[Federal Register: July 11, 2000 (Volume 65, Number 133)]
[Rules and Regulations]               
[Page 42624-42634]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11jy00-6]                         

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SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

 
Business Loan Program

AGENCY: Small Business Administration (SBA).

ACTION: Final rule.

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SUMMARY: In this Final Rule a Certified Development Company (CDC) will 
be permitted to apply to have an area of operations that goes beyond 
its state of incorporation, and beyond a local economic area in an 
adjacent state, into a contiguous state to its state of incorporation. 
This amendment includes specific additional membership, loan committee, 
and board requirements. Also in the Final Rule, for counties with a 
population of 100,000 or more that have an existing CDC that is 
adequately serving the county, an application from a new or expanding 
CDC will be permitted for that same county if the existing CDC has no 
objection. In addition, the Final Rule allows a CDC to contract out 
management and staff under specified circumstances. The changes 
implemented by this Final Rule seek to enhance competition and improve 
the effectiveness of the CDC program.

DATES: Effective: August 10, 2000.

[[Page 42625]]


FOR FURTHER INFORMATION CONTACT: Gail Hepler, 202-205-6490.

SUPPLEMENTARY INFORMATION:

1. CDC Area of Operations

    The proposed amendments to Sec. 120.802, Sec. 120.810, 
Sec. 120.822(b), Sec. 120.823(b), Sec. 120.835, and Sec. 120.837 in the 
Proposed Rule relate to the issue of where a CDC may operate. Public 
Law 85-699 published August 21, 1958 enacted Title V of the Small 
Business Investment Act of 1958 (``Act'')--Loans to State and Local 
Development Companies (``Pub. L. 85-699''). In the Proposed Rule, SBA 
set forth its understanding that Pub. L. 85-699 authorized SBA to 
assist development companies that are (1) principally composed of and 
controlled by persons residing or doing business in that community and 
(2) formed for the purpose of furthering economic development in the 
community. The Proposed Rule also noted that when the Sec. 503 
Development Company Loan Program was authorized in 1980, its purpose 
was to provide financing through corporations ``formed by local 
citizens whose primary purpose is to improve their community's 
economy.'' (Emphasis added. Legislative History, Pub. L. 100-590, p. 
22.) Aware that this concept of local citizens working to develop and 
improve their local economy is a fundamental aspect of SBA's 
Development Company Loan Program (``504 Program''), SBA attempted in 
the Proposed Rule to balance this fundamental principle of local 
economic development with SBA's goal of increasing the availability of 
504 lending to small businesses across the country. The Small Business 
Investment Act, section 504, authorized the private sale of CDC 
debentures to fund CDC loans. The program is now traditionally referred 
to as the 504 program.

a. Adequately Served Counties

    In the Proposed Rule, SBA proposed to allow an applicant CDC 
(Sec. 120.810) or existing CDC (Sec. 120.835) to apply to operate in a 
county within its State of incorporation even if that county is 
currently being ``adequately served'' (as defined by SBA) by another 
CDC, if that county has a population of 100,000 or more and only one 
CDC incorporated in that State includes that county in its Area of 
Operations. SBA stated in the Proposed Rule that, ``this will give 
small businesses more choices.'' In this Final Rule, SBA retains the 
conditions set forth in the Proposed Rule and, for the reasons set 
forth below, adds the condition that the CDC that includes the county 
in its Area of Operations submit a statement of no objection.
    Several commentors supported competition among CDCs. A typical 
supporting comment read: ``Because we are focused on the end customer 
(i.e., the citizens of our member communities) we believe he will only 
be aided by a higher level of competition--whether because it makes us 
sharper and more innovative, or because there is greater exposure for 
the 504 program, resulting in more loans made to more borrowers.'' A 
few commentors noted that competition in overlapping Areas of 
Operations has already been successful in their areas: ``Competition is 
good for the 504 Loan Program * * * competition stimulated activity, 
service to the community and enhancement of the 504 Loan Program.''
    On the other hand, more than three-quarters of the commentors were 
opposed to the Proposed Rule for several reasons. Many commentors were 
concerned that competition in the more densely populated counties of a 
CDC's Area of Operations would affect the CDC's ability to do projects 
in more rural counties. One commentor stated: ``I am concerned that 
this proposed regulation would have the opposite effect of that 
intended. Allowing CDCs to form in counties that are already being 
adequately serviced would encourage participation in those areas that 
offer a high probability of success, while leaving the `Rural,' `Less-
Growth' areas unattended. In fact, an existing CDC may be potentially 
forced to reduce its focus from the rural areas of its territory, to 
those areas attractive to a start-up CDC * * *. The National 
Association of Development Companies (NADCO), the CDC industry trade 
association, commented that ``we are deeply concerned that the Proposed 
Rule will foster a high level of CDC competition in areas of high small 
business density, to the detriment of rural areas where it might be 
difficult to make and service 504 loans.''
    Another concern expressed by several commentors was that increased 
competition might burden or reduce a small CDC's cash flow thus hurting 
its ability to cover its expenses related to 504 loans. One commentor 
stated: ``It takes a population base of several hundred thousand to 
produce sufficient revenue for a CDC to be self-sustaining. What is 
being proposed will ultimately weaken existing CDCs and result in 
cutting services and assistance to (small businesses) as CDCs try to 
cut expenses due to less revenue.'' Several commenters stated that many 
CDCs depend on the cashflow of the 504 loan program to subsidize other 
local economic activities, such as participation in the microloan 
program or the provision of a revolving line of credit program. These 
commentors indicated their beliefs that a CDC approved to expand into 
an adequately served county would not reinvest in the local community. 
``Our concern is that another CDC operating in our community would not 
be reinvesting in our community, but taking the fee income generated 
and spending it on marketing and salaries instead of the businesses 
that are in [the county].''
    Many commentors used the term ``cherry-picking'' to describe the 
effect of allowing other CDCs to compete in the more lucrative markets: 
``Market forces will lead the larger, more urban CDCs to `cherry pick' 
the more lucrative projects from larger companies who require a lower 
level of service and assistance. Organizations such as ours use the 
returns from the occasional large debentures to subsidize the higher 
costs of providing service to small, needier borrowers * * * It would 
be extremely damaging to the cause of competition in the 504 loan 
program if the large CDCs were ever able to invade the territory of 
performing small CDCs. Many of the small rural performing CDCs just 
barely bring in enough revenue to support our small staffs, and a 
`cherry picking' statewide [CDC] would eventually be able to rob many 
of us of the ability to operate. The result would be to decrease 
competition rather than an increase.''
    The comments made it clear to SBA that concerns that competition 
will hurt a CDC's ability to promote economic development in less 
densely populated counties should be further considered. The comments 
indicated that many CDCs subsidize their rural economic development 
efforts with the servicing fees generated by 504 loans made in the more 
densely populated counties. The comments also indicated that this 
subsidization would be frustrated by the loss of revenue caused by 
increased competition in the more densely populated counties. In 
addition, CDCs would be inspired to ``cherry pick'' or seek counties 
with high small business density to gain more fee income. The result 
would likely be a general shift of CDC resources and focus on high-
density counties at the expense of more rural counties.
    SBA remains committed to the concept of expanding local economic 
development through increased competition in the 504 program. The 
commentors raised legitimate concerns but did not provide enough 
evidence or other support for SBA to totally accept their assessment of 
the negative impact competition would have on CDC operations. However, 
the negative predictions by the commentors raised

