Streamlining and Modernizing Certified Development Company Program (504 Loan Program) Corporate Governance Requirements, 66287-66296 [2019-26042]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 84, Number 233 (Wednesday, December 4, 2019)]
[Rules and Regulations]
[Pages 66287-66296]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-26042]



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Rules and Regulations
                                                Federal Register
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Federal Register / Vol. 84, No. 233 / Wednesday, December 4, 2019 / 
Rules and Regulations

[[Page 66287]]



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: Final rule.

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SUMMARY: This final rule streamlines and updates 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 changes include 
streamlining the requirements that apply to the corporate governance of 
CDCs, and updating the requirements that 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 Premier Certified Lender Program (PCLP) 
CDC must maintain in its Loan Loss Reserve Fund.

DATES: This rule is effective on January 3, 2020.

FOR FURTHER INFORMATION CONTACT: Linda Reilly, Chief, 504 Program 
Branch, Office of Financial Assistance, U.S. 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 a U.S. Small Business Administration (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.
    On April 15, 2019, SBA published a proposed rule in the Federal 
Register 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. See 84 FR 15147. The comment period was open 
until June 14, 2019. SBA received a total of 100 comments from 58 CDCs, 
18 individuals who are employed by or otherwise associated with a CDC, 
11 other individuals, 2 trade associations, 4 banks (SBA received two 
comments from the same bank for a total of 5 comments from banks), 3 
from other private companies, and 3 from anonymous sources. The 
comments are summarized and addressed below.

II. Summary of Comments Received

A. Section 120.818 Applicability to Existing For-Profit CDCs

    SBA proposed to amend Sec.  120.818 to reinstate the prohibition, 
which was inadvertently eliminated from the regulations in 2014, 
against any person or entity owning or controlling more than ten 
percent of a for-profit CDC's voting stock. The purpose of the 10 
percent limit on stock ownership was to ensure that no one person or 
entity can control a for-profit CDC. SBA received 55 comments on Sec.  
120.818; all but one of the commenters supported reinstating this 
requirement. One of the commenters who supported reinstating an 
ownership limit argued that the 10 percent limit is lower than needed 
to prevent control by a person or entity and recommended a 20 percent 
limit instead.
    The one opposing commenter argued that there is no rational basis 
for the 10 percent limit and that imposing this limit on for-profit 
CDCs is inconsistent with the intent behind 13 CFR 120.818 that for-
profit and non-profit CDCs be subject to the same regulations. The 
commenter also argued that SBA must either compensate the stockholders 
who would have to divest as a result of the 10 percent limit or phase 
in the requirement over the course of a number of years to allow 
recovery on the investment; otherwise, the commenter argued, the 10 
percent limit would be subject to challenge as a regulatory ``taking.'' 
In addition, the commenter disagreed with SBA's conclusion that this 
change will not have a significant impact on a substantial number of 
small entities and contended that this change requires SBA to conduct 
an initial regulatory flexibility analysis under 5 U.S.C. 603.
    SBA has considered these comments and has decided to adopt the 
proposed changes to the ownership and control requirements with two 
revisions: (1) The 10 percent limit on the ownership of stock by any 
one person or entity will be raised to 25 percent; and (2) for non-
profit CDCs with a Board of Directors elected or appointed by the CDC's 
membership, no person or entity can control more than 25 percent of the 
voting membership of the CDC.
    With respect to the first revision, SBA reviewed the current 
ownership percentages for each of the four for-profit CDCs and 
determined that the largest stock ownership by any one shareholder is 
just under 24 percent. (SBA notes that a CDC's corporate (or treasury) 
stock should not be included in the calculation of the ownership 
percentage of the CDC's voting stock.) With the increase of the limit 
to 25 percent, no person or entity currently owning any stock in a for-
profit CDC will be required to divest any portion of their stock 
ownership and, thus, there will be no significant economic impact on 
any small entity as a result of this provision.
    With respect to the second revision, SBA agrees with the commenter 
that for-

[[Page 66288]]

profit and non-profit CDCs should be subject to the same standards 
governing control of a CDC. Almost half of non-profit CDCs have chosen 
to continue to have memberships since the membership requirement was 
eliminated in 2014 and, under the bylaws of many of these CDCs, the 
members appoint or elect directors to the CDC's Board. To ensure that 
no one individual or entity can control the voting membership of a CDC 
when the members elect or appoint directors to the Board, the 25 
percent limit should apply to these non-profit CDCs in the same manner 
that the 25 percent limit will apply to for-profit CDCs. Accordingly, 
in response to the comments, SBA is revising Sec.  120.816 by adding a 
paragraph (d) to provide that, if a non-profit CDC's membership elects 
or appoints the voting directors to the CDC's Board of Directors, no 
one person or entity can control more than 25 percent of the voting 
membership of the CDC.
    These two revisions will reinstate what has long been a feature of 
SBA's development company programs--that no one person or entity can 
control a CDC. Before the 10 percent limit was inadvertently removed 
from the regulations in 2014, it had been SBA's policy since 1982, 
nearly from the beginning of the 503 Development Company Program,\1\ to 
limit the ownership or control that any one person or entity could have 
over a development company to 10 percent. See 13 CFR 108.503-1(c)(1) 
(1983) (``No member or stockholder [of a 503 company] may own or 
control more than ten percent of the development company's stock or 
voting membership''). In addition, as early as 1973, SBA prohibited any 
shareholder or member of a development company participating in the 502 
Local Development Company Program (which is no longer funded) from 
owning in excess of 25 percent of the voting control in the development 
company under certain circumstances. See 13 CFR 108.2(d)(2) (1974).
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    \1\ The 503 Development Company Program was authorized by Sec.  
113 of Public Law 96-392, approved July 2, 1980 (94 Stat. 833). This 
program was the predecessor program to the 504 Loan Program.
---------------------------------------------------------------------------

