay the effective date of the final 

rule until May 20, 2017, to give the new administration time to further 

consider the rule. 82 FR 14428. After completing its review, SBA issued 

another delay notice at 82 FR 20433 (May 2, 2017), which stated that 

SBA was considering removing a provision in the final rule published on 

December 28, 2016 that would allow SBICs to use a blocker corporation 

if an investor in an SBIC had elected to be taxed as a regulated 

investment company (RIC), and if a direct investment into the operating 

company



[[Page 39336]]



would jeopardize the investor's RIC status. As part of this document, 

SBA asked for additional comments regarding the removal of this 

provision, and delayed the effective date of the December 28, 2016 

final rule until August 18, 2017. SBA received one comment in response 

to its proposed change. This comment is addressed in Section II.

    SBA is withdrawing the final rule published on December 28, 2016, 

and is replacing it with this final rule. This final rule expands 

permitted investments in passive businesses, provides further 

clarification with regard to investments in such businesses, and adds 

certain requirements to improve SBA's ability to monitor such 

investments. The rule also includes a conforming change to the 

regulations regarding the amount of Leverage available to SBICs under 

common control to be consistent with the Consolidated Appropriations 

Act, 2016, Public Law 114-113, 129 Stat. 2242 (December 22, 2015), 

which increased the maximum amount of such Leverage from $225 million 

to $350 million.



II. Section-by-Section Analysis



    This section discusses the comments SBA received on the proposed 

rule dated October 5, 2017 (80 FR 60077), as well as the comment 

received in response to the notice published on May 2, 2017 (82 FR 

20433).



A. Passive Business Rules



Section 107.720--Small Businesses That May Be Ineligible for Financing

    1. Changes to Holding Company Exception Sec.  107.720(b)(2): SBA 

proposed revisions to Sec.  107.720(b)(2) to explicitly permit an SBIC 

to form and finance a passive business that will either pass the 

proceeds through to or use the proceeds to acquire all or part of a 

non-passive business. These changes were intended to codify SBA's 

existing interpretation of the regulations.

    SBA received two comments on Sec.  107.720(b)(2) indicating that 

the proposed changes would be more effective if the passive business 

directly financed was not required to own at least 50 percent of the 

underlying active business. Commenters also suggested that SBICs be 

allowed to structure investments using passive investment vehicles 

``irrespective of the number of parent entities involved so long as the 

parent entities in question directly or indirectly own or control at 

least 50 percent of the voting or economic interests of the active 

business.'' SBA received similar comments as part of the rulemaking 

process when it last proposed expanding the permitted use of passive 

businesses on December 23, 2013 (78 FR 77377). SBA considered these 

comments a second time in developing this final rule; however, neither 

set of comments was adopted. SBA believes that complex investment 

structures involving passive entities require more protections, not 

fewer. Although the new Sec.  107.720(b)(4) should help address some of 

SBA's credit concerns with respect to these structures, SBA believes 

that the subsidiary relationship between the financed passive business 

and the active company must be maintained to facilitate SBA's access to 

the information and records needed to effectively monitor these 

transactions and to aid in the recovery of assets in the event of a 

default. SBA also maintains its position that effective monitoring of 

transactions with unlimited levels of passive companies would require 

resources well beyond those available to the Agency. Proposed Sec.  

107.720(b)(2) is adopted without change.

    2. Changes to Blocker Corporation Exception--Sec.  107.720(b)(3): 

The proposed rule included the following changes to Sec.  

107.720(b)(3):

    a. Removing the requirement to obtain SBA's prior approval to form 

a blocker corporation;

    b. Permitting an SBIC to form a blocker corporation to enable any 

foreign investors to avoid effectively connected income (ECI) under the 

Internal Revenue Code;

    c. Permitting a blocker corporation to provide financing to a 

second passive small business that passes the proceeds through to a 

non-passive small business in which it owns at least 50 percent of the 

outstanding voting securities (effectively permitting an investment 

structured with two levels of passive companies, one of which is the 

blocker corporation); and

    d. Removing outdated language indicating that an SBIC's ownership 

of a blocker corporation formed under Sec.  107.720(b)(3) will not 

constitute a violation of Sec.  107.865(a). This provision was rendered 

unnecessary by a rule change in 2002 (67 FR 64789) that revised Sec.  

107.865(a) to permit an SBIC to exercise control over a small business 

for up to seven years without SBA approval.

