Federal Register: October 28, 2009 (Volume 74, Number 207)

DOCID: fr28oc09-32 FR Doc E9-25416

SUBJECT CATEGORY:

Small Business Size Regulations; 8(a) Business Development/Small Disadvantaged Business Status Determinations

DATES: Comments must be received on or before December 28, 2009.

DOCUMENT SUMMARY:

This rule proposes to make changes to the regulations governing the 8(a) Business Development (8(a) BD) and Small Disadvantaged Business (SDB) programs, and to the U.S. Small Business Administration's (SBA or Agency) size regulations. Some of the changes involve technical issues such as changing the term ``SIC code'' to ``NAICS code'' to reflect the national conversion to the North American Industry Classification System. Other changes are more substantive and result from SBA's experience in implementing the current regulations. For example, SBA has learned through experience that certain of its rules governing the 8(a) BD program are too restrictive and serve to unfairly preclude firms from being admitted to the program. In other cases, SBA has determined that a rule is too expansive or indefinite and has sought to restrict or clarify that rule. In one case wording changes are being proposed to correct past public or agency misinterpretation. Also, new situations have arisen that were not anticipated when the current rules were drafted and the proposed rule seeks to cover those situations. Finally, one of the changes, involving Native Hawaiian Organizations (NHO's), implements a statutory change.

SUMMARY:

Small Business Administration

SUPPLEMENTAL INFORMATION

This rule proposes to make a number of changes to the regulations governing the 8(a) BD and SDB programs, and several changes to SBA's size regulations. Some of the changes involve technical issues. Other changes are more substantive and result from SBA's experience in implementing the current regulations.

The following specific changes are being proposed to SBA's regulations. There are six proposed changes to SBA's size regulations, two dealing with mentor/prot[eacute]g[eacute] situations, one amending requirements for joint ventures, one clarifying how a procurement should be classified, one further explaining the nonmanufacturer rule, and one relating to who may request a formal size determination. The remaining proposed changes are to the regulations governing SBA's 8(a) BD and SDB programs. It is noted that all regulations governing the 8(a) program apply to the SDB program, unless otherwise specified. While the SDB program no longer has an application and certification component, the provisions specifying what constitutes an SDB are still needed for selfcertification and protest purposes.
Exception to Affiliation for Mentor/Prot[eacute]g[eacute] Programs

The first proposed change would clarify when SBA would consider a prot[eacute]g[eacute] firm not to be affiliated with its mentor based on assistance received from the mentor through a mentor/
prot[eacute]g[eacute] agreement. The current regulation may be misconstrued to allow other Federal agencies to establish mentor/ prot[eacute]g[eacute] programs and exempt prot[eacute]g[eacute]s from SBA's size affiliation rules. That was never SBA's intent. The exception to affiliation contained in Sec. 121.103(b)(6) was meant to apply to SBA's 8(a) BD mentor/prot[eacute]g[eacute] program and other Federal mentor/prot[eacute]g[eacute] programs that specifically authorize an exception to affiliation in their authorizing statute. Because of the business development purposes of the 8(a) BD program, SBA administratively established an exception to affiliation for prot[eacute]g[eacute] firms. Specifically, prot[eacute]g[eacute] firms are not affiliated with their mentors based on assistance received from their mentors through an SBAapproved 8(a) BD mentor/
prot[eacute]g[eacute] agreement. That exception exists in the current rule and remains in this proposed rule. The proposed rule merely spells out more explicitly the affiliation exception for clarity purposes.

In addition, the proposed rule makes clear that an exception to affiliation for prot[eacute]g[eacute]s in other Federal mentor/ prot[eacute]g[eacute] programs will be recognized by SBA only where specifically authorized by statute (e.g., the Department of Defense mentor/prot[eacute]g[eacute] program) or where SBA has authorized an exception to affiliation for a mentor/prot[eacute]g[eacute] program of another Federal agency under the procedures set forth in Sec. 121.903. By statute, SBA is the sole agency responsible for determining size for purposes of any Federal assistance. SBA does not believe that another agency should be able to exempt firms from SBA's affiliation rules (and in effect make programspecific size rules) by itself. There is a formal process spelled out in Sec. 121.903 that an agency must use if it would like to deviate from SBA's size rules, including those relating to affiliation. This process must be followed and SBA must specifically authorize an exception to affiliation for another Federal mentor/prot[eacute]g[eacute] program in order for SBA to recognize the exception. SBA does not anticipate approving exceptions to affiliation to agencies seeking to have such an exception for their mentor/ prot[eacute]g[eacute] programs except in limited circumstances. SBA believes that the 8(a) BD program is a unique business development program that is unlike other Federal programs. If a program of another agency is also intended to assist business development and an exclusion from affiliation for joint ventures conducted under that agency's mentor/prot[eacute]g[eacute] program would promote such business development, SBA would be inclined to grant an exclusion from affiliation because it would serve the same purpose as the exclusion from affiliation for 8(a) mentor/prot[eacute]g[eacute] relationships. Joint Ventures

The second proposed change to the size rules pertains to joint ventures.
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Under current Sec. 121.103(h), a joint venture is an entity with limited duration. Specifically, the current regulation limits a specific joint venture to submitting no more than three offers over a two year period. Two firms (including an 8(a) prot[eacute]g[eacute] firm and its mentor) are limited to pursuing three contract opportunities under one joint venture, but there is nothing in the regulations prohibiting the same two firms from forming a second joint venture and pursuing three additional contract opportunities. The rule limiting the number of contract opportunities any single joint venture can pursue was actually intended to loosen the requirements of the prior regulations. SBA's previous regulations defined a joint venture to be an entity that was ``formed * * * to engage in and carry out a single, specific business venture for joint profit * * *'' The genesis for the change initially came from 8(a) firms, which complained that it was hard and costly for them to go out and form a new joint venture entity (usually in the form of a limited liability company (LLC)) for every contract opportunity that they sought. SBA agreed, and decided to provide more flexibility. SBA did so by changing the size regulations, the place in SBA's regulations where the term joint venture was defined. Because the provision appears in part 121 of SBA's regulations, it applies to all of SBA's programs, including the 8(a) BD program (as intended).