[[Page 42626]]

additional issues that require further consideration as SBA seeks to 
increase competition in the 504 program. For example, it is a 
reasonable assertion that the drain in resources and possible loss of 
loan volume caused by competition in counties with high small business 
density could hinder a CDC's efforts to serve rural counties. The 
question is whether, and to what degree, this really will happen. SBA 
believes the best way to respect the concerns of the commentors while 
remaining committed to increasing competition is to approach increasing 
competition in two phases. The first phase will be implemented by this 
Final Rule. By this Rule, SBA will adopt a policy allowing an applicant 
or expanding CDC to apply to serve a county with a population of 
100,000 or more if:
    <bullet> The county is part of the Area of Operations of only one 
CDC;
    <bullet> The county has not become part of another CDC's Area of 
Operations within the past 24 months;
    <bullet> The applicant CDC is incorporated in the State where the 
county is located; and
    <bullet> The CDC that includes the county in its Area of Operations 
submits a statement of no objection.
    SBA added in this Final Rule the requirement that the CDC already 
serving the county submit a statement of no objection so that such CDC 
could oppose competition in the area if such competition would cause a 
negative impact on the original CDC's economic development efforts. SBA 
added this requirement because we believe there is merit to the 
concerns that competition may, in some circumstances, hinder the 
original CDC's economic development efforts. So, at this time, SBA will 
give CDCs the opportunity to draw on their knowledge of their markets 
and operations to assess whether competition will hurt their economic 
development efforts. It has been SBA's experience that a CDC will not 
object to the introduction of competition when it will help serve the 
local community in ways that the existing CDC is not able to do and 
will not be counterproductive to the CDC's ability to meet its local 
economic objectives.
    The second step that SBA will take to increase competition in the 
504 program will be its publication of an Advanced Notice of Proposed 
Rulemaking (``ANPR'') specifically soliciting comments on some of the 
concerns regarding competition raised in response to the Proposed Rule. 
This ANPR will be published shortly and will give SBA the opportunity 
to further consider the issue of competition as well as other 504 
program issues.

b. Multi-State Expansions

    When Title V of the Small Business Investment Act of 1958--Loans to 
State and Local Development Companies--was enacted by Public Law 85-699 
on August 21, 1958, it defined a Development Company as ``an enterprise 
* * * formed for the purpose of furthering economic development of its 
community and environs, and with authority to promote and assist the 
growth and development of small-business concerns in the areas covered 
by their operations * * * A local development company is a corporation 
chartered under any applicable State corporation law to operate in a 
specified area within a State * * * A local development company shall 
be principally composed of and controlled by persons residing or doing 
business in the locality * * *'' (13 CFR part 108, section 2, as of 
January 1, 1967).
    When the Sec. 503 Development Company Loan Program was authorized 
in 1980, its purpose was to provide financing through corporations 
``formed by local citizens whose primary purpose is to improve their 
community's economy. They assist in the planned economic growth of the 
community by promoting and assisting the development of small business 
concerns in their area.'' (Legislative History, Pub. L. 100-590, p. 22) 
It continues, ``to qualify for this program, a development company must 
be chartered in the State where it intends to operate * * *'' (Id. at 
23)).
    Since the inception of the 504 Program, no CDC has been certified 
to operate permanently in more than one State, except for a relatively 
few circumstances when the CDC's operations crossed state lines, but 
only to the extent that the area was determined to be a Local Economic 
Area. Regulations published on August 10, 1982, permitted a CDC to 
operate within two States if ``(i) a State line bisects a city, in 
which case the 503 company may operate city-wide or (ii) the 503 
company has obtained prior written approval to operate within a 
contiguous economic area, as determined by SBA, which crosses a State 
line.'' Since this regulation was published, of the approximately 270 
active CDCs, only nine have applied for and been approved by SBA to 
have their permanent Areas of Operations cross State lines to include a 
contiguous bi-sected local economic area. Currently, the permanent Area 
of Operations of all the other CDCs are within their State of 
incorporation.
    There still remain substantial numbers of under-served counties. 
And, a few CDCs proposed to expand their Areas of Operations beyond 
their States of incorporation and beyond contiguous bi-sected local 
economic areas to include some of these under-served counties. To 
address these issues, and to achieve the goal of stimulating 504 
lending activity in underserved areas, SBA proposed to permit out-of-
state CDCs (Multi-State CDCs) to apply to cover such underserved areas. 
At the same time, SBA designed the Proposed Rule to ensure that Multi-
State CDCs continue the 504 Program's statutory intent that local 
citizens responsible for assuring that the program contribute to the 
local economic development in their communities.
    The many comments on this part of the Proposed Rule generally fall 
into three categories: (1) Those opposed to Multi-State CDCs under any 
circumstances; (2) those favoring Multi-State CDCs, but critical of the 
proposed organizational requirements; and (3) those supporting the 
strict controls SBA proposed on Multi-State CDCs which are designed to 
continue the emphasis on local involvement and influence in the 
economic development of each State. Approximately one-quarter of the 
comments were in the second category with the large majority of the 
comments closely divided between the first and third categories.
    Commentors in the first category did not support the concept of 
Multi-State CDCs contained in the Proposed Rule. These commentors 
strongly disagreed with allowing CDCs to cross state lines to serve 
underserved counties. Representative comments include: ``I cannot see 
how permanent expansion beyond State borders * * * can conceivably 
result in increased local involvement * * * It seems contra-intuitive 
to me * * * '' and ``Creating multi-state CDCs and removing the 
territorial boundaries may in the short-run bolster the program's 
production numbers, but ultimately the overall quality and integrity of 
the program will suffer.'' Many of these commentors believed that the 
local citizens helping their local economy principle would be violated. 
One commentor stated, ``* * * the 504 program is grounded in federal 
legislation which mandates a strong role for local community 
involvement in the loan making process * * * If non-local and out of 
state CDCs have the ability to make and process loans, I believe you 
will lose the closeness and community involvement and you eventually 
will end up with a production line lending program, which, I believe, 
is contrary to the program's intent.'' Other commentors believe that 
large CDCs would develop and drive many small

[[Page 42627]]