    The limitation on ownership and control was carried over into the 
504 Loan Program in 1986, with the former Sec.  108.503-1(d)(1) (1987) 
requiring a CDC to have at least 25 members (if non-profit) and 25 
stockholders (if for-profit) and prohibiting any one person or entity 
from owning or controlling more than 10 percent of the CDC's stock or 
voting membership. With the Board of a nonprofit CDC chosen from the 
CDC's membership, and the Board of a for-profit CDC chosen by the CDC's 
stockholders, it was necessary to prohibit any one person or entity 
from controlling the voting membership or stock of the CDC to avoid any 
one person or entity from being able to control the Board. Thus, SBA 
has consistently applied the same ownership and control standards to 
both for-profit and non-profit CDCs and is continuing that practice in 
this final rule.
    The opposing commenter also argued that fewer owners of a for-
profit CDC generally means a greater investment by those owners and 
that, with a greater investment, the owners have more to lose from non-
performing loans and more incentive to comply with SBA's Loan Program 
Requirements. SBA notes that all CDCs are required to comply with SBA's 
Loan Program Requirements, and the commenter provided no evidence to 
support the view that permitting a greater financial stake in a CDC by 
individual owners would increase the likelihood of such compliance. In 
any event, SBA believes that a greater financial stake by an individual 
shareholder should not be necessary to ensure such compliance or to 
motivate the CDC to make successful loans. As reflected in the long 
regulatory history of the program, the primary purpose of the 504 Loan 
Program (and its predecessor development company programs) is to foster 
economic development, and SBA has long emphasized the pro bono publico 
nature of the 504 Loan Program over the profit incentive and that the 
program was not intended to be a profit center for owners. See, e.g., 
13 CFR 108.2 (1995) (Definition of ``Development company'') (``the 
primary objective of the development company must be the benefit to the 
community as measured by increased employment, payroll, business volume 
. . . rather than monetary profits to its shareholders or members; any 
monetary profits or other benefits which flow to the shareholders or 
members of the local development company must be merely incidental 
thereto'') (emphasis added); see also 51 FR 20764, 20765 (June 6, 1986) 
(``The nature of the 503 company is to be a catalyst in fostering 
economic development, and not a profit center for owners or members'').
    SBA believes that the public purpose of the 504 Loan Program is 
best achieved when the profit motive is not amplified by allowing the 
control of a for-profit CDC to be concentrated in any one person or 
entity. Moreover, SBA believes that economic development is best 
fostered by having a wider range of views and interests represented in 
the CDC's decision-making and that, by not allowing the ownership or 
control of a CDC to be concentrated in any one individual or entity, it 
is more likely that the economic benefits of the 504 Loan Program will 
be dispersed throughout the community. Therefore, after consideration 
of the comments, SBA is finalizing the proposal with the two changes 
described above.

B. Section 120.823 CDC Board of Directors

    SBA proposed to amend Sec.  120.823 by:
    (1) Revising paragraph (a) to lower the minimum number of directors 
required for the CDC's Board from nine to seven, which reduces the 
number needed for a quorum from five to four. For consistency with this 
change, SBA also proposed to amend Sec.  120.823(d)(4)(ii)(B) to reduce 
the number of members needed for a quorum of the CDC's Loan Committee 
from five to four;
    (2) removing the provision in Sec.  120.823(a) that recommends that 
a CDC have no more than 25 directors;
    (3) clarifying in paragraphs (a) and (d)(4)(ii)(E) that Board and 
Loan Committee members are required ``to live or work in the CDC's 
State of incorporation''. SBA proposed to use this simpler phrase 
instead of the current language--which states that members are required 
``to live or work in the Area of Operations of the State where the 504 
project they are voting on is located''--because today the minimum Area 
of Operations for each CDC is the State in which the CDC is 
incorporated. SBA also proposed to allow Board members to live or work 
in an area that would meet the definition of a Local Economic Area 
(LEA) for the CDC. For consistency, the rule proposed to apply this 
same standard to Loan Committee members;
    (4) deleting the requirement in Sec.  120.823(a) that CDCs must 
have at least one voting director who only represents the economic, 
community, or workforce development fields, and adding ``the economic, 
community, or workforce development fields'' to the five other areas of 
expertise identified in the current Sec.  120.823(a) that must be 
represented on the Board; and
    (5) removing Sec.  120.823(c)(4), which limits the number of 
directors in the commercial lending field to less than 50 percent of 
the Board of Directors.
    SBA received 58 comments on the above changes, with 56 commenters 
supporting all of the changes and two commenters opposing a few of the 
changes. One CDC opposed deleting the requirement that the Board have 
at least