This provision, however, has caused confusion. Some firms misunderstood that the limitation contained in the regulation was on the number of offers submitted by the joint venture instead of the number of contracts awarded to the joint venture. As such, some joint ventures continued to submit offers beyond the three permitted by the regulation and were determined not to be eligible for award where the joint venture was otherwise the apparent successful offeror, but the offer was a fourth (or more) offer. Firms have recommended to SBA that if there is such a limit, it should be on contracts, not offers. Upon further reflection, SBA agrees and proposes to change the limit of three offers to a limit of three contract awards under one joint venture agreement.

The proposed rule would clarify that three contract awards is not an absolute limit for a specific joint venture agreement. A joint venture could choose to pursue and be awarded a fourth (or more) contract award, but in doing so would cause the partners to the joint venture to be deemed affiliated for all purposes. Again, the two (or more) firms could form a second joint venture and be awarded three additional contracts, and a third joint venture to be awarded three more. At some point, however, such a longstanding relationship or contractual dependence would lead to a finding of general affiliation, even in the 8(a) mentor/prot[eacute]g[eacute] joint venture context. As an alternative, SBA also considered revising this provision to limit the number of contract awards that the same partners to one or more joint ventures could receive without the partners being deemed affiliates for all purposes. SBA thought that three awards might be too restrictive and considered limiting the number of contracts that the same joint venture partners could be awarded to five. Under this approach, the identical partners could form one joint venture and receive five contracts or form several joint ventures and receive five contracts in total before SBA would find the partners to be affiliated for all purposes. SBA specifically requests comments on this approach, specifically addressing whether this approach is preferable to the one proposed.

In drafting the current three offers over two years requirement, SBA did not intend to limit the number of contracting opportunities that two (or more) firms could seek or contracts that they could be awarded through a joint venture relationship. As noted above, SBA believes that a ``joint venture'' is an entity of limited duration. If SBA did not limit the number of contracting opportunities, or under this proposed rule the number of contract awards, that a specific joint venture could receive, then the joint venture could be an ongoing entity with unlimited duration. In determining the size of a joint venture, the receipts or employees of the joint venture partners are generally aggregated (unless an exclusion from affiliation applies). If the aggregated receipts or employees are less than the size standard assigned to the relevant procurement, the joint venture qualifies as a small business. If one of the joint venture partners seeks a different contract opportunity apart from the joint venture, its size is generally considered individually (unless there are other bases for finding affiliation). If a specific ``joint venture'' could seek unlimited contracting opportunities and be awarded unlimited contracts, then the parties to the joint venture would necessarily be deemed affiliates for all purposes because of their interdependent contractual relations. This is the case because in effect the ``joint venture'' would be a new ongoing business entity that is owned by two individual firms. Because of this affiliation, the revenues or employees would be aggregated even where one of the firms sought a contract opportunity individually.

The proposed rule also clarifies the time at which SBA will determine whether this three in two years requirement has been met. SBA understands that any offeror, including a joint venture offeror, may seek more than one contract opportunity at the same time. Under SBA's regulations, size is determined as of the date a concern submits a written selfcertification that it is small as part of its initial offer including price. See 13 CFR 121.404(a). As long as a concern is small as of that date, it may be awarded a contract as a small business even if it has grown to be other than small as of the date of award. In other words, even if a concern has received additional revenues which would render it other than small after it certifies itself to be small as part of its initial offer including price, it may be awarded a contract as a small business. Having one specific point in time to determine size gives certainty to the procurement process for both the concern and the procuring agency. SBA believes that compliance with the three awards in two years rule should be treated similarly. As such, SBA proposes to determine compliance with the three in two years rule as of the date of initial offer including price. An individual joint venture may have submitted offers to perform two, three or more procurements before it finds out that it has won any specific competition. If at the time of offer the joint venture had not yet received three contract awards, then the joint venture would be able to submit offers for several procurement opportunities and ultimately be awarded any contract for which it submitted an offer before receiving a third contract. For example, Joint Venture AB has received two contracts. On April 2, Joint Venture AB submits an offer for Solicitation 1. On June 6, Joint Venture AB submits an offer for Solicitation 2. On July 13, Joint Venture AB submits an offer for Solicitation 3. In September, Joint Venture AB is found to be the apparent successful offeror for all three solicitations. Even though the award of the three contracts would give Joint Venture AB a total of five contract awards, it could receive those awards without causing general affiliation between its joint venture partners because Joint Venture AB had not yet received three contract awards as of the dates of the offers for each of three solicitations at issue.

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The proposed rule also clarifies that while a joint venture may or may not be a separate legal entity (e.g., an LLC), it must exist through a written document. Thus, even an ``informal'' joint venture must have a written agreement between the partners. In addition, the rule clarifies SBA's current policy that a joint venture may or may not be populated (i.e., have its own separate employees). Whether a joint venture needs to be populated or have separate employees depends upon the legal structure of the joint venture. If a joint venture is a separate legal entity, then it must have its own employees. If a joint venture merely exists through a written agreement between two or more individual business entities, then it need not have its own separate employees and employees of each of the individual business entities may perform work for the joint venture.

There has also been confusion as to whether this three in two year rule applies to the 8(a) BD program. Some individuals mistakenly believed that it did not apply to joint ventures between mentors and prot[eacute]g[eacute] firms in the 8(a) BD program. This is not the case. Because the rule appears in SBA's size regulations, it applies to all of SBA's programs. That is, it applies to all situations in which a joint venture seeks to qualify as a ``small business concern.'' Because this confusion is limited and SBA believes that the size regulations clearly apply the three in two year rule to all joint venture situations, SBA does not believe that a regulatory change is necessary to specifically apply the rule to the 8(a) BD program.