CDCs out of business: ``* * * the growth of large CDCs will ultimately 
prove the death knell of smaller CDCs that know their local areas well 
but do not have skills or capacity to overcome the relationships large 
CDCs can build with lenders.'' (Emphasis in the original.) SBA 
understands the concerns but, at this time, believes that the increased 
program access for small businesses, that would result from allowing 
out-of-state CDCs justifies allowing such expansions. However, SBA will 
closely monitor the effect this rule has on smaller CDCs and will 
propose additional appropriate regulatory changes, if necessary.
    The second group of commentors favored allowing CDCs to cover 
under-served counties outside of their States of incorporation but 
believed the proposed conditions were too restrictive. One commentor 
stated: ``Your proposal to restrict the use of funds earned by a CDC to 
the area in which they were realized is impractical and will only make 
expansions impossible * * * The funds of a company are budgeted where 
they are needed to produce the most product and generate income.'' Most 
of these comments were centered on the proposed membership and Board 
requirements. A representative comment is the following: ``We suggest * 
* * the membership requirement be modified to reflect a total 
membership proportional with the CDC's population served in each of its 
areas of operations.'' Another commentor stated that it opposed the 
requirement for a ``CDC to expand its Board of Directors substantially 
if the CDC is authorized to expand into a limited number of counties in 
a neighboring state.''
    SBA seriously considered requiring proportional representation for 
both CDC membership and Board membership but ultimately reasoned that a 
Multi-State CDC should meet the same minimum local presence 
requirements in each State as any other CDC incorporated in that State. 
The current Board and membership requirements in each State are minimum 
requirements for all CDCs in the State irrespective of the size of 
their Area of Operations. Thus, adopting a ``proportional'' standard 
for Multi-State CDCs would mean that a Multi-State CDC with the minimum 
number of members would need fewer members in the State to satisfy SBA 
requirements than a new CDC applying to cover the same area in that 
same State. To avoid these kinds of outcomes, SBA concluded that a 
Multi-State CDC should be required to meet the same membership and 
Board requirements a new CDC would need to meet if it applied to cover 
the under-served county or counties in the State.
    In considering these comments, though, SBA has reconsidered the 
requirement for equal representation on the Board for each state in 
which the CDC is approved to operate by SBA. A Multi-State CDC must 
meet the minimum requirement of having a Board of Directors comprised 
of at least three of the four membership groups (government 
organizations responsible for economic development in the Area of 
Operations and acceptable to SBA; financial institutions that provide 
commercial long-term fixed asset financing in the Area of Operations; 
community organizations dedicated to economic development in the Area 
of Operations; and businesses in the Area of Operations) for each State 
in which it operates. However, the Final Rule will not require that the 
Board composition also be equally divided by the number of States in 
which the Multi-State CDC operates. SBA was persuaded that maintaining 
equal representation on the Board for each state could be impractical 
and overly burdensome as Directors' vacancies were created as a result 
of resignations or other reasons.
    Commentors in this group also criticized other restrictions on 
Multi-State CDCs found in the Proposed Rule. A representative comment 
was the following: ``(The commentor) disagrees with the proposed 
regulation of not counting Multi-State CDC loan production when SBA is 
considering either a new CDC certification or an expansion by an 
existing CDC [incorporated in the state]. In order to prepare for 
production in a new market, a Multi-State CDC would be required to make 
a substantial commitment of personnel and capital. Allowing another CDC 
to be approved while a Multi-State CDC is developing a new territory 
would serve as a deterrent for expansion of services in under-served 
areas across state lines.'' SBA considered these comments and was 
persuaded that if SBA required the same membership, Board membership, 
and financial investment that it requires of a CDC incorporated in the 
state, then the Multi-State CDC should receive the same protection of 
its area as any CDC incorporated in the State. In the final rule SBA 
has modified the Proposed Rule to treat Multi-State CDCs the same as 
other CDCs in regards to counting loans to determine whether an area is 
adequately served and also to protect the area from expansion by 
another applicant CDC for a period of twenty-four months.
    Commentors in the last category were generally opposed conceptually 
to Multi-State expansions but also recognized the failure of CDCs 
incorporated in the States where the under-served counties were located 
to provide adequate access to the 504 Program in these under-served 
areas. One commentor stated: ``There are a few cases where entire 
States are substantially under-served by 504. It is my opinion that in 
these States local, regional and statewide initiatives have failed to 
invest sufficient resources needed to insure the operation of a 
successful program. This is not the responsibility of SBA nor is it 
SBA's fault.'' While reluctant to accept the concept of Multi-State 
CDCs, they support the organizational restrictions in the Proposed 
Rule. A commentor stated that ``Overall, I believe the Agency has done 
an excellent job on the proposed rules for multi-state CDCs, and if 
anything, did not go far enough.'' Another commented: ``If it's 
determined that a multi-state CDC is a necessity * * * the safeguards 
in the Proposed Rule are carefully drawn and we would support them.'' 
Another commentor agreed with SBA's requirement that a Multi-State CDC 
``must abide by the same organizational rules, membership requirements, 
Board of Directors makeup, and uses of income. A CDC cannot truly serve 
an area of operations remote from the territory without local 
representation.'' Another expressed his concerns as follows: ``Our 
experience regarding multi-state CDCs demonstrates a need for better 
accountability, which could occur through local memberships, directors 
and loan review committees.''
    Another set of comments in this category suggested a modification 
to the Proposed Regulations by recommending that the under-served 
counties that the Multi-State CDC could apply for had to be in a state 
that was contiguous to the Multi-State CDC's State of incorporation. 
The following are examples of comments that favored the addition of the 
concept of ``contiguous'' to the Area of Operations covered by Multi-
State CDCs. One stated, ``I would strongly encourage you to add 
`contiguous' to any application being considered for expansion * * * I 
think to remove contiguous totally takes our economic development 
identity, that is unique to the 504 program, and throws it in the 
trash. Any CDC that applies to cross state lines * * * in a non-
contiguous basis, in almost every instance, is not concerned with 
economic development, they are concerned with money.'' Another stated, 
``CDCs need to operate in a contiguous area * * * Each market area

[[Page 42628]]

requires a CDC to develop an understanding of the types of businesses, 
commercial lenders, etc. in that area. If a CDC's area is not 
contiguous then the CDC will try to standardize their lending process 
for all loans in all types of lending environments.''
    SBA was persuaded by the rationale expressed in these comments and 
has decided to add to the Final Rule the requirement that any Multi-
State expansion be into a ``contiguous'' state in order to further 
ensure the local focus. The change is also based, in part, on SBA's 
decision not to require Multi-State CDCs to have an equal number of 
Board Members in each state in which it operates. As a result of this 
change, it will now be possible for a Multi-State CDC to have a 
majority of Board Members from its State of incorporation control the 
out-of-state activities of the CDC. SBA believes this change makes it 
more important for SBA to monitor carefully how Multi-State CDC local 
activities are shaped by local members. Given this concern, SBA reasons 
that limiting Multi-State CDC expansions to states contiguous to its 
State of incorporation will serve several goals. First, the temporary 
CDC expansions discussed in the Proposed Rule that engendered the 
Multi-State CDC concept were all into contiguous states to the 
expanding CDC's State of incorporation. Second, it will limit the 
number of expansions, thus making it more likely that SBA will be able 
to carefully monitor all Multi-State CDC expansions. Third, the closer 
physical proximity of the home office to the out-of-state operations 
will make it more likely that members will have some familiarity with 
the markets in each state covered by the CDC and will participate in 
scheduled meetings, thus facilitating the development of local 
strategies appropriate for each community the CDC covers. This will 
help ensure that corporate policy does not favor the CDC's Area of 
Operations in its State of incorporation over the Multi-State areas in 
the contiguous states. Thus, when the Executive Director or full Board 
vote on matters, their understanding of all markets the CDC covers will 
be stronger as a result.
    However, in order to give more specialized consideration to the 
issue of whether CDCs should be allowed to expand into non-contiguous 
states, SBA will include questions related to this topic in the ANPR 
that it intends to publish shortly. SBA also intends to use the ANPR 
process to solicit opinions regarding whether CDCs that are approved to 
operate across state lines as Multi-State CDCs should then also be 
eligible to expand into contiguous local economic development areas 
under the regulations regarding those expansions.

