Streamlining and Modernizing Certified Development Company Program (504 Loan Program) Corporate Governance Requirements, 15147-15154 [2019-07318]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 84, Number 72 (Monday, April 15, 2019)]
[Proposed Rules]
[Pages 15147-15154]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-07318]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

RIN 3245-AG97


Streamlining and Modernizing Certified Development Company 
Program (504 Loan Program) Corporate Governance Requirements

AGENCY: U.S. Small Business Administration.

ACTION: Proposed rule.

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SUMMARY: This rule proposes to streamline and update the operational 
and organizational requirements for Certified Development Companies 
(CDCs) in order to improve efficiencies and reduce costs without unduly 
increasing risk in the 504 Loan Program. The proposed changes include 
streamlining the requirements that would apply to the corporate 
governance of CDCs, and updating the requirements that would apply to 
professional services contracts entered into by CDCs, the requirements 
related to the audit and review of a CDC's financial statements, and 
the requirements related to the balance that a PCLP CDC must maintain 
in its Loan Loss Reserve Fund.

DATES: The U.S. Small Business Administration (SBA) must receive 
comments on this proposed rule on or before June 14, 2019.

ADDRESSES: You may submit comments, identified by RIN: 3245-AG97, by 
any of the following methods:
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     Mail: Linda Reilly, Chief, 504 Program Branch, Office of 
Financial Assistance, Small Business Administration, 409 3rd Street SW, 
Washington, DC 20416.
     Hand Delivery/Courier: Linda Reilly, Chief, 504 Program 
Branch, Office of Financial Assistance, Small Business Administration, 
409 3rd Street SW, Washington, DC 20416.
    SBA will post all comments on https://www.regulations.gov. If you 
wish to submit confidential business information (CBI) as defined in 
the User Notice at https://www.regulations.gov, please submit the 
information to Linda Reilly, Chief, 504 Program Branch, Office of 
Financial Assistance, Small Business Administration, 409 3rd Street SW, 
Washington, DC 20416. Highlight the information that you consider to be 
CBI and explain why you believe SBA should hold this information as 
confidential. SBA will review the information and make the final 
determination whether it will publish the information.

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

SUPPLEMENTARY INFORMATION: 

I. Background

    The 504 Loan Program is an SBA financing program authorized under 
Title V of the Small Business Investment Act of 1958, 15 U.S.C. 695 et 
seq. The core mission of the 504 Loan Program is to provide long-term 
financing to small businesses for the purchase or improvement of land, 
buildings, and major equipment in an effort to facilitate the creation 
or retention of jobs and local economic development. Under the 504 Loan 
Program, loans are made to small businesses by Certified Development 
Companies (CDCs), which are certified and regulated by SBA to promote 
economic development within their community. In general, a project in 
the 504 Loan Program (a 504 Project) is financed with: A loan obtained 
from a private sector lender with a senior lien covering at least 50 
percent of the project cost (the Third Party Loan); a loan obtained 
from a CDC (the 504 Loan) with a junior lien covering up to 40 percent 
of the total cost (backed by a 100 percent SBA-guaranteed debenture 
sold in private pooling transactions); and a contribution from the 
Borrower of at least 10 percent equity.

II. Proposed Changes to CDC Operational and Organizational Requirements

    SBA is proposing to simplify, streamline, and update SBA's 
regulations relating to CDC operational and organizational requirements 
in order to improve efficiencies and achieve cost savings without 
compromising performance in the 504 Loan Program. To accomplish this 
goal, SBA proposes to amend the following sections in 13 CFR part 120:

A. Section 120.818 Applicability to Existing For-Profit CDCs

    Prior to 2014, 13 CFR 120.822 required CDCs to have a membership 
consisting of at least 25 members. This provision also provided that 
``no person or entity can own or control more than 10 percent of the 
CDC's voting membership (or stock).'' When SBA removed the CDC 
membership requirement in 2014, the prohibition against any person or 
entity owning or controlling more than 10 percent of a for-profit CDC's 
voting stock was inadvertently eliminated. See 79 FR 15641 (March 21, 
2014). SBA is proposing to reinstate this provision by adding it to 
Sec.  120.818. The purpose of the 10 percent limit on stock ownership 
is to ensure that no one person or entity can control a for-profit CDC.

B. Section 120.823 CDC Board of Directors

    SBA proposes to amend Sec.  120.823(a) by lowering the minimum 
number of directors required for the CDC's Board from nine (9) to seven 
(7). To satisfy SBA's quorum requirements set forth in Sec.  
120.823(c)(2), a Board with nine directors must have at least five 
directors present in order to hold a meeting. SBA is aware of the 
difficulty that some small and mid-sized CDCs have in satisfying the 
quorum

[[Page 15148]]