This proposed rule would also amend Sec. 124.513(e) to clarify the requirement that SBA approve 8(a) joint ventures prior to award for a second or third 8(a) contract award to a specific joint venture. The current regulation states that SBA must approve a joint venture for an 8(a) contract prior to contract award. There has been some confusion about how this requirement relates to the size provision which would now allow three contract awards over a two year period to a specific joint venture. Prior to the first contract award, SBA would have to approve the joint venture. SBA's review would examine the structure of the joint venture and the work each joint venture partner would perform on the proposed 8(a) contract. For the second (and third) 8(a) contract, SBA would not need to examine the structure of the joint venture again, but would need to determine that the work to be done by the joint venture partners on the proposed second (or third) 8(a) contract meets SBA's requirements. To this end, the 8(a) Participant to the joint venture must submit to SBA an addendum to the joint venture agreement explaining how the work will be performed on the contract, specifying what resources will be provided by each joint venture partner, and providing any other information necessary to fulfill the requirements set forth in 13 CFR 124.512(c). If the second (and/or third) contract to be awarded to a specific joint venture is not an 8(a) contract, the joint venture entity would not be required to submit an addendum to SBA prior to award, but would, as explained in the following paragraph, be required to meet the general 8(a) joint venture requirements.
Exclusion from Affiliation for Mentor/Prot[eacute]g[eacute] Joint Ventures

The third proposed change to the size regulations also pertains to exceptions to affiliation. Currently, SBA's regulations authorize an exception to affiliation where two firms approved by SBA to be a mentor and prot[eacute]g[eacute] under the 8(a) BD program seek to joint venture and perform a contract as a small business concern for any Federal Government procurement. For a procurement to be awarded through the 8(a) BD program, SBA's regulations at Sec. 124.513 require SBA to approve the joint venture agreement prior to award and specify what must be included in the joint venture agreement. There has been some confusion as to whether the requirements for 8(a) joint venture agreements apply to non8(a) procurements. SBA believes that any joint venture seeking to use the 8(a) mentor/prot[eacute]g[eacute] status as a basis for an exception to affiliation requirements must follow the 8(a) requirements (i.e., it must meet the content requirements set forth in Sec. 124.513(c) and the performance of work requirements set forth in Sec. 124.513(d)). Although SBA does not approve joint venture agreements for procurements outside the 8(a) program, if the size of a joint venture claiming an exception to affiliation is protested, the requirements of Sec. 124.513(c) and (d) must be met in order for the exception to affiliation to apply. The reason SBA's 8(a) regulations permit exceptions to affiliation on small business contracts outside the 8(a) program (e.g., small business set asides, HUBZone set asides, service disabled veteran owned small business set asides) is to further assist prot[eacute]g[eacute] 8(a) BD Participants in their business development. If the requirements ensuring control and performance of work by the 8(a) prot[eacute]g[eacute] firm are not enforced, a large business would be able to have unchecked and inappropriate access to Federal procurements intended for small business. While this is not a change to how SBA has interpreted this regulation, SBA believes that it should be spelled out in the regulation to avoid any further confusion and, thus, clarifying language has been added to Sec.
121.103(h)(3)(iii). SBA is also considering whether to limit the exclusion to affiliation for a joint venture that is comprised of a prot[eacute]g[eacute] firm and its SBAapproved mentor only to 8(a) contracts. If this proposal were adopted, mentor/prot[eacute]g[eacute] joint ventures for small business set aside contracts (or other small business contracts) would not receive an exclusion from affiliation. As such, if the mentor were a large business, the joint venture would be large and, thus, ineligible for a small business set aside contract. Proponents of this view believe that benefits for 8(a) firms should be limited to contracts obtained through the 8(a) program, and not extended to other small business programs. They believe that it is unfair for non8(a) small business concerns to have to compete against a joint venture involving a prot[eacute]g[eacute] firm and a large mentor for small business contracts outside the 8(a) program. SBA specifically requests comments on whether this policy should be changed in a subsequent final rule.

Classification of a Procurement for Supplies

SBA's current regulations provide that acquisitions for supplies must be classified under the appropriate manufacturing NAICS code, not under a wholesale trade NAICS code. The fourth proposed change to the size regulations would clarify that a procurement for supplies also cannot be classified under a retail trade NAICS code.

Application of the Nonmanufacturer Rule

The fifth proposed change to the size regulations would provide further guidance to the current nonmanufacturer rule (i.e., the rule that requires, in pertinent part, a firm that is not itself the manufacturer of the end item being procured to provide the product of a small business manufacturer). Several procuring agencies have misconstrued when to apply the nonmanufacturer rule. The proposed rule would explicitly state that the nonmanufacturer rule applies only where the procuring agency has classified a procurement as a manufacturing procurement by assigning the procurement a NAICS code under Sectors 31 33. It would also clarify that the nonmanufacturer rule does not apply to supply contracts that
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do not involve manufacturing. For example, the nonmanufacturer rule would not apply to situations where a procuring agency is acquiring agricultural commodities that are not processed or changed and the procuring agency classifies the contract as crop production under NAICS Subsector 111.

In addition, the rule applies only to the manufacturing or supply component of a manufacturing procurement. The rule provides two examples to clarify SBA's position regarding the rule. Where a procuring agency has classified a procurement as a manufacturing procurement and is also acquiring services, the nonmanufacturer rule would apply to the supply component of that procurement only. In other words, a firm seeking to qualify as a small business nonmanufacturer must supply the product of a small business manufacturer (unless a nonmanufacturer waiver applies), but need not perform any specific portion of the accompanying services. Since the procurement is classified under a manufacturing NAICS code, it cannot also be considered a services procurement and, thus, the 50% performance of work requirement set forth in Sec. 125.6 for services does not apply to that procurement. In classifying the procurement as a manufacturing/ supply procurement, the procuring agency must have determined that the ``principal nature'' of the procurement was supplies. As a result, any work done by a subcontractor on the services portion of the contract cannot rise to the level of being ``primary and vital'' requirements of the procurement, and therefore cannot be the basis or affiliation as an ostensible subcontractor. Conversely, if a procuring agency determines that the ``principal nature'' of the procurement is services, only the requirements relating to services contracts apply. The nonmanufacturer rule, which applies only to manufacturing/supply contracts, would not apply. Thus, although a firm seeking to qualify as a small business with respect to such a contract must certify that it will perform at least 50% of the cost of the contract incurred for personnel with its own employees, it need not supply the product of a small business manufacturer on the supply component of the contract. In order to qualify as a nonmanufacturer, a firm must be primarily engaged in the retail or wholesale trade and normally sell the type of item being supplied. We are proposing to further define this statutory requirement to mean that the firm takes ownership or possession of the item(s) with its personnel, equipment or facilities in a manner consistent with industry practice. This change is primarily in response to situations where SBA has waived the nonmanufacturer rule and the prime contractor essentially subcontracts all services, such as warehousing or delivery, to a large business. Such an arrangement, where the prime contractor can legally provide the product of a large business and then subcontract all tangential services to a large business, is contrary to the intent and purpose of the Small Business Act, i.e., providing small businesses with an opportunity to perform prime contracts. Such an arrangement inflates the cost to the Government of contract performance and inflates the statistics for prime contracting dollars awarded to small business, which is detrimental to other small businesses that are willing and able to perform Government contracts.