c. Other

    SBA initially proposed to limit the eligibility of counties to be 
included in an applicant CDC's or expanding CDC's Area of Operations to 
counties that had not become part of an Area of Operations of another 
CDC within the last 24 months. This proposed regulation was designed by 
SBA to permit a CDC to benefit from the upfront costs of establishing 
itself in a county. All comments were in favor of the new restriction. 
However, a few of the comments suggested that the timeframe of the 
restriction should be increased to 36 months. A representative comment 
states: ``After a new or expanding CDC is allowed to enter a county, 
the proposed regulation provides that another application will not be 
approved for 2 years. In our opinion, a CDC given a new county should 
be allowed 3 years before another CDC is allowed to operate in the 
county. The proposed 2 year period is insufficient. Generally, it takes 
18 to 24 months just to establish the 504 program in a new market.'' 
SBA considered these comments but was not persuaded that the 24-month 
timeframe, which did not exist as a regulation previously, is not 
adequate.
    SBA received several comments on SBA's Proposed Regulation that 
deleted the timeframe for the AA/FA to make his or her final decision 
on applications for a new CDC or an existing CDC to expand its Area of 
Operations requesting that the 504 Program retain a specific for such 
decisions. SBA understands the desire to have an identified timeframe 
and intends to use reasonable efforts to issue timely decisions. 
However, SBA anticipates that the Final Rule will significantly 
increase the volume and complexity of the applications and may involve 
many new policy considerations. Given these factors and SBA's limited 
staff, SBA believes that establishing a specific timeframe would not be 
feasible or desirable.

2. CDC Organization and Operational Requirements

    The proposed amendments to Sec. 120.820, Sec. 120.822, 
Sec. 120.823, Sec. 120.824, and Sec. 120.825 in the Proposed Rule 
relate to CDC organization and operational requirements. SBA received 
many comments and suggestions on the proposed changes covering CDC 
membership, Boards of Directors, and professional management and staff.
    In this Final Rule SBA adopts the policies concerning a CDC's Board 
of Directors as set forth in the Proposed Rule, with one modification. 
In light of the comments received on the Proposed Rule and several 
other factors, as discussed below, SBA has decided to amend the 
Proposed Rule to allow a CDC Manager to serve on its Board of 
Directors.
    In the Proposed Rule, SBA prohibited all CDC staff, including the 
CDC Manager, from serving on the CDC's Board. SBA proposed this because 
we were concerned about the apparent possible loss of Board objectivity 
and independence if a Board were comprised of a number of CDC 
employees. SBA was concerned that a Board comprised of such members 
would lack the detached objectivity necessary to evaluate properly the 
performance of the CDC. However, as addressed below, SBA has amended 
the Final Rule to allow the CDC Manager, as the only CDC staff member, 
to participate as a Board Member. SBA believes that this approach will 
allow us to account for the concerns expressed by commentors while not 
impacting a Board's ability to operate independently.
    In response to the Proposed Rule, SBA received several comments 
supporting the prohibition against CDC staff and management serving on 
its Board. However, more than two-thirds of the comments indicated that 
requiring CDCs to remove CDC Managers from their Boards would disrupt 
unnecessarily CDC operations. Commenters stated that CDC Managers 
typically manage the delivery of many small business assistance 
programs, including the 504 loan program, making it impractical, and 
therefore disruptive, to prohibit a CDC Manager from serving on a Board 
which oversees the full compliment of a CDC's economic development 
programs. SBA is persuaded by these comments and now better understands 
how disruptive it could be to prohibit a CDC Manager from serving on 
the CDC's Board.
    In addition, the comments suggested that allowing only one 
individual employed by the CDC, the CDC Manager, to serve on the Board 
would not affect a Board's objectivity and independence. SBA now agrees 
with this position. Currently, for each Board vote, SBA regulations 
require a quorum of 5 Directors. If only one of those Directors is an 
employee of the CDC, then it is unlikely that a Board's objectivity and 
independence would be compromised. The authority of all the other 
Directors to vote on, and their responsibility to monitor, CDC

[[Page 42629]]