requirements for Board meetings based on a nine-member Board. Although 
CDCs may, under the current rule, request that SBA approve a Board with 
fewer members than nine for good cause, SBA has decided to reduce the 
required minimum number of Board members to seven, which will lower the 
number of members needed for a quorum from five to four. SBA has also 
determined that each CDC should be permitted to determine the maximum 
number of members on its Board and is, therefore, proposing to remove 
the recommendation in Sec.  120.823(a) that a CDC have no more than 25 
voting Directors on the Board. For consistency, SBA is proposing to 
reduce the number of members needed for a quorum of the CDC's Loan 
Committee under Sec.  120.823(d)(4)(ii)(B) from five to four.
    SBA is also proposing to insert language in Sec.  120.823(a) to 
make it clear that Board members are required to live or work in the 
CDC's Area of Operations. Historically, SBA interpreted former Sec.  
120.822(b) (see, e.g., 13 CFR 120.822(b)(2013)) to require CDC Board 
members to live or work in the CDC's Area of Operations. However, the 
regulatory text supporting this interpretation was removed when the CDC 
membership requirement set forth in Sec.  120.822 was removed in 2014. 
See 79 FR 15641 (March 21, 2014). SBA notes that, with certain 
exceptions, the current regulations require Loan Committee members to 
live or work in the Area of Operations of the State where the 504 
Project they are voting on is located. To be consistent, SBA is 
proposing to revise the regulations to expressly apply this 
requirement, with a slight modification in the wording (explained 
below), to Board members as well since the Board is required to vote on 
projects greater than $2 million and, if no Loan Committee is 
established, on projects less than $2 million.
    In addition, the intent of this requirement--that Board members 
have a local connection to the area in which the CDC operates--would 
also be served by allowing Board members to live or work in an area 
that, although not in the CDC's Area of Operations, is contiguous to 
the Area and meets the definition in Sec.  120.802 of a Local Economic 
Area (LEA) for the CDC, such as a metropolitan statistical area that is 
bisected by a State line. SBA is therefore proposing to amend Sec.  
120.823(a) to allow Board members to satisfy the ``work or live in'' 
requirement in this manner. For consistency, SBA is proposing to amend 
Sec.  120.823(d)(4)(ii)(E) to allow Loan Committee members to satisfy 
the ``work or live in'' requirement by working or living in an area 
that meets the definition of an LEA as well.
    SBA is also proposing to simplify the phrase ``live or work in the 
Area of Operations of the State where the 504 project they are voting 
on is located''. Today, the minimum Area of Operations for each CDC is 
the State in which the CDC is incorporated. See Sec.  120.802 
(Definition of ``Area of Operations''). It would, therefore, be simpler 
to replace this phrase with ``live or work in the CDC's State of 
incorporation''.
    In addition, SBA proposes to delete the requirement in Sec.  
120.823(a) that requires CDCs to have at least one voting director who 
represents the economic, community, or workforce development fields. By 
removing this requirement, SBA is clarifying that a CDC need not 
appoint a director who has expertise only in the economic, community, 
or workforce development fields. Instead, SBA is proposing to add ``the 
economic, community, or workforce development fields'' to the other 
areas of expertise identified in the current Sec.  120.823(a) that must 
be represented on the Board. The five other areas of expertise that 
must be represented on the Board include internal controls, financial 
risk management, commercial lending, legal issues relating to 
commercial lending, and corporate governance. For purposes of complying 
with the representational requirements in Sec.  120.823(a), one 
director may have more than one area of expertise.
    SBA is also proposing to remove the requirement in Sec.  
120.823(c)(4) that limits the number of directors in the commercial 
lending field to less than 50% of the Board of Directors. With this 
change, SBA would allow CDCs to determine the number of directors on 
the Board who have a commercial lending background. By requiring that 
the Board include members with background and expertise in the six 
identified areas, SBA believes that proposed Sec.  120.823(a) would 
ensure an appropriate level of diversity of experience on the Board.

C. Section 120.824 Professional Management and Staff

1. Professional Services Contracts Between CDCs
    A CDC may currently obtain, under a written contract that is pre-
approved by SBA, services from qualified individuals and entities to 
perform management, marketing, packaging, processing, closing, 
servicing, or liquidation functions in accordance with the requirements 
set forth in Sec.  120.824(a) through (f). Known as professional 
services contracts, a few CDCs have contracted with other CDCs to 
obtain assistance under this provision (although none are obtaining 
management services from another CDC). The type of relationship that 
may be created between CDCs through these contracts is limited by Sec.  
120.820(d), which prohibits a CDC from affiliating (as determined in 
accordance with 13 CFR 121.103) with another CDC.
    SBA believes that some smaller CDCs may benefit from the assistance 
available from their larger counterparts that operate in the same SBA 
Region or in contiguous States, and SBA is proposing to permit a CDC to 
enter into a professional services contract with another CDC under 
certain conditions, even if the arrangement would give rise to an 
affiliation between the CDCs based on an ``identity of interest'', as 
defined under 13 CFR 121.103(f).\1\ With this rulemaking, SBA is 
proposing to establish the conditions under which a CDC may contract 
with another CDC for marketing, packaging, processing, closing, 
servicing, or liquidation functions. Specifically, SBA proposes to 
incorporate the existing provisions of Sec.  120.824(a) through (f) 
into a new paragraph (a), which would address professional services 
contracts generally (i.e., between a CDC and any third party), and is 
proposing the following conditions as a new paragraph (b), which would 
specifically address professional services contracts between CDCs:
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    \1\ Under 13 CFR 121.103(f), an identity of interest is created 
when the CDCs have identical or substantially identical business or 
economic interests or are economically dependent through contractual 
or other relationships. For example, under Sec.  121.103(f), if all 
or most of the CDC's key functions (including 504 and non-504 
functions in the aggregate) are performed by staff that is obtained 
under contract with another CDC, the two CDCs may be affiliated 
based on an identity of interest.
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(a) Prior Approval of Contracts
    The contract between the CDCs for marketing, packaging, processing, 
closing, servicing, or liquidation functions must be pre-approved by 
the Director of the Office of Financial Assistance (D/FA) (or 
designee), in consultation with the Director of the Office of Credit 
Risk Management (D/OCRM) (or designee), who will determine in his or 
her discretion that such approval is in the best interests of the 504 
Loan Program and that the contract includes terms and conditions 
satisfactory to SBA.
    SBA notes that, generally, a CDC is required under the current 
Sec.  120.824(a) (to be redesignated as Sec.  120.824(a)(1)) to have at 
least one salaried professional that is employed directly by the CDC as