    SBA received comments on proposed Sec.  107.720(b)(3) as discussed 

below:

    a. Regulated Investment Company (RIC) Exception. All three 

commenters asked that the regulations provide an additional exception 

for SBICs that are wholly owned subsidiaries of Business Development 

Companies (BDCs). A BDC typically elects to be taxed as a RIC pursuant 

to Subchapter M of the Internal Revenue Code of 1986. In general, a RIC 

is not subject to U.S. Federal income taxes on income and gains that it 

distributes to stockholders, provided that it satisfies certain minimum 

distribution requirements. To qualify as a RIC, a BDC must satisfy 

certain source of income and asset-diversification tests; among other 

things, a RIC must generally derive at least 90% of its gross income 

for each taxable year from certain types of investment. In particular, 

the commenters explained that equity interests in pass-through entities 

(such as an LLC or S corporation) generate operating income that, if 

received or deemed received directly by a BDC, could disqualify the BDC 

from maintaining RIC status, and therefore, such interests must often 

be held through a blocker corporation. The commenters requested that 

Sec.  107.720(b)(3) be revised to permit an SBIC to form a blocker 

corporation to avoid adverse tax consequences to an investor (typically 

a parent BDC) that has elected to be taxed as a RIC.

    The final rule published on December 28, 2016 (81 FR 95419) adopted 

this comment. However, in the delay notice published on May 2, 2017 (82 

FR 20433), SBA stated that it was considering removing this provision 

and solicited comment from the public on that proposed action. The 

notice cited SBA's concern that, in light of the increased complexities 

involved in monitoring and examining investments structured through 

blocker entities, the expanded use of such entities could increase risk 

to the SBIC program unless SBA were to increase examination resources 

to monitor these complex transactions. The notice further explained 

that while SBA expects limited use of blocker entities for the purposes 

of avoiding UBTI and ECI (because these situations apply to only a few 

SBICs), SBA would expect significantly greater usage of blocker 

entities by SBICs that are subsidiaries of BDCs that have elected to be 

taxed as RICs. Currently, there are 31 SBICs with BDC investors (BDC-

SBICs) that collectively account for over 23% of SBA's outstanding 

Leverage, and SBA expects that most of them would make use of blocker 

entities if the RIC exception were to be finalized.

    SBA received one comment stating that not including the RIC 

exception would prevent BDC-SBICs from taking equity positions and 

benefiting from the upside afforded by equity investments. While the 

commenter strongly



[[Page 39337]]



supported SBA's goal of protecting taxpayers, the commenter believed 

that this goal may be better served by including the RIC exception and 

thereby increasing a BDC-SBIC's potential for maximizing profits. The 

commenter further noted that the profits from a single successful 

equity investment can offset losses on other investments and that SBA's 

guarantee is protected by a BDC-SBIC's portfolio as a whole. The 

commenter suggested that SBA consider creating the RIC exception, but 

making the exception subject to SBA prior approval. SBA recognizes that 

not including the RIC exception for blocker corporations limits a BDC-

SBIC's ability to execute some transactions; however, due to the large 

amount of outstanding Leverage held by BDC-SBICs, SBA remains concerned 

that these investments would unacceptably increase risk to SBA absent 

an increase in SBA's resources to monitor and examine such investments. 

Adding a requirement for SBA's prior approval of a blocker entity does 

not address this concern; SBA would still need to review and approve 

the transactions and examine each of the passive businesses used in the 

transaction. For this reason, this final rule does not include the RIC 

exception. SBA notes that BDC-SBICs may still take equity positions in 

small businesses not structured as pass through entities and also may 

invest using any passive structure permitted under Sec.  107.720(b)(2).

    b. Blocker Entity Form of Organization. At the proposed stage of 

this rule, SBA received two comments suggesting that non-corporate 

forms of organization should be permitted for blocker entities. The 

commenters explained that these structures are often ``more streamlined 

in terms of corporate formalities than a C corporation'' and suggested 

the regulations allow ``any entity that elects to be taxed as a 

corporation for Federal income tax purposes.'' SBA considered this 

suggestion to be overly broad, but partially adopted this suggestion in 

this final rule by allowing a blocker entity to be structured as an LLC 

that elects to be taxed as a corporation.

    c. Two Level Holding Company Financing. Two commenters indicated 

that Sec.  107.720(b)(3) should allow SBICs to structure a financing 

with a blocker entity coupled with two additional levels of passive 

holding companies as defined in Sec.  107.720(b)(2). The commenters 

stated that the proposed rule puts an SBIC that requires a blocker 

entity to accommodate its investors at a disadvantage compared to other 

SBICs that do not require a blocker entity, since the blocker entity 

can only finance a single passive business entity that in turn makes an 

investment into an active business. For example, an SBIC with a foreign 

investor would not be able to participate in a financing that is 

structured as a two-level passive business financing under Sec.  