operations will help assure that each Board decision is independent and 
objective.
    SBA also notes that there are other protections in place that will 
help assure independent action by the Board even when a CDC Manager 
serves on it. First, each Board Member has a general fiduciary duty of 
care and good faith to the CDC. This duty applies to the CDC Manager if 
the Manager sits on the Board. Secondly, with the Final Rule SBA 
requires that each Board have a member, other than the CDC Manager, who 
has commercial loan experience. This will assure that the Directors who 
are not employees of the CDC will have the requisite expertise to 
objectively and independently evaluate loan decisions. Thirdly, with 
this Final Rule SBA prohibits a Board Member from being a contractor 
with the CDC. SBA has encountered situations where CDC Managers who 
serve as Directors have recommended that the CDC contract with them for 
certain services. SBA believes that such a recommendation could impact 
a Board's objectivity and independence. Therefore, when the CDC Manager 
is a contractor, the manager will not be permitted to serve on the 
CDC's Board.
    In light of all of the above, in this Final Rule, SBA has decided 
to uphold the prohibition against CDC staff serving as Board Members, 
but has decided to permit the CDC Manager to serve on the Board, 
provided that the CDC Manager is not a contractor, or an associate of a 
contractor, of the CDC. SBA believes that this approach will allow CDCs 
to operate most efficiently and appropriately to manage the delivery of 
all of the CDC's economic assistance programs. In addition, SBA 
believes that having only one member of the Board employed by the CDC 
will not adversely impact the Board's objectivity and independence. 
Moreover, the other protections contained in the Final Rule (e.g., the 
prohibition against contractors serving as Board Members) and the 
general fiduciary duties of Board Members will further protect the 
objectivity and independence of the Board.
    As a result of some comments, SBA is clarifying the Proposed Rule 
regarding a CDC's Loan Committees. The Proposed Rule established 
requirements for CDC Loan Committees to ensure that those CDCs that 
operated with Loan Committees were also in compliance with the current 
regulations that require a vote by a quorum of the CDC's Board on every 
504 loan approval or servicing action. Some comments indicated 
confusion as to what was meant by a Loan Committee. One commentor 
stated that ``We have a group of 30 Members of our Board of Directors 
that meet semi-annually. [Eleven] of those Board Members then meet as 
needed (once or twice a month) to approve loans and take servicing and 
collection actions, etc. These Loan Committee Members are elected by 
the full Board and are made up of the four required representative 
groups.'' What this commentor describes meets the current regulatory 
requirements for CDC Board loan approval and servicing actions. In the 
Proposed Rule, SBA intended to deal only with Loan Committees composed 
of non-Board Members whose actions must be ratified by a quorum of the 
CDC's Board in order to comply with the current regulations.
    A few comments expressed concerns that the proposed required 
composition of the Loan Committee would be redundant to the 
requirements of the Board membership. One commentor stated that he did 
not ``understand the need for the Board to ratify the actions of the 
Loan Committee if the Loan Committee structure meets the make-up 
requirements of the 3 groups, has a quorum of at least 5, (and) has a 
lender at the meeting * * *'' SBA was persuaded by the comments of the 
need to clarify the definition of Loan Committee by adding ``non-Board 
Members'' to the definition in the Final Rule. Since the Board must 
ratify the decisions of the Loan Committee, SBA agrees that some of the 
requirements in the Proposed Rule may be eliminated. The final rule 
eliminates the requirement that the Loan Committee members represent 
three of the four membership groups. SBA believes that regulations 
governing Loan Committees are especially important for Multi-State CDCs 
because such regulations help ensure local involvement with CDC loan-
making decisions. Since the requirements for the Board of Directors for 
Multi-State CDCs have been modified in the Final Rule, the role of Loan 
Committees in each State for a Multi-State CDC will have increased 
importance to assure the local influence over 504 loan decisions and to 
minimize concerns about the Multi-State CDC concept expressed.
    In the Proposed Rule, SBA clarified under what circumstances a CDC 
may contract out its management and staffing functions. Some of the 
comments received indicated confusion regarding what was meant by 
contracts. The opening paragraph of the Proposed Rule states: ``CDCs 
may obtain, under written contract, marketing, packaging, processing, 
closing, or liquidation services provided by qualified individuals and 
entities who live or do business in the CDC's Area of Operations.'' 
This explanation was apparently not clear because a few commentors 
raised concerns about the requirement that SBA approve contracts 
entered into by a CDC for space, equipment, etc. One commentor stated: 
``This type of micro-management is neither necessary nor within the 
spirit of SBA oversight.'' SBA agrees that this would indeed be micro-
managing. The Final Rule adds language to clarify that contracts for 
other than staffing or management do not have to be reviewed and 
approved by SBA. In the Final Rule, SBA also is adding the word 
``servicing'' since that was inadvertently omitted in the list of staff 
functions that may be contracted out. In the Preamble to the Proposed 
Rule, SBA stated that ``No contractor or Associate of a contractor may 
be a voting or non-voting member of the CDC's Board or Loan 
Committee.'' However, SBA also inadvertently omitted the phrase ``or 
non-voting'' from Sec. 120.824(e) of the Proposed Rule. SBA has 
corrected this omission by adding the phrase ``or non-voting'' to 
Sec. 120.824(f) of this Final Rule.
    Many commentors were in favor of the Proposed Rule regarding a 
CDC's staff requirements. One commentor states, ``The proposed 
regulation gives further emphasis on full-time CDC management and on 
the manager being an employee, not a contractor. We heartily endorse 
this amendment and look forward to the enforcement of this regulation 
in the field.'' The following comment is representative of several 
CDCs' concerns about contracting: ``I believe it is very important that 
the CDC become independent of any affiliate * * * providing financial 
and management support as soon as deemed economically feasible by SBA 
upon its contract review as required every two years. This would avoid 
the possibility of the affiliate * * * rolling up its fee charges when 
the CDC starts to produce an income beyond the cost of the current 
contract. This could seriously inhibit the growth of the CDC and its 
services provided. I know this has happened in the past and is still 
(occurring).''
    Several commentors were in support of the Proposed Rule with a 
modification. A typical comment follows: ``Our organization contracts 
with a local, one county, non-profit, economic development corporation. 
Because they have four employees, they can easily obtain health 
insurance, etc. for employees. We do not believe insurance companies 
will provide health insurance for a company with one employee. If they 
do, then the costs for the insurance will be higher.''

[[Page 42630]]

Another commentor is more specific: ``The staff [of the non-profit 
affiliate] is required to maintain individual daily logs, in hours, for 
each revenue center (SBA, EDA, USDA, and Indirect) that is being 
benefited to prevent overcharging any loan program. One of EDA's audit 
contentions was their funds supplemented the SBA 504 Loan Program. 
Subsequently, each program has its own balance sheet and operating 
statement and pays its fair share of the cost of the lending 
organization. Compliance is assured by an annual certified audit and 
agency review * * * We respond to the loan requests without regard for 
the specific loan program.''
    SBA is persuaded by these comments and has modified the Final Rule 
to eliminate the requirement that the non-profit affiliate that is 
contributing staff to the CDC must be financially subsidizing the CDC's 
operations. SBA was originally concerned that the non-profit affiliate 
could overcharge the CDC for the contract staff. SBA is persuaded by 
the comments that SBA's review of such contracts will minimize such 
risk. SBA notes that, in its experience, non-profit affiliates have no 
history of overcharging CDCs for staff. SBA reasons that non-profit 
affiliates have less incentive to overcharge than profit-making 
entities which occasionally have been found by SBA to charge staff 
costs that may be inappropriate. Finally, SBA's current policy already 
requires SBA to pre-approve all CDC contracts for staff and management 
as well as review the contracts annually. At this time, SBA believes 
its continued review that its oversight responsibility make of staff 
and management contracts is appropriate to minimize the possibility of 
abuse. We intend, however, to further address this issue in the 
Agency's ANPR to be published soon.
    Some of the comments were concerned with SBA's role in pre-
approving and reviewing all management and staff contracts. SBA 
considered these comments but did not modify the Proposed Rule 
regarding SBA oversight responsibilities. SBA is the regulatory agency 
for CDCs and, as such, is responsible for overseeing and reviewing many 
aspects of a CDC's operations. When a CDC contracts out its staff and 
management requirements, SBA must review such contracts to satisfy its 
CDC oversight responsibilities. Otherwise, SBA would fail in its 
responsibility to review how a CDC is satisfying its most fundamental 
responsibilities to borrowers as required by SBA regulations.
    Although, as mentioned previously, several commentors, were 
strongly in favor of contracts having a limited term, other commentors 
were concerned that the proposed restrictions would increase the cost 
of contracted services as well as limit the choice of contractors. A 
representative comment was the following: ``The time constraint--2 
years--being the maximum length of a contract is far too short of a 
period of time. It is frequently normal and customary business practice 
to negotiate contract for services that exceed two years. We would urge 
SBA to avoid needless contract length regulation that could lead to 
higher costs and lower quality contract services for CDCs.'' SBA 
considered these comments and has modified the Proposed Rule to remove 
the time constraint initially proposed. SBA believes that other 
requirements in the Final Rule, such as the requirement that SBA review 
the contracts annually and the requirement that the contract clearly 
identify procedures satisfactory to SBA which permit the CDC to 
terminate the contract prior to its expiration date, are sufficient to 
monitor contractual relationships. SBA will continue to review the 
matter and intends to re-address this issue in the ANPR.
    A few commentors wanted to continue to contract with for-profit 
affiliates that receive income from the CDC that exceeds the fees for 
actual services performed. SBA considered these comments but was not 
persuaded that the benefit to a CDC from such arrangements outweigh 
concerns about shifting 504 income to other entities. As a commentor 
that was concerned about the possible impact of aggressive contracting 
out explained: ``There are very profound factors which drive generally 
for-profit packagers and similar service providers to attempt, if you 
will, to take control of CDCs * * * the income potential is enormous in 
such a takeover, and SBA very properly guards against that * * * I 
would suggest that on this issue, fees for * * * services be limited to 
fees for services actually performed, for example hourly services. And 
that no rights to * * * income be permitted beyond the contracting term 
* * * The purpose * * * is to provide self sufficiency, the ability of 
the CDC to stand on its two feet. It's very easy in these relationships 
for the financial strength of the CDC to be drained in such a way that 
would make it, for all purposes, perpetually dependent on our 
contracting relationship.'' These comments mirror SBA's concerns. SBA 
believes that its Final Rule strikes an appropriate balance by 
continuing to allow CDCs to contract out for some services, when such 
strategy is efficient and cost-effective while assuring that such 
contracting out is appropriately monitored by SBA. SBA wants to ensure 
that CDCs are given every opportunity to become independent and self-
sufficient.
    As indicated throughout this preamble, working with the CDC 
industry and its trade association, SBA intends to continue its 
consideration of a number of issues affecting CDC program operations. 
In addition to the issues already cited, in the ANPR that the Agency 
intends to publish shortly, SBA will seek comments regarding whether 
and under what circumstances CDCs should be required to engage in or 
support economic development activities other than the 504 program; 
whether and under what circumstances CDCs should be allowed to 
participate in profit-making activities; and whether SBA should amend 
the existing standard for determining that an area is adequately served 
by the 504 program, among others.