[[Page 66289]]

one voting director to represent the economic, community, or workforce 
development fields (described in paragraph (4) above). The commenter 
stated that the CDC has benefited from having a director devoted to the 
economic field, and that this expertise has proven invaluable to 
lending in rural areas. The commenter believes that it would be a loss 
from a national perspective to eliminate the requirement. SBA 
appreciates the commenter's perspective, but points out that, with this 
change, the CDC would still be required to have the economic, community 
or workforce development fields represented on the Board. The 
difference is that the Board member would be able to represent more 
than one area of expertise and not only the economic, community or 
workforce development fields.
    The same commenter also opposed removing the requirement that 
limits the number of directors in the commercial lending field to less 
than 50 percent of the Board (described in paragraph (5) above). The 
commenter stated that this change could result in a Board composed of 
all commercial lenders, which may not serve the 504 Loan Program's 
purpose of promoting economic development. However, as noted in the 
proposed rule, the regulation will continue to require that the Board 
include members with background and expertise in the five other 
identified areas, including the economic, community or workforce 
development fields; internal controls; financial risk management; legal 
issues relating to commercial lending; and corporate governance. SBA 
believes that this requirement will ensure an appropriate level of 
diversity of experience on the Board.
    Another commenter wrote in opposition to the change described in 
paragraph (3) above. This commenter argued that requiring Board members 
to live or work in the CDC's Area of Operations is a new legal 
requirement that provides no benefit to the program and deprives CDCs 
of the assistance of individuals who own second homes in the State or 
temporarily reside outside the State for work or other reasons while 
retaining a strong connection to the State. However, as noted in the 
proposed rule, it has long been SBA's policy to require Board members 
to live or work in the CDC's Area of Operations (today, the minimum 
Area of Operations for each CDC is the State in which the CDC is 
incorporated and, therefore, it is more accurate to use the phrase 
``State of incorporation'' instead of ``Area of Operations'' in 
connection with this policy). This requirement to live or work in the 
CDC's State of incorporation furthers the local nature of the 504 Loan 
Program, obligates Board members to have more than a temporary or 
tenuous connection to the CDC's State of incorporation, and ensures 
that the CDC is under the control of individuals with a vested and 
demonstrable interest in the community in which the CDC is investing. 
In addition, members who live or work in the CDC's State of 
incorporation will have a better knowledge of the Area's economic 
environment. By reducing the required number of Board members from 9 to 
7, SBA is also making it less difficult for CDCs to find individuals to 
serve on the Board.
    SBA is adopting all of the changes to Sec.  120.823 as proposed. In 
addition, to conform Sec.  120.823(d)(4)(i)(B) to the change described 
in paragraph (1) above, SBA is reducing the minimum number of voting 
members who must be present to conduct business on the CDC's Executive 
Committee (if established) from five to four.

C. Section 120.824 Professional Management and Staff

1. Professional Services Contracts Between CDCs
    SBA proposed to amend Sec.  120.824 to permit a CDC to contract 
with another CDC for marketing, packaging, processing, closing, 
servicing, or liquidation functions under the following conditions:
    (1) A CDC may enter into a professional services contract with 
another CDC 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); \2\
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    \2\ 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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    (2) the contract between the CDCs 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. 
(The proposed rule also provided that a contract for management 
services with another CDC may be entered into only in accordance with 
redesignated Sec.  120.824(a)(1)(ii) and with the prior approval of the 
D/FA (or designee), in consultation with the D/OCRM (or designee));
    (3) 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;
    (4) a CDC may provide assistance to only one CDC per State;
    (5) 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;
    (6) 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). 
The CDCs are also prohibited from comingling any funds;
    (7) the CDCs and the contract must comply with the other 
requirements for professional services contracts set forth in the 
proposed Sec.  120.824(a) (which are now set forth in the final rule in 
Sec.  120.824(c));
    (8) a contract between CDCs may not include services for either 
independent loan reviews or management services (except rural CDCs 
could continue to contract for management services with another CDC as 
described in the current Sec.  120.824(a)(2)); and
    (9) affiliation between CDCs based on grounds other than identity 
of interest, including but not limited to, through ownership or common 
management under Sec.  121.103(c) and (e), respectively, would continue 
to be prohibited.
    SBA received a total of 63 comments on some or all of the above 
changes. Most expressed general support for the flexibility that the 
above changes would provide with respect to the contracts between CDCs, 
but nearly all expressed opposition to the following two changes: (A) 
The geographic restrictions on contracts between CDCs (paragraphs (3), 
(4), and (5) above), and (B) the prohibition against CDCs conducting 
independent loan reviews for each other (paragraph 8 above).
(A) Geographic Restrictions on Contracts Between CDCs
    SBA received 62 comments on the changes described in paragraphs 
(3), (4), and (5) above which place geographic limits on these 
contracts, with one commenter writing to generally support

[[Page 66290]]

