82 FR 39335 - Small Business Investment Companies: Passive Business Expansion and Technical Clarifications

SMALL BUSINESS ADMINISTRATION

Federal Register Volume 82, Issue 159 (August 18, 2017)

The U.S. Small Business Administration (SBA) is withdrawing the final rule concerning Small Business Investment Company (SBIC) investments in passive businesses that was published on December 28, 2016, and is replacing it with this final rule. This final rule expands SBIC permitted investments in passive businesses and includes new reporting and other requirements for passive investments. This rule also makes a few minor technical amendments.

[Federal Register Volume 82, Number 159 (Friday, August 18, 2017)]
[Rules and Regulations]
[Pages 39335-39341]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2017-17456]



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Federal Register / Vol. 82, No. 159 / Friday, August 18, 2017 / Rules 
and Regulations

[[Page 39335]]



SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

RIN 3245-AG67


Small Business Investment Companies: Passive Business Expansion 
and Technical Clarifications

AGENCY: U.S. Small Business Administration.

ACTION: Final rule and withdrawal of final rule.

-----------------------------------------------------------------------

SUMMARY: The U.S. Small Business Administration (SBA) is withdrawing 
the final rule concerning Small Business Investment Company (SBIC) 
investments in passive businesses that was published on December 28, 
2016, and is replacing it with this final rule. This final rule expands 
SBIC permitted investments in passive businesses and includes new 
reporting and other requirements for passive investments. This rule 
also makes a few minor technical amendments.

DATES: As of August 18, 2017, the final rule published December 28, 
2016 (81 FR 95424), delayed until March 21, 2017, on January 26, 2017 
(82 FR 8499), further delayed until May 20, 2017, on March 21, 2017 (82 
FR 14428), and further delayed until August 18, 2017, on May 2, 2017 
(82 FR 20433), is withdrawn. The amendments in this rule are effective 
September 18, 2017.

FOR FURTHER INFORMATION CONTACT: Theresa Jamerson, Office of Investment 
and Innovation, (202) 205-7563 or [email protected].

SUPPLEMENTARY INFORMATION:

I. Background Information

    The SBIC Program is an SBA financing program authorized under Title 
III of the Small Business Investment Act of 1958, 15 U.S.C. 681 et seq. 
Congress created the Small Business Investment Company (SBIC) program 
to ``stimulate and supplement the flow of private equity capital and 
long-term loan funds, which small-business concerns need for the sound 
financing of their business operations and for their growth, expansion, 
and modernization, and which are not available in adequate supply. . . 
.'' 15 U.S.C. 661. Congress intended that the program ``be carried out 
in such manner as to insure the maximum participation of private 
financing sources.'' Id. In accordance with that policy, SBA does not 
invest directly in small businesses. Rather, through the SBIC Program, 
SBA licenses and provides debenture leverage (Leverage) to SBICs. SBICs 
are privately-owned and professionally managed for-profit investment 
funds that make loans to, and investments in, qualified small 
businesses using a combination of privately raised capital and Leverage 
guaranteed by SBA. SBA will guarantee the repayment of debentures 
issued by an SBIC up to a maximum of $150 million or three times the 
amount of the SBIC's qualifying private capital, whichever is less 
(although pursuant to SBA's regulations and credit policies, SBA rarely 
approves an SBIC to have a maximum amount of Leverage outstanding in 
excess of two times the amount of the SBIC's qualifying private 
capital).
    SBICs are generally prohibited from investing in passive businesses 
under the Act. Prior to this final rule, the SBIC program regulations 
provided for the following two exceptions that allowed an SBIC to 
structure an investment utilizing a passive small business as a pass-
through:
    A. ``Holding company exception''--Sec.  107.720(b)(2): This 
exception provides conditions under which an SBIC may structure an 
investment through up to two levels of passive entities to make an 
investment in a non-passive business that is a subsidiary of the 
passive business directly financed by the SBIC. The regulation defines 
a subsidiary company as one in which the financed passive business 
directly or indirectly owns at least 50% of the outstanding voting 
securities. As an example, this exception allows an SBIC to finance ABC 
Holdings 1, a passive small business, with the proceeds flowing through 
ABC Holdings 2, another passive small business, and then to ABC 
Manufacturing, a non-passive small business in which ABC Holdings 1 
owns directly or indirectly at least 50% of the outstanding voting 
securities.
    B. ``Blocker corporation exception''--Sec.  107.720(b)(3): This 
exception enables a partnership SBIC, with SBA's prior approval, to 
provide financing to a small business through a passive, wholly-owned C 
corporation, but only if a direct financing would cause one or more of 
the SBIC's investors to incur Unrelated Business Taxable Income (UBTI). 
A passive C corporation formed under the second exception is commonly 
known as a blocker corporation.
    On October 5, 2015, SBA published a proposed rule, Small Business 
Investment Companies: Passive Business Expansion and Technical 
Clarifications (80 FR 60077), to further expand the permitted use of 
passive businesses, provide clarification with regard to investments in 
such businesses, and make minor technical clarifications. SBA received 
three comments on the proposed rule, not including one comment that 
generally questioned the fairness of the Act as a whole and did not 
provide any specific comments on the rule. The three comments pertinent 
to the rule are addressed in Section II.
    On December 28, 2016, SBA published a final rule regarding SBIC 
investments in passive businesses, 81 FR 95419, which had an effective 
date of January 27, 2017. On January 26, 2017, SBA published a notice 
in the Federal Register at 82 FR 8499, to delay the effective date of 
the final rule until March 21, 2017, and to re-open the rule for 
additional public comment in accordance with the memorandum dated 
January 20, 2017, from the Assistant to the President and Chief of 
Staff, entitled ``Regulatory Freeze Pending Review.'' SBA received one 
comment that supported the December 2016 final rule. On March 21, 2017, 
SBA published another notice to delay the effective date of the final 
rule until May 20, 2017, to give the new administration time to further 
consider the rule. 82 FR 14428. After completing its review, SBA issued 
another delay notice at 82 FR 20433 (May 2, 2017), which stated that 
SBA was considering removing a provision in the final rule published on 
December 28, 2016 that would allow SBICs to use a blocker corporation 
if an investor in an SBIC had elected to be taxed as a regulated 
investment company (RIC), and if a direct investment into the operating 
company