107.720(b)(2), if it also needed a separate passive business to serve 

as a blocker entity in order to avoid effectively connected income. If 

adopted, this suggestion would effectively permit up to three levels of 

passive businesses between the SBIC and the operating business. These 

additional levels of passive businesses impose a burden on SBA as 

regulator and increase the Agency's credit risk. SBA believes that two 

levels of passive businesses under either exception should provide 

SBICs with sufficient flexibility to operate successfully, and this 

final rule does not adopt the suggested change.

    d. SBA did not receive any comments on the proposed change to Sec.  

107.720(b)(3) regarding the removal of outdated language. This rule 

adopts the change as proposed.

    3. Additional Passive Business Guidance--Sec.  107.720(b)(4): The 

proposed rule identified SBA's concerns with regard to passive 

investments, including ensuring the financing dollars go to the 

eligible non-passive small business, fees being charged at each passive 

business level, and SBA's ability to access passive business financial 

records, especially in the case of a defaulting SBIC. To address these 

concerns, SBA proposed making the following changes in new Sec.  

107.720(b)(4), which would apply to any eligible passive investment 

made under Sec.  107.720(b)(2) or (b)(3):

    a. ``Substantially All'' Definition. Clarifying the meaning of 

``substantially all'' in Sec.  107.720(b)(2) and (b)(3) to mean 99 

percent of the financing proceeds after deduction of actual application 

fees, closing fees, and expense reimbursements, which may not exceed 

those permitted under Sec.  107.860.

    b. Fee Requirements. Requiring fees charged by an SBIC or its 

Associate under Sec. Sec.  107.860 and 107.900 to not exceed those 

permitted if the SBIC had directly financed the eligible Small Business 

and requiring any such fees received by an SBIC's Associate to be paid 

to the SBIC in cash within 30 days of receipt.

    c. ``Portfolio Concern'' Clarification. Clarifying that both 

passive and non-passive businesses included in a financing are 

``Portfolio Concerns''; therefore, they are subject to record keeping 

and reporting obligations with respect to any ``Portfolio Concern,'' 

defined in Sec.  107.50 as ``a Small Business Assisted by a Licensee.''

    SBA received 3 comments on proposed Sec.  107.720(b)(4) as 

discussed below:

    a. ``Substantially All'' Definition. Commenters suggested that the 

definition of ``substantially all'' be lowered to 95 percent of the 

proceeds instead of 99% of the proceeds because they were concerned 

that the 99 percent threshold ``may be too limiting and pose issues in 

deal structuring.'' SBA did not adopt this comment. The definition 

already excludes allowable fees and expense reimbursements permitted 

under Sec. Sec.  107.860 and 107.900, and SBA believes that a 95 

percent threshold could result in excessive expenses being charged by 

the passive businesses, effectively diverting proceeds from the 

intended operating business. Although this percentage may seem 

inconsequential, 4% of a $20 million financing represents $800,000 that 

could be diverted from the operating business.

    b. Fee Requirements. Two commenters suggested removing the 

requirement that fees received by an Associate must be paid over in 

cash to the SBIC. They noted that SBIC program policy guidance known as 

TechNote 7a, which provides guidelines concerning allowable management 

expenses for leveraged SBICs (see www.sba.gov/sbicpolicy), already 

requires that 100% of fees collected under Sec.  107.860 or Sec.  

