[Federal Register Volume 67, Number 204 (Tuesday, October 22, 2002)]
[Rules and Regulations]
[Pages 64789-64791]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-26546]
========================================================================
Rules and Regulations
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains regulatory documents
having general applicability and legal effect, most of which are keyed
to and codified in the Code of Federal Regulations, which is published
under 50 titles pursuant to 44 U.S.C. 1510.
The Code of Federal Regulations is sold by the Superintendent of Documents.
Prices of new books are listed in the first FEDERAL REGISTER issue of each
week.
========================================================================
Federal Register / Vol. 67, No. 204 / Tuesday, October 22, 2002 /
Rules and Regulations
[[Page 64789]]
SMALL BUSINESS ADMINISTRATION
13 CFR Part 107
RIN 3245-AE88
Small Business Investment Companies
AGENCY: U.S. Small Business Administration (SBA).
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: This final rule allows a Small Business Investment Company
(SBIC) to assume control over a small business concern, without notice
to the SBA, and to retain such control for a period of up to seven
years, or longer with SBA approval. The final rule also allows an SBIC
to sell equity securities in a portfolio concern to a competitor of
that portfolio concern.
DATES: This rule is effective on November 21, 2002.
FOR FURTHER INFORMATION CONTACT: Carol Fendler, Director, Office of
Licensing and Program Standards, Investment Division, Office of Capital
Access, (202) 205-7559 or [email protected].
SUPPLEMENTARY INFORMATION:
I. Background
The Small Business Investment Corrections Act of 2000, Public Law
106-554, Title IV, section 402, amended section 103(5)(A)(i) of the
Small Business Investment Act (Act) to clarify that a small business
concern controlled by venture capital firms, including licensed small
business investment companies (SBICs), does not for that reason cease
to qualify as independently owned and operated. Under the statute, a
business would be considered a small business concern ``regardless of
the allocation of control during the investment period under any
investment agreement between the business concern and the entity making
the investment.'' (15 U.S.C. 662(5)(A)(i)).
On May 17, 2002, SBA published in the Federal Register a proposed
rule (67 FR 35055) to simplify its regulation governing control of a
small business and bring it into conformity with the Act, as amended in
2000. The proposed rule also removed a regulatory restriction on the
right of an SBIC to sell securities of a small business to a competitor
of that business.
SBA received six comments on the proposed rule. These are discussed
in the following section-by-section analysis.
II. Section-by-Section Analysis
SBA amends Sec. 107.865 by revising the heading. This change
recognizes that SBICs are now allowed to exercise control over a Small
Business.
SBA amends paragraph (a) of Sec. 107.865 to allow an SBIC to
exercise control over a Small Business. The period of control is
limited to the seventh anniversary of the date on which control was
initially acquired. This is a change from the proposed rule, which
would have permitted control for up to five years.
SBA received six comments on the proposed rule. Four of those
submitted comments supported the proposed rule as drafted. The other
two that commented supported the concept that SBICs should be permitted
to take control of portfolio companies but indicated that the proposed
five year period of control was insufficient. One proposed that a seven
year time frame would be more appropriate, particularly where
investments are in seed stage companies. This commenter indicated that
such investments typically have a 4-7 year investment horizon. SBA
recognizes that some investments, particularly earlier stage
investments, may require additional time for the investment to mature.
Recent historical experience indicates that the percentage of SBIC
investments in start-up businesses has ranged from approximately 30
percent to 45 percent. By including add-on investments in companies
that were originally financed as start-ups by SBICs, the percentage
increases to over 50 percent. In view of this investing pattern and the
potential need to grow and support start-up businesses, SBA has
modified the rule to allow for control to be exercised for a period of
seven years.
The final commenter stated that a ten year period would be more
appropriate than the proposed five year term, for a number of reasons.
First, the commenter pointed out that market conditions may require
SBICs to seek extensions of the control period beyond five years. The
commenter expected that SBA would likely grant these extension
requests, but suggested that SBA would be spared the expenditure of
scarce resources needed to address such requests by adopting the ten
year period at the outset. SBA believes that extension requests will be
considerably less frequent with the change to a seven-year control
period, and believes that it has the resources to respond to those
requests that will be received.
The commenter also noted that a ten-year term would be consistent
with the regulations promulgated by the Board of Governors of the
Federal Reserve System and the Department of Treasury in implementing
the Gramm-Leach-Bliley Act (GLB), Public Law 106-102. The commenter
suggested that a differing time period for the exercise of control
between SBA's regulations and those implementing GLB may result in the
SBIC program being less attractive to banks and may limit their
participation in the program.
SBA believes that the SBIC program will continue to be an
attractive option for banks interested in making equity investments.
Although the regulations promulgated under GLB do permit control for a
period of up to ten years, the restrictions on the exercise and scope
of that control are greater than in the SBIC program. For example,
banks taking controlling positions in a portfolio company under GLB are
prohibited from managing or operating that portfolio company. SBICs,
however, are not subject to that same type of restriction.
SBA also believes that banks will remain interested in the SBIC
program for reasons other than the ability to take controlling
positions in their investments. Many banks find the SBIC program to be
an attractive option since investment in an SBIC by a bank is presumed
to meet the standards for a qualified investment for purposes of
investment performance under the Community Reinvestment Act
regulations. Furthermore, many banks continue to invest in SBICs that
obtain
[[Page 64790]]
financial assistance from SBA at favorable rates.
In adopting seven years as the allowable control period, SBA also
considered the structure of the SBIC program and SBICs. For most SBICs,
the projected investment cycle is a 3-5 year investing program with
exits anticipated after a 3-5 year holding period. Since SBICs
typically do not expect to hold investments for ten years, a control
period of that length should not generally be necessary. Although SBA
recognizes that company and market conditions may impact the ability to
exit an investment, SBA believes that a seven year control period
should be sufficient.