[[Page 39336]]

would jeopardize the investor's RIC status. As part of this document, 
SBA asked for additional comments regarding the removal of this 
provision, and delayed the effective date of the December 28, 2016 
final rule until August 18, 2017. SBA received one comment in response 
to its proposed change. This comment is addressed in Section II.
    SBA is withdrawing the final rule published on December 28, 2016, 
and is replacing it with this final rule. This final rule expands 
permitted investments in passive businesses, provides further 
clarification with regard to investments in such businesses, and adds 
certain requirements to improve SBA's ability to monitor such 
investments. The rule also includes a conforming change to the 
regulations regarding the amount of Leverage available to SBICs under 
common control to be consistent with the Consolidated Appropriations 
Act, 2016, Public Law 114-113, 129 Stat. 2242 (December 22, 2015), 
which increased the maximum amount of such Leverage from $225 million 
to $350 million.

II. Section-by-Section Analysis

    This section discusses the comments SBA received on the proposed 
rule dated October 5, 2017 (80 FR 60077), as well as the comment 
received in response to the notice published on May 2, 2017 (82 FR 
20433).

A. Passive Business Rules

Section 107.720--Small Businesses That May Be Ineligible for Financing
    1. Changes to Holding Company Exception Sec.  107.720(b)(2): SBA 
proposed revisions to Sec.  107.720(b)(2) to explicitly permit an SBIC 
to form and finance a passive business that will either pass the 
proceeds through to or use the proceeds to acquire all or part of a 
non-passive business. These changes were intended to codify SBA's 
existing interpretation of the regulations.
    SBA received two comments on Sec.  107.720(b)(2) indicating that 
the proposed changes would be more effective if the passive business 
directly financed was not required to own at least 50 percent of the 
underlying active business. Commenters also suggested that SBICs be 
allowed to structure investments using passive investment vehicles 
``irrespective of the number of parent entities involved so long as the 
parent entities in question directly or indirectly own or control at 
least 50 percent of the voting or economic interests of the active 
business.'' SBA received similar comments as part of the rulemaking 
process when it last proposed expanding the permitted use of passive 
businesses on December 23, 2013 (78 FR 77377). SBA considered these 
comments a second time in developing this final rule; however, neither 
set of comments was adopted. SBA believes that complex investment 
structures involving passive entities require more protections, not 
fewer. Although the new Sec.  107.720(b)(4) should help address some of 
SBA's credit concerns with respect to these structures, SBA believes 
that the subsidiary relationship between the financed passive business 
and the active company must be maintained to facilitate SBA's access to 
the information and records needed to effectively monitor these 
transactions and to aid in the recovery of assets in the event of a 
default. SBA also maintains its position that effective monitoring of 
transactions with unlimited levels of passive companies would require 
resources well beyond those available to the Agency. Proposed Sec.  
107.720(b)(2) is adopted without change.
    2. Changes to Blocker Corporation Exception--Sec.  107.720(b)(3): 
The proposed rule included the following changes to Sec.  
107.720(b)(3):
    a. Removing the requirement to obtain SBA's prior approval to form 
a blocker corporation;
    b. Permitting an SBIC to form a blocker corporation to enable any 
foreign investors to avoid effectively connected income (ECI) under the 
Internal Revenue Code;
    c. Permitting a blocker corporation to provide financing to a 
second passive small business that passes the proceeds through to a 
non-passive small business in which it owns at least 50 percent of the 
outstanding voting securities (effectively permitting an investment 
structured with two levels of passive companies, one of which is the 
blocker corporation); and
    d. Removing outdated language indicating that an SBIC's ownership 
of a blocker corporation formed under Sec.  107.720(b)(3) will not 
constitute a violation of Sec.  107.865(a). This provision was rendered 
unnecessary by a rule change in 2002 (67 FR 64789) that revised Sec.  
107.865(a) to permit an SBIC to exercise control over a small business 
for up to seven years without SBA approval.
    SBA received comments on proposed Sec.  107.720(b)(3) as discussed 
below:
    a. Regulated Investment Company (RIC) Exception. All three 
commenters asked that the regulations provide an additional exception 
for SBICs that are wholly owned subsidiaries of Business Development 
Companies (BDCs). A BDC typically elects to be taxed as a RIC pursuant 
to Subchapter M of the Internal Revenue Code of 1986. In general, a RIC 
is not subject to U.S. Federal income taxes on income and gains that it 
distributes to stockholders, provided that it satisfies certain minimum 
distribution requirements. To qualify as a RIC, a BDC must satisfy 
certain source of income and asset-diversification tests; among other 
things, a RIC must generally derive at least 90% of its gross income 
for each taxable year from certain types of investment. In particular, 
the commenters explained that equity interests in pass-through entities 
(such as an LLC or S corporation) generate operating income that, if 
received or deemed received directly by a BDC, could disqualify the BDC 
from maintaining RIC status, and therefore, such interests must often 
be held through a blocker corporation. The commenters requested that 
Sec.  107.720(b)(3) be revised to permit an SBIC to form a blocker 
corporation to avoid adverse tax consequences to an investor (typically 
a parent BDC) that has elected to be taxed as a RIC.
    The final rule published on December 28, 2016 (81 FR 95419) adopted 
this comment. However, in the delay notice published on May 2, 2017 (82 
FR 20433), SBA stated that it was considering removing this provision 
and solicited comment from the public on that proposed action. The 
notice cited SBA's concern that, in light of the increased complexities 
involved in monitoring and examining investments structured through 
blocker entities, the expanded use of such entities could increase risk 
to the SBIC program unless SBA were to increase examination resources 
to monitor these complex transactions. The notice further explained 
that while SBA expects limited use of blocker entities for the purposes 
of avoiding UBTI and ECI (because these situations apply to only a few 
SBICs), SBA would expect significantly greater usage of blocker 
entities by SBICs that are subsidiaries of BDCs that have elected to be 
taxed as RICs. Currently, there are 31 SBICs with BDC investors (BDC-
SBICs) that collectively account for over 23% of SBA's outstanding 
Leverage, and SBA expects that most of them would make use of blocker 
entities if the RIC exception were to be finalized.
    SBA received one comment stating that not including the RIC 
exception would prevent BDC-SBICs from taking equity positions and 
benefiting from the upside afforded by equity investments. While the 
commenter strongly