3. A Section by Section Description of the Changes to the Proposed 
Rule

    Section 120.802 Definitions. The definition of Multi-State CDC was 
modified to limit the States into which a CDC can apply to operate in 
as a Multi-State CDC to those States contiguous to the applicant CDC's 
State of incorporation.
    Section 120.810 Applications for Certification as a CDC. The Final 
Rule modifies subparagraph (a) to reflect SBA's decision, based on the 
comments received, to allow a CDC to expand its Area of Operations into 
a county with a population of 100,000 or more that is already 
adequately served by only one existing CDC only when that CDC does not 
oppose the application. Also, subparagraph (a) was modified to allow 
loans made by a Multi-State CDC to be used when determining if a county 
is adequately served. Finally, subparagraph (a) was modified to 
prohibit applications to cover a county if the county has become part 
of a Multi-State CDC's Area of Operations within the last 24 months. 
This gives any CDC 24 months to fully establish its operations in a new 
county before another CDC can apply to operate in it. This change was 
made so that a Multi-State CDC's out-of-state operations would not be 
treated differently from the local operations of any other CDC. In the 
Proposed Rule, the 24-month grace period only applied when the county 
was part of a CDC's Area of Operations within its State of 
incorporation.
    Section 120.820 CDC non-profit status. No changes from the Proposed

[[Page 42631]]

Rule. The requirement that the non-profit corporation be in good 
standing refers to its being in good standing with the State in which 
it is incorporated.
    Section 120.822 CDC Membership. No changes from Proposed Rule.
    Section 120.823 CDC Board of Directors. The Final Rule modifies the 
Proposed Rule to permit the CDC Manager to be a member of the CDC's 
Board of Directors, but specifies that the requirement that ``one Board 
Member with commercial loan experience'' be satisfied by a Board Member 
other than the CDC manager. The Final Rule continues to prohibit other 
CDC staff members from being on the Board of Directors. The Proposed 
Rule also was reworded to require that a Multi-State CDC meet the Board 
representation requirements for each State, rather than requiring it to 
have separate Boards for each State or to have proportional Board 
representation as discussed above.
    In addition, the Final Rule removes the requirement that Loan 
Committee members represent three of the four membership groups. This 
change was made because the Board already has representation from at 
least three of the four membership groups and a quorum of Board Members 
must approve, through a Board resolution (SBA Form 1528), its CDC's 
application for SBA's guarantee of each Debenture the CDC issues to 
fund one of its 504 loans prior to the sale of that Debenture. 
Requiring Loan Committee members to live or work in the State where the 
project they are voting on is located assures that local citizens will 
be part of the approval process for each loan made in their community. 
The Final Rule clarifies that this regulation only applies to a Loan 
Committee comprised of non-Board Members. The phrase ``* * * no 
appearance of a conflict of interest'' is changed to ``no actual or 
apparent conflict of interest'' throughout to emphasize the fact that 
actual conflicts of interest are prohibited and not just apparent 
conflicts. The Final Rule also clarifies that Multi-State CDCs are 
required to have Loan Committees in each State in which the Multi-State 
CDC operates. As stated above, this will assure local citizen 
participation in the loan approval process for each loan made in their 
community.
    Section 120.824 Professional management and staff. The Final Rule 
corrects a technical error and adds ``servicing'' back into the list of 
services a CDC may obtain under contract. It also splits subparagraph 
(a) into two sections ((a)(1) and (a)(2)) for ease of reading. The 
Final Rule removes the phrase ``that is financially subsidizing the 
CDC's operations'' from 120.824(a) thus removing the condition that a 
non-profit affiliate of the CDC financially subsidize it before the CDC 
can apply for the waiver set forth in the section. Paragraphs (c) 
through (e) were expanded to (c) through (f) and were broken down into 
smaller paragraphs and subparagraphs for ease of reading. The phrase 
``or non-voting'' was added to (f).
    Section 120.825 Financial ability to operate. No change from the 
Proposed Rule.
    Section 120.835 Application to expand an Area of Operations. The 
Final Rule reorders the section so that requests from CDCs to expand 
into counties within their State of incorporation or into a Local 
Economic Area are covered in section 120.835(a), requests from CDCs to 
expand into Multi-State Areas are covered in Section 120.835(b), and 
the general requirements for both are covered in 120.835(c).
    The Final Rule modifies the Proposed Rule to reflect SBA's 
decision, based on the comments it received, to accept a CDC's 
application for expansion into a county with a population of 100,000 or 
more that is already being adequately served by only one existing CDC 
only if the original CDC does not oppose the application. The Proposed 
Rule was modified to allow loans made by a Multi-State CDC to be used 
when determining if a county is adequately served. The Proposed Rule 
was modified to prohibit CDC applications for a county if the county 
has become part of a Multi-State's Area of Operations within the last 
24 months. (See discussion of changes to the Proposed Rule pertaining 
to Sec. 120.810 above.)
    The Final Rule removes the requirement for equal representation of 
each State on the Boards of Multi-State CDCs because SBA believes 
meeting the minimum Board requirements for each State is enough to 
assure proper local participation.
    Section 120.837 SBA decision on application for a new CDC or for an 
existing CDC to expand Area of Operations. The Final Rule removes the 
parentheses from around the list of SBA programs conferring some 
special status, and changes ``based solely on its activity'' to ``based 
solely on its activity and performance'' to clarify the concept. The 
Final Rule also clarifies that any special status that a CDC's has 
earned such as ALP or PCLP only applies in the State or States in which 
that status was earned.