the geographic restrictions and the remaining 61 commenters writing to 
oppose them. Nearly all of the opposing commenters argued that these 
contracts should be evaluated primarily on the quality of the CDC 
service provider, not on geography. They contended that permitting a 
CDC to contract with another CDC outside its SBA Region would allow a 
CDC to select from a larger and more competitive field of qualified 
providers and avoid concerns about sharing market and customer data 
with a potential competitor. Some also objected to applying this 
restriction to contracts currently in place, and state that SBA's 
concerns can be addressed through the current contract review process.
    In addition, four commenters suggested that a CDC should not be 
able to provide services to more than three other CDCs in its SBA 
Region (one of the commenters suggested that the limit should be two), 
arguing that this limit would prevent CDCs from essentially becoming 
regional through these agreements, and that it would ensure that the 
assisting CDC continues to focus on its primary area of operation. Two 
commenters stated that a CDC should be allowed to service another CDC 
only if the CDC has demonstrated its first responsibility to its 
primary market by making an average of 10 or more loans in its primary 
State during the previous 3 years.
    SBA has considered these comments and has decided to adopt the 
geographic restrictions on these contracts as proposed, with exceptions 
for liquidation services and independent loan reviews as described 
below. SBA's decision to not allow CDCs to contract outside their SBA 
Region or a contiguous State is based on its commitment to maintaining 
a balance among three factors: The local nature of the 504 Loan 
Program, SBA's interest in helping smaller CDCs obtain assistance from 
their larger counterparts when needed to function in the best interests 
of the 504 Loan Program, and SBA's current regulatory framework that 
allows CDCs to expand their Area of Operations only under certain 
prescribed conditions, e.g., Multi-State and Local Economic Area 
expansions under Sec.  120.835. SBA has long been concerned about CDCs 
using these contracts to circumvent the established expansion standards 
and to encroach into areas far beyond their established Area of 
Operations. In balancing these factors, SBA continues to conclude that 
CDCs should be able to contract with each other even if the arrangement 
gives rise to an affiliation based on identity of interest, but only 
under the conditions described above, including that the CDCs must be 
located within the same SBA Region or in a contiguous State. SBA also 
believes that the proposed geographic restrictions taken together--
including that CDCs entering into the contract must be located either 
in the same SBA Region or in a contiguous State, that a CDC may provide 
assistance to only one CDC per State, and that 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--will adequately protect 
against any one CDC dominating its SBA Region. SBA further expects that 
a CDC in need of assistance from another CDC will be motivated to 
contract only with those CDCs that have demonstrated their ability and 
capacity to perform effectively in their primary market.
    With respect to the comments that object to applying the geographic 
restrictions to any contract currently in place between CDCs, SBA 
begins by noting that current Sec.  120.820(a) requires CDCs to be 
independent (with exceptions for certain types of affiliations). To 
ensure that contracts between CDCs would not undermine the intent of 
this regulation, SBA has required since 2015 that contracts between 
CDCs be limited in time and scope and have a transition phase leading 
to contract termination. See SOP 50 10 5(H), Subpart A, Chapter 3, ] 
II.A.7.(e)(ii). (To provide more certainty with respect to the 
permitted duration for these contracts, SBA added a 5-year limit to the 
SOP in January 2018. See SOP 50 10 5(J), Subpart A, Chapter 3, ] 
II.A.8.d)(ii)). Any CDC that currently contracts with another CDC 
outside its SBA Region has, therefore, been on notice for several years 
that SBA policy prohibited its contract from continuing indefinitely. 
There are four CDCs that currently have contracts with five other CDCs 
outside their SBA Region. As stated in the proposed rule, these CDCs 
will be permitted to continue these contracts until the current term of 
the contract expires, giving them the opportunity to make the changes 
necessary to comply with the final rule.
    As indicated above, SBA is adopting an exception to the geographic 
restriction for contracts for liquidation services. (The second 
exception for independent loan reviews is discussed in paragraph (B) 
below.) SBA believes that it will be beneficial to the 504 Loan Program 
to allow a CDC to assist another CDC with liquidation services when 
needed, regardless of the location of the CDCs. Because liquidation 
services are provided at the final stage of a 504 loan, there is no 
risk of a CDC using a liquidation services contract as a means to 
expand its 504 operations into other SBA Regions. Accordingly, SBA is 
revising the rule to allow a CDC to contract with another CDC outside 
its SBA Region for liquidation services.
(B) Independent Loan Reviews
    SBA received a total of 54 comments on the prohibition in paragraph 
(8) against a CDC contracting with another CDC for services for 
independent loan reviews. One commenter supported this prohibition due 
to the potential conflict of interest problems that could arise, and 
the remaining 53 opposed the prohibition (except that one of these 
commenters argued that two CDCs should not be able to conduct reviews 
for each other). The opposing commenters observed that CDCs are 
currently allowed to perform these reviews internally if they use staff 
that are independent from the function being reviewed and, therefore, 
they argued that CDCs should be able to provide this service to each 
other. The commenters recognized that SBA would need to carefully 
monitor the contracts between CDCs and that CDCs would also need to 
carefully consider potential conflicts of interest. They argued that 
SBA would have the opportunity to evaluate the quality of these reviews 
when they are submitted with the CDC's Annual Report.
    Based on these comments, SBA has decided to allow a CDC to contract 
with another CDC for independent loan review services without any 
geographic restriction subject to the following two conditions. First, 
to avoid any possibility of a quid-pro-quo, the CDCs may not review 
each other's portfolios or exchange any other services, nor may they 
enter into any other arrangement with each other that could appear to 
bias the outcome or integrity of the independent loan review. Second, 
due to the potential conflicts of interest that may arise, the 
contracts between CDCs for independent loan reviews must be pre-
approved by the D/FA (or designee) in consultation with the D/OCRM (or 
designee).
2. Other Changes That Would Apply to All Professional Services 
Contracts
    SBA proposed the following changes to Sec.  120.824 that would 
apply to all professional services contracts (including professional 
services contracts between CDCs):
    (1) SBA's prior approval would be required for 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