[[Page 15149]]

its full time manager. Currently, a CDC may seek a waiver of this 
requirement and SBA's prior approval of a contract for management 
services from another CDC only if the CDC in need of management 
services is located in a rural area and satisfies the other conditions 
for a waiver of the management requirement, as set forth in the current 
Sec.  120.824(a)(2) (to be redesignated as Sec.  120.824(a)(1)(ii)). 
This proposed rule would not change these provisions, except that SBA 
proposes to require that a rural CDC's contract for management services 
must be pre-approved by the D/FA (or designee) in consultation with the 
D/OCRM (or designee), instead of pre-approved by the D/FA only.
    SBA also notes that a CDC may petition for a waiver of the 
management requirement under the current Sec.  120.824(a)(1) (to be 
redesignated as Sec.  120.824(a)(1)(i)) to obtain management services 
from another non-profit entity under certain conditions. SBA has 
interpreted this provision to mean that the other non-profit entity may 
not be another CDC. To make this clear, SBA is proposing to expressly 
state in the redesignated Sec.  120.824(a)(1)(i) that the non-profit 
entity from which a CDC may obtain management services cannot be 
another CDC. The proposed rule would continue to require that the 
contract and request for waiver must be pre-approved by the D/FA (or 
designee), but it would add that this approval must be done in 
consultation with the D/OCRM (or designee).
(b) CDCs Must Be Located in Same SBA Region or Contiguous States
    The CDCs entering into the contract must be located either in the 
same SBA Region or, if not in the same SBA Region, must be located in 
contiguous States. For purposes of this provision, the location of a 
CDC is the CDC's State of incorporation. SBA does not want a CDC to be 
able to use professional services contracts with other CDCs as a means 
to establish a presence outside of its home SBA Region or a contiguous 
State. This is consistent with the history and purpose of the program 
as a local development program, where CDCs are closely tied to the 
localities in which they lend and perform other economic development 
activities. For any CDC that currently provides services under contract 
to another CDC outside the allowed areas, the CDCs would be permitted 
to continue the contract until the term of the current contract 
expires.
(c) Assistance May Be Provided to Only One CDC per State
    A CDC may provide assistance to only one CDC per State. SBA does 
not want any one CDC to be able to use professional services contracts 
with other CDCs in a way that discourages new CDCs from forming in a 
State or that is detrimental to the viability of existing CDCs in the 
State.
(d) Other Geographic Limits on Where CDCs May Provide Assistance
    No CDC may provide assistance to another CDC in its State of 
incorporation or in any State in which the CDC has Multi-State 
authority. Again, SBA does not want any one CDC to be able to use 
professional services contracts with other CDCs in a way that 
discourages new CDCs from forming in a State or that is detrimental to 
the viability of existing CDCs in the State. SBA would also like to 
solicit comments from the public on whether SBA should place any 
limitations on the ability of a CDC that has expanded its operations 
into a Local Economic Area to provide assistance to another CDC that 
operates in the LEA.
(e) Independent CDCs
    The Board of Directors for each CDC entering into the contract must 
be separate and independent and may not include any common directors, 
whether voting or non-voting. In addition, if either of the CDCs is 
for-profit, neither CDC may own any stock in the other CDC 
(notwithstanding Sec.  120.820(d), which allows a CDC to invest in or 
finance another CDC with the prior written approval of SBA officials). 
SBA wants the CDCs to retain the independence and control provided by 
separate Boards and does not want a CDC to be able to exercise any 
degree of control over another CDC through any ownership interest in 
the other CDC. In addition, the CDCs are prohibited from comingling any 
funds.
(f) Other Requirements That Apply to These Contracts
    The CDCs and the contract must comply with the other requirements 
for professional services contracts set forth in proposed Sec.  
120.824(a). A contract between CDCs may not include either services for 
independent loan reviews or management services (except for rural CDCs 
as provided in accordance with redesignated Sec.  120.824(a)(1)(ii)). 
In addition, affiliation between CDCs based on grounds other than 
identity of interest, including but not limited to through common 
management or ownership under Sec.  121.103(c) and (d), respectively, 
would continue to be prohibited.
2. Other Changes That Would Apply to All Professional Services 
Contracts
    SBA proposes to incorporate the provisions currently set forth in 
13 CFR 120.824(a) through (f) into a new paragraph (a) that would apply 
to all professional services contracts (including professional services 
contracts between CDCs) with the following changes:
(a) Contracts Requiring Prior Approval
    The types of contracts that a CDC may enter into, with SBA's prior 
approval, are listed in current Sec.  120.824(b), and include contracts 
for assistance in management, marketing, packaging, processing, 
closing, servicing, or liquidation functions. SBA wants to clarify in 
this rule that the CDC must obtain SBA's prior approval of co-
employment contracts that a CDC wants to enter into with a third party, 
such as a professional employer organization, to obtain employee 
benefits, such as retirement and health benefits, on a more cost-
effective basis for the CDC's staff. The contracts that some CDCs have 
submitted to SBA for prior approval have provided that the CDC's staff 
were deemed to be the co-employees of both the CDC and the contractor. 
SBA wants CDCs and their staff to be able to obtain the cost savings 
and benefits that can be obtained under these types of contracts, but 
wants to ensure that the contract provides that the CDC retains the 
final authority to hire and fire the CDC's staff.
    In addition, under the current regulation, CDCs may contract for 
legal and accounting services without SBA approval, except for legal 
services in connection with loan liquidation or litigation. SBA is 
proposing to include services for information technology and 
independent loan reviews in the types of contracts listed in current 
120.824(b) (to be redesignated as Sec.  120.824(a)(2)) that CDCs may 
enter into without obtaining prior SBA approval. As indicated in 
section II.C.1(f) above, however, CDCs may not contract with other CDCs 
for the performance of independent loan reviews.
(b) Other Clarifying and Technical Changes
    Under the current Sec.  120.824(e)(1), the CDC's Board must 
demonstrate to SBA that ``the compensation under the [professional 
services] contract is only from the CDC''. For clarity, SBA is 
proposing to revise this provision (to be redesignated as Sec.  
120.824(a)(3)(i)) to state that ``the compensation under the contract 
is paid only by the CDC.'' In

