8(a) Program: SBA Final Rule Makes Important Changes

The 8(a) Program regulations will undergo some significant changes as part of the major final rule recently released by the SBA, and effective August 24, 2016.

Here at SmallGovCon, we’ve already covered big changes to the SDVOSB Program and HUBZone Program brought about by the new SBA rule.  But the 8(a) program is affected by the new rule too, and important changes involving eligibility, the application process, sole source awards, NHOs, and more will kick in later this month.

The final rule implements the following major changes:

Social Disadvantage

In order to be admitted to the 8(a) Program, a company must be controlled by one or more individuals who are considered socially disadvantaged.  While members of certain groups are presumed socially disadvantaged, others (such as Caucasian women and disabled Caucasian veterans) must individually prove their social disadvantage by a preponderance of the evidence.

The SBA’s current regulations leave a lot to be desired when it comes to explaining how an applicant must prove his or her individual social disadvantage.  This lack of clarity leads to confusion; many applicants, for example, incorrectly believe that the SBA is simply looking for a list of all of the bad things that have happened in their lives.  This confusion, of course, causes many applications to be returned or denied.

The SBA’s new regulation attempts to provide some more clarity.  The final rule specifies that “[a]n individual claiming social disadvantage must present facts and evidence that by themselves establish that the individual has suffered social disadvantage that has negatively impacted his or her entry into or the business world in order for it to constitute an instance of social disadvantage.”  In that regard, “[e]ach instance of alleged discriminatory conduct must be accompanied by a negative impact on the individual’s entry into or advancement in the business world in order for it to constitute an instance of social disadvantage.”  And SBA “may disregard a claim of social disadvantage where a legitimate alternative ground for an adverse employment action or other perceived adverse action exists and the individual has not presented evidence that would render his/her claim any more likely than the alternative ground.”

Importantly, the SBA includes two examples demonstrating how the analysis works.  For instance, one of those examples provides:

A woman who is not a member of a designated group attempts to establish her individual social disadvantage based on gender. She certifies that while working for company Y, she was not permitted to attend a professional development conference, even though male employees were allowed to attend similar conferences in the past. Without additional facts, that claim is insufficient to establish an incident of gender bias that could lead to a finding of social disadvantage. It is no more likely that she was not permitted to attend the conference based on gender bias than based on non-discriminatory reasons. She must identify that she was in the same professional position and level as the male employees who were permitted to attend similar conferences in the past, and she must identify that funding for training or professional development was available at the time she requested to attend the conference.

When SBA released its proposal to implement these changes to the social disadvantage rules, some people familiar with the 8(a) Program were concerned that these changes were being proposed in order to make it more difficult for individuals to prove social disadvantage.  But I don’t view it that way.  To my eyes, the change merely attempts to better explain how the SBA already evaluates social disadvantage, and doesn’t seem to impose any new burdens on applicants.  Hopefully my optimistic view will be borne out in practice.

Experience of Disadvantaged Individual

The current 8(a) Program regulations don’t require that a disadvantaged individual possess managerial experience in the specific industry in which the 8(a) applicant is doing business. Instead, the regulations state that the disadvantaged individual “must have managerial experience of the extent and complexity needed to run the concern.”  Nevertheless, in my experience, the 8(a) application analysts have often focused on the industry-specific experience of the disadvantaged individual, rather than the individual’s overall managerial experience.

The SBA’s new regulations should ease the burden on 8(a) applicants to demonstrate industry-specific experience.  The new rule states that “[m]anagement experience need not be related to the same or similar industry as the primary industry classification of the applicant or Participant.” In the preamble to its new rule, the SBA writes that it “did not intend to require in all instances that a disadvantaged individual must have managerial experience in the same or similar line of work as the applicant or Participant.”  The SBA explains:

For example, an individual who has been a middle manager of a large aviation firm for 20 years and can demonstrate overseeing the work of a substantial number of employees may be deemed to have managerial experience of the extent and complexity needed to run a five-employee applicant firm whose primary industry category was in emergency management consulting even though that individual had no technical knowledge relating to the emergency management consulting field.

But the rule change doesn’t mean that industry-specific experience will never be considered.  In the preamble, the SBA states that more specific industry-related experience may be required in “appropriate circumstances,” such as “where a non-disadvantaged owner (or former owner) who has experience related to the industry is actively involved in the day-to-day management of the firm.”