[[Page 66291]]

and health benefits, for the CDC's staff. These contracts must provide 
that the CDC retains the final authority to hire and fire the CDC's 
employees;
    (2) Services for information technology and independent loan 
reviews would be added to the list of the types of contracts that CDCs 
may enter into without obtaining prior SBA approval (except, as 
discussed above, the proposed rule prohibited CDCs from contracting 
with another CDC for independent loan reviews);
    (3) SBA proposed to make the following clarifying and technical 
changes to Sec.  120.824:
    (a) Under the current Sec.  120.824(c) (to be redesignated in the 
final rule as Sec.  120.824(c)(2)(ii)), 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 
proposed to revise the standard under which the CDC procuring the 
services may terminate the contract to ``with or without cause'';
    (b) Under the current Sec.  120.824(d), the CDC must provide copies 
of these contracts to SBA for review annually. SBA proposed to revise 
this provision (to be redesignated in the final rule as Sec.  
120.824(c)(4)) 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 executed 
contract to SBA;
    (c) 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 proposed to 
revise this provision (to be redesignated in the final rule as Sec.  
120.824(c)(2)(i)) to state that ``the compensation under the contract 
is paid only by the CDC'';
    (d) Under 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 
proposed to revise this provision (to be redesignated as Sec.  
120.824(c)(2)(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;
    (e) Under the current Sec.  120.824(f) (to be redesignated in the 
final rule as Sec.  120.824(c)(3)), 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 proposed to replace the phrase ``Associate of a 
contractor'' with text that is consistent with the definition of 
Associate in Sec.  120.10: ``Neither the contractor nor any officer, 
director, 20 percent or more equity owner, or key employee of a 
contractor may be a voting or non-voting member of the CDC's Board.''
    SBA received no comments opposing these changes and is adopting the 
changes to Sec.  120.824 as proposed except that, as discussed above in 
SBA's response to the comments on the geographic limits on contracts 
between CDCs, the D/FA (or designee), in consultation with the D/OCRM 
(or designee), must pre-approve contracts between CDCs for independent 
loan reviews.
    In addition, SBA is reorganizing this section to make it simpler 
and clearer. Specifically, in the final rule, subsection (a) of 120.824 
now addresses the management requirements that apply to CDCs and under 
what circumstances a CDC may request a waiver of the requirement that 
the CDC directly employ the CDC manager and obtain management services 
through a contract; subsection (b) now addresses the functions that the 
professional staff of the CDC must be capable of performing; subsection 
(c) now addresses the requirements that apply when a CDC obtains 
services through a professional services contract; and subsection (d) 
now addresses the additional requirements that apply to professional 
services contracts between CDCs. The reorganization of this section is 
not intended to make any substantive changes to the content of the rule 
other than as described above in this section C.

D. Section 120.826 Basic Requirements for Operating a CDC

    SBA proposed to increase the dollar threshold that triggers an 
annual audit of the CDC's financial statements under Sec.  120.826 from 
$20 million to $30 million. Under the rule as proposed, for loan 
portfolio balances of less than $30 million, the CDC would be able to 
submit a financial statement that is reviewed by an independent 
certified public accountant in accordance with generally accepted 
accounting principles (GAAP) instead of an audited financial statement. 
There are currently 60 CDCs with a portfolio balance under $20 million 
and the increase to $30 million would add 19 CDCs to the number of CDCs 
that may submit reviewed financial statements, for a total of 79 CDCs 
that would save the difference in cost between an audited financial 
statement and a reviewed financial statement. SBA estimates the cost 
savings to be $15,000 annually for each CDC. As noted in the proposed 
rule, 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 received 62 comments on the proposed changes to Sec.  120.826, 
and all 62 comments supported the proposal but requested that SBA 
increase the amount that triggers the annual audit requirement to $50 
million instead of $30 million. SBA considered these comments but, due 
to the inherent risks of a larger portfolio and due to the fact that 
SBA is already raising the amount that triggers the audit by 50 
percent, SBA believes that it would not be prudent to raise the amount 
further. SBA is adopting the changes to Sec.  120.826 as proposed.

E. Section 120.835 Application To Expand an Area of Operations

    SBA proposed to amend paragraph (c) of Sec.  120.835 to offer the 
following alternative to establishing a Loan Committee in each State 
into which the CDC expands as a Multi-State CDC: 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 must 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 are permitted to 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 the CDC's State of 
incorporation, SBA proposed 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 allow two individuals who live or work in the 
additional State to be included on the CDC's Board of Directors when 
voting on a Project in that State. SBA also proposed to amend three 
other provisions to conform the rules to this amendment, including 
adding a reference about the alternative in Sec.  120.823(d)(4)(ii)(E), 
removing the reference to Sec.  120.839 in Sec.  120.823(d)(4)(ii)(E), 
and using the phrase ``live or work in the CDC's State of 
incorporation'' instead of ``live or

[[Page 66292]]

work in the Area of Operations of the State where the 504 project they 
are voting on is located''.
    SBA received a total of 57 comments on this proposed change. There 
were no opposing comments, though two commenters submitted differing 
points of view with respect to whether the two individuals added to the 
Loan Committee or Board should only be able to vote on Projects located 
in the additional State. One commenter requested that the two 
individuals be able to vote on all of the CDC's Projects, and the 
second commenter argued that the two members who represent the 
additional State on the CDC's Loan Committee or Board should be 
different persons than those serving on the Loan Committee or Board in 
the CDC's State of incorporation.
    The latter commenter's suggestion is consistent with SBA's intent 
in providing this alternative option and is the reason why SBA proposed 
to revise Sec.  120.823(d)(4)(ii)(E) to require that the Loan Committee 
consist only of members who live or work in the CDC's State of 
incorporation or in an area that would qualify as an LEA. The purpose 
behind this change was to give CDCs an alternative that would be less 
costly to creating a separate Loan Committee in the additional State, 
and not to expand the area from which a CDC could choose the members 
for its Board or Loan Committee in its State of incorporation.
    Based on the comments, SBA believes that it can be made clearer 
that the two individuals who are added to either the Board or the Loan 
Committee under the alternative option may vote only on Projects in the 
additional State and, accordingly, SBA is adding the following sentence 
at the end of Sec.  120.835(c)(2): ``These two members may vote only on 
Projects located in the additional State.''
    SBA is adopting the rule as proposed with this revision.