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addition, in the current Sec.  120.824(e)(3), the CDC's Board must 
demonstrate that the contracts do not ``evidence'' any actual or 
apparent conflict of interest or self-dealing. For clarity, SBA is 
proposing to revise this provision (to be redesignated as Sec.  
120.824(a)(3)(iii)) to require the Board to demonstrate that there is 
no actual or apparent conflict of interest or self-dealing in the 
negotiation, approval or implementation of the contract.
    In addition, under the current Sec.  120.824(d), the CDC must 
provide copies of these contracts to SBA for review annually. SBA is 
proposing to revise this provision (to be redesignated as Sec.  
120.824(a)(5)) to clarify that the CDC procuring the services must 
provide a copy of all executed contracts to SBA as part of the CDC's 
Annual Report submitted under Sec.  120.830(a) unless the CDC certifies 
that it has previously submitted an identical copy of the contract to 
SBA.
    Another change being proposed concerns the current Sec.  
120.824(c), under which the contracts must clearly identify terms and 
conditions satisfactory to SBA that permit the CDC to terminate the 
contract prior to its expiration date on a reasonable basis. To give 
CDCs procuring services maximum flexibility, SBA is proposing to revise 
the standard under which the CDC procuring the services may terminate 
the contract to ``with or without cause''. SBA is proposing to add this 
requirement to the current Sec.  120.824(e)(2) (to be redesignated as 
Sec.  120.824(a)(3)(ii)).
    Finally, under the current Sec.  120.824(f), no contractor or 
Associate of a contractor may be a voting or non-voting member of the 
CDC's Board. The term ``Associate'' is generally defined in Sec.  
120.10 with respect to a lender, CDC or small business, but not with 
respect to a contractor of a CDC. SBA is proposing therefore to replace 
the phrase ``Associate of a contractor'' with text that is consistent 
with the definition of Associate in Sec.  120.10.

D. Section 120.826 Basic Requirements for Operating a CDC

    Under the current Sec.  120.826(c), each CDC with a 504 loan 
portfolio balance of $20 million or more must have its financial 
statements audited annually by a certified public accountant (CPA) that 
is independent and experienced in auditing financial institutions, and 
each CDC with a 504 loan portfolio balance of less than $20 million 
must have its financial statements reviewed annually. SBA is proposing 
to revise this paragraph by increasing the dollar threshold that would 
trigger an annual audit requirement of the CDC's financial statements 
from $20 million to $30 million. For loan portfolio balances of less 
than $30 million, the CDC's financial statements would be required to 
be reviewed by an independent CPA in accordance with generally accepted 
accounting principles (GAAP). However, under the proposed change, a CDC 
with a portfolio balance of less than $30 million may be required to 
provide audited financial statements at the discretion of the D/OCRM 
when the CDC is in material noncompliance with SBA's Loan Program 
Requirements (defined in Sec.  120.10), such as with requirements 
related to financial solvency or business integrity. SBA notes that 
CDCs that participate in other SBA programs, such as the Community 
Advantage Pilot Loan Program or the Microloan Program, must continue to 
comply with the audit requirements of those other SBA programs.
    There are currently 19 CDCs (about 9% of all CDCs) with portfolio 
balances of at least $20 million but less than $30 million. By 
increasing the dollar threshold for audited financial statements to $30 
million, these 19 CDCs would save the difference in cost between an 
audited and a reviewed financial statement, which SBA estimates to be 
$15,000 annually for each CDC, without unduly increasing risk. There 
are currently 60 CDCs (about 28% of all CDCs) with portfolio balances 
under $20 million. Therefore, a total of 79 CDCs (about 37% of all 
CDCs) would not be required to provide audited financial statements 
unless, as noted above, circumstances warrant.