Request for Formal Size Determination

The sixth proposed change to the size regulations would amend Sec. 121.1001(b) to give the SBA's Office of Inspector General (OIG) the authority to ask for a formal size determination. Because the OIG is not currently listed in the regulations as an individual who can request a formal size determination, the OIG must currently seek a formal size determination through the relevant SBA program office. SBA believes that the Inspector General should be able to seek a formal size determination when questions about a concern's size arise in the context of an investigation or other review of SBA programs by the Office of Inspector General.

Completion of Program Term

The first proposed change to SBA's 8(a) BD regulations is an amendment to the current rule to specify that a firm that merely completes its program term is not deemed to ``graduate'' from the 8(a) program. Pursuant to the Small Business Act, a Participant is considered to graduate only if it successfully completes the program by substantially achieving the targets, objectives, and goals contained in the concern's business plan, thereby demonstrating its ability to compete in the marketplace without 8(a) assistance. 15 U.S.C. 636(j)(10)(H). Sections 124.2, 124.301 and 124.302 would be amended to effect this change. In addition, the proposed rule would add a new Sec. 124.112(f) to require SBA to determine if a firm should be deemed to graduate from the 8(a) BD program at the end of its nineyear program term. As part of the final annual review performed by SBA prior to the expiration of a Participant's nineyear program term, SBA would determine whether the firm has met the targets and objectives set forth in its business plan.

Definitional Changes

This rule would amend Section 124.3, to add a definition of NAICS code. Additionally, the term ``SIC code'' would be changed to ``NAICS code'' everywhere it appears in part 124 to take into account the replacement of the Standard Industry Classification (SIC) code system with the North American Industry Classification System. The NAICS code system is used to classify businesses for size purposes. Specifically, the term ``NAICS code'' would replace the term ``SIC code'' in Sec. Sec. 124.110(c), 124.111(d), 124.502(c)(3), 124.503(b), 124.503(b)(1), 124.503(b)(2), 124.503(c)(1)(iii), 124.503(g)(3), 124.505(a)(3), 124.507(b)(2)(i), 124.513(b)(1), 124.513(b)(1)(i), 124.513(b)(1)(ii)(A), 124.513(b)(2), 124.513(b)(3), 124.514(a)(1), 124.515(d), 124.517(d)(1), 124.517(d)(2), 124.519(a)(1), 124.519(a)(2), 124.1002(b)(1), 124.1002(b)(1)(i), 124.1002(b)(1)(ii), and 124.1002(f)(3).

The rule also proposes to amend the definition of primary industry classification to specifically recognize that a Participant may change its primary industry classification over time. The rule would allow a Participant to change its primary industry classification from one NAICS code to another where it can demonstrate that the majority of its revenues during a twoyear period have evolved from its former primary NAICS code to another NAICS code. The proposed rule would also add a new Sec. 124.112(e) to permit a Participant to request a change in its primary industry classification with its servicing SBA district office where it can demonstrate that its revenues have in fact evolved from one NAICS code to another.

The rule would also add a definition of the term ``regularly maintains an office.'' This definition is important in determining whether a participant has a bona fide place of business in a particular geographic location. While the definition proposed is not a change in current SBA policy, SBA believes that the definition should be added to the regulations for clarity purposes. Under the proposed rule, a Participant would be deemed to regularly maintain an office in a particular location if it conducts business activities as an ongoing business concern from a fixed location on a daily basis. The rule would also provide that the best evidence of the regular maintenance of an office is documentation that shows that third parties routinely transact
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business with a participant at that location. Such evidence includes advertisements, bills, correspondence, lease agreements, land records, and evidence that the participant has complied with all local requirements concerning registering, licensing, or filing with the State or County where the place of business is located. This means that a firm would generally be required to have a license to do business in a particular location in order to ``regularly maintain an office'' there. The firm would not, however, be required to have a construction license or other specific type of license in order to regularly maintain an office and thus have a bona fide place of business in a specific location. SBA's bona fide place of business requirement is met with a license to do business generally. Whether a firm is or is not able to get a specific type of contract because it does not possess an additional license is not a bona fide place of business issue. Size for Primary NAICS Code

This rule proposes to amend Sec. 124.102(a) to require that a firm remain small for its primary NAICS code during its term of participation in the 8(a) BD program, and correspondingly to revise Sec. 124.302 to permit SBA to graduate a Participant prior to the expiration of its program term where the firm exceeds the size standard corresponding to its primary NAICS code for two successive program years. SBA has historically permitted a firm to remain in the 8(a) program and receive 8(a) contracts in secondary NAICS codes as long as it remains small for such secondary codes. SBA has reexamined this policy and concluded that if a firm has grown to be other than small in its primary NAICS code, it can reasonably be said that the firm has achieved its goals and objectives. Understanding that the size of a firm can vary from year to year based on the receipts/number of employees in any given year, SBA is proposing that a firm be graduated early only where it exceeds the size standard for its primary NAICS code in two successive program years. SBA believes that it would be unfair to early graduate a firm from the 8(a) program where it has one very successful program year that may not again be repeated. This does not mean that a firm cannot change its primary NAICS code during its participation in the program. As noted in the Supplementary Information corresponding to the definition of primary industry classification in Sec. 124.3, the proposed rule would authorize a firm to change its primary NAICS code by demonstrating that the majority of its revenues during a twoyear period have evolved from its former primary NAICS code to another NAICS code. As such, SBA may early graduate a firm from the 8(a) BD program if the firm exceeds the size standard corresponding to its primary NAICS code (whether its initial primary NAICS code or a revised primary NAICS code) for two successive program years. Economic Disadvantage

SBA proposes to amend Sec. 124.104 Who is Economically Disadvantaged? to incorporate into the regulations certain interpretations and policies that have been followed informally by SBA. Some of these policies and regulatory interpretations are currently set forth in SBA's Standard Operating Procedures (SOPs) or in decisions rendered by the SBA Office of Hearings and Appeals (OHA). A sentence would be added to paragraph (b)(2) to clarify that SBA does not take community property laws into account when determining economic disadvantage. This means that property that is legally in the name of one spouse would be considered wholly that spouse's property, whether or not the couple lived in a community property state. Since community property laws are usually applied when a couple separates and since spouses in community states generally have the freedom to keep their property separate while they are married, SBA has decided to treat property owned solely by one spouse as that spouse's property for economic disadvantage determinations. This policy also results in equal treatment for applicants in community and noncommunity property states. Community property laws will continue to be applied in Sec. 124.105(k) for purposes of determining ownership of an applicant or Participant firm, but they will not be applied for any other purpose. Paragraph (b)(2) would also be amended to provide that SBA may consider a spouse's financial situation in determining an individual's access to capital and credit. This addition reflects current practice.