[[Page 39337]]

supported SBA's goal of protecting taxpayers, the commenter believed 
that this goal may be better served by including the RIC exception and 
thereby increasing a BDC-SBIC's potential for maximizing profits. The 
commenter further noted that the profits from a single successful 
equity investment can offset losses on other investments and that SBA's 
guarantee is protected by a BDC-SBIC's portfolio as a whole. The 
commenter suggested that SBA consider creating the RIC exception, but 
making the exception subject to SBA prior approval. SBA recognizes that 
not including the RIC exception for blocker corporations limits a BDC-
SBIC's ability to execute some transactions; however, due to the large 
amount of outstanding Leverage held by BDC-SBICs, SBA remains concerned 
that these investments would unacceptably increase risk to SBA absent 
an increase in SBA's resources to monitor and examine such investments. 
Adding a requirement for SBA's prior approval of a blocker entity does 
not address this concern; SBA would still need to review and approve 
the transactions and examine each of the passive businesses used in the 
transaction. For this reason, this final rule does not include the RIC 
exception. SBA notes that BDC-SBICs may still take equity positions in 
small businesses not structured as pass through entities and also may 
invest using any passive structure permitted under Sec.  107.720(b)(2).
    b. Blocker Entity Form of Organization. At the proposed stage of 
this rule, SBA received two comments suggesting that non-corporate 
forms of organization should be permitted for blocker entities. The 
commenters explained that these structures are often ``more streamlined 
in terms of corporate formalities than a C corporation'' and suggested 
the regulations allow ``any entity that elects to be taxed as a 
corporation for Federal income tax purposes.'' SBA considered this 
suggestion to be overly broad, but partially adopted this suggestion in 
this final rule by allowing a blocker entity to be structured as an LLC 
that elects to be taxed as a corporation.
    c. Two Level Holding Company Financing. Two commenters indicated 
that Sec.  107.720(b)(3) should allow SBICs to structure a financing 
with a blocker entity coupled with two additional levels of passive 
holding companies as defined in Sec.  107.720(b)(2). The commenters 
stated that the proposed rule puts an SBIC that requires a blocker 
entity to accommodate its investors at a disadvantage compared to other 
SBICs that do not require a blocker entity, since the blocker entity 
can only finance a single passive business entity that in turn makes an 
investment into an active business. For example, an SBIC with a foreign 
investor would not be able to participate in a financing that is 
structured as a two-level passive business financing under Sec.  
107.720(b)(2), if it also needed a separate passive business to serve 
as a blocker entity in order to avoid effectively connected income. If 
adopted, this suggestion would effectively permit up to three levels of 
passive businesses between the SBIC and the operating business. These 
additional levels of passive businesses impose a burden on SBA as 
regulator and increase the Agency's credit risk. SBA believes that two 
levels of passive businesses under either exception should provide 
SBICs with sufficient flexibility to operate successfully, and this 
final rule does not adopt the suggested change.
    d. SBA did not receive any comments on the proposed change to Sec.  
107.720(b)(3) regarding the removal of outdated language. This rule 
adopts the change as proposed.
    3. Additional Passive Business Guidance--Sec.  107.720(b)(4): The 
proposed rule identified SBA's concerns with regard to passive 
investments, including ensuring the financing dollars go to the 
eligible non-passive small business, fees being charged at each passive 
business level, and SBA's ability to access passive business financial 
records, especially in the case of a defaulting SBIC. To address these 
concerns, SBA proposed making the following changes in new Sec.  
107.720(b)(4), which would apply to any eligible passive investment 
made under Sec.  107.720(b)(2) or (b)(3):
    a. ``Substantially All'' Definition. Clarifying the meaning of 
``substantially all'' in Sec.  107.720(b)(2) and (b)(3) to mean 99 
percent of the financing proceeds after deduction of actual application 
fees, closing fees, and expense reimbursements, which may not exceed 
those permitted under Sec.  107.860.
    b. Fee Requirements. Requiring fees charged by an SBIC or its 
Associate under Sec. Sec.  107.860 and 107.900 to not exceed those 
permitted if the SBIC had directly financed the eligible Small Business 
