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OIG Reports

Report 3-33 - Audit of SBIC Oversight

Date Issued: 
Tuesday, July 1, 2003
Report Number: 

U.S. Small Business Administration
Office of Inspector General
Washington, DC 20416


To: Jeffrey Pierson, Associate Administrator
for the Investment Division

From: Robert G. Seabrooks, Assistant Inspector Original Signed – FOIA Ex. 6
General for Auditing

Subject: Audit of SBIC Oversight

Attached is a copy of the subject audit report. The report contains one finding and four recommendations to the Associate Administrator for the Investment Division. You agreed with one recommendation and partially agreed with a second, and nonconcurred with two recommendations. The partial agreement and nonconcurrences will be resolved during the audit resolution process. As a result of your comments, we modified certain passages in the report.

Your comments have been synopsized in the report and included as an attachment .

The finding in this report is the conclusion of the Office of Inspector General’s Auditing Division. The finding and recommendations are subject to your review and corrective action by your office in accordance with existing Agency procedures for audit follow-up and resolution.
Please provide your management response to the recommendations within 30 days from the date of this report on the attached SBA Forms 1824, Recommendation Action Sheet. The SBA Forms 1824 should be sent to:

Audit Manager
SBA OIG/Auditing Field Office, Suite 1803
233 Peachtree Street, NE
Atlanta, Georgia 30303
Any questions you may have regarding this report may be directed to Garry Duncan,
Director, Credit Programs Group, at 202.205-7732.

cc: ADA/Capital Access
Washington, DC
July 1, 2003

The finding in this report is the conclusion of the OIG’s Auditing Division based on testing of SBA operations. The finding and recommendations are subject to review, management decision, and corrective action in accordance with existing Agency procedures for follow-up and resolution. The report may contain proprietary information subject to the provisions of 18 USC 1905 and must be released to the public or another agency without permission of the Office of Inspector General.


The Small Business Administration (SBA) is authorized by the Small Business Investment Act to establish a program to stimulate and supplement the flow of equity capital and
long-term loans to small business concerns using Small Business Investment Companies (SBICs). The SBICs are private investment firms, licensed by SBA, that independently make their own investment decisions utilizing private capital plus borrowed funds guarantied by SBA.

The borrowed funds are either in the form of debentures for which interest is to be paid semiannually and the principal repaid at maturity, or participating securities which are redeemable preferred equity-type securities with quarterly interest payments (prioritized payments) made only to the extent of the SBIC’s profits. The redemption period for both types of securities is generally 10 years. The SBICs typically provide financing to small business concerns in the form of loans, debt-securities, and equity investments. The program is managed within SBA by the Investment Division (Division) which is responsible for regulatory and financial oversight and providing leverage guaranties to over 400 SBICs.

Our audit objective was to determine whether SBA’s oversight process limited financial risk as it pertains to the evaluation of each SBIC’s reported financial condition and the
management of financially troubled SBICs. We examined the controls, policies, and procedures used to assess the financial condition of SBICs and those methods used to limit financial risk to SBA. The audit showed that the evaluation of each SBIC’s reported financial condition and the management actions taken to limit risk from financially troubled SBICs needed improvement to ensure the risk of financial loss is effectively limited for SBA.


  • SBA’s ability to limit risk was restricted by the “Forbearance Concept”. This concept precludes SBA from considering SBICs as capitally impaired (a financial condition occurring when an SBIC’s net realized and unrealized losses exceed its earnings and unrealized gains ) for up to 8 years after receiving their first participating securities. As a result, the liquidation of capitally impaired SBICs was delayed, resulting in an erosion of the value of the SBICs portfolio assets and the unnecessary disbursement of prioritize payments. We determined that the forbearance concept:

    • used decision points to implement forbearance which were not supported by analyses and, therefore, may be inappropriate,

    • decreased SBA’s potential for recovery of leveraged Federal funds due to the reduced value of SBIC assets, and

    • resulted in the unnecessary payment of about $13 million in prioritized payments for capitally impaired SBICs that were not transferred to liquidation status timely.

  • SBA’s ability to limit risk was also impeded by the fact that existing guidance for the operation of the SBIC program, Standard Operating Procedure (SOP) 10 06, had not been revised since March 1989. This SOP was no longer adequate because it did not:

  • address current practices and procedures,

  • require an analysis of SBIC financial data to determine the potential for recovery of SBIC leverage guarantied by SBA,

  • include procedures to ensure the consistent implementation of restrictive operations,

  • ensure the consistent application of forbearance, and

  • provide a systematic approach for transferring capitally impaired SBICs withparticipating securities to liquidation status and include the use of receiverships to effect recovery, when warranted.

We recommend that the Associate Administrator for the Investment Division improve the Division’s ability to limit risk by reassessing the appropriateness of forbearance regulations and obtaining a written opinion from the Office of General Counsel concerning whether SBICs with participating securities and a condition of capital impairment can be liquidated using receiverships. Additionally, we recommend that the Associate Administrator revise SOP 10 06 to ensure that: (i) financial analyses include the potential for recovery, (ii) the implementation of restrictive operations includes consideration of the level of impairment, time periods and types of remedies to be used, and the applicability of forbearance regulations, (iii) a systematic approach is used in determining whether to transfer SBICs with participating securities to liquidation to ensure prioritized interest payments are kept to a minimum, (iv) and that receiverships be considered, where appropriate and if deemed an acceptable approach by the Office of General Counsel.

The Investment Division’s response provided justification for the concept of forbearance, and agreed: (a) to obtain a written opinion from the Office of General Counsel as to whether capitally impaired SBICs with participating securities can be liquidated using receiverships; (b) to provide support for the forbearance periods; and, (c) to revise SOP 10 06. The Division did not agree to provide support for the forbearance capital impairment decision points nor did the Division agree with our recommendations concerning restrictive operations.

To view the complete article, see the attachment below.

File Attachments: 
Attachments Size
3-33 Audit of SBIC Oversight 146Kb