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

    SBA proposed to expand paragraph (a) of Sec.  120.839 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 received a total of 57 comments in support of this 
change. One commenter requested that SBA allow a CDC to make loans 
outside its Area of Operations based on a Third Party Lender's prior 
lending relationship with a business. However, what is important to SBA 
is that the CDC have the prior lending relationship with the business 
or its affiliates and, thus, SBA will not expand the change to allow 
CDCs to make loans outside their Area of Operations based on the prior 
relationship of a Third Party Lender. SBA is adopting the changes to 
Sec.  120.839 as proposed.

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

    SBA proposed 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 one percent of the original 
principal amount, of the PCLP Debenture after the loan is seasoned for 
10 years. However, SBA proposed that 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) or (j) of Sec.  120.847. In the latter case, 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 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. In paragraph (g), SBA also proposed to 
change the official to whom withdrawal requests should be forwarded 
from the Lead SBA Office to the D/OCRM (or designee).
    SBA received a total of 55 comments supporting the proposed changes 
to Sec.  120.847. There were no opposing comments. SBA is adopting the 
changes to Sec.  120.847 as proposed, except that, upon further 
consideration, SBA has decided to retain the Lead SBA Office as the 
office to which the PCLP CDC must forward requests for withdrawals.

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) determined that this 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 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 13771

    This final rule is an E.O. 13771 deregulatory action with an 
annualized savings of $273,515 and a net present value of $3,907,360 in 
savings, both in 2016 dollars.
    This rule is expected to produce $15,000 of savings for each of the 
19 CDCs that currently have 504 loan portfolio balances between $20 
million and $30 million and will no longer be required to provide 
audited financial statements. This estimate of savings is based on 
conversations with CDCs. In addition, SBA is decreasing the number of 
members that a CDC is required to appoint to its Board of Directors 
from nine to seven and reducing the amount that PCLP CDCs need to 
maintain in the Loan Loss Reserve Fund. While it is difficult to 
quantify the benefits of these changes, they are meant to provide more 
flexibility and options to CDCs.
    Any costs to CDCs due to changes in this rule are difficult to 
quantify but are likely to be insignificant.

Executive Order 13132

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

[[Page 66293]]

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

    SBA has determined that, while this final rule will not impose new 
reporting or recordkeeping requirements, some of the regulatory 
amendments require changes to SBA Form 1253 to clarify existing 
requirements, such as the type of contracts that CDCs must report to 
SBA, and to remove certain reporting requirements that are no longer 
applicable as a result of the rule changes. Accordingly, SBA Form 1253, 
Certified Development Company (CDC) Annual Report Guide (OMB Approval 
3245-0074), will be revised to clarify or add information that CDCs are 
required to submit with their Annual Report, including:
    (a) With respect to the information required to be submitted in the 
Operating Report (Tab 2A) related to the members of the CDC's Board of 
Directors and the Loan Committee, in the event that a Multi-State CDC 
chooses the option created under the new Sec.  120.835(c)(2), the form 
will be revised to inform CDCs to provide information on the two 
additional members who are appointed to the Board or to the Loan 
Committee, if established, to vote on Projects in the State into which 
the CDC expanded.
    (b) With respect to the information that the CDC is required to 
provide in the Operating Report (Tab 2C) related to contracts requiring 
SBA's prior written approval, the form currently instructs the CDC to 
submit a copy of all contracts for management and/or staff in place 
during the reporting period. The form currently identifies examples of 
the types of contracts subject to this requirement. It will be revised 
to add co-employment contracts (which SBA proposed to add in the 
proposed rule) and contracts for independent loan reviews between CDCs 
(which SBA has added to this final rule in response to comments 
received) to the list. However, as stated in the proposed rule, SBA 
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 a fully executed 
copy of any contract after obtaining SBA's prior approval. As a result, 
SBA is revising the instruction in the form to make it clear that CDCs 
would no longer be required to submit a copy of these contracts with 
the Annual Report if a copy of the current and executed contract was 
previously submitted to SBA. The CDC will 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 will also need to state to whom and on what 
date the contract was provided to SBA.
    In addition, the form will be changed to no longer require the CDC 
to provide a copy of other documents that SBA already has in its 
possession, including SBA's approval of each contract or management 
waiver, a copy of the Board's resolution approving the contract, or a 
copy of the Board's explanation for why it believes that it is in the 
best interest of the CDC to enter into the contract.
    (c) With respect to the information required to be submitted in the 
Operating Report (Tab 2F) related to the Independent Loan Review 
Package, as noted above, the final rule will allow a CDC to contract 
with another CDC to perform the independent loan review but only with 
SBA's prior written approval, and the form will be revised to reflect 
this change.
    (d) 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 final rule raises this threshold 
to $30 million and, therefore, 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 audited financial statements.
    SBA invited comments on the proposed changes to the underlying 
regulations that would impact Form 1253. SBA received five comments on 
Form 1253. The commenters requested that CDCs only be required to 
include in the Annual Report information related to Board minutes, 
financial statements, tax returns, and jobs and other economic 
development activity. This change would eliminate several items from 
the Annual Report, including information related to the Board of 
Directors, Executive Committee, Loan Committee, professional staff, 
contracts, affiliations, legal certifications, and compensation. The 
commenters argued that, with the changes planned in SBA's electronic 
records system, SBA will have ready access to the information currently 
provided with the Annual Report. However, SBA has concluded that all of 
the information that will be submitted with this form continues to be 
needed to support SBA's efforts to maintain quality control in the 504 
Loan Program.\3\
---------------------------------------------------------------------------