107.900 must benefit the SBIC, either by being paid directly to the 

SBIC or (if paid to an Associate) through a corresponding reduction in 

the management fee paid by the SBIC, typically called a ``management 

fee offset.'' Commenters also indicated that management fee offsets 

have tax advantages relative to other approaches. Although SBA 

recognizes that management fee offsets can provide tax advantages, SBA 

did not adopt this suggestion because of the difficulty in monitoring 

investments utilizing passive businesses and identifying fees 

associated with each passive business in addition to those paid by the 

operating business.

    c. ``Portfolio Concern'' Clarification. Two commenters indicated 

that the clarification of Portfolio Concern should be revised to apply 

only ``for the purposes of this part 107.720'' to avoid any unintended 

effects arising from the use of the term ``Portfolio Concern'' in other 

sections of the regulations. The commenters indicated that this 

adjustment would still allow SBA to retain the necessary information 

rights contemplated by the proposed rule. A search for the term 

``Portfolio Concern''



[[Page 39338]]



within the regulations identified the following:

     Sec.  107.50 defines ``Portfolio Concern'' as ``a Small 

Business Assisted by a Licensee.''

     Sec. Sec.  107.600-107.660 describe record keeping and 

information requirements, including those for a Portfolio Concern.

     Sec.  107.730 discusses conflicts of interest with regards 

to Portfolio Concerns.

     Sec.  107.760 discusses how a change in size or activity 

affect the Licensee with regard to a Portfolio Concern.

     Sec.  107.850 discusses restrictions on redemption of 

Equity Securities of a Portfolio Concern.



SBA believes that all of the requirements in these sections are 

applicable to passive business financings. Therefore, this suggestion 

was not adopted.

    4. Section 107.610 Required certifications for Loans and 

Investments. The proposed rule also added a certification requirement 

to Sec.  107.610 to require an SBIC that finances a business under 

Sec.  107.720(b)(3) to certify as to the qualifying basis for such 

financing. The certification replaces the requirement for SBA prior 

approval of the formation and financing of a blocker corporation.

    As previously discussed under the changes to Sec.  107.720(b)(3) 

paragraph, the December 2016 final rule, 81 FR 95419 (December 28, 

2016), would have permitted the formation of a blocker entity by an 

SBIC with an investor that had elected to be taxed as a RIC. Since this 

final rule does not include the RIC exception, that portion of the 

certification requirement has been removed from Sec.  107.610 in this 

final rule. The final Sec.  107.610 adopts the proposed rule (80 FR 

60077) language with respect to the formation of blocker entities to 

accommodate investors subject to UBTI or ECI with minor technical 

changes to clarify these two permitted exceptions.



B. Technical Changes



    SBA also proposed the following technical changes to the 

regulations:

    1. Section 107.50 Definition of terms. Changing ``Associates's'' to 

``Associate's''.

    2. Section 107.210 Minimum capital requirements for Licensees. 

Modifying paragraph (a) of Sec.  107.210 to allow both Leverageable 

Capital and Regulatory Capital to fall below the stated minimums if the 

reductions are performed in accordance with an SBA-approved wind-up 

plan per Sec.  107.590(c), to conform with SBA's current oversight 

practices.

    3. Section 107.503 Licensee's adoption of an approved valuation 

policy. Changing the last sentence of Sec.  107.503(a) to indicate that 

valuation guidelines for SBICs may be obtained from the SBIC program's 

public Web site, www.sba.gov/sbic.

    4. Section 107.630 Requirement for Licensees to file financial 

statements with SBA (Form 468). Removing current Sec.  107.630(d), 

which provides a mailing address for submission of SBA Form 468, and 

re-designating paragraph (e) as paragraph (d). These instructions are 

no longer necessary because SBICs submit this information 

electronically using the SBA's web-based application.

    5. Section 107.1100 Types of Leverage and application procedures. 

Correcting the misspelling of ``Yu'' to ``You'' and removing paragraph 

(c), which identifies where to send Leverage applications. This 

paragraph is unnecessary because the application forms provide these 

instructions.

    None of the comments SBA received in response to the proposed rule 

were related to these technical changes. This final rule incorporates 

these changes as proposed.



C. Increase to Maximum Leverage to SBICs Under Common Control



    Section 521 of the Consolidated Appropriations Act, 2016, amended 

section 303(b)(2) of the Act to increase the maximum amount of Leverage 

available to two or more SBICs under Common Control from $225 million 

to $350 million. SBA defines Common Control in 13 CFR 107.50 to mean a 

condition where two or more persons, either through ownership, 

management, contract, or otherwise, are under the control of one group 

or person. SBA presumes that two or more SBICs are under Common Control 

if, among other things, they have common officers, directors, or 

general partners. Currently, 13 CFR 107.1150(b) limits two or more 

SBICs under Common Control to the maximum aggregate amount of 

outstanding Leverage of $225 million, which amount is subject to 

further limitations under SBA's credit policies. Solely as a conforming 

change, this rule increases the maximum amount set forth in the 

regulation from $225 million to $350 million. This statutory change was 

not addressed previously because it had not yet been enacted when the 

rule was proposed. Now that it has, the technical change has been 

included to ensure consistency between the regulations and the current 

law.



