American Technology Corporation, No. MSB-547 (June 11, 1996)
Docket No. MSBE-95-11-20-27

                    UNITED STATES OF AMERICA

                  SMALL BUSINESS ADMINISTRATION

                 OFFICE OF HEARINGS AND APPEALS

                        WASHINGTON, D.C.

______________________________
                              )
IN THE MATTER OF:             )
                              )  Docket No. MSBE-95-11-20-27
American Technology           )
Corporation                   )
______________________________)

                           APPEARANCES

For the Petitioner:                For the Agency:

Shekar M. Swamy                    John T. Spotila, Esq.
President and CEO                  General Counsel
American Technology Corporation    Robinson S. Nunn, Esq.
Rose Tree Corporate Center I       Agency Representative
1400 N. Providence Rd.             Small Business Administration
Suite 105                          409 Third Street, SW
Media, PA 19063-2052               Washington, DC 20416

                             DIGEST

The 8(a) application process affords the applicant an evenhanded
and impartial evaluation of its qualifications.  It also provides
applicants with the necessary due process rights to ensure
fundamental fairness.  In this regard, 13 C.F.R. Section
124.206(c) permits applicants an opportunity to respond to issues
raised by the SBA in an initial denial of an 8(a) application by
requesting reconsideration.  In addition, if the concern is
declined on reconsideration, "solely for reasons not identified
in the initial decline, the concern will be afforded all rights
which were available to it on its initial decline."  13 C.F.R. 
Section 124.206(c)(1).

Section 553 of the Administrative Procedure Act (5 U.S.C. Section
553)  provides that an agency, such as the SBA, must publish
notice of a proposed rule in the Federal Register and allow
interested persons to submit comments on the proposed rule before
it becomes final.  Interpretative rules and general statements of
policy, however, are exempt from the notice-and-comment
provision, but legislative and substantive rules are not.

The distinction between exempt interpretative rules and general
statements of policy and nonexempt legislative and substantive
rules can be muddled.  There are certain general principles,
however, which courts have applied to make this distinction: 
First, the agency's own label, while relevant, is not
dispositive.  An interpretative rule simply states what the
administrative agency thinks the statute means, and only reminds
affected parties of existing duties.  On the other hand, if by
its action the agency intends to create new law, rights or
duties, the rule is properly considered to be a legislative rule.

Neither part 124 nor part 134 suggests a remedy for a failure by
the SBA to afford an 8(a) applicant an opportunity to address new
matters the SBA raises when denying a request for reconsidera-
tion.  On one hand, a failure of the SBA to afford an applicant
an opportunity to address new matters could be considered
arbitrary, capricious, or contrary to law.  On the other, the
matter can be remanded to the SBA with instructions to adhere to
Section 124.206(c)(1), affording an 8(a) applicant an opportunity
to respond to the new matter and allowing the SBA an opportunity
to evaluate that matter.  The latter approach will avoid a
piecemeal review of the issues in the case.

                    DECISION AND REMAND ORDER

                          June 11, 1996

ARKOW, Administrative Law Judge:

     Petitioner American Technology Corporation (ATC) is
appealing a decision by Respondent U.S. Small Business
Administration (SBA) denying it entry into the 8(a) program[1]
because the individual claiming to be socially and economically
disadvantaged does not control and manage ATC.[2]  Initially, the
SBA concluded that ATC's disadvantaged owner did not manage ATC
on a full-time basis because he did not meet the SBA's "policy"
requirement to be available during normal working hours at the
firm's principal place of business.  Subsequently, the SBA added
a new reason for denial--that a nondisadvantaged individual
controlled or had the power to control ATC.  ATC was not given an
opportunity to rebut this conclusion prior to this appeal.  This
requires remand to allow ATC the opportunity to address the new
reason for denial and to permit the SBA to reevaluate its
conclusions based on a complete record before deciding whether
the SBA acted arbitrarily, capriciously, or contrary to law.

                          Jurisdiction

     Jurisdiction on appeal is properly based on 15 U.S.C.
Section 637(a)(9) and 13 C.F.R. parts 124 and 134.  The appeal
was timely filed under 13 C.F.R. Sections 124.210(b) and
134.11(a)(7) (1995).[3]

                              Issue

     Whether ATC was denied the opportunity to respond to the
SBA's new reason for denial and establish that ATC's President
controlled ATC.  13 C.F.R. Section 124.206(c)(1).

                              Facts

     On November 24, 1994, ATC applied for admission into the
8(a) program.  On June 27, 1995, the SBA denied ATC's application
because it concluded that the President of ATC, Mr. Shekar Swamy,
did not "devote full-time to the management of the applicant
concern."  Administrative Record at Ex. 6.  The denial letter
states: "Current SBA policy requires that an 8(a) concern be
managed full-time by the disadvantaged individual and that he or
she be available during normal working hours at the principal
place of business of the firm."  Id.  The basis for that
conclusion was that Mr. Swamy lives near Philadelphia,
Pennsylvania and ATC maintains its principal place of business in
St. Louis, Missouri.  