Paragraph (c)(2) would be amended to exempt funds in Individual Retirement Accounts (IRAs) and other official retirement accounts from the calculation of net worth provided that the funds cannot currently be withdrawn from the account prior to retirement age without a significant penalty. Retirement accounts are not assets to be currently enjoyed, rather they are held for purposes of ensuring future income when an individual is no longer working. SBA believes it is unfair to count those assets as current assets. Through experience SBA has found that the inclusion of IRA's and other retirement accounts in the calculation of an individual's net worth does not serve to disqualify wealthy individuals from participation in the program; rather, it has worked to make middle and lower income individuals ineligible to the extent they have invested prudently in accounts to ensure income at a time in their lives that they are no longer working. SBA is cognizant of the potential for abuse of this proposed provision, with individuals attempting to hide current assets in funds labeled ``retirement accounts.'' Obviously, SBA does not believe such attempts to remove certain assets from an individual's economic disadvantage determination would be appropriate. Therefore, it has added the condition that in order for funds not to be counted in an economic disadvantage determination, the funds cannot be currently withdrawn from the account without a significant penalty. A significant penalty would be one equal or similar to the penalty assessed by the Internal Revenue Service for early withdrawal. In order for SBA to determine whether funds invested in a specific account labeled a ``retirement account'' may be excluded from an individual's net worth calculation, the individual must provide to SBA information about the terms and conditions of the account. SBA is interested in hearing from the public concerning this proposed revision, and specifically requests comments on how best to exclude legitimate retirement accounts without affording others a mechanism to circumvent the economic disadvantage criterion.

SBA is also proposing to amend paragraph (c)(2) to exempt income from an S Corporation from the calculation of both income and net worth to the extent such income is reinvested in the firm or used to pay taxes arising from the normal course of operations of an S corporation. Therefore, while the income of an S corporation flows through and is taxed to individual shareholders in accordance with their interest in the S corporation for Federal tax purposes, SBA will take such income into account for economic disadvantage purposes only if it is actually distributed to the particular shareholder. This change would result in equal treatment of corporate income for C and S corporations. In cases where that income is reinvested in the firm or used to pay taxes arising from the normal course of operations of the S corporation and not retained by the individual, SBA believes it should be treated the same as C corporation
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income for purposes of determining economic disadvantage. In order to be excluded, the owner of the S corporation would be required to clearly demonstrate that he or she paid taxes of the S corporation or reinvested certain funds into the S corporation within 12 months of the distribution of income. Conversely, the owner of an S corporation could not subtract S corporation losses from the income paid by the S corporation to him/her or from the individual's total income from whatever source. S corporation losses, like C corporation losses, are losses to the company only, not losses to the individual, and based upon the legal structure of the corporation and the protections affording the principals through this structure, the individual is not personally liable for the debts representing any of those liabilities. Thus, it is inappropriate to consider these personal losses and individuals should not be able to use them to reduce their personal incomes.

A new paragraph (c)(3) would be added to provide that SBA would presume that an individual is not economically disadvantaged if his or her adjusted gross income averaged over the past two years exceeds $200,000. SBA considered incorporating into the regulation the present policy that an individual is not economically disadvantaged if his or her adjusted gross income exceeds that for the top two percent of all wage earners according to Internal Revenue Service (IRS) statistics. Under the current approach, SBA compares the income of the individual claiming disadvantage to the most currently available final IRS income tax return data. In some cases, SBA may be comparing IRS information relating to one tax year to an individual's income from a succeeding tax year because final IRS information is not available for that succeeding tax year. Although that policy has been upheld by SBA's OHA and the Federal courts (see SRS Technologies v. United States, 894 F. Supp. 8 (D.D.C. 1995); Matter of Pride Technologies, Inc., SBA No. 557 (1996) SBA No. MSB557), SBA believes that a straight line numerical figure is more understandable, easier to implement, and avoids any appearance of unfair treatment when statistics for one tax year are compared to an income level for another tax year. SBA is proposing an income level of $200,000 because that figure closely approximates the income level corresponding to the top two percent of all wage earners, which has been upheld as a reasonable indicator of a lack of economic disadvantage. Although a $200,000 income may seem unduly high as a benchmark, we note that this amount is being used only to presume, without more information, that the individual is not economically disadvantaged. We also note that average income for a small business owner is higher than average income for the population at large. SBA may consider incomes lower than $200,000 as indicative of lack of economic disadvantage. However, it would not presume lack of economic disadvantage in that case. It may also consider income in connection with other factors when determining an individual's access to capital. SBA specifically requests comments on both the straight line approach proposed and the current comparison of income levels to the IRS statistics. The rule also proposes to establish a two year average income level of $250,000 for continued 8(a) BD program eligibility. SBA believes that a higher income level may be more appropriate as a firm becomes more developed, but does not want to sanction too high a level. SBA requests comments on the $250,000 level, including whether the same $200,000 level should be used for both initial and continued 8(a) BD eligibility and whether some other level (e.g., $225,000) should be used for continued eligibility.

The proposed regulation would permit applicants to rebut the presumption of lack of economic disadvantage upon a showing that the income is not indicative of lack of economic disadvantage. For example, the presumption could be rebutted by a showing that the income was unusual (inheritance) and is unlikely to occur again or that the earnings were offset by losses as in the case of winnings and losses from gambling resulting in a net gain far less than the actual income received. SBA may still consider any unusual earnings or windfalls as part of its review of total assets. Thus, although an inheritance of $5 million, for example, may be unusual income and excluded from SBA's determination of economic disadvantage based on income, it would not be excluded from SBA's determination of economic disadvantage based on total assets. In such a case, a $5 million inheritance would render the individual not economically disadvantaged based on total assets. This paragraph would also provide that S corporation income will not be considered in determining an individual's average income if the S corporation owner submits evidence that such income was reinvested in the firm or used to pay corporate taxes within 12 months of the distribution of income. Again, while the income of an S corporation flows through and is taxed to individual shareholders in accordance with their interest in the S corporation, SBA will take such income into account only if it is actually distributed to the particular shareholder.