and requiring any such fees received by an SBIC's Associate to be paid 
to the SBIC in cash within 30 days of receipt.
    c. ``Portfolio Concern'' Clarification. Clarifying that both 
passive and non-passive businesses included in a financing are 
``Portfolio Concerns''; therefore, they are subject to record keeping 
and reporting obligations with respect to any ``Portfolio Concern,'' 
defined in Sec.  107.50 as ``a Small Business Assisted by a Licensee.''
    SBA received 3 comments on proposed Sec.  107.720(b)(4) as 
discussed below:
    a. ``Substantially All'' Definition. Commenters suggested that the 
definition of ``substantially all'' be lowered to 95 percent of the 
proceeds instead of 99% of the proceeds because they were concerned 
that the 99 percent threshold ``may be too limiting and pose issues in 
deal structuring.'' SBA did not adopt this comment. The definition 
already excludes allowable fees and expense reimbursements permitted 
under Sec. Sec.  107.860 and 107.900, and SBA believes that a 95 
percent threshold could result in excessive expenses being charged by 
the passive businesses, effectively diverting proceeds from the 
intended operating business. Although this percentage may seem 
inconsequential, 4% of a $20 million financing represents $800,000 that 
could be diverted from the operating business.
    b. Fee Requirements. Two commenters suggested removing the 
requirement that fees received by an Associate must be paid over in 
cash to the SBIC. They noted that SBIC program policy guidance known as 
TechNote 7a, which provides guidelines concerning allowable management 
expenses for leveraged SBICs (see www.sba.gov/sbicpolicy), already 
requires that 100% of fees collected under Sec.  107.860 or Sec.  
107.900 must benefit the SBIC, either by being paid directly to the 
SBIC or (if paid to an Associate) through a corresponding reduction in 
the management fee paid by the SBIC, typically called a ``management 
fee offset.'' Commenters also indicated that management fee offsets 
have tax advantages relative to other approaches. Although SBA 
recognizes that management fee offsets can provide tax advantages, SBA 
did not adopt this suggestion because of the difficulty in monitoring 
investments utilizing passive businesses and identifying fees 
associated with each passive business in addition to those paid by the 
operating business.
    c. ``Portfolio Concern'' Clarification. Two commenters indicated 
that the clarification of Portfolio Concern should be revised to apply 
only ``for the purposes of this part 107.720'' to avoid any unintended 
effects arising from the use of the term ``Portfolio Concern'' in other 
sections of the regulations. The commenters indicated that this 
adjustment would still allow SBA to retain the necessary information 
rights contemplated by the proposed rule. A search for the term 
``Portfolio Concern''

[[Page 39338]]

within the regulations identified the following:
     Sec.  107.50 defines ``Portfolio Concern'' as ``a Small 
Business Assisted by a Licensee.''
     Sec. Sec.  107.600-107.660 describe record keeping and 
information requirements, including those for a Portfolio Concern.
     Sec.  107.730 discusses conflicts of interest with regards 
to Portfolio Concerns.
     Sec.  107.760 discusses how a change in size or activity 
affect the Licensee with regard to a Portfolio Concern.
     Sec.  107.850 discusses restrictions on redemption of 
Equity Securities of a Portfolio Concern.

SBA believes that all of the requirements in these sections are 
applicable to passive business financings. Therefore, this suggestion 
was not adopted.
    4. Section 107.610 Required certifications for Loans and 
Investments. The proposed rule also added a certification requirement 
to Sec.  107.610 to require an SBIC that finances a business under 
Sec.  107.720(b)(3) to certify as to the qualifying basis for such 
financing. The certification replaces the requirement for SBA prior 
approval of the formation and financing of a blocker corporation.
    As previously discussed under the changes to Sec.  107.720(b)(3) 
paragraph, the December 2016 final rule, 81 FR 95419 (December 28, 
2016), would have permitted the formation of a blocker entity by an 
SBIC with an investor that had elected to be taxed as a RIC. Since this 
final rule does not include the RIC exception, that portion of the 
certification requirement has been removed from Sec.  107.610 in this 
final rule. The final Sec.  107.610 adopts the proposed rule (80 FR 
60077) language with respect to the formation of blocker entities to 
accommodate investors subject to UBTI or ECI with minor technical 
changes to clarify these two permitted exceptions.