8(a) Application Processing

As I discussed in a blog post in April 2016, 8(a) Program participation is down 34% since 2010, and the SBA is attempting to reverse the decline by–in part–streamlining and improving the application process.  The new rule includes some baby steps in that direction, including:

  • The SBA will no longer require that all 8(a) applicants submit IRS Form 4506T (Request for Transcript of Tax Return).
  • The SBA will require all applications to be submitted electronically, instead of allowing hard copy applications (for which processing times are often very slow).
  • The SBA has deleted the requirement for “wet” signatures and will allow application documents to be electronically signed.
  • In cases where an applicant has a criminal record, the SBA has always referred the application to its Office of Inspector General, delaying the process.  The SBA now will exercise reasonable discretion in determining whether such a referral is appropriate.  For example, “an application evidencing a 20 year old disorderly conduct offense for an individual claiming disadvantaged status when that individual was in college should not be referred to OIG where that is the only instance of anything concerning the individual’s good character.”
  • Perhaps most importantly for most applicants, the SBA will no longer require a narrative statement of each applicant’s economic disadvantage.  These statements have served little practical purpose, as the SBA has long evaluated economic disadvantage by reference to an individual’s income and net worth.  The final rule acknowledges that economic disadvantage is based on “objective financial data,” rendering the narratives unnecessary.

8(a) Program Suspensions

The new regulation allows an 8(a) Program participant to voluntarily suspend its nine-year term when one of two things happen: (1) the participant’s principal office is located in an area declared a major disaster area; or (2) there is a lapse in federal appropriations.  The SBA explains that these changes were “intended to allow a firm to suspend its term of participation in the 8(a) BD program in order to not miss out on contract opportunities that the firm might otherwise have lost due to a disaster or a lapse in federal funding.”

If a firm elects to suspend its term, the participant “would not be eligible for 8(a) BD program benefits, including set-asides . . . but would not ‘lose time’ in its program term due to the extenuating circumstances” caused by the disaster or lapse in federal funding.

Management of Tribally-Owned 8(a) Participants

The final rule adopts new language specifying that “[t]he individuals responsible for the management and daily operations of a tribally-owned concern cannot manage more than two Program Participants at the same time.”  The SBA clarifies:

An individual’s officer position, membership on the board of directors or position as a tribal leader does not necessarily imply that the individual is responsible for the management and daily operations of a given concern.  SBA looks beyond these corporate formalities and examines the totality of the information submitted by the applicant to determine which individual(s) manage the actual day-to-day operations of the applicant concern.

The new rule further clarifies that “Officers, board members, and/or tribal leaders may control a holding company overseeing several tribally-owned or ANC-owned companies, provided they do not actually control the day-to-day management of more than two current 8(a) BD Program participant firms.”

Native Hawaiian Organizations

Under the current rule governing participation in the 8(a) Program by companies owned by Native Hawaiian Organizations, “SBA considers the individual economic status of the NHO’s members,” and a majority of the individual members must qualify as economically disadvantaged.  The individual members of the NHO are held to the same income and net worth requirements as other socially disadvantaged individuals under 13 C.F.R. 121.104.

After receiving a great deal of feedback from the Native Hawaiian community, the SBA changed its perspective, writing in the preamble to the final rule that “basing the economic disadvantage status of an NHO on individual Native Hawaiians who control the NHO does not seem to be the most appropriate way to do so.”  The preamble continues:

The crucial point is that an NHO must be a community service organization that benefits Native Hawaiians. It is certainly understood that an NHO must serve economically disadvantaged Native Hawaiians, but nowhere is there any hint that economically disadvantaged Native Hawaiians must control the NHO. The statutory language merely requires that an NHO must be controlled by Native Hawaiians. In order to maximize benefits to the Native Hawaiian community, SBA believes that it makes sense that an NHO should be able to attract the most qualified Native Hawaiians to run and control the NHO. If the most qualified Native Hawaiians cannot be part of the team that controls an NHO because they may not qualify individually as economically disadvantaged, SBA believes that is a disservice to the Native Hawaiian community.

To implement this changed policy, the final rule adopts a system much like that already used by the SBA in evaluating applications from companies owned and controlled by Indian tribes.  The final rule states that “[i]n order to establish than an NHO is economically disadvantaged, it must demonstrate that it will principally benefit economically disadvantaged Native Hawaiians.”  To do this, the NHO must provide economic data on the condition of the Native Hawaiian community it intends to serve, including things like the unemployment rate, poverty level, and per capita income.  Once a particular NHO establishes its economic disadvantage in connection with the application of one firm owned and controlled by the NHO, it ordinarily need not reestablish its economic disadvantage in connection with a second 8(a) firm.

The final rule also clarifies that the individual members or directors of an NHO need not have the technical expertise or possess a required license in order for the NHO to be found to control an 8(a) company.  Rather, as with “regular” 8(a) companies, the individual members or directors ordinarily need only possess the managerial experience of the extent and complexity necessary to run the company.  But as with those “regular” 8(a) companies, the SBA may examine industry-specific experience “in appropriate circumstances,” such as where a non-disadvantaged owner (or former owner) who has experience related to the industry is involved in the day-to-day management of the firm.