This rule also proposes to amend Sec. 124.104(c) to establish an objective standard by which an individual can qualify as economically disadvantaged based on his or her total assets. The regulations have historically authorized SBA to use total assets as a basis for determining economic disadvantage, but did not identify a specific level below which an individual would be considered disadvantaged. The regulations also did not spell out a specific level of total assets above which an individual would not qualify as economically disadvantaged. Although SBA has used total assets as a basis for denying an individual participation in the 8(a) BD program based on a lack of economic disadvantage, the precise level at which an individual no longer qualifies as economically disadvantaged is not certain. SBA's findings that an individual was not economically disadvantaged with total asset levels of $4.1 million and $4.6 million have been upheld as reasonable. See Matter of Pride Technologies, SBA No. 557 (1996), and SRS Technologies v. U.S., 843 F. Supp. 740 (D.D.C. 1994).
Alternatively, SBA's finding that an individual was not economically disadvantaged with total assets of $1.26 million was overturned. See Matter of Tower Communications, SBA No. 587 (1997). This rule proposes to eliminate any confusion as to what level of total assets qualifies as economic disadvantage for 8(a) BD purposes. Under the proposed rule, an individual would not be considered economically disadvantaged if the fair market value of all his or her assets exceeds $3 million at the time of 8(a) application and $4 million for purposes of continued 8(a) BD program participation. While the proposed rule would exclude retirement accounts from an individual's net worth in determining economic disadvantage, it would not exclude such amounts from the individual's total assets in determining economic disadvantage on that basis.

Changes to Ownership Requirements

SBA is proposing to amend Sec. 124.105(g) governing ownership to provide more flexibility in determining whether to admit to the 8(a) program companies owned by individuals where such individuals have immediate family members who are owners of current or
[[Page 55700]]
former 8(a) concerns. The current rule provides that ``the individuals determined to be disadvantaged for purposes of one Participant, their immediate family members, and the Participant itself, may not hold, in the aggregate, more than a 20 percent equity ownership interest in any other single Participant.'' Because of the wording of that provision, SBA has been forced to deny 8(a) program admission to companies solely because the owners of those firms have family members who are disadvantaged owners of other 8(a) concerns. In some cases, the two firms are in different industries and are located in different parts of the country.

SBA believes that it serves no purpose to automatically disqualify a firm simply because the individual seeking to qualify the firm has an immediate family member already participating in the program. Although there may be situations in which SBA would choose to deny admission to a firm based on a family member's program participation, such a decision must necessarily be made on a casebycase basis. For example, SBA may wish to deny admission to the program to a construction firm owned by a woman whose father owns an 8(a) firm in the construction industry where the program term of the father's firm is about to end, if it appears that the daughter does not have sufficient management experience to manage the firm and there are indications that the applicant is simply a front for the current firm.

In order to prevent disadvantaged individuals from using family members to extend their program terms and to prevent fronts, SBA proposes to amend Sec. 124.105(g) to provide that an individual may not use his or her disadvantaged status to qualify a firm if such individual has an immediate family member who has used his or her disadvantaged status to qualify another firm for participation in the 8(a) BD program. However, the proposed rule will permit the SBA's Associate Administrator for Business Development (AA/BD) to waive this prohibition under certain circumstances. Those circumstances are similar to the clear line of fracture exception to the identity of interest rule in the size regulations.

SBA would waive the prohibition where there are no or negligible connections between the two firms, either in the form of ownership, control or contractual relations, and where the individual seeking to use his or her disadvantaged status to qualify the firm can demonstrate he or she has sufficient management and technical experience to operate the firm. If a firm seeking a waiver is in the same or similar line of business as a current or former 8(a) Participant of a family member, there would be a presumption against granting a waiver. The applicant must provide clear and compelling evidence that no connection exists between the two firms.

SBA believes that this narrow exception to the general prohibition against family members owning 8(a) concerns in the same or similar line of business will permit the Agency sufficient flexibility to admit firms where they are clearly operating separately and independently from the relative's firm. SBA also proposes to add a provision specifying that it may terminate an 8(a) concern for which it had granted a waiver if connections between the two firms become apparent (e.g., sharing of employees, contractual relationships between the two firms) or if that firm begins to operate in the same or a similar line of business as the current or former 8(a) concern owned by the disadvantaged immediate family member.

SBA also proposes to amend Sec. 124.105 to add a phrase that was inadvertently omitted from the current rule. The words ``or a principal of such firm'' were inadvertently omitted from Sec. 124.105(h)(2) after the words ``A nonParticipant concern.'' That provision prohibits concerns in the same or a similar line of business as an 8(a) concern from owning more than a 10 percent interest in an 8(a) concern in the developmental stage of program participation or more than a 20 percent interest in a Participant in the transitional stage of the program. The intent was to also prohibit principals of such concerns from owning these same percentages. However, the necessary language to effect this was inadvertently omitted. This omission is made particularly evident by the rule permitting former Participants and principals of former Participants to own up to 20 percent of a program Participant in the developmental stage of program participation and up to 30 percent of a Participant in the transitional stage. The anomalous result of the omission was to permit principals of non8(a) concerns to own greater percentages of 8(a) firms in the same or similar line of business than principals of former 8(a) concerns even though the clear intent of the rule was to afford former 8(a) firms and their principals greater ownership rights. SBA has corrected that error in this proposed rule. Changes to Control Requirements

SBA also proposes to amend Sec. 124.106, which addresses control of an 8(a) applicant or Participant. SBA proposes to add an additional requirement to this section that the disadvantaged manager of an 8(a) applicant or Participant must reside in the United States and spend part of every month physically present at the primary offices of the applicant or Participant. This change is being proposed in response to a recent Small Disadvantaged Business (SDB) eligibility appeal before SBA's Office of Hearings and Appeals. In OHA's decision on that case, which was vacated on other grounds, the Administrative Judge held that a disadvantaged owner of a firm seeking SDB status controlled the firm from her residence in Paris, France. SBA believes that an individual seeking to qualify as eligible for the SBA's 8(a) BD program must reside in the United States. There is a presumption in the regulations for such residency, but it is not explicit. The regulations require an individual seeking 8(a) eligibility to be a citizen of the United States and individuals who are nondesignated group members are required to establish their individual social disadvantage based on instances of bias or discrimination ``in American society, not in other countries.'' In addition, SBA believes that in order for an individual to exercise the requisite degree of control of an 8(a) firm, such individual must be physically present at the offices of the firm at least part of every month. In SBA's view, the potential for negative control is great when an individual onsite manager is relied on by an absent chief executive. The proposed rule would also add a conforming change to the general requirements for 8(a) BD eligibility contained in Sec. 124.104(a) to recognize the residency requirement.