Compliance With Executive Orders 12866, 12988, 13132, 13563, and 13771, 

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. 

This is also not a ``major'' rule under the Congressional Review Act, 5 

U.S.C. 801, et seq.



Executive Order 12988



    This rule 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 rule does not 

have retroactive or presumptive effect.



Executive Order 13132



    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, for the purposes of Executive 

Order 13132, Federalism, SBA determines that this rule has no 

federalism implications warranting the preparation of a federalism 

assessment.



Executive Order 13563



    This final rule was developed in response to comments received on 

previously proposed amendments to these regulations on investments in 

passive businesses. See 78 FR 77377 (December 23, 2013). SBA received 

one set of comments on that proposed rule that suggested changes to 

further liberalize permitted financings to passive businesses under 

Sec.  107.720(b). In response to the comment, SBA indicated in the 

related final rule published on October 21, 2014 (79 FR 62819), that it 

would further consider the suggested changes in a future rulemaking. As 

part of that reconsideration, SBA discussed the comments with industry 

representatives and solicited additional comments in the proposed rule 

published in October 2015 at 80 FR 60077. In December 2016, SBA 

published a final rule that reflected the industry feedback, as well as 

comments from the general public. 81 FR 95419 (December 28, 2016). 

After reconsideration of that published final rule in accordance with 

the memorandum, dated January 20, 2017, from the Assistant to the 

President and Chief of Staff, entitled ``Regulatory Freeze Pending 

Review,'' as discussed above, on three separate occasions SBA delayed 

implementation of the rule.



[[Page 39339]]



SBA also solicited additional comments from the public. Any comments 

received in response to those requests were also considered in 

finalizing this rule.



Executive Order 13771



    This rule is not an EO 13771 regulatory action because this rule is 

not significant under EO 12866.



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



    SBA has determined that this rule would impose additional reporting 

and recordkeeping requirements under the Paperwork Reduction Act. In 

particular, this rule implements changes to the Portfolio Financing 

Report, SBA Form 1031 (OMB Control Number 3245-0078), to clarify 

information to be reported in Parts A, B, and C of the form. Both the 

proposed rule (80 FR 60077) and the December 2016 Final Passive 

Business Rule (81 FR 95419) included additional questions in a new Part 

D on the Form 1031 to collect information regarding Impact SBIC 

investments. These additions were related to the proposed rule, 

entitled ``Impact SBICs,'' published on February 3, 2016 (81 FR 5666), 

which would have defined a new class of SBICs in the regulations. 

However, because SBA is not finalizing that rule, these questions are 

no longer required and have been removed from the Form 1031. As a 

result, proposed Parts E and F have been designated as Parts D and E, 

respectively, in the revised Form 1031 and are discussed in detail 

below.

    The title, description of respondents, description of the 

information collection and the changes to it are discussed below with 

an estimate of the revised annual burden. Included in the estimate is 

the time for reviewing instructions, searching existing data sources, 

gathering and maintaining the data needed, and completing and reviewing 

each collection of information.

    Title: Portfolio Financing Report, SBA Form 1031 (OMB Control 

Number 3245-0078).

    Summary: SBA Form 1031 is a currently approved information 

collection. SBA regulations, specifically Sec.  107.640, require all 

SBICs to submit a Portfolio Financing Report using SBA Form 1031 for 

each financing that an SBIC provides to a Small Business Concern within 

30 days after closing an investment. SBA uses the information provided 

on Form 1031 to evaluate SBIC compliance with regulatory requirements. 