B. Technical Changes

    SBA also proposed the following technical changes to the 
regulations:
    1. Section 107.50 Definition of terms. Changing ``Associates's'' to 
``Associate's''.
    2. Section 107.210 Minimum capital requirements for Licensees. 
Modifying paragraph (a) of Sec.  107.210 to allow both Leverageable 
Capital and Regulatory Capital to fall below the stated minimums if the 
reductions are performed in accordance with an SBA-approved wind-up 
plan per Sec.  107.590(c), to conform with SBA's current oversight 
practices.
    3. Section 107.503 Licensee's adoption of an approved valuation 
policy. Changing the last sentence of Sec.  107.503(a) to indicate that 
valuation guidelines for SBICs may be obtained from the SBIC program's 
public Web site, www.sba.gov/sbic.
    4. Section 107.630 Requirement for Licensees to file financial 
statements with SBA (Form 468). Removing current Sec.  107.630(d), 
which provides a mailing address for submission of SBA Form 468, and 
re-designating paragraph (e) as paragraph (d). These instructions are 
no longer necessary because SBICs submit this information 
electronically using the SBA's web-based application.
    5. Section 107.1100 Types of Leverage and application procedures. 
Correcting the misspelling of ``Yu'' to ``You'' and removing paragraph 
(c), which identifies where to send Leverage applications. This 
paragraph is unnecessary because the application forms provide these 
instructions.
    None of the comments SBA received in response to the proposed rule 
were related to these technical changes. This final rule incorporates 
these changes as proposed.

C. Increase to Maximum Leverage to SBICs Under Common Control

    Section 521 of the Consolidated Appropriations Act, 2016, amended 
section 303(b)(2) of the Act to increase the maximum amount of Leverage 
available to two or more SBICs under Common Control from $225 million 
to $350 million. SBA defines Common Control in 13 CFR 107.50 to mean a 
condition where two or more persons, either through ownership, 
management, contract, or otherwise, are under the control of one group 
or person. SBA presumes that two or more SBICs are under Common Control 
if, among other things, they have common officers, directors, or 
general partners. Currently, 13 CFR 107.1150(b) limits two or more 
SBICs under Common Control to the maximum aggregate amount of 
outstanding Leverage of $225 million, which amount is subject to 
further limitations under SBA's credit policies. Solely as a conforming 
change, this rule increases the maximum amount set forth in the 
regulation from $225 million to $350 million. This statutory change was 
not addressed previously because it had not yet been enacted when the 
rule was proposed. Now that it has, the technical change has been 
included to ensure consistency between the regulations and the current 
law.

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

Executive Order 12866

    The Office of Management and Budget has determined that this rule 
is not a ``significant'' regulatory action under Executive Order 12866. 
This is also not a ``major'' rule under the Congressional Review Act, 5 
U.S.C. 801, et seq.

Executive Order 12988

    This rule meets applicable standards set forth in section 3(a) and 
3(b)(2) of Executive Order 12988, Civil Justice Reform, to minimize 
litigation, eliminate ambiguity, and reduce burden. The rule does not 
have retroactive or presumptive effect.

Executive Order 13132

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

Executive Order 13563

    This final rule was developed in response to comments received on 
previously proposed amendments to these regulations on investments in 
passive businesses. See 78 FR 77377 (December 23, 2013). SBA received 
one set of comments on that proposed rule that suggested changes to 
further liberalize permitted financings to passive businesses under 
Sec.  107.720(b). In response to the comment, SBA indicated in the 
related final rule published on October 21, 2014 (79 FR 62819), that it 
would further consider the suggested changes in a future rulemaking. As 
part of that reconsideration, SBA discussed the comments with industry 
representatives and solicited additional comments in the proposed rule 
published in October 2015 at 80 FR 60077. In December 2016, SBA 
published a final rule that reflected the industry feedback, as well as 
comments from the general public. 81 FR 95419 (December 28, 2016). 
After reconsideration of that published final rule in accordance with 
the memorandum, dated January 20, 2017, from the Assistant to the 
President and Chief of Staff, entitled ``Regulatory Freeze Pending 
Review,'' as discussed above, on three separate occasions SBA delayed 
implementation of the rule.

[[Page 39339]]

SBA also solicited additional comments from the public. Any comments 
received in response to those requests were also considered in 
finalizing this rule.

Executive Order 13771

    This rule is not an EO 13771 regulatory action because this rule is 
not significant under EO 12866.