    \3\ Under the proposed rule, SBA gave notice that SBA Form 2233 
would be revised to change the office to which this form is 
submitted from the ``Lead SBA Office'' to the ``Office of Credit 
Risk Management''. SBA received no comments on this form. Form 2233 
will no longer need to be revised because the final rule will retain 
the Lead SBA Office as the office to which PCLP CDCs must submit 
requests for withdrawal from the Loan Loss Reserve Fund.
---------------------------------------------------------------------------

    SBA has determined that the changes needed for the form described 
above are non-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 final rulemaking, section 604 of the 
Regulatory Flexibility Act (RFA), 5 U.S.C. 601-612, requires the agency 
to ``prepare and make available for public comment a final regulatory 
flexibility analysis'' which will ``describe the impact of the final 
rule on small entities, significant issues raised by the public about 
the impact on small entities and the steps that the agency has taken to 
minimize the significant economic impact on small entities.'' Section 
605 of the RFA allows an agency to certify a rule in lieu of preparing 
an analysis, if the rule will not have a significant economic impact on 
a substantial number of small entities. Although the rulemaking will 
impact all 210 CDCs (all of which are small), SBA continues to believe 
the economic impact will not be significant. The final rule will 
streamline the operational and organizational requirements that CDCs 
must satisfy and reduce their costs.
    For example, under the final rule, the 19 CDCs that currently have 
504 loan portfolio balances between $20 million and $30 million will 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. This estimate is 
based on conversations with CDCs.
    In addition, SBA is reducing the regulatory requirements imposed on 
CDCs related to corporate governance. For example, SBA is decreasing 
the number of members that a CDC is required to appoint to its Board of 
Directors from nine to seven. This change will also make it easier for 
a CDC to meet the quorum requirements for conducting its business. In 
addition, SBA is: (1) Expanding the area in which

[[Page 66294]]

Board and Loan Committee members may work or live; (2) removing the 
limit on the number of members that may serve on the Board from the 
commercial lending fields; (3) allowing 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; (4) eliminating the 
requirement that CDCs establish a separate Loan Committee in each State 
into which the CDC expands as a Multi-State CDC; (5) expanding the 
criteria under which a CDC may make a 504 loan outside its Area of 
Operations; and (6) allowing a CDC to contract with another CDC to 
perform the required independent loan reviews under certain 
circumstances and with SBA's prior written approval.
    Another change 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 will be available to 
support the CDC's operations or to invest in other economic development 
activities without unduly increasing risk.
    In addition, SBA received one comment opposing the certification of 
the proposed rule because of the proposal to prohibit any person or 
entity from owning or controlling more than 10 percent of a for-profit 
CDC's voting stock. As discussed above, this final rule provides that 
an individual or entity will be limited to owning no more than 25 
percent of a CDC's stock. With this change, no individual or entity 
will be required to divest any stock because no stockholder of any for-
profit CDC currently owns more than 25 percent of the CDC's stock and, 
thus, SBA concludes that the 25 percent limit will not have a 
significant economic impact on any small entities. Similarly, this 
final rule applies the 25 percent limit to membership interests in a 
non-profit CDC. Applying the 25 percent limit to non-profit CDCs would 
not have a significant economic impact on any small entity because a 
membership interest in a CDC has no economic value to the member. A 
membership interest in a non-profit CDC does not entitle the member to 
receive any distribution of income or assets from the CDC.
    Except for the change in the audit requirements discussed above, 
the total costs to CDCs due to the other changes in this rule are 
difficult to quantify. However, based on the nature of the changes, SBA 
believes that CDCs are likely to experience cost reductions if there is 
any cost impact at all. SBA believes that this final rule is the 
Agency's best available means for facilitating American job 
preservation and creation by removing unnecessary regulatory 
requirements. The preamble sections above provide additional detailed 
explanations regarding how and why this final rule will reduce 
regulatory burdens and responsibly increase program participation 
flexibility and discusses the high level of public support for these 
changes.
    For these reasons, SBA has determined that the final rule will not 
have a significant economic impact on a substantial number of small 
entities and certifies this rule as such.

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 is amending 13 CFR part 
120 as follows:

PART 120--BUSINESS LOANS

0
1. The authority for 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); Pub. L. 111-5, 123 Stat. 115, Pub. L. 111-240, 124 Stat. 2504.


0
2. Amend Sec.  120.816 by adding paragraph (d) to read as follows:


Sec.  120.816   CDC non-profit status and good standing.

* * * * *
    (d) If a non-profit CDC has a membership and the members are 
responsible for electing or appointing voting directors to the CDC's 
Board of Directors, no person or entity can control more than 25 
percent of the CDC's voting membership.

0
3. 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 25 percent of 
a for-profit CDC's stock.