The form is also SBA's primary source of information for compiling 

statistics on the SBIC program as a provider of capital to small 

businesses. The proposed rule (80 FR 60077) invited the public to 

provide comments on the following changes to SBA Form 1031:

    (1) Clarifying that SBICs should report the non-passive Small 

Business Concern information in the Form 1031. SBA has noted that SBICs 

sometimes report data on the passive Small Business Concern rather than 

the non-passive Small Business Concern when reporting financing 

information. SBA has clarified that the SBIC should report data on the 

non-passive Small Business Concern when reporting information on 

financings using passive businesses in the Form 1031 Part A--the Small 

Business Concern; Part B--the pre-financing data; and Part C--the 

financing information, with the exception of the financing dollars in 

Question 29. The amount of financing dollars provided by the SBIC 

should be the total amount of such financing, regardless of whether the 

dollars were provided directly or indirectly to the non-passive 

business concern. Example: The SBIC provides $5 million in equity to 

ABC Holding Corporation, which passes $4.98 million to the non-passive 

business, Acme Manufacturing LLC. In addition, the SBIC provides $5 

million in debt directly to Acme Manufacturing LLC. The SBIC would 

report information on Acme Manufacturing LLC in Parts A, B, and C. 

However, the total financing dollars would be reported as $5 million in 

equity and $5 million in debt for a total of $10 million in total 

financing dollars.

    (2) Identifying financings using one or more passive businesses. 

SBA has added a question on whether the financing utilizes one or more 

passive businesses as part of the financing, to help SBA identify these 

financings.

    (3) Adding information on passive business financings to aid in 

regulatory compliance monitoring. SBA has also added a requirement 

under the new Part D for SBICs to upload a file in Portable Document 

Format (PDF) that contains the following information, which SBA will 

use to help assess whether the financing meets regulatory compliance:

    (a) Qualifying exception: Identification of the passive business 

exception under which the financing is made (i.e., Sec.  107.720(b)(2) 

Exception for pass-through of proceeds to subsidiary, or Sec.  

107.720(b)(3) Exception for certain Partnership Licensees). If the SBIC 

indicates that the financing is made under Sec.  107.720(b)(3), it 

would also indicate the qualifying basis for the financing (i.e., 

financing would cause an investor in the fund to incur unrelated 

business taxable income or effectively connected income).

    (b) Passive Business Entities: Identification of the name and 

employer ID number for each passive business entity used within the 

financing. This is needed so that SBA can identify all Portfolio 

Concerns involved in the financing.

    (c) Financing Structure Description: A description of the financing 

structure, including the flow of the money between the SBIC and the 

non-passive Small Business Concern that receives the proceeds 

(including amounts and types of securities between each entity), and 

the ownership from the SBIC through each entity to the non-passive 

Small Business Concern. This information will help SBA assess that the 

Small Business Concern receives ``substantially all'' the financing 

dollars and the ownership percentages are in compliance with the 

regulations. This will also help SBA with SBICs transferred to the 

Office of Liquidation to identify the structure of the financing and 

aid in recovery of SBA leverage.

    SBA did not receive any comments on the proposed changes. 

Therefore, except as described above, all other changes are adopted as 

final in this rule. SBA updated the below burden estimates from the 

December 2016 final rule (81 FR 31489) to remove the Impact SBIC burden 

estimate and update the estimates based on the SBIC portfolio as of 

June 2017, more recent SBIC financing data, and updated hourly costs.

    Description of Respondents and Burden: As of June 2017 there were 

approximately 316 licensed SBICs. All of these SBICs are required to 

submit SBA Form 1031 for each financing. The current estimated number 

of responses (i.e., number of financings) is 2,695 based on a recent 

three year period (FY 2014 through 2016). The current estimate 

indicates that it takes approximately 12 minutes to complete the form, 

for a total annual burden of 539 hours.

    Neither the number of respondents nor the number of responses per 

year is expected to be affected by this rule. However, SBA estimates an 

increase in the burden hours as a result of the additional reporting in 

new passive business reporting section, as discussed below.

    Passive Business Reporting. SBA believes that the SBIC should be 

able to provide the passive business information since it should be 

readily available as part of the financing. SBA estimates that 

providing the information will take on average an additional 30 minutes 

for those financings utilizing passive businesses, with no incremental 

burden for those financings that do not



[[Page 39340]]



use a passive business. SBA estimates that about 14% of the annual 

responses relate to passive businesses financings (based on financing 

data for the three year period of FYs 2014 through 2016). Based on the 

number of SBICs reporting such financings the total estimated annual 

hour burden resulting from Part D reporting would be 189.

    Therefore, the total estimated annual hour burden for all SBICs 

submitting SBA Form 1031s in a year would be 728 hours.