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

    SBA has determined that this rule would impose additional reporting 
and recordkeeping requirements under the Paperwork Reduction Act. In 
particular, this rule implements changes to the Portfolio Financing 
Report, SBA Form 1031 (OMB Control Number 3245-0078), to clarify 
information to be reported in Parts A, B, and C of the form. Both the 
proposed rule (80 FR 60077) and the December 2016 Final Passive 
Business Rule (81 FR 95419) included additional questions in a new Part 
D on the Form 1031 to collect information regarding Impact SBIC 
investments. These additions were related to the proposed rule, 
entitled ``Impact SBICs,'' published on February 3, 2016 (81 FR 5666), 
which would have defined a new class of SBICs in the regulations. 
However, because SBA is not finalizing that rule, these questions are 
no longer required and have been removed from the Form 1031. As a 
result, proposed Parts E and F have been designated as Parts D and E, 
respectively, in the revised Form 1031 and are discussed in detail 
below.
    The title, description of respondents, description of the 
information collection and the changes to it are discussed below with 
an estimate of the revised annual burden. Included in the estimate is 
the time for reviewing instructions, searching existing data sources, 
gathering and maintaining the data needed, and completing and reviewing 
each collection of information.
    Title: Portfolio Financing Report, SBA Form 1031 (OMB Control 
Number 3245-0078).
    Summary: SBA Form 1031 is a currently approved information 
collection. SBA regulations, specifically Sec.  107.640, require all 
SBICs to submit a Portfolio Financing Report using SBA Form 1031 for 
each financing that an SBIC provides to a Small Business Concern within 
30 days after closing an investment. SBA uses the information provided 
on Form 1031 to evaluate SBIC compliance with regulatory requirements. 
The form is also SBA's primary source of information for compiling 
statistics on the SBIC program as a provider of capital to small 
businesses. The proposed rule (80 FR 60077) invited the public to 
provide comments on the following changes to SBA Form 1031:
    (1) Clarifying that SBICs should report the non-passive Small 
Business Concern information in the Form 1031. SBA has noted that SBICs 
sometimes report data on the passive Small Business Concern rather than 
the non-passive Small Business Concern when reporting financing 
information. SBA has clarified that the SBIC should report data on the 
non-passive Small Business Concern when reporting information on 
financings using passive businesses in the Form 1031 Part A--the Small 
Business Concern; Part B--the pre-financing data; and Part C--the 
financing information, with the exception of the financing dollars in 
Question 29. The amount of financing dollars provided by the SBIC 
should be the total amount of such financing, regardless of whether the 
dollars were provided directly or indirectly to the non-passive 
business concern. Example: The SBIC provides $5 million in equity to 
ABC Holding Corporation, which passes $4.98 million to the non-passive 
business, Acme Manufacturing LLC. In addition, the SBIC provides $5 
million in debt directly to Acme Manufacturing LLC. The SBIC would 
report information on Acme Manufacturing LLC in Parts A, B, and C. 
However, the total financing dollars would be reported as $5 million in 
equity and $5 million in debt for a total of $10 million in total 
financing dollars.
    (2) Identifying financings using one or more passive businesses. 
SBA has added a question on whether the financing utilizes one or more 
passive businesses as part of the financing, to help SBA identify these 
financings.
    (3) Adding information on passive business financings to aid in 
regulatory compliance monitoring. SBA has also added a requirement 
under the new Part D for SBICs to upload a file in Portable Document 
Format (PDF) that contains the following information, which SBA will 
use to help assess whether the financing meets regulatory compliance:
    (a) Qualifying exception: Identification of the passive business 
exception under which the financing is made (i.e., Sec.  107.720(b)(2) 
Exception for pass-through of proceeds to subsidiary, or Sec.  
107.720(b)(3) Exception for certain Partnership Licensees). If the SBIC 
indicates that the financing is made under Sec.  107.720(b)(3), it 
would also indicate the qualifying basis for the financing (i.e., 
financing would cause an investor in the fund to incur unrelated 
business taxable income or effectively connected income).
    (b) Passive Business Entities: Identification of the name and 
employer ID number for each passive business entity used within the 
financing. This is needed so that SBA can identify all Portfolio 
Concerns involved in the financing.
    (c) Financing Structure Description: A description of the financing 
structure, including the flow of the money between the SBIC and the 
non-passive Small Business Concern that receives the proceeds 
(including amounts and types of securities between each entity), and 
the ownership from the SBIC through each entity to the non-passive 
Small Business Concern. This information will help SBA assess that the 
Small Business Concern receives ``substantially all'' the financing 
dollars and the ownership percentages are in compliance with the 
regulations. This will also help SBA with SBICs transferred to the 
Office of Liquidation to identify the structure of the financing and 
aid in recovery of SBA leverage.
    SBA did not receive any comments on the proposed changes. 
Therefore, except as described above, all other changes are adopted as 
final in this rule. SBA updated the below burden estimates from the 
December 2016 final rule (81 FR 31489) to remove the Impact SBIC burden 
estimate and update the estimates based on the SBIC portfolio as of 
June 2017, more recent SBIC financing data, and updated hourly costs.
    Description of Respondents and Burden: As of June 2017 there were 
approximately 316 licensed SBICs. All of these SBICs are required to 
submit SBA Form 1031 for each financing. The current estimated number 
of responses (i.e., number of financings) is 2,695 based on a recent 
three year period (FY 2014 through 2016). The current estimate 
indicates that it takes approximately 12 minutes to complete the form, 
for a total annual burden of 539 hours.
    Neither the number of respondents nor the number of responses per 
year is expected to be affected by this rule. However, SBA estimates an 
increase in the burden hours as a result of the additional reporting in 
new passive business reporting section, as discussed below.
    Passive Business Reporting. SBA believes that the SBIC should be 
able to provide the passive business information since it should be 
readily available as part of the financing. SBA estimates that 
providing the information will take on average an additional 30 minutes 
for those financings utilizing passive businesses, with no incremental 
burden for those financings that do not