Sole Source 8(a) Awards

Earlier this summer, I blogged about an SBA Office of Inspector General report, which found that DoD 8(a) sole source awards over $20 million to companies owned by Indian tribes and ANCs has dropped by more than 86% since 2011, when Congress adopted a requirement that a Contracting Officer issue a written justification and approval for any sole source award over $20 million (a regulatory update in 2015 increased the threshold to $22 million).

To date, the 2011 statutory requirements have been implemented only in the FAR.  The final rule updates the SBA’s regulations to require that a procuring agency that is offering a sole source requirement that exceeds $22 million to confirm that the justification and approval has occurred.  However, “SBA will not question and does not need to obtain a copy of the justification and approval, but merely ensure that it has been done.”

In its preamble, the SBA explains that the J&A requirement appears to have caused confusion:

SBA believes that there is some confusion in the 8(a) and procurement communities regarding the requirements of section 811. There is a misconception by some that there can be no 8(a) sole source awards that exceed $22 million. That is not true. Nothing in either section 811 or the FAR prohibits 8(a) sole source awards to Program Participants owned by Indian tribes and ANCs above $22 million. All that is required is that a contracting officer justify the award and have that justification approved at the proper level. In addition, there is no statutory or regulatory requirement that would support prohibiting 8(a) sole source awards above any specific dollar amount, higher or lower than $22 million.

Perhaps the SBA’s commentary will help clarify for Contracting Officers that sole source authority remains for contracts over $22 million; the 2011 statute and corresponding regulations merely require a J&A.

Changes in Primary Industry Classification

The final rule allows the SBA to change an 8(a) Program participant’s primary industry classification “where the greatest portion of the Participant’s total revenues during the Participant’s last three completed fiscal years has evolved from one NAICS code to another.”  The SBA will, as part of its annual 8(a) Program review, “consider whether the primary NAICS code contained in a participant’s business plan continues to be appropriate.”

If the SBA believes that a change is warranted, the SBA will notify the 8(a) Program participant and give the participant the opportunity to oppose the SBA’s plan.  And, “[a]s long as the Participant provides a reasonable explanation as to why the identified primary NAICS code continues to be its primary NAICS code, SBA will not change the Participant’s primary NAICS code.”

The SBA’s preamble notes that the portion of its proposal dealing with changes in primary NAICS codes received the most comments of any portion of the proposed rule–apparently even more so than comments on the universal mentor-protege program, which was established under the same final rule.  While NAICS codes aren’t always the most exciting things in the world, it’s easy to see why this proposal caused so much concern.

For “regular” 8(a) companies owned by socially and economically disadvantaged individuals, a change in NAICS code can affect ongoing 8(a) eligibility.  That’s because, under 13 C.F.R. 124.102, an 8(a) company must qualify as small in its primary NAICS code.  If the SBA reassigns an 8(a) company from a NAICS code designated with a higher size standard to one designated with a lower standard, it could put the company at risk of early graduation.

For example, consider an 8(a) company with $20 million in average annual receipts, admitted to the 8(a) Program under NAICS code 236220 (Industrial Building Construction), which carries a $36.5 million size standard under the current SBA size standards table.  Now let’s say that same company has earned almost all of its revenues performing plumbing work.  If the SBA reassigns the company to NAICS code 238220 (Plumbing, Heating, and Air-Conditioning Contractors), with an associated $15.0 million size standard, the company is suddenly no longer small in its primary industry, threatening its ongoing 8(a) Program status.

But the preamble makes clear that much of the angst over the SBA’s proposal came from individuals representing tribal and/or ANC interests.  Under 13 C.F.R. 124.109, a tribe or ANC “may not own 51% or more of another firm which, either at the time of application or within the previous two years, has been operating in the 8(a) Program under the same primary NAICS code as the applicant.”  While the rule permits such firms to operate in secondary, related NAICS codes, a reassignment to the same NAICS code as another 8(a) Program participant owned by the same tribe or ANC would cause major problems.

In its final rule, the SBA acknowledges these concerns, but doesn’t back off its position.  The final rule provides:

Where an SBA change in the primary NAICS code of an entity-owned firm results in the entity having two Participants with the same primary NAICS code, the second, newer Participant will not be able to receive any 8(a) contracts in the six-digit NAICS code that is the primary NAICS code of the first, older Participant for a period of time equal to two years after the first Participant leaves the 8(a) BD program.

It remains to be seen how the SBA will implement the new policy on primary NAICS codes, but there can be little doubt that the new regulation will put some ANCs and tribes at risk.

In Conclusion

The SBA’s final rule takes effect on August 24, 2016.  And while the new small business mentor-protege program will generate most of the headlines, it’s essential for 8(a) Program participants (and potential applicants) to be aware of the major 8(a) Program changes established under the same final rule.