E. Section 120.835 Application To Expand an Area of Operations

    Under the current Sec.  120.835(c), a CDC is required to establish 
a separate Loan Committee in each State into which it expands as a 
Multi-State CDC and all of the members of that Loan Committee must live 
or work in the State into which the CDC expands. SBA is proposing to 
amend paragraph (c) of Sec.  120.835 to offer the following alternative 
to establishing a Loan Committee in each such additional State: If the 
CDC has established a Loan Committee in its State of incorporation, 
then when voting on a Project in the additional State, the CDC may 
include at least two individuals who live or work in that State on the 
CDC's Loan Committee. To make it clear that the two individuals added 
to the Loan Committee may vote only on the Projects located in the 
additional State into which the CDC expands and would not be eligible 
to participate in voting on Projects in any other State, SBA is 
proposing to add the term ``only'' after ``[c]onsist'' in Sec.  
120.823(d)(4)(ii)(E). If the CDC has not established a Loan Committee 
in its State of incorporation, the alternative would require that at 
least two individuals who live or work in the additional State be 
included on the CDC's Board of Directors when voting on a Project in 
that State.
    This alternative to the separate Loan Committee requirement would 
reduce the time and expense that a CDC incurs in establishing and 
maintaining a separate Loan Committee in each State into which it 
expands, while still requiring a local connection when the Board or its 
Loan Committee votes on these Multi-State projects. With this change, 
Multi-State CDCs would have an alternative to establishing a separate 
Loan Committee in each State in which they operate.
    If the proposed revision to Sec.  120.835(c) discussed in the 
preceding two paragraphs is adopted, it will be necessary to make a 
conforming change to the current Sec.  120.823(d)(4)(ii)(E). In 
addition, as noted above in section II.B, SBA is proposing to simplify 
the phrase in the current regulation that members must ``live or work 
in the Area of Operations of the State where the 504 project they are 
voting on is located''. As noted above, the minimum Area of Operations 
is the State in which the CDC is incorporated. It would, therefore, be 
simpler to replace this phrase with ``live or work in the CDC's State 
of incorporation''. In addition, with this change, it would no longer 
be necessary to provide an exception in Sec.  120.823(d)(4)(ii)(E) for 
projects that ``fall[ ] under one of the exceptions listed in Sec.  
120.839''. Under the proposed revision, the CDC's Loan Committee 
established under Sec.  120.823(d)(4)(ii)(E) would be able to approve 
projects that fall under Sec.  120.839 and SBA is, therefore, proposing 
to remove the reference to Sec.  120.839.

F. Section 120.839 Case-by-Case Application To Make a 504 Loan Outside 
of a CDC's Area of Operations

    Section 120.839 currently permits a CDC to make a 504 loan outside 
of a CDC's Area of Operations if certain conditions are satisfied, 
including that the CDC has previously assisted the business to obtain a 
504 loan. SBA is proposing to expand paragraph (a) of this section to 
allow a CDC to apply to make a 504 loan outside its Area of Operations 
if the CDC has previously assisted either the business ``or its 
affiliate(s).'' SBA believes that, if the CDC had previously assisted 
an affiliate of the business, the CDC would have sufficient familiarity 
with the business'

[[Page 15151]]

management and credit risk to prudently assist the business.

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

    Currently, CDCs that participate in the Premier Certified Lenders 
Program (PCLP CDCs) are required to establish and maintain an LLRF in 
an amount equal to one percent of the original principal amount of the 
PCLP Debentures issued by the CDC. The amount maintained in the LLRF 
for each PCLP Debenture remains the same even as the principal balance 
of the Debenture is paid down over time.
    SBA is proposing to revise paragraph (b) of this section to allow 
PCLP CDCs to maintain a balance in the LLRF equal to one percent of the 
current principal amount, instead of the original principal amount, of 
the PCLP Debenture after the loan is seasoned for 10 years. However, a 
CDC may not use the declining balance methodology: (1) With respect to 
any PCLP Debenture that has been purchased, in which case the CDC must 
restore the balance maintained in the LLRF with respect to that 
Debenture to one percent of the original principal amount within 30 
days after purchase; or (2) with respect to any other PCLP Debenture if 
SBA notifies the CDC in writing that it has failed to satisfy the 
requirements in paragraphs (e), (f), (h), (i) and (j) of Sec.  120.847. 
In the latter case, the CDC will not be required to restore the balance 
maintained in the LLRF to one percent of the original principal amount 
of the Debenture but must base the amount maintained in the LLRF on one 
percent of the principal amount of the Debenture as of the date of 
notification. The CDC may not begin to use the declining balance 
methodology again until SBA notifies the CDC in writing that SBA has 
determined, in its discretion, that the CDC has corrected the 
noncompliance and has demonstrated its ability to comply with these 
requirements.
    For example, if a CDC fails to timely submit one or more periodic 
loan loss reserve reports under Sec.  120.847(f) (which are required to 
be submitted on a quarterly basis pursuant to SBA Form 2233), SBA would 
notify the CDC that it may no longer use the declining balance 
methodology. The CDC would not be required to restore the balance 
maintained in the LLRF to one percent of the original principal amount 
of the Debenture, but would be required to maintain an amount based on 
one percent of the principal amount of the Debenture as of the date of 
notification. Upon the CDC's submission of the delinquent report(s), 
SBA would notify the CDC that it may again use the declining balance 
methodology based on the original principal amount if SBA determines 
the CDC is able to comply with the reporting requirement going forward.
    By allowing PCLP CDCs to utilize a declining balance methodology 
for each Debenture that is at least 10 years old, more cash would be 
available to support the CDC's operations or to invest in other 
economic development activities without unduly increasing risk. All 
withdrawals must be made in accordance with the requirements of Sec.  
120.847(g). This provision currently requires the CDC to forward 
requests for withdrawals to the Lead SBA Office, but SBA is proposing 
to change the official to whom withdrawal requests should be forwarded 
to the D/OCRM (or designee). If the change in permitted use of the 
declining balance methodology is adopted, SBA will monitor whether the 
adequacy of the CDC's LLRF is affected.

III. Compliance With Executive Orders 12866, 13563, 12988, 13771, and 
13132, the Paperwork Reduction Act (44 U.S.C. Ch. 35), and the 
Regulatory Flexibility Act (5 U.S.C. 601-612)

Executive Order 12866

    The Office of Management and Budget (OMB) has determined that this 
proposed rule is not a ``significant'' regulatory action for the 
purposes of Executive Order 12866. In addition, this is not a major 
rule under the Congressional Review Act, 5 U.S.C. 800.

