Barry McVay's FEDERAL CONTRACTS DISPATCH
DATE: August 14, 2000
FROM: Barry McVay, CPCM
SUBJECT: Small Business Administration; Management-Ownership of Small Business Investment Companies (SBICs)
SOURCE: Federal Register, August 14, 2000, Vol. 65, No. 157, page 49511
AGENCIES: Small Business Administration (SBA)
ACTION: Proposed Rule
SYNOPSIS: SBA is proposing to amend its SBIC regulations to prohibit the ownership of more than 70% of a leveraged SBIC by any single investor or group of affiliated investors.
EDITOR'S NOTE: The SBA's regulations are in Title 13 of the Code of Federal Regulations. The SBA SBIC regulations are in Chapter 1, Small Business Administration, Part 107, Small Business Investment Companies.
DATES: Submit comments on or before September 13, 2000.
ADDRESSES: Send comments to Leonard Fagan, Investment Division, U.S. Small Business Administration, 409 3rd Street, SW, Suite 6300, Washington, DC 20416.
FOR FURTHER INFORMATION CONTACT: Leonard W. Fagan, 202-205-7583.
SUPPLEMENTAL INFORMATION: To prevent abuses that SBA had observed in SBICs owned and operated by a single individual or group of individuals (such as conflict of interest transactions, misapplication of funds, and other types of self-dealing activities), SBA adopted in 1994 a regulation that required all SBICs to have independence, or "diversity", between the management and the ownership of the company - Section 107.150, Management and Ownership Diversity Requirement. SBA is proposing to several changes to Section 107.150 to ensure that each new leveraged SBIC has managers that exercise independence in managing the operations of the SBIC.
- To satisfy Section 107.150, at least 30% of the capital of the SBIC has to be owned by investors who were not part of the SBIC's management team and did not control the SBIC's management team. In general, three such "diversity investors" were required, but a single diversity investor would suffice if the investor was an entity that met certain net worth and regulatory oversight requirements.
Overall, SBA believes the management-ownership diversity regulation has been successful in encouraging the presence of investors who are truly independent of management. Nevertheless, SBA has had concerns with whether independence is assured when a single investor, unrelated to the management team, owns substantially all of an SBIC ("all" is "at least 30%"). At some ownership level, an investor's power to influence effectively becomes the power to control the managers of the SBIC, and the management team can no longer be said to have the ability to act independently. SBA finds that it is difficult to objectively establish when that ownership level is reached. However, if the largest investor is limited to owning not more than 70%, and there is a 30% diversity investor that is independent of both the management and the largest investor, the largest investor's degree of potential influence on management becomes acceptable.
Accordingly, SBA proposes to amend Section 107.150 to prohibit ownership of more than 70% of a leveraged SBIC by a single investor or group of affiliated investors.
- SBA recognizes there may be categories of investors who can be permitted to own in excess of 70% of an SBIC without destroying the SBIC's management-ownership diversity, such as the traditional investment company. A subsidiary SBIC of a traditional investment company can offer meaningful management-ownership diversity even if the investment company owns substantially all of the SBIC because (1) a traditional investment company has managers who are largely unrelated to and unaffiliated with the investors in the firm, and (2) the managers of a traditional investment company and its subsidiary SBIC are authorized and motivated to make investments that are likely to produce significant returns to all investors in the investment company and in the SBIC, and (3) a traditional investment company benefits from the use of a subsidiary SBIC only if the SBIC makes profitable investments. Therefore, Section 107.150 would be revised to permit a traditional investment company to own and control more than 70% of an SBIC. SBA is seeking comments on this particular change and suggestions as to whether a similar exception should be provided for other types of investors in an SBIC.
- The 30% test in the current diversity regulation would continue to be required under the proposed regulation, but with slight modifications.
- Paragraph (a)(2), which treats publicly-traded licensees as automatically satisfying the 30% test, would be eliminated. SBA expects that the small number of license applicants intending to be public companies should easily be able to demonstrate their compliance with the 30% test.
- Two new categories would be added to the list of institutional investors currently permitted to serve as the sole (30%) diversity investor in an SBIC, and would clarify one of the existing categories. The two new categories would be (1) investors listed on the New York Stock Exchange, or (2) investors that are publicly-traded and meets the minimum numerical and corporate governance listing standards of the New York Stock Exchange. Companies satisfying either of these listing standards have sufficient size and public oversight and visibility to justify treating them the same as regulated companies for purposes of the diversity regulation.
- The category that would be clarified is "entities regulated by state or federal authorities satisfactory to SBA." The proposed rule would be changed to "entities whose overall activities are regulated and periodically examined by state, federal, or other governmental authorities satisfactory to SBA" to clarify that this category is intended to cover only those entities whose overall activities are both regulated and periodically examined by a satisfactory governmental authority. U.S. federal and state bank regulators or insurance commissions are examples of satisfactory governmental authorities for this purpose. Regulation of an entity's health and safety activities by the Office of Safety and Health Administration (OSHA) would not be acceptable.
The proposed management-ownership diversity regulation would apply to an existing SBIC only if SBA requires management-ownership diversity as a condition of SBA's approval of the licensee's change of control or if a non-leveraged SBIC wants to be approved as eligible to issue leverage. Therefore, SBA is proposing to revise paragraph (c) of Section 107.440, Standards Governing Prior SBA Approval for a Proposed Transfer of Control, from "require compliance with any other conditions set by SBA," to "require compliance with any other conditions set by SBA, including compliance with the requirements for minimum capital and management-ownership diversity as in effect at such time for new license applicants." This would clarify that SBA's approval of a change of control of an SBIC may be conditioned upon the licensee's compliance with the diversity regulation, as well as minimum capital requirements, then in effect. This change would reflect SBA's practice since the diversity regulation was first adopted.
FOR FURTHER INFORMATION CONTACT: Barry McVay at 703-451-5953 or by e-mail to BarryMcVay@FedGovContracts.com.
Copyright 2000 by Panoptic Enterprises. All Rights Reserved.
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