The Agency recognizes that the 21st century has created new opportunities for offsite management through the increased use of e mail and overnight express and decreasing interstate and international telephone costs, and that these new and improved technologies enable managers to maintain control over the operations of their businesses without the need for a constant or consistent physical presence. Nevertheless, SBA believes that in order to prevent negative control and to ensure that the disadvantaged majority owner(s) are the true managers of the 8(a) concern or applicant, the disadvantaged manager must generally be present in the firm's primary offices at least part of every month and must be
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able to physically reach the firm in a matter of a few hours from his or her residence should the need arise. SBA considered requiring physical presence by the individual(s) claiming disadvantaged status in the headquarters of the applicant or participant firm for a minimum amount of time each month (e.g., 10 hours, 20 hours, or some other higher number of hours) and specifically asks for comments on whether such a requirement makes sense in today's world (and, if so, what should the minimum number of hours be) or whether control should be determined on a casebycase basis. SBA also understands that any provision requiring presence in every month may be unworkable. With such a strict requirement, a disadvantaged owner who took a monthlong vacation one year would be ineligible for continued 8(a) BD participation. As such, the proposed rule has the requirement that a disadvantaged owner must ``generally'' spend part of every month at the firm's principal office, imposing a monthly presence requirement while at the same time allowing for unusual circumstances in any given month.

Section 124.106 would also be amended by deleting the word ``such'' from the second sentence in the preamble of paragraph (e) so as to make clear that paragraphs (e)(1) and (e)(2) apply to all nondisadvantaged individuals and not just to those nondisadvantaged individuals involved in the management of an applicant or Participant or who are stockholders, partners, limited liability members, officers, or directors of the applicant or Participant. This change is needed to correct a misinterpretation of this regulation by SBA's Office of Hearings and Appeals (OHA). That decision, In the Matter of Avasar Corporation, No. 209 (August 24, 2004), incorrectly held that paragraphs (a)(1), (a)(2), and (a)(3) as well as paragraph (g) of Sec. 124.106 concerning nondisadvantaged control, applied only to non disadvantaged individuals involved in the management of an applicant or Participant, or stockholders, partners, limited liability members, officers, and/or directors of the applicant or Participant. The result of that decision was that under certain circumstances, non
disadvantaged individuals would be permitted to control an 8(a) concern. This is an absurd result and contrary to statute. The proposed change makes it clear that the above paragraphs apply to all non disadvantaged individuals, regardless of their current or former relationship to the applicant or Participant.

The proposed rule would also add a new Sec. 124.106(h) regarding control of an 8(a) BD Participant where a disadvantaged individual upon whom eligibility is based is a reserve component member in the United States military who has been called to active duty. Currently, there is no statutory or regulatory authority to permit such a firm to stay in the 8(a) BD program, whether on an active or inactive basis, while the individual upon whom eligibility is based is away from the firm for an extended period of time. Some have even questioned whether SBA should in fact terminate such a firm from the 8(a) BD program for failure to maintain control by one or more disadvantaged individuals. SBA believes that termination in these circumstances would be inappropriate. Specifically, the proposed rule would permit a Participant to designate one or more individuals to control its daily business operations during the time that a disadvantaged individual upon whom eligibility has been called to active duty in the United States military. The proposed rule would also amend Sec. 124.305 to authorize the Participant to suspend its 8(a) BD participation during the active duty callup period. If the Participant elects to designate one or more individuals to control the concern on behalf of the disadvantaged individual during the active duty callup period, the concern will continue to be treated as an eligible 8(a) Participant and no additional time will be added to its program term. If the Participant elects to suspend its status as an eligible 8(a) Participant, the Participant's program term would be extended by the length of the suspension when the individual returns from active duty.

Benchmarks

The proposed rule would remove Sec. 124.108(f), as well as other references to the achievement of benchmarks contained in Sec. Sec. 124.302(d), 124.403(d), and 124.504(d). When these regulations were first implemented, the Department of Commerce was supposed to update industry codes every few years to determine those industries which minority contractors were underrepresented in the Federal market. It is SBA's view that because these industry categories have never been revised since the initial publication, references to them are outdated and should be removed.

Changes Applying Specifically to TriballyOwned Firms

The Small Business Act permits 8(a) Participants to be owned by ``an economically disadvantaged Indian tribe (or a wholly owned business entity of such tribe).'' 15 U.S.C. 637(a)(4)(A)(i)(II). The term Indian tribe includes any Alaska Native village or regional corporation. 15 U.S.C. 637(a)(13). Pursuant to the Alaska Native Claims Settlement Act, a concern which is majority owned by an Alaska Native Corporation (ANC) is deemed to be both owned and controlled by Alaska Natives and an economically disadvantaged business. As such, ANCs do not have to establish that they are ``economically disadvantaged.'' Conversely, Indian tribes are not afforded the same automatic statutory economic disadvantage designation. Current Sec. 124.109(b) requires tribes to demonstrate their economic disadvantage through the submission of data, including information relating to tribal unemployment rate, per capita income of tribal members, and the percentage of the tribal population below the poverty level. SBA requests comments on how best to determine whether a tribe should be considered ``economically disadvantaged.'' Some have advocated a bright line assets or net worth test for tribes. SBA is not convinced that such a test truly captures the economic disadvantage status of a tribe. SBA continues to believe that the factors set forth in current Sec. 124.109(b)(2) paint a truer picture, but specifically requests comments from tribes on this issue. The current regulation also requires a tribe to demonstrate its economic disadvantage only once. SBA also requests comments regarding whether this one time demonstration of economic disadvantage makes sense.

