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

 
CONTENT
Federal Register, Volume 84 Issue 233 (Wednesday, December 4, 2019)
[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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This section of the FEDERAL REGISTER contains regulatory documents
having general applicability and legal effect, most of which are keyed
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under 50 titles pursuant to 44 U.S.C. 1510.
The Code of Federal Regulations is sold by the Superintendent of Documents.
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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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