Executive Order 13563

    The agency coordinated outreach efforts to engage stakeholders 
before proposing this rule. The 504 Loan Program operates through the 
agency's lending partners, which for this program are CDCs. The agency 
has participated in lender conferences and trade association meetings 
and received feedback from CDCs, a trade association, and third-party 
lenders that provided valuable insight to SBA.

Executive Order 13771

    This proposed rule is not expected to be an E.O. 13771 regulatory 
action because this proposed rule is not significant under E.O. 12866.

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 proposed 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 
proposed rule has no federalism implications warranting preparation of 
a federalism assessment.

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

    SBA has determined that this proposed rule would require that SBA 
Form 1253, Certified Development Company (CDC) Annual Report Guide (OMB 
Approval 3245-0074), be revised to clarify or add information that CDCs 
are required to submit with their Annual Report. With respect to the 
Financial Report (Tab 3) of the form, a CDC is currently allowed to 
submit a reviewed financial statement instead of an audited financial 
statement if it has a 504 loan portfolio balance of less than $20 
million. This proposed rule would raise this threshold to $30 million 
and, if adopted, it will be necessary to revise the instruction in the 
form accordingly. The substance of the information that would be 
collected is not being changed, only that fewer CDCs would need to 
submit it.
    In addition, with respect to the Operating Report (Tab 2) of SBA 
Form 1253, the CDC is currently required to submit a copy of all 
contracts for management and/or staff in place during the reporting 
period. The types of contracts in question, as currently described in 
the regulations (e.g., managing, marketing, servicing, etc.), are the 
same contracts that must be submitted to SBA for pre-approval; however, 
the list does not specifically identify co-employment contracts under 
which a third party (such as a professional employer organization) is 
responsible for the management and administration of certain employment 
benefits, such as retirement and health benefits. Accordingly, the form 
would be changed to clarify that SBA must pre-approve these contracts.
    SBA has also determined that, as currently written, the requirement 
to submit a copy of all contracts with the Annual Report could result 
in duplicative reporting since CDCs should have provided SBA with an 
executed copy of any contract after obtaining SBA's prior approval. As 
a result, SBA is proposing to revise this requirement

[[Page 15152]]

to make it clear that CDCs would no longer be required to submit a copy 
of its contracts with the Annual Report if a copy of the current and 
executed contract has been previously submitted to SBA. The CDC would 
be required to provide a certification with its Annual Report that it 
has previously submitted a copy of the executed contract to SBA and 
that no changes have been made to it. The certification would also need 
to state to whom and on what date the contract was provided to SBA.
    Another form that would require a change as a result of this 
proposed rule is SBA Form 2233, Premier Certified Lenders Program 
(PCLP), Quarterly Loan Loss Reserve Report (OMB Approval 3245-0346). 
This form instructs the PCLP CDC to submit the completed form to the 
``Lead SBA Office''. This proposed rule would change the office to 
which this form is submitted to the ``Office of Credit Risk 
Management'', and this form would be revised accordingly.
    SBA invites comments on the proposed changes to the underlying 
regulations that would impact these forms by the deadline for comments 
noted in the DATES section. SBA has determined that the changes 
proposed for the forms described above are not substantive in nature 
and do not need to be submitted to OMB for approval.

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 an initial regulatory analysis'' which 
will ``describe the impact of the proposed rule on small entities.'' 
Section 605 of the RFA allows an agency to certify a rule, in lieu of 
preparing an analysis, if the proposed rulemaking is not expected to 
have a significant economic impact on a substantial number of small 
entities. Although the rulemaking will impact all 215 CDCs (all of 
which are small), SBA does not believe the impact will be significant. 
As stated above, the proposed rule will streamline the operational and 
organizational requirements that CDCs must satisfy and reduce their 
costs, and therefore will not increase their burden.
    For example, under the proposed rule, the 19 CDCs that currently 
have 504 loan portfolio balances between $20 million and $30 million 
would no longer be required to provide audited financial statements, 
but may submit reviewed financial statements instead. As noted above, 
SBA estimates that the elimination of the audited review for these CDCs 
will save each CDC approximately $15,000 per year.
    In addition, SBA is proposing to reduce the regulatory requirements 
imposed on CDCs related to corporate governance. For example, SBA is 
proposing to decrease the number of members that a CDC is required to 
appoint to its Board of Directors from nine to seven. This change would 
also make it easier for a CDC to meet the quorum requirements for 
conducting its business. SBA is also proposing to expand the area in 
which Board and Loan Committee members may work or live; remove the 
limit on the number of members that may serve on the Board from the 
commercial lending fields; allow CDCs in need of assistance to contract 
for services with another CDC under certain circumstances even if the 
CDCs would become affiliated as a result; eliminate the requirement 
that CDCs establish a separate Loan Committee in each State into which 
the CDC expands as a Multi-State CDC; and expand the criteria under 
which a CDC may make a 504 loan outside its Area of Operations.
    Another significant change being proposed is the reduction in the 
amount that PCLP CDCs need to maintain in the Loan Loss Reserve Fund. 
By allowing PCLP CDCs to utilize a declining balance methodology for 
the LLRF after a Debenture has been outstanding for 10 years, more cash 
would be available to support the CD`C's operations or to invest in 
other economic development activities without unduly increasing risk.
    SBA believes that this 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 
proposed rule is to reduce unnecessary regulatory burdens, a review of 
the preamble sections above will provide additional detailed 
explanations regarding how and why this proposed rule will reduce 
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 proposes to amend 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 (7), and 697(a) and 
(e); Public Law 111-5, 123 Stat. 115, Public Law 111-240, 124 Stat. 
2504.