0
4. Amend Sec.  120.823 by:
0
a. Revising paragraph (a);
0
b. Removing paragraph (c)(4) and redesignating paragraph (c)(5) as 
paragraph (c)(4);
0
c. In paragraph (d)(4)(i)(B), by removing ``five'' and adding ``four'' 
in its place;
0
d. In paragraph (d)(4)(ii)(B), by removing ``five (5)'' and adding 
``four'' in its place; and
0
e. Revising paragraph (d)(4)(ii)(E).
    The revisions read as follows:


Sec.  120.823   CDC Board of Directors.

    (a) The CDC, whether for-profit or non-profit, 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) * * *
    (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 Sec.  120.835(c)(1) or (2) when voting on that 
Project.
* * * * *

0
5. Revise Sec.  120.824 to read as follows:


Sec.  120.824   Professional management and staff, and contracts for 
services.

    (a) Management. A CDC must have full-time professional management, 
including an executive director or the equivalent (CDC manager) to 
manage daily operations. This requirement is met if the CDC has at 
least one salaried professional employee that is employed directly (not 
a contractor or an officer, director, 20 percent 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 obtain, under a 
written contract, management services provided by a qualified 
individual under the following circumstances:
    (1) The CDC must submit a request for the D/FA (or designee) to 
approve, in consultation with the D/OCRM (or designee), a waiver of the 
requirement

[[Page 66295]]

that the manager be employed directly by the CDC. In its request, the 
CDC must demonstrate that:
    (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 submitting the request for the 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 CDC must submit a request for the D/FA (or designee), in 
consultation with the D/OCRM (or designee), to pre-approve the contract 
for management services. This contract must comply with paragraphs 
(c)(2) through (4) and, if applicable, paragraph (d) of this section.
    (b) Professional staff. The CDC must 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.
    (c) Professional services contracts. Through a written contract 
with qualified individuals or entities, a CDC may obtain services for 
marketing, packaging, processing, closing, servicing, or liquidation 
functions, or for other services (e.g., legal, accounting, information 
technology, independent loan reviews, and payroll and employee 
benefits), provided that:
    (1) The contract must be pre-approved by the D/FA (or designee), 
subject to the following exceptions:
    (i) CDCs may contract for legal, accounting, and information 
technology services without SBA approval, except for legal services in 
connection with loan liquidation or litigation.
    (ii) CDCs may contract for independent loan review services with 
non-CDC entities without SBA approval. Contracts between CDCs for 
independent loan reviews must be pre-approved by SBA in accordance with 
paragraph (d) of this section.
    (2) If the contract requires SBA's prior approval under paragraph 
(c)(1) of this section, the CDC's Board must explain to SBA why it is 
in the best interest of the CDC to obtain services through a contract 
and must demonstrate that:
    (i) The compensation under the contract is paid only by the CDC 
obtaining the services, 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 or self-
dealing on the part of any of the CDC's officers, management, or staff, 
including members of the Board and Loan Committee, in the negotiation, 
approval or implementation of the contract.
    (3) Neither the contractor nor any officer, director, 20 percent or 
more equity owner, or key employee of a contractor may be a voting or 
non-voting member of the CDC's Board.
    (4) The CDC procuring the services must provide a copy of all 
executed contracts requiring SBA prior approval 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.
    (5) 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.
    (6) If the contract is between CDCs, the CDCs and the contract must 
also comply with paragraph (d) of this section.
    (d) Professional Services Contracts between CDCs. Notwithstanding 
the prohibition in 13 CFR 120.820(d) against a CDC affiliating with 
another CDC, a CDC may obtain services through a written contract with 
another CDC for managing, marketing, packaging, processing, closing, 
servicing, independent loan review, 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. For management services, a CDC 
may contract with another CDC only in accordance with paragraph 
(a)(1)(ii) of this section.
    (2) Except for contracts for liquidation services and independent 
loan reviews:
    (i) 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 provision, the location of a 
CDC is the CDC's State of incorporation;
    (ii) A CDC may provide assistance to only one CDC per State; and
    (iii) No CDC may provide assistance to another CDC in its State of 
incorporation or in any State in which it has Multi-State authority.
    (3) 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.
    (4) With respect to contracts for independent loan reviews, CDCs 
may not review each other's portfolios or exchange any other services, 
nor may they enter into any other arrangement with each other that 
could appear to bias the outcome or integrity of the independent loan 
review.
    (5) The contract must satisfy the requirements set forth in 
paragraphs (c)(2) through (4) of this section.


Sec.  120.826   [Amended]

0
6. Amend Sec.  120.826 in paragraph (c) by:
0
a. Removing the term ``$20 million'' wherever it appears and adding the 
term ``$30 million'' in its place; and
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
7. Amend Sec.  120.835 by:
0
a. Adding a subject heading to paragraph (c);
0
b. Revising the last sentence of paragraph (c); and
0
c. Adding paragraphs (c)(1) and (2).
    The additions read as follows:


Sec.  120.835  January 3, 2020 Application to expand an Area of 
Operations.

* * * * *
    (c) Multi-State expansion. * * * 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:

[[Page 66296]]

    (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. These two members may vote only on 
Projects located in the additional State.


Sec.  120.839   [Amended]

0
8. Amend Sec.  120.839 by adding the words ``or its affiliate(s)'' 
after ``business'' in paragraph (a).

0
9. Amend Sec.  120.847 by revising the third and fourth sentences in 
paragraph (b) and adding paragraphs (b)(1) and (2) to read as follows:


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

* * * * *
    (b) * * * 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: November 25, 2019.
Christopher M. Pilkerton,
Acting Administrator.
[FR Doc. 2019-26042 Filed 12-3-19; 8:45 am]
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