March 27, 2013
Best Practices: New Operational and Organizational Requirements for Certified Development Companies
by Victor A. Diaz
Included among the changes recently proposed by the SBA are new operational and organizational requirements for Certified Development Companies (CDC) participating in the 504 Loan Program. While many of the proposed changes deal with technical corrections to clarify existing regulations, a significant portion deal with corporate governance issues aimed at improving internal controls and financial accountability. Principal among those are the composition and responsibilities of the CDC’s governing Board of Directors.
Under existing regulations, a CDC must have a Board of Directors (the “Board”) representing at least three of the following groups: (i) government organizations. (ii) financial institutions (lenders), (iii) community organizations, such as chambers of commerce, foundations, trade associations, colleges, universities, or small business development centers, or (iv) businesses in the CDC’s geographic areas of operations. SOP 50 10 5 (E), page 49. The size, composition and makeup of the Board are left largely to the discretion of each CDC, except that at least one member of the Board must possess commercial lending experience and five Directors are required to constitute a quorum.
In keeping with the exigencies of a post Sarbanes-Oxley environment, the proposed regulation will require a Board be composed of individuals with expertise in the areas of: (i) internal controls, (ii) financial risk management, (iii) commercial lending, (iv) legal issues relating to commercial lending, and (iv) corporate governance, at a minimum. Federal Register, Vol. 78, No. 37, page 12644. Additionally, each CDC must have at least one voting director who represents the economic, community or workforce development fields. Two voting members of the Board of Directors must possess commercial lending experience satisfactory to SBA and must be present and vote when the Board votes on SBA loan approval or servicing actions. (Emphasis added). And, though CDCs will no longer be required to have members, each CDC, whether for-profit or nonprofit, must have a Board composed of at least 11 and not more than 25 voting Directors.
Signaling a shift towards more accountability and focus on risk management, the proposed rule requires the Board to incorporate in their Bylaws a minimum of 15 explicit governance requirements. They include, among others: (i) adopting internal controls, (ii) setting salaries for CDC managers as well as reviewing all other salaries, (iii) hiring an independent auditor to ensure compliance with loan program requirements, (iv) setting adequate reserves, and (v) establishing commercially reasonable loan approval policies, procedures, and standards. The Bylaws must include a credit approval process, in accordance with terms promulgated in the proposed rule. CDCs would also be required to maintain Director’s and Officer’s Liability and Errors and Omissions insurance in an amount of at least $5,000,000 with a deductible of not more than $50,000.
In general, the proposed rule promotes and emphasizes compliance with existing laws and regulations and helps CDCs achieve effective, transparent and efficient operations. If adopted, the new rule will compel CDCs to revisit the composition of their Board, amend or re-write their Bylaws, and obtain adequate insurance coverage. For any further questions, please contact Victor Diaz, at VDiaz@StarfieldSmith.com or by phone at (407) 667-8811.