0
2. Amend Sec.  120.818 by designating the undesignated paragraph as 
paragraph (a) and adding paragraph (b) to read as follows:


Sec.  120.818   Applicability to existing for-profit CDCs.

* * * * *
    (b) No person or entity can own or control more than 10 percent of 
a for-profit CDC's stock.
0
3. Amend Sec.  120.823 by:
0
a. Revising paragraph (a);
0
b. Adding the word ``and'' at the end of paragraph (c)(3);
0
c. Removing paragraph (c)(4) and redesignating paragraph (c)(5) as 
paragraph (c)(4); and
0
d. Revising paragraphs (d)(4)(ii)(B) and (E).
    The revisions read as follows:


Sec.  120.823   CDC Board of Directors.

    (a) The CDC, whether for-profit or nonprofit, must have a Board of 
Directors with at least seven (7) voting directors who live or work in 
the CDC's State of incorporation or in an area that is contiguous to 
that State that meets the definition of a Local Economic Area for the 
CDC. 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, corporate governance, and economic, 
community or workforce development. Directors may be either currently 
employed or retired.
* * * * *
    (d) * * *
    (4) * * *
    (ii) * * *
    (B) Have a quorum of at least four (4) Loan Committee members 
authorized to vote;
* * * * *
    (E) Consist only of Loan Committee members who live or work in the 
CDC's State of incorporation or in an area that meets the definition of 
a Local Economic Area for the CDC, except that, for Projects that are 
financed under a CDC's Multi-State authority, the CDC must satisfy the 
requirements of either

[[Page 15153]]

Sec.  120.835(c)(1) or (2) when voting on that Project.
* * * * *
0
4. Revise Sec.  120.824 to read as follows:


 Sec.  120.824   Professional management and staff.

    A CDC must have full-time professional management, including an 
Executive Director (or the equivalent) to manage daily operations. It 
must also have a full-time professional staff qualified by training and 
experience to market the 504 Loan Program, package and process loan 
applications, close loans, service, and, if authorized by SBA, 
liquidate the loan portfolio, and to sustain a sufficient level of 
service and activity in the Area of Operations.
    (a) Professional services contracts. Through a written contract 
with qualified individuals or entities, a CDC may obtain services for 
management, marketing, packaging, processing, closing, servicing, or 
liquidation functions, provided that:
    (1) The CDC must have at least one salaried professional employee 
that is employed directly (not a contractor or an officer, director, 
20% or more equity owner, or key employee of a contractor) on a full-
time basis to manage the CDC. The CDC manager must be hired by the 
CDC's Board of Directors and subject to termination only by the Board. 
A CDC may petition SBA to waive the requirement of the manager being 
employed directly by the CDC if:
    (i) Another non-profit entity (that is not a CDC) that has the 
economic development of the CDC's Area of Operations as one of its 
principal activities will provide management services to the CDC and, 
if the manager is also performing services for the non-profit entity, 
the manager will be available to small businesses interested in the 504 
program and to 504 loan borrowers during regular business hours; or
    (ii) The CDC petitioning SBA for such waiver is rural, has 
insufficient loan volume to justify having management employed directly 
by the CDC, and is requesting to contract with another CDC located in 
the same general area to provide the management.
    (2) The contract must be pre-approved by the D/FA (or designee), 
except that with respect to contracts for management services and 
requests for waivers under paragraph (a)(1) of this section, the 
contract and request for waiver must be pre-approved by the D/FA (or 
designee) in consultation with the D/OCRM (or designee). With respect 
to any contract under which the CDC's staff are deemed co-employees of 
both the CDC and the contractor (e.g., contracts with professional 
employer organizations to obtain employee benefits, such as retirement 
and health benefits, for the CDC's staff), the contract must provide 
that the CDC retains the final authority to hire and fire the CDC's 
employees. (CDCs may contract for legal, accounting, information 
technology, and independent loan review services without SBA approval, 
except for legal services in connection loan liquidation or litigation. 
In addition, a CDC may not contract with another CDC for independent 
loan review services.)
    (3) If a CDC's Board believes that it is in the best interest of 
the CDC to obtain services under paragraph (a) of this section, the 
CDC's Board must explain its reasoning to SBA. The CDC's Board must 
demonstrate to SBA that:
    (i) The compensation under the contract is paid only by the CDC 
obtaining the service, is reasonable and customary for similar services 
in the Area of Operations, and is only for actual services performed;
    (ii) The full term of the contract (including options) is necessary 
and appropriate and the contract permits the CDC procuring the services 
to terminate the contract prior to its expiration date with or without 
cause; and
    (iii) There is no actual or apparent conflict of interest of self-
dealing on the part of any of the CDC's officers, management, and 
staff, including members of the Board and Loan Committee, in the 
negotiation, approval or implementation of the contract.
    (4) Neither the contractor nor any officer, director, 20% or more 
equity owner, or key employee of a contractor may be a voting or non-
voting member of the CDC's Board.
    (5) The CDC procuring the services must provide a copy of all 
executed contracts to SBA as part of the CDC's Annual Report submitted 
under Sec.  120.830(a) unless the CDC certifies that it has previously 
submitted an identical copy of the executed contract to SBA.
    (6) If the contract is between CDCs, the CDCs and the contract must 
comply with paragraph (b) of this section, and the contract may not 
include management services (except in accordance with paragraph 
(a)(1)(ii) of this section) or services for independent loan reviews.
    (b) Professional services contracts between CDCs. Notwithstanding 
the prohibition in Sec.  120.820(d) against a CDC affiliating with 
another CDC, a CDC may obtain services through a written contract with 
another CDC for marketing, packaging, processing, closing, servicing, 
or liquidation functions, provided that:
    (1) The contract between the CDCs must be pre-approved by the D/FA 
(or designee), in consultation with the D/OCRM (or designee), who 
determines in his or her discretion that such approval is in the best 
interests of the 504 Loan Program and that the terms and conditions of 
the contract are satisfactory to SBA. A CDC may contract with another 
CDC for a management function only in accordance with paragraph 
(a)(1)(ii) of this section.
    (2) The CDCs entering into the contract must be located in the same 
SBA Region or, if not located in the same SBA Region, must be located 
in contiguous States. For purposes of this paragraph (b)(2), the 
location of a CDC is the CDC's State of incorporation.
    (3) A CDC may provide assistance to only one CDC per State.
    (4) No CDC may provide assistance to another CDC in its State of 
incorporation or in any State in which the CDC has Multi-State 
authority.
    (5) The Board of Directors for each CDC entering into the contract 
must be separate and independent and may not include any common 
directors. In addition, if either of the CDCs is for-profit, neither 
CDC may own any stock in the other CDC. The CDCs are also prohibited 
from comingling any funds.
    (6) The contract must satisfy the requirements set forth in 
paragraph (a) of this section.