     ATC was advised that it could request reconsideration of the
SBA's decision.  ATC was also advised that, if it requested
reconsideration, it should provide evidence that Mr. Swamy was
"engaged full-time in the day-to-day operation of the firm."  Id.

     On August 10, 1995, ATC requested reconsideration of the
SBA's decision denying it entry into the 8(a) program.  The
reconsideration request presents evidence ATC believes would
satisfy the SBA's request and establish that Mr. Swamy manages
ATC on a full-time basis despite the fact that his office is not
at the firm's principal place of business.  Specifically,
Mr. Swamy urges the SBA to consider that he devotes 60-80 hours
per week running ATC and has no other business interests. 
Mr. Swamy substantiates this with a copy of his tax return.  He
maintains he is in daily contact with ATC's key employees by
telephone and computer networks and makes all of the key
decisions for ATC.  He bases these decisions on daily updates of
bank balances, accounts receivable, accounts payable, and an
order transaction log.  Mr. Swamy indicates that he must
personally approve all of ATC's purchases over $2,000 and
personally resolves contract issues.  He insists he is singularly
responsible for securing major contracts; all hiring decisions
require his express consent; and all employment agreements
require his signature.  ATC maintains branch offices in Seattle,
Dallas, and Chicago as well as those in St. Louis and
Philadelphia.  Mr. Swamy feels that this arrangement provides for
the most efficient management of ATC.  Administrative Record at
Ex. 5.  

     On October 6, 1995, the SBA denied ATC's reconsideration
request.  Administrative Record at Ex. 3.  The reconsideration
denial letter states that ATC did not present sufficient evidence
to overcome the reason for declining the application because
Mr. Swamy did "not devote full-time to the day-to-day management
of [ATC]."  Id.  The reconsideration denial letter concluded:

     Current 8(a) program eligibility criteria require that
     an applicant concern be one whose management and daily
     business operations are controlled by an individual, or
     individuals, determined by SBA to be socially and
     economically disadvantaged.

     . . . .

     An applicant concern shall be declined if it is
     determined that nondisadvantaged individuals as
     stockholders, Officers, Directors, or employees in the
     applicant concern exercise actual control over the
     operations of the business concern.

     In each of your statements, you demonstrated your
     dependence upon "second hand information"; that is, the
     observations, assessments, and data input from
     personnel in your St. Louis location.  Since
     Mr. Koester is co-located in the St. Louis office and
     is the highest ranking corporate official at that
     location, it has been determined that Mr. Koester has
     the power to control (block, edit, or transmit)
     operational information to you.

     Consequently, it has been determined that a
     nondisadvantaged individual (Mr. Anthony Koester)
     controls, or has the power to control day-to-day
     operations of the applicant concern.

Id.  (Emphasis added).  

     On November 20, 1995, ATC filed an appeal of the SBA's
denial of ATC's reconsideration request.  ATC contends that the
SBA's denial is arbitrary and presents arguments to the effect
that Mr. Koester does not control or have the power to control
ATC because there are sufficient checks and balances in place to
maintain control of ATC.  In ATC's Appeal Petition Mr. Swamy
states, "I therefore look forward to a hearing in which I can
present information, exhibits and testimony as evidence to the
fact that I control and run the operations of American Technology
Corporation, and should be admitted into the 8(a) program."[4]

                           Discussion

                                I

     The 8(a) application process affords the applicant an
evenhanded and impartial evaluation of its qualifications.  It
also provides applicants with the necessary due process rights to
ensure fundamental fairness.  In this regard, 13 C.F.R. Section
124.206(c) permits applicants an opportunity to respond to issues
raised by the SBA in an initial denial of an 8(a) application by
requesting reconsideration.  In addition, if the concern is
declined on reconsideration, "solely for reasons not identified
in the initial decline, the concern will be advised that SBA will
treat the decline as an initial decline, and that the concern
will be afforded all rights which were available to it on its
initial decline."  13 C.F.R. Section 124.206(c)(1).

     In its initial denial, the SBA concluded that Mr. Swamy did
not devote full-time to the management of ATC because SBA
"policy" requires the disadvantaged individual to be available
during normal working hours at the firm's principal place of
business.  Thus, the SBA reasoned that, because Mr. Swamy
conducts ATC's business from the firm's branch office in
Philadelphia rather than at the firm's principal place of
business in St. Louis, he does not devote full-time to the
management of ATC.  

     ATC attempted to rebut in its reconsideration request the
SBA's conclusion that Mr. Swamy did not manage ATC on a full-time
basis, by submitting an explanation of how ATC is managed and how
Mr. Swamy makes his management decisions.  In its reconsideration
denial, the SBA acknowledged the evidence submitted by ATC to
show that Mr. Swamy devotes all of his working time to ATC and
has no other business interests.  It disagreed, however, with its
significance and adhered to its original decision.  No reason,
other than the SBA's "policy," was given why the evidence
submitted on reconsideration did not satisfy the SBA that
Mr. Swamy devotes all of his time to the management of ATC.  