    The current cost estimate for completing SBA Form 1031 uses a rate 

of $35 per hour for an accounting manager to fill out the form. Using 

that same rate, the cost per form would change from $7 per form to 

$9.45 per form. However, SBA has increased its estimate of an hourly 

rate for an accounting manager to $46 per hour (estimated using 

www1.salary.com/Accounting-Manager-hourly-wages.html in May 2017), 

which rate results in a new cost per form of $12.43 for an aggregate 

cost of $33,488 for the 2,695 estimated responses.

    This final rule also identifies information that an SBIC must 

maintain in its files to support the required changes. SBA believes 

that the SBICs should already be maintaining this information since a 

passive business by definition is a Portfolio Concern and the SBIC 

should be maintaining all documents needed to support each financing. 

The rule makes this expectation explicit. Furthermore, currently, an 

SBIC must maintain this information for it to effectively monitor and 

evaluate an investment that uses a passive business to finance a non-

passive business. Therefore, SBA does not believe this recordkeeping 

requirement increases the burden.

    The rule also requires a certification under Sec.  107.610 when the 

SBIC makes a financing using the exemption in Sec.  107.720(b)(3). This 

includes maintaining records supporting the certification. Since this 

regulation effectively replaces the requirement for SBICs to seek prior 

SBA approval, SBA does not believe this change will increase the 

burden.



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 a Final Regulatory Flexibility Act (FRFA) analysis 

which describes whether the impact of the rule will have a significant 

economic impact on a substantial number of small entities. However, 

Section 605 of the RFA allows an agency to certify a rule, in lieu of 

preparing an FRFA, if the rulemaking is not expected to have a 

significant economic impact on a substantial number of small entities. 

This rule would affect all SBICs, of which there are currently 316. SBA 

estimates that approximately 98 percent of these SBICs are small 

entities. Therefore, SBA has determined that this rule would have an 

impact on a substantial number of small entities. However, SBA has 

determined that the economic impact on entities affected by the rule 

would not be significant. As discussed under the Paperwork Reduction 

Act section, SBICs would need to provide descriptions of the 

transactions in the Form 1031 for which the annual burden totals 189 

hours for the 316 SBICs. Based on the estimated $46 per hour, the cost 

for each SBIC would be approximately $28 per year (189 hours divided by 

316 SBICs multiplied by $46 per hour). The changes in the passive 

business regulation provide SBICs with additional flexibility to employ 

transaction structures commonly used by private equity or venture 

capital funds that are not SBICs.

    SBA asserts that the economic impact of the rule, if any, would be 

minimal and beneficial to small SBICs. Accordingly, the Administrator 

of the SBA certifies that this rule would not have a significant 

economic 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 13 CFR part 107 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, 683, 687(c), 687b, 687d, 687g, 687m.





Sec.  107.50  [Amended]



0

2. Amend Sec.  107.50 by removing from the definition of ``Lending 

Institution'' the term ``Associates's'' and adding in its place the 

term ``Associate's''.



0

3. Amend Sec.  107.210 by revising paragraph (a) introductory text to 

read as follows:





Sec.  107.210  Minimum capital requirements for Licensees.



    (a) Companies licensed on or after October 1, 1996. A company 

licensed on or after October 1, 1996, must have Leverageable Capital of 

at least $2,500,000 and must meet the applicable minimum Regulatory 

Capital requirement in this paragraph (a), unless lower Leverageable 

Capital and Regulatory Capital amounts are approved by SBA as part of a 

Wind-Up Plan in accordance with Sec.  107.590(c):

* * * * *



0

4. Amend Sec.  107.503 by revising the last sentence of paragraph (a) 

to read as follows:





Sec.  107.503  Licensee's adoption of an approved valuation policy.



    (a) * * * These guidelines may be obtained from SBA's SBIC Web site 

at www.sba.gov/sbic.

* * * * *



0

5. Amend Sec.  107.610 by adding paragraph (g) to read as follows:





Sec.  107.610  Required certifications for Loans and Investments.



* * * * *

    (g) For each passive business financed under Sec.  107.720(b)(3), a 

certification by you, dated as of the closing date of the Financing, as 

to the basis for the qualification of the Financing under Sec.  

107.720(b)(3) and identifying one or more limited partners for which a 

direct Financing would cause those investors:

    (1) To incur ``unrelated business taxable income'' under section 

511 of the Internal Revenue Code (26 U.S.C. 511); or

    (2) To incur ``effectively connected income'' to foreign investors 

under sections 871 and 882 of the Internal Revenue Code (26 U.S.C. 871 

and 882).