[[Page 39340]]

use a passive business. SBA estimates that about 14% of the annual 
responses relate to passive businesses financings (based on financing 
data for the three year period of FYs 2014 through 2016). Based on the 
number of SBICs reporting such financings the total estimated annual 
hour burden resulting from Part D reporting would be 189.
    Therefore, the total estimated annual hour burden for all SBICs 
submitting SBA Form 1031s in a year would be 728 hours.
    The current cost estimate for completing SBA Form 1031 uses a rate 
of $35 per hour for an accounting manager to fill out the form. Using 
that same rate, the cost per form would change from $7 per form to 
$9.45 per form. However, SBA has increased its estimate of an hourly 
rate for an accounting manager to $46 per hour (estimated using 
www1.salary.com/Accounting-Manager-hourly-wages.html in May 2017), 
which rate results in a new cost per form of $12.43 for an aggregate 
cost of $33,488 for the 2,695 estimated responses.
    This final rule also identifies information that an SBIC must 
maintain in its files to support the required changes. SBA believes 
that the SBICs should already be maintaining this information since a 
passive business by definition is a Portfolio Concern and the SBIC 
should be maintaining all documents needed to support each financing. 
The rule makes this expectation explicit. Furthermore, currently, an 
SBIC must maintain this information for it to effectively monitor and 
evaluate an investment that uses a passive business to finance a non-
passive business. Therefore, SBA does not believe this recordkeeping 
requirement increases the burden.
    The rule also requires a certification under Sec.  107.610 when the 
SBIC makes a financing using the exemption in Sec.  107.720(b)(3). This 
includes maintaining records supporting the certification. Since this 
regulation effectively replaces the requirement for SBICs to seek prior 
SBA approval, SBA does not believe this change will increase the 
burden.

Regulatory Flexibility Act, 5 U.S.C. 601-612

    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601, requires 
administrative agencies to consider the effect of their actions on 
small entities, small non-profit businesses, and small local 
governments. Pursuant to the RFA, when an agency issues a rule, the 
agency must prepare a Final Regulatory Flexibility Act (FRFA) analysis 
which describes whether the impact of the rule will have a significant 
economic impact on a substantial number of small entities. However, 
Section 605 of the RFA allows an agency to certify a rule, in lieu of 
preparing an FRFA, if the rulemaking is not expected to have a 
significant economic impact on a substantial number of small entities. 
This rule would affect all SBICs, of which there are currently 316. SBA 
estimates that approximately 98 percent of these SBICs are small 
entities. Therefore, SBA has determined that this rule would have an 
impact on a substantial number of small entities. However, SBA has 
determined that the economic impact on entities affected by the rule 
would not be significant. As discussed under the Paperwork Reduction 
Act section, SBICs would need to provide descriptions of the 
transactions in the Form 1031 for which the annual burden totals 189 
hours for the 316 SBICs. Based on the estimated $46 per hour, the cost 
for each SBIC would be approximately $28 per year (189 hours divided by 
316 SBICs multiplied by $46 per hour). The changes in the passive 
business regulation provide SBICs with additional flexibility to employ 
transaction structures commonly used by private equity or venture 
capital funds that are not SBICs.
    SBA asserts that the economic impact of the rule, if any, would be 
minimal and beneficial to small SBICs. Accordingly, the Administrator 
of the SBA certifies that this rule would not have a significant 
economic impact on a substantial number of small entities.

List of Subjects in 13 CFR Part 107

    Investment companies, Loan programs--business, Reporting and 
recordkeeping requirements, Small businesses.

    For the reasons stated in the preamble, the Small Business 
Administration amends 13 CFR part 107 as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

0
1. The authority citation for part 107 continues to read as follows:

    Authority: 15 U.S.C. 681, 683, 687(c), 687b, 687d, 687g, 687m.


Sec.  107.50  [Amended]

0
2. Amend Sec.  107.50 by removing from the definition of ``Lending 
Institution'' the term ``Associates's'' and adding in its place the 
term ``Associate's''.

0
3. Amend Sec.  107.210 by revising paragraph (a) introductory text to 
read as follows:


Sec.  107.210  Minimum capital requirements for Licensees.

    (a) Companies licensed on or after October 1, 1996. A company 
licensed on or after October 1, 1996, must have Leverageable Capital of 
at least $2,500,000 and must meet the applicable minimum Regulatory 
Capital requirement in this paragraph (a), unless lower Leverageable 
Capital and Regulatory Capital amounts are approved by SBA as part of a 
Wind-Up Plan in accordance with Sec.  107.590(c):
* * * * *

0
4. Amend Sec.  107.503 by revising the last sentence of paragraph (a) 
to read as follows:


Sec.  107.503  Licensee's adoption of an approved valuation policy.