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

    The Office of Management and Budget reviewed this rule as a 
``significant'' regulatory action under Executive Order 12866.
    SBA has determined that this Final Rule will not have a significant 
economic impact on a substantial number of small entities within the 
meaning of the Regulatory Flexibility Act, 5 U.S.C. 601-612. Currently, 
out of approximately 24 million small businesses in the United States, 
about 4,000 receive 504 loans annually. As described in the preamble, 
through this regulation, SBA hopes to increase the number of 504 loans 
made to small businesses. Even if SBA were to assume a generous result 
of a 20 percent increase in loans, it would only result in an annual 
increase of 800 loans per year. SBA does not consider this a 
significant impact on a substantial number of small entities. Other 
aspects of this rule clarify the management and structural requirements 
for CDCs. These aspects would have no economic impact on small 
entities, as they merely alter CDC requirements.
    SBA has determined that this Final Rule does not impose any 
additional reporting or recordkeeping requirements under the Paperwork 
Reduction Act, 44 U.S.C., Chapter 35.
    For purposes of Executive Order 12988, SBA certifies that this 
Final Rule is drafted, to the extent practicable, to accord with the 
standards set forth in section 3 of that Order.
    For purposes of Executive Order 13132, SBA has determined that this 
Final Rule has no federalism implications.

List of Subjects in 13 CFR Part 120

    Loan Programs--business, small business.

    For the reasons set forth above, SBA amends 13 CFR part 120 as 
follows:

PART 120--BUSINESS LOANS

    1. The authority citation for part 120 is revised to read as 
follows:

    Authority: 15 U.S.C. 634 (b)(6), 636(a) and (h), 696(3), and 
697(a)(2).

    2. Amend Sec. 120.802 to revise the definition of Area of 
Operations and add definitions of Local Economic Area and Multi-State 
CDC in alphabetical order to read as follows:


Sec. 120.802  Definitions.

* * * * *

[[Page 42632]]

    Area of Operations is the geographic area where SBA has approved a 
CDC's request to provide 504 program services to small businesses on a 
permanent basis.
* * * * *
    Local Economic Area is an area, as determined by SBA, that is in a 
State other than the State in which an existing CDC (or an applicant 
applying to become a CDC) is incorporated, shares a border with the 
CDC's existing Area of Operations (or applicant's proposed Area of 
Operations) in its State of incorporation, and is a part of a local 
trade area that is contiguous to the CDC's Area of Operations (or 
applicant's proposed Area of Operations) within its State of 
incorporation. Examples of a local trade area would be a city that is 
bisected by a State line or a metropolitan statistical area that is 
bisected by a State line.
    Multi-State CDC is a CDC that is incorporated in one State and is 
authorized by SBA to operate as a CDC in a State contiguous to its 
State of incorporation beyond any contiguous Local Economic Areas.
* * * * *

    3. Revise Sec. 120.810 to read as follows:


Sec. 120.810  Applications for certification as a CDC.

    Applicants for certification as a CDC must apply to the SBA 
District Office serving the area in which the applicant has or proposes 
to locate its headquarters.
    (a) An SBA District Office may accept an application for a county 
only if:
    (1) There is no CDC that includes the county in its Area of 
Operations;
    (2) Any CDCs that include the county in their Areas of Operations 
have not averaged together at least one 504 loan approval per 100,000 
population per year averaged over the 24 months prior to SBA receiving 
a complete application from the applicant; and the county has not 
become part of another CDC's Area of Operations within the prior 24 
months; or
    (3) The county is part of the Area of Operations of only one CDC; 
the county has a population of 100,000 or more; the county has not 
become part of an Area of Operations within the prior 24 months of 
another CDC; the applicant is incorporated in the State where the 
county is located; and the CDC that includes the county in its Area of 
Operations submits a statement of no objection to the application.
    (b) An applicant whose application has been accepted must then 
demonstrate that it satisfies the certification and operating criteria 
in Secs. 120.820 through 120.829 and the need for 504 services in the 
Area Of Operations (if there is already a CDC in the Area of 
Operations, the applicant must justify the need for another and present 
a plan to avoid duplication or overlap). Applications must also include 
an operating budget approved by the applicant's Board of Directors, and 
a plan to meet CDC operating requirements (without specializing in a 
particular industry). An applicant's proposed Area of Operations may 
include Local Economic Areas. An applicant may not apply to cover an 
area as a Multi-State CDC. The AA/FA shall make the certification 
decision.

    4. Revise Sec. 120.820 to read as follows:


Sec. 120.820  CDC non-profit status.

    A CDC must be a non-profit corporation in good standing. (For-
profit CDCs certified by SBA prior to January 1, 1987 may retain their 
certifications.) An SBIC may not become a CDC.

    5. Revise Sec. 120.822 to read as follows:


Sec. 120.822  CDC membership.

    (a) A CDC must have at least 25 members (or stockholders for for-
profit CDCs approved prior to January 1, 1987). The CDC membership must 
meet annually. No person or entity may own or control more than 10 
percent of the CDC's voting membership (or stock). Members must be 
representative of and provide evidence of active support in the Area of 
Operations. Members must be from each of the following groups:
    (1) Government organizations responsible for economic development 
in the Area of Operations and acceptable to SBA;
    (2) Financial institutions that provide commercial long term fixed 
asset financing in the Area of Operations;
    (3) Community organizations dedicated to economic development in 
the Area of Operations such as chambers of commerce, foundations, trade 
associations, colleges, or universities; and
    (4) Businesses in the Area of Operations.
    (b) A CDC that is incorporated in one State and is operating as a 
Multi-State CDC in another State must meet the membership requirements 
for each State.
    6. Revise Sec. 120.823 to read as follows:


Sec. 120.823  CDC Board of Directors.

    The CDC must have a Board of Directors chosen from the membership 
by the members, and representing at least three of the four membership 
groups. No single group shall control. No person who is a member of a 
CDC's staff may be a voting member of the Board except for the CDC 
manager. The Board Members must be responsible officials of the 
organizations they represent and at least one member other than the CDC 
manager must possess commercial lending experience. The Board must meet 
at least quarterly and shall be responsible for CDC staff decisions and 
actions. A quorum shall require at least 5 Directors authorized to 
vote. When the Board votes on SBA loan approval or servicing actions, 
at least one Board Member with commercial loan experience acceptable to 
SBA, other than the CDC manager, must be present and vote. There must 
be no actual or apparent conflict of interest with respect to any 
actions of the Board.
    (a) The Board may establish a Loan Committee of non-Board Members 
that reports to the Board. Loan Committee members must include at least 
one member with commercial lending experience acceptable to SBA. All 
members of the Loan Committee must live or work in the Area of 
Operations of the State where the 504 project they are voting on is 
located unless the project falls under one of the exceptions listed in 
Sec. 120.839, Case-by-case extensions. No CDC staff may serve on a Loan 
Committee. A quorum must have at least five committee members 
authorized to vote. The CDC's Board must ratify the actions of any Loan 
Committee. There must be no actual or apparent conflict of interest 
with respect to any actions of the Loan Committee.
    (b) If the CDC is incorporated in one State and is approved as a 
Multi-State CDC to operate in another State, the CDC must meet the 
Board requirements for each State and must have a Loan Committee for 
each State.

    7. Revise Sec. 120.824 to read as follows:


Sec. 120.824  Professional management and staff.