Sec.  107.630  [Amended]



0

6. Amend Sec.  107.630 by removing paragraph (d) and redesignating 

paragraph (e) as paragraph (d).



0

7. Amend Sec.  107.720 by revising paragraphs (b)(2) and (3) and adding 

paragraph (b)(4) to read as follows:





Sec.  107.720  Small Businesses that may be ineligible for financing.



* * * * *

    (b) * * *

    (2) Exception for pass-through of proceeds to subsidiary. You may 

provide Financing directly to a passive business, including a passive 

business that you have formed, if it is a Small Business and it passes 

substantially all the proceeds through to (or uses substantially all 

the proceeds to acquire) one or more subsidiary companies, each of 

which is an eligible Small Business



[[Page 39341]]



that is not passive. For the purpose of this paragraph (b)(2), 

``subsidiary company'' means a company in which the financed passive 

business either:

    (i) Directly owns, or will own as a result of the Financing, at 

least 50 percent of the outstanding voting securities; or

    (ii) Indirectly owns, or will own as a result of the Financing, at 

least 50 percent of the outstanding voting securities (by directly 

owning the outstanding voting securities of another passive Small 

Business that is the direct owner of the outstanding voting securities 

of the subsidiary company).

    (3) Exception for certain Partnership Licensees. If you are a 

Partnership Licensee, you may form one or more blocker entities in 

accordance with this paragraph (b)(3). For the purposes of this 

paragraph, a ``blocker entity'' means a corporation or a limited 

liability company that elects to be taxed as a corporation for Federal 

income tax purposes. The sole purpose of a blocker entity must be to 

provide Financing to one or more eligible, unincorporated Small 

Businesses. You may form such blocker entities only if a direct 

Financing to such Small Businesses would cause any of your investors to 

incur ``unrelated business taxable income'' under section 511 of the 

Internal Revenue Code (26 U.S.C. 511) or to incur ``effectively 

connected income'' to foreign investors under sections 871 and 882 of 

the Internal Revenue Code (26 U.S.C. 871 and 882). Your ownership and 

investment of funds in such blocker entities will not constitute a 

violation of Sec.  107.730(a). For each passive business financed under 

this section 107.720(b)(3), you must provide a certification to SBA as 

required under Sec.  107.610(g). A blocker entity formed under this 

paragraph may provide Financing:

    (i) Directly to one or more eligible non-passive Small Businesses; 

or

    (ii) Directly to a passive Small Business that passes substantially 

all the proceeds directly to (or uses substantially all the proceeds to 

acquire) one or more eligible non-passive Small Businesses in which the 

passive Small Business directly owns, or will own as a result of the 

Financing, at least 50% of the outstanding voting securities.

    (4) Additional conditions for permitted passive business 

financings. Financings permitted under paragraphs (b)(2) or (3) of this 

section must meet all of the following conditions:

    (i) For the purposes of this paragraph (b), ``substantially all'' 

means at least 99 percent of the Financing proceeds after deduction of 

actual application fees, closing fees, and expense reimbursements, 

which may not exceed those permitted by Sec.  107.860.

    (ii) If you and/or your Associate charge fees permitted by Sec.  

107.860 and/or Sec.  107.900, the total amount of such fees charged to 

all passive and non-passive businesses that are part of the same 

Financing may not exceed the fees that would have been permitted if the 

Financing had been provided directly to a non-passive Small Business. 

Any such fees received by your Associate must be paid to you in cash 

within 30 days of the receipt of such fees.

    (iii) For the purposes of this part 107, each passive and non-

passive business included in the Financing is a Portfolio Concern. The 

terms of the financing must provide SBA with access to Portfolio 

Concern information in compliance with this part 107, including without 

limitation Sec. Sec.  107.600 and 107.620.

* * * * *





Sec.  107.1100   [Amended]



0

8. Amend Sec.  107.1100 by removing the term ``Yu'' in the second to 

the last sentence of paragraph (b) and adding in its place ``You'', and 

by removing paragraph (c).





Sec.  107.1150  [Amended]



0

9. Amend Sec.  107.1150 by removing the term ``$225 million'' in the 

first sentence of paragraph (b) and adding in its place ``$350 

million''.



    Dated: August 10, 2017.

Linda E. McMahon,

Administrator.

[FR Doc. 2017-17456 Filed 8-17-17; 8:45 am]

 BILLING CODE 8025-01-P