    (a) * * * These guidelines may be obtained from SBA's SBIC Web site 
at www.sba.gov/sbic.
* * * * *

0
5. Amend Sec.  107.610 by adding paragraph (g) to read as follows:


Sec.  107.610  Required certifications for Loans and Investments.

* * * * *
    (g) For each passive business financed under Sec.  107.720(b)(3), a 
certification by you, dated as of the closing date of the Financing, as 
to the basis for the qualification of the Financing under Sec.  
107.720(b)(3) and identifying one or more limited partners for which a 
direct Financing would cause those investors:
    (1) To incur ``unrelated business taxable income'' under section 
511 of the Internal Revenue Code (26 U.S.C. 511); or
    (2) To incur ``effectively connected income'' to foreign investors 
under sections 871 and 882 of the Internal Revenue Code (26 U.S.C. 871 
and 882).


Sec.  107.630  [Amended]

0
6. Amend Sec.  107.630 by removing paragraph (d) and redesignating 
paragraph (e) as paragraph (d).

0
7. Amend Sec.  107.720 by revising paragraphs (b)(2) and (3) and adding 
paragraph (b)(4) to read as follows:


Sec.  107.720  Small Businesses that may be ineligible for financing.

* * * * *
    (b) * * *
    (2) Exception for pass-through of proceeds to subsidiary. You may 
provide Financing directly to a passive business, including a passive 
business that you have formed, if it is a Small Business and it passes 
substantially all the proceeds through to (or uses substantially all 
the proceeds to acquire) one or more subsidiary companies, each of 
which is an eligible Small Business

[[Page 39341]]

that is not passive. For the purpose of this paragraph (b)(2), 
``subsidiary company'' means a company in which the financed passive 
business either:
    (i) Directly owns, or will own as a result of the Financing, at 
least 50 percent of the outstanding voting securities; or
    (ii) Indirectly owns, or will own as a result of the Financing, at 
least 50 percent of the outstanding voting securities (by directly 
owning the outstanding voting securities of another passive Small 
Business that is the direct owner of the outstanding voting securities 
of the subsidiary company).
    (3) Exception for certain Partnership Licensees. If you are a 
Partnership Licensee, you may form one or more blocker entities in 
accordance with this paragraph (b)(3). For the purposes of this 
paragraph, a ``blocker entity'' means a corporation or a limited 
liability company that elects to be taxed as a corporation for Federal 
income tax purposes. The sole purpose of a blocker entity must be to 
provide Financing to one or more eligible, unincorporated Small 
Businesses. You may form such blocker entities only if a direct 
Financing to such Small Businesses would cause any of your investors to 
incur ``unrelated business taxable income'' under section 511 of the 
Internal Revenue Code (26 U.S.C. 511) or to incur ``effectively 
connected income'' to foreign investors under sections 871 and 882 of 
the Internal Revenue Code (26 U.S.C. 871 and 882). Your ownership and 
investment of funds in such blocker entities will not constitute a 
violation of Sec.  107.730(a). For each passive business financed under 
this section 107.720(b)(3), you must provide a certification to SBA as 
required under Sec.  107.610(g). A blocker entity formed under this 
paragraph may provide Financing:
    (i) Directly to one or more eligible non-passive Small Businesses; 
or
    (ii) Directly to a passive Small Business that passes substantially 
all the proceeds directly to (or uses substantially all the proceeds to 
acquire) one or more eligible non-passive Small Businesses in which the 
passive Small Business directly owns, or will own as a result of the 
Financing, at least 50% of the outstanding voting securities.
    (4) Additional conditions for permitted passive business 
financings. Financings permitted under paragraphs (b)(2) or (3) of this 
section must meet all of the following conditions:
    (i) For the purposes of this paragraph (b), ``substantially all'' 
means at least 99 percent of the Financing proceeds after deduction of 
actual application fees, closing fees, and expense reimbursements, 
which may not exceed those permitted by Sec.  107.860.
    (ii) If you and/or your Associate charge fees permitted by Sec.  
107.860 and/or Sec.  107.900, the total amount of such fees charged to 
all passive and non-passive businesses that are part of the same 
Financing may not exceed the fees that would have been permitted if the 
Financing had been provided directly to a non-passive Small Business. 
Any such fees received by your Associate must be paid to you in cash 
within 30 days of the receipt of such fees.
    (iii) For the purposes of this part 107, each passive and non-
passive business included in the Financing is a Portfolio Concern. The 
terms of the financing must provide SBA with access to Portfolio 
Concern information in compliance with this part 107, including without 
limitation Sec. Sec.  107.600 and 107.620.
* * * * *


Sec.  107.1100   [Amended]

0
8. Amend Sec.  107.1100 by removing the term ``Yu'' in the second to 
the last sentence of paragraph (b) and adding in its place ``You'', and 
by removing paragraph (c).


Sec.  107.1150  [Amended]

0
9. Amend Sec.  107.1150 by removing the term ``$225 million'' in the 
first sentence of paragraph (b) and adding in its place ``$350 
million''.

    Dated: August 10, 2017.
Linda E. McMahon,
Administrator.
[FR Doc. 2017-17456 Filed 8-17-17; 8:45 am]
 BILLING CODE 8025-01-P