The proposed rule would also amend Sec. 124.109(c)(3)(ii) to more clearly define the type of work that a triballyowned firm may perform in the 8(a) program. One of the goals of the 8(a) BD program is to develop businesses to the point where they can be independent, viable businesses when they graduate or otherwise leave the 8(a) BD program. In order to encourage a triballyowned firm to continue to operate as an independent business after it leaves the 8(a) BD program, SBA has prohibited for many years a triballyowned applicant from having the same primary NAICS code as another firm in the 8(a) BD program owned by the same tribe or one that has left the program within the last two years. It could perform secondary work in such a NAICS code, but it could not duplicate the primary NAICS code of another or recently former triballyowned 8(a) Participant. SBA believed that this requirement would encourage tribes to expand their business activities [[Page 55702]]
by having two or more viable businesses doing separate and distinct work. In some cases, however, SBA admitted a second triballyowned firm into the 8(a) BD program under one primary NAICS code and it immediately began to perform all or most of its work in a NAICS code that was the primary NAICS code of a firm owned by the tribe that recently graduated from the 8(a) BD program. This is not what SBA envisioned. Again, the purpose of the 8(a) BD program is to promote business development. Having one business take over work previously performed by another does not advance the business development of two distinct firms. In order to further encourage the continued, longterm viability of two separate businesses, this rule proposes that a newly certified triballyowned Participant cannot receive an 8(a) contract in a secondary NAICS code that is the primary NAICS code of another Participant (or former participant that has left the program within two years of the date of application) owned by the tribe for a period of two years from the date of admission to the program. SBA also considered allowing such secondary work on a limited basis (e.g., no more than 20% or 30% of its 8(a) work could be in a NAICS code that was/is the primary NAICS code of a former/other triballyowned Participant). SBA seeks comments on both approaches.

SBA also proposes to delete the word ``disadvantaged'' in Sec. 124.109(c)(4) to make clear that any tribal member may participate in the management of a triballyowned firm and need not individually qualify as economically disadvantaged. Under current rules, a tribal member would generally have to qualify as economically disadvantaged to run the daily business operations of a triballyowned concern. Tribal representatives emphasized the need for this change to enable them to attract the most qualified tribal members to assist in running tribal businesses and further allow them to assist economic and community development through their triballyowned concerns. SBA agrees that the current rule is overly restrictive and proposes this change. This change would also eliminate the requirement that directors and officers must submit copies of their individual tax returns to establish their economic disadvantage. If, however, there is a question as to whether an individual filed taxes, SBA could request proof of payment of taxes to satisfy the good character requirement. SBA also requests specific comments on whether the individuals involved in the management of a triballyowned concern should be members of the tribe that owns the concern or, in the alternative, whether membership in any tribe should suffice. Currently, the regulations generally require management by individuals who are members of the tribe that owns the concern. SBA requests comments on whether that is too restrictive for the tribal community.

This rule also proposes to clarify the potential for success requirement for triballyowned applicants contained in Sec. 124.109(c)(6). SBA believes that the current regulation does not adequately capture the realities of triballyowned firms. In substantial part, the current regulation for potential for success applicable to triballyowned firms is the same as that applicable to firms owned by socially and economically disadvantaged individuals. Under the current rule, the firm must generally be in business for two years and have revenues in its primary industry classification. A firm that is in business for less than two years may be deemed to possess the necessary potential for success if the individuals who manage and control its daily operations have substantial technical and managerial experience, the applicant has a record of successful performance on contracts in its primary industry category, and the applicant has adequate capital to sustain its business operations. SBA believes that those two approaches continue to be valid ways to find that a tribally owned firm meets the potential for success requirement. In addition, SBA believes that a third basis to find potential for success should be made available to triballyowned firms. It is undisputed that a firm owned by a tribe may have financial and physical resources available to it that a firm owned by one or more disadvantaged individuals may not have. While a firm owned by disadvantaged individuals is designed to make a profit and its survivability depends on its ability to do so, that is not necessarily the case for a triballyowned concern. The purpose of a triballyowned concern may be to increase tribal employment, assist in tribal community development, or serve other tribal needs. If a tribe pledges to use the resources of the tribe to support an applicant concern and to not allow that concern to cease its operations, SBA believes that the concern should be deemed to meet the potential for success requirement. As such, this rule proposes to find potential for success where a tribe has made a firm written commitment to support the operations of the applicant concern and the tribe has the financial ability to do so.

The Government Accountability Office (GAO) and SBA's Office of Inspector General have recently reviewed participation in the 8(a) BD program by firms owned by ANCs. These reviews questioned certain aspects of SBA's oversight of ANCowned firms. In particular, there was a concern that SBA did not adequately track the extent to which the benefits of the 8(a) BD program reached individual Alaska natives or the native community. As such, SBA proposes to amend the requirements for annual reviews contained in Sec. 124.112(b) to require the submission of such information. SBA also believes that the same reporting requirements should apply to 8(a) Participants owned by tribes, Native Hawaiian Organizations (NHOs), and Community Development Corporations (CDCs). Specifically, the proposed rule would require each Participant owned by a tribe, ANC, NHO or CDC to submit information showing how its 8(a) participation has benefited the tribal or native members and/or the tribal, native or other community as part of its annual review submission. The firm should submit information relating to funding cultural programs, employment assistance, jobs, scholarships, internships, subsistence activities, and other services to the affected community.

Excessive Withdrawals

The proposed rule would also amend Sec. 124.112(d) requiring what amounts should be considered excessive withdrawals, and thus a basis for possible termination or early graduation. SBA believes that the current definition of withdrawal unreasonably restricts Participants. For example, by including the income of all officers and all bonuses, a Participant is hampered in its ability to recruit and retain key employees or to pay fair wages to its officers. Under the current regulation, if the income of all officers in the aggregate exceeds $300,000 for a multimillion dollar firm, the income alone would be deemed ``excessive'' and could be a basis for termination or early graduation. SBA believes that this does not make sense, particularly in light of the income level permitted in determining economic disadvantage. In determining whether an individual is e

FOR FURTHER INFORMATION CONTACT

LeAnn Delaney, Deputy Associate Administrator, Office of Business Development, at (202) 2055852, or leann.delaney@sba.gov.

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