SBA amends Sec. 107.865(b) to clarify that this paragraph, which
sets forth conditions that create a presumption of control over a small
business concern, relates only to control based on ownership of voting
securities. Control may still exist by other means as outlined in Sec.
107.865 (a). No comments were received on this change.
SBA amends Sec. 107.865(d) to allow for extension of the control
period in certain circumstances, with SBA's approval. One commenter
indicated that the reasons for granting an extension should be expanded
to allow for consideration of the financial stability of the SBIC in
addition to the financial stability of the portfolio concern. SBA
recognizes that relinquishment of control may be difficult to
accomplish; however, SBA also recognizes that the financial stability
of the SBIC may have no relationship to its control position in a
particular portfolio concern and that allowing control to continue may
be viewed as being adverse to the interests of the portfolio concern.
SBA will consider the reasons why divestiture cannot be completed
within seven years when reviewing the request for an extension, and
will consider the best interests of both the SBIC and the small
business concern. SBA believes the regulations as promulgated have
sufficient breadth to allow for a number of considerations. Therefore,
SBA does not believe that the financial stability of the SBIC should be
a specifically enunciated consideration.
SBA amends Sec. 107.865 by deleting paragraphs (e) and (f) and
redesignating paragraph (g) as (e). The deleted paragraphs are no
longer necessary.
SBA amends Sec. 107.885 by removing paragraph (b) and removing the
designation ``(a)''. This change allows a SBIC to sell its interests in
a portfolio concern to a competitor of that portfolio concern. This
change recognizes that in the venture capital industry a likely exit
for an investment is the sale of an interest in a portfolio concern to
a competitor of the portfolio concern. Three commenters addressed this
provision directly, all favorably.
Compliance With Executive Orders 12866, 12988, and 13132, the Paperwork
Reduction Act (44 U.S.C. Ch. 35), and the Regulatory Flexibility Act (5
U.S.C. 601-612)
Compliance With Executive Order 12866
The Office of Management and Budget (OMB) did not review this rule
as a ``significant'' regulatory action under Executive Order 12866. The
rule implements technical corrections to the SBIC program. The rule
will not have an annual effect on the economy of $100 million or more,
adversely affect the economy in a material way, create a serious
inconsistency or otherwise interfere with an action taken or planned by
another agency, materially alter the budgetary impact of loan programs
or other governmental programs, or raise novel legal or policy issues
arising out of legal mandates or the President's priorities.
Compliance With Executive Order 12988
For purposes of Executive Order 12988, the SBA has determined that
this rule was drafted, to the extent practicable, in accordance with
the standards set forth in section 3 of that order.
Compliance With Executive Order 13132
For purposes of Executive Order 13132, SBA has determined that the
rule will not have substantial direct effects on the States, on the
relationship between the national government and the States, or on the
distribution of power and responsibilities among the various levels of
government. Therefore, under Executive Order 13132, SBA has determined
that the rule does not have sufficient federalism implications
warranting the preparation of a Federalism Assessment.
Compliance with Paperwork Reduction Act, 44 U.S.C. Ch. 35
The rule does not impose any new information collection
requirements from SBA which require approval by OMB under the Paperwork
Reduction Act, 44 U.S.C. Ch. 35.
Compliance with the Regulatory Flexibility Act, 5 U.S.C. 601-612
SBA determined that the rule will not have a significant impact on
a substantial number of small entities. SBA invited comments on this
determination but received none.
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, amend part 107 of title 13
of the Code of Federal Regulations as follows:
PART 107--SMALL BUSINESS INVESTMENT COMPANIES
1. The authority citation for part 107 continues to read as
follows:
Authority: 15 U.S.C. 681 et seq., 683, 687(c), 687b, 687d, 687g,
and 687m.
2. In Sec. 107.865, revise the section heading and paragraphs (a),
(b), and (d), remove paragraphs (e) and (f), and redesignate paragraph
(g) as paragraph (e) to read as follows:
Sec. 107.865 Control of a small business by a licensee.
(a) In general. You, or you and your Associates (in the latter
case, the ``Investor Group''), may exercise Control over a Small
Business for purposes connected to your investment, through ownership
of voting securities, management agreements, voting trusts, majority
representation on the board of directors, or otherwise. The period of
such Control will be limited to the seventh anniversary of the date on
which such Control was initially acquired, or any earlier date
specified by the terms of any investment agreement.
(b) Presumption of control. Control over a Small Business based on
ownership of voting securities will be presumed to exist whenever you
or the Investor Group own or control, directly or indirectly:
(1) At least 50 percent of the outstanding voting securities, if
there are fewer than 50 shareholders; or
(2) More than 25 percent of the outstanding voting securities, if
there are 50 or more shareholders; or
(3) At least 20 percent of the outstanding voting securities, if
there are 50 or more shareholders and no other party holds a larger
block.
* * * * *
(d) Extension of Control. With SBA's prior written approval you, or
the Investor Group, may retain Control for such additional period as
may be reasonably necessary to complete divestiture of Control or to
ensure the financial stability of the portfolio company.
* * * * *
[[Page 64791]]
Sec. 107.885 [Amended]
3. Amend Sec. 107.885 by removing paragraph (b) and removing the
paragraph designation ``(a)''.
Dated: October 10, 2002.
Hector V. Barreto,
Administrator.
[FR Doc. 02-26546 Filed 10-21-02; 8:45 am]
BILLING CODE 8025-01-P