Sec.  20.826  [Amended]

0
5. Amend Sec.  120.826(c) by:
0
a. Removing the term ``$20 million'' wherever it appears and adding the 
term ``$30 million'' in its place;
0
b. Removing the period at the end of the last sentence and adding ``, 
except that the D/OCRM may require a CDC with a portfolio balance of 
less than $30 million to submit an audited financial statement in the 
event the D/OCRM determines, in his or her discretion, that such audit 
is necessary or appropriate when the CDC is in material noncompliance 
with Loan Program Requirements.''
0
6. Amend Sec.  120.835(c) by:
0
a. Adding a paragraph heading;
0
b. Removing the last sentence and adding the phrase ``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 either:'' in 
its place; and
0
c. Adding paragraphs (c)(1) and (2).
    The additions read as follows:


Sec.  120.835   Application to expand an Area of Operations.

* * * * *

[[Page 15154]]

    (c) Multi-State expansion. * * *
    (1) The CDC establishes a Loan Committee in the additional State 
consisting only of members who live or work in that State and that 
satisfies the other requirements in Sec.  120.823(d)(4)(ii)(A) through 
(D); or
    (2) For any Project located in the additional State, the CDC's 
Board or Loan Committee (if established in the CDC's State of 
incorporation) includes at least two members who live or work in that 
State when voting on that Project.


Sec.  120.839  [Amended]

0
7. Amend Sec.  120.839(a) by adding the words ``or its affiliate(s)'' 
after ``business''.
0
8. Amend Sec.  120.847 by:
0
a. Revising paragraph (b); and
0
b. Removing the term ``Lead SBA Office'' in third sentence of paragraph 
(g) and adding in its place ``the D/OCRM (or designee)''.
    The revision reads as follows:


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

* * * * *
    (b) PCLP CDC Exposure and LLRF deposit requirements. A PCLP CDC's 
``Exposure'' is defined as its reimbursement obligation to SBA with 
respect to default in the payment of any PCLP Debenture. The amount of 
a PCLP CDC's Exposure is 10 percent of any loss (including attorney's 
fees; litigation costs; and care of collateral, appraisal and other 
liquidation costs and expenses) sustained by SBA as a result of a 
default in the payment of principal or interest on a PCLP Debenture. 
For each PCLP Debenture a PCLP CDC issues, it must establish and 
maintain an LLRF equal to one percent of the original principal amount 
of the PCLP Debenture. The amount the PCLP CDC must maintain in the 
LLRF for each PCLP Debenture remains the same even as the principal 
balance of the PCLP Debenture is paid down over time except that, after 
the first 10 years of the term of the Debenture, the amount maintained 
in the LLRF may be based on one percent of the current principal amount 
of the PCLP Debenture (the declining balance methodology), as 
determined by SBA. All withdrawals must be made in accordance with the 
requirements of paragraph (g) of this section. A CDC may not use the 
declining balance methodology:
    (1) With respect to any Debenture that has been purchased. Within 
30 days after purchase, the CDC must restore the balance maintained in 
the LLRF for the Debenture that was purchased to one percent of the 
original principal amount of that Debenture; or
    (2) With respect to any other Debenture if SBA notifies the CDC in 
writing that it has failed to satisfy the requirements in paragraph 
(e), (f), (h), (i) or (j) of this section. In such case, the CDC will 
not be required to restore the balance maintained in the LLRF to one 
percent of the original principal amount of the Debenture but must base 
the amount maintained in the LLRF on one percent of the principal 
amount of the Debenture as of the date of notification. The CDC may not 
begin to use the declining balance methodology again until SBA notifies 
the CDC in writing that SBA has determined, in its discretion, that the 
CDC has corrected the noncompliance and has demonstrated its ability to 
comply with these requirements.
* * * * *

    Dated: April 5, 2019.
Linda E. McMahon,
Administrator.
[FR Doc. 2019-07318 Filed 4-12-19; 8:45 am]
 BILLING CODE 8025-01-P