    A CDC must have full-time professional management, including an 
Executive Director (or the equivalent) managing daily operations. It 
must also have a full-time professional staff qualified by training and 
experience to market the 504 Program, package and process loan 
applications, close loans, service, and, if authorized by SBA, 
liquidate the loan portfolio, and sustain a sufficient level of service 
and activity in the Area of Operations. CDCs may obtain, under written 
contract, marketing, packaging, processing, closing, servicing or 
liquidation services provided by qualified individuals and entities who 
live or do business in the CDC's Area of Operations under the following 
circumstances:
    (a) The CDC has at least one salaried professional employee that is 
employed

[[Page 42633]]

directly (not contracted) full-time to manage the CDC. A CDC may 
petition SBA to waive the requirement of at least one full-time manager 
if:
    (1) The CDC is rural and has insufficient loan volume to justify 
its own management, and another CDC located in the same general area 
will provide the management; or
    (2) The management of a CDC is to be contributed by a non-profit 
affiliate of the CDC that has the economic development of the CDC's 
Area of Operations as one of its principal activities. In the latter 
case, the management contributed by the affiliate may work on and 
operate other economic development programs of the affiliate, but must 
be available to 504 customers during regular business hours.
    (b) SBA must pre-approve contracts the CDC makes for managing, 
marketing, packaging, processing, closing, servicing, or liquidation 
functions. (CDCs may contract for legal and accounting services without 
SBA approval, except for legal services in connection with loan 
liquidation or litigation.)
    (c) 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.
    (d) The CDC must provide copies of these contracts to SBA for 
review annually.
    (e) If a CDC's Board believes that it is in the best interest of 
the CDC to contract for a management, marketing, packaging, processing, 
closing, servicing or liquidation function, the CDC's Board must 
explain its reasoning to SBA. The CDC's Board must demonstrate to SBA 
that:
    (1) The compensation under the contract is only from the CDC, 
reasonable and customary for similar services in the Area of 
Operations, and is only for actual services performed;
    (2) The full term of the contract (including options) is 
reasonable; and
    (3) The contract does not evidence any actual or apparent conflict 
of interest or self-dealing on the part of any of the CDC's officers, 
management, and staff, including members of the Board and any Loan 
Committee.
    (f) No contractor (under this section) or Associate of a contractor 
may be a voting or non-voting member of the CDC's Board.
    8. Revise Sec. 120.825 to read as follows:


Sec. 120.825  Financial ability to operate.

    A CDC must be able to sustain its operations continuously, with 
reliable sources of funds (such as income from services rendered and 
contributions from government or other sponsors). Any funds generated 
from 503 and 504 loan activity by a CDC remaining after payment of 
staff and overhead expenses must be retained by the CDC as a reserve 
for future operations or for investment in other local economic 
development activity in its Area of Operations. If a CDC is operating 
as a Multi-State CDC, it must maintain a separate accounting for each 
State of all 504 fee income and expenses and provide, upon SBA's 
request, evidence that the funds resulting from its Multi-State CDC 
operations are being invested in economic development activities in 
each State in which they were generated.
    9. Revise Sec. 120.835 to read as follows:


Sec. 120.835  Application to expand an Area of Operations.

    An existing, active CDC applying to expand its Area of Operations 
must be operating in conformance with all existing SBA regulations, 
policies, and performance benchmarks and be well qualified to serve the 
proposed area. A CDC seeking to expand its Area of Operations must 
apply in writing to the SBA District Office where the CDC is 
headquartered, unless it is applying to be a Multi-State CDC. In that 
case, the CDC must apply to the SBA District Office that services the 
area where the Multi-State CDC intends to locate its principal office 
for that State.
    (a) An SBA District Office may accept a CDC's application to expand 
its Area of Operations into a county within its State of incorporation, 
or in a Local Economic Area only if:
    (1) There is no CDC that includes the county in its Area of 
Operations; or
    (2) Any CDCs that include the county in their Areas of Operations 
have not averaged together at least one 504 loan approval per 100,000 
population per year averaged over the 24 months prior to SBA receiving 
a complete application from the applicant CDC; and the county has not 
become part of an Area of Operations of another CDC within the prior 24 
months; or
    (3) The county is part of the Area of Operations of only one CDC; 
the county has a population of 100,000 or more; the county has not 
become part of an Area of Operations within the prior 24 months of 
another CDC; the applicant is incorporated in the State where the 
county is located; and the CDC that includes the county in its Area of 
Operations submits a statement of no objection to the application.
    (b) An SBA District Office may accept a CDC's application to expand 
and service an area as a Multi-State CDC only if:
    (1) There is no CDC that includes the county in its Area of 
Operations, or the CDCs that include the county in their Areas of 
Operations have not averaged together at least one 504 loan approval 
per 100,000 population per year averaged over the previous 24 months 
prior to SBA receiving a complete application from the applicant CDC; 
and the county has not become part of an Area of Operations of another 
CDC within the last 24 months; and
    (2) The State it seeks to expand into is contiguous to the State of 
the CDC's incorporation; and
    (3) The requirements in Section 120.822, Membership, are separately 
met for the Area of Operations within the CDC's State of incorporation 
and for each State in which it operates or seeks to operate as a Multi-
State CDC; and
    (4) The requirements in Section 120.823, Board of Directors, are 
separately met for the State of incorporation and each additional State 
in which it operates or seeks to operate as a Multi-State CDC; and
    (5) The CDC has a Loan committee meeting the requirements of 
Sec. 120.823(b).
    (c) An applicant whose application for expansion has been accepted 
must demonstrate to the satisfaction of SBA that it satisfies all of 
the certification and operating criteria in Secs. 120.820 through 
120.829. It must demonstrate that it has the ability to provide full 
service to small businesses in the requested area including processing, 
closing, servicing, and, if authorized, liquidating 504 loans. It must 
also demonstrate the need for 504 services in the Area of Operations 
and present a plan for servicing the area. If there is already one or 
more CDCs in the requested Area of Operations, the applicant must 
justify the need for another.
    10. Revise Sec. 120.837 to read as follows:


Sec. 120.837  SBA decision on application for a new CDC or for an 
existing CDC to expand Area of Operations.

    The processing District Office must solicit the comments of any 
other District Office in which the CDC operates or proposes to operate. 
The processing District Office must determine that the CDC is in 
compliance with SBA's regulations, policies, and performance 
benchmarks, including pre-approval and annual review by SBA of any 
management or staff contracts, and the timely submission of all annual 
reports. In making its recommendation on the application, the District 
Office

[[Page 42634]]

may consider any information presented to it regarding the requesting 
CDC, the existing CDC, or CDCs that may be affected by the application, 
and the proposed Area of Operations.
    (a) The SBA District office will submit the application, 
recommendation, and supporting materials within 60 days of the receipt 
of a complete application from the CDC to the AA/FA, who will make the 
final decision. The AA/FA may consider any information submitted or 
available related to the applicant and the application.
    (b) If a CDC is approved to operate as a Multi-State CDC, any 
unilateral authority that a CDC has in its State of incorporation under 
any SBA program, including Accredited Lender's Program (ALP), Premier 
Certified Lenders Program (PCLP), or Expedited Closing Process 
(Priority CDC), does not carry over into a State in which it is 
approved to operate as a Multi-State CDC. The CDC must earn the status 
in each State based solely on its activity and performance in that 
State.

    Dated: June 28, 2000.
Aida Alvarez,
Administrator.
[FR Doc. 00-16842 Filed 7-10-00; 8:45 am]
BILLING CODE 8025-01-P