     It is problematic whether the application of this "policy,"
which has not been published in the Federal Register, is
arbitrary, capricious, or contrary to law.  The "policy" may be
subject to the notice-and-comment rulemaking requirements of the
Administrative Procedure Act.  5 U.S.C. Section 553.  Section 553
provides that an agency, such as the SBA, must publish notice of
a proposed rule in the Federal Register and allow interested
persons to submit comments on the proposed rule before it becomes
final.  Id.  "Interpretative rules" and "general statements of
policy," however, are exempt from the notice-and-comment
provision.  5 U.S.C. Section 553(b)(3)(A).  But legislative and
substantive rules are not exempt from the notice-and-comment
requirements.  Lincoln v. Vigil, 508 U.S. 182 (1993).

     The distinction between exempt interpretative rules and
general statements of policy, on one hand, and nonexempt
legislative and substantive rules, on the other, can be muddled. 
American Mining Congress v. Mine Safety and Health
Administration, 995 F.2d 1106, 1108-1109 (D.C. Cir. 1993);
National Family Planning and Reproductive Health Ass'n, Inc. v.
Sullivan, 979 F.2d 227 (D.C. Cir. 1992).  Courts have applied
certain general principles, however, to make this distinction:

     First, the agency's own label, while relevant, is not
     dispositive.  An interpretative rule simply states what
     the administrative agency thinks the statute means, and
     only "'reminds' affected parties of existing duties." 
     On the other hand, if by its action the agency intends
     to create new law, rights or duties, the rule is
     properly considered to be a legislative rule.

General Motors Corp. v. Ruckelshaus, 742 F. 2d 1561, 1565 (D.C.
Cir. 1984) (citations omitted) (quoted in First Nat'l Bank of
Lexington v. SBA, 946 F. 2d 1185, 1188 (6th Cir. 1991)).  

     If the SBA's unpublished "policy" is not exempt from the
notice-and-comment requirement, then it cannot be used as the
basis for denying ATC's 8(a) application.  See, e.g., Community
Nutrition Institute v. Young, 818 F.2d 943, 949 (D.C. Cir. 1987). 
Accordingly, the issue of whether this "policy" is an exempt
general statement of policy or a nonexempt legislative rule must
be resolved before I can decide whether the SBA acted
arbitrarily, capriciously, or contrary to law.

     It is also problematic whether the "policy" is contrary to
the plain language of 13 C.F.R. Section 124.104(a).  That section
provides that an applicant concern must be managed on a full-time
basis by a disadvantaged individual who possess the necessary
management or technical capabilities to run the firm; and that
the full-time manager must hold the position of President or
Chief Executive Officer, which precludes outside employment or
any other business interest which conflicts with the management
of the applicant firm.  Id.  Section 124.104(a) does not impose
or imply an additional requirement that the disadvantaged
individual work at the firm's principal place of business rather
than at a firm's branch office.  There is no dispute that
Mr. Swamy, as President of ATC, possesses the necessary
management and technical capabilities, and has no other outside
business interests.  Thus, I must also resolve whether the plain
language of the regulation rather than the "policy" controls
before I can decide whether the SBA acted arbitrarily,
capriciously, or contrary to law.[5]

                               II

     In its reconsideration denial the SBA also reached a new
additional conclusion:  Mr. Koester, ATC's Executive Vice
President and 49% stockholder, is in charge of the St. Louis
headquarters of ATC.  Thus, he controls or has the power to
control ATC because he can block, edit or transmit operational
information to Mr. Swamy.  Because the reconsideration request is
the last opportunity an 8(a) applicant has to present evidence to
support its admission into the 8(a) program, ATC was unable to
present additional evidence to the SBA to rebut this new
conclusion and establish that Mr. Koester does not have the power
to control ATC.

     In its appeal petition ATC presented evidence to the
Administrative Law Judge to rebut the SBA's new conclusion 
concerning control.  This new evidence was not considered by the
SBA.  ATC also indicated in its appeal that it expects to have an
opportunity at a hearing to present additional evidence to rebut
the SBA's new conclusion.  New evidence cannot be considered in
this appeal.  13 C.F.R. Section 124.210(h).  Moreover, in the
absence of a showing that the SBA's determination may have
resulted from bad faith or improper behavior, the regulations do
not permit ATC to have a hearing to present evidence on this new
issue.  Id.  

     The SBA's conclusion that Mr. Koester controls or has the
power to control ATC may have resulted from the SBA's failure to
realize that 13 C.F.R. Section 124.104 was amended on June 7,
1995.[6]  Prior to the amendment, that section provided that
"management and daily business operations must be controlled" by
a disadvantaged individual.  Now the regulation provides that
"management and daily business operations must be conducted" by a
disadvantaged individual.[7]  Compare the reconsideration denial
letter ("management and daily business operations are
controlled"), supra, with 13 C.F.R. Section 124.104 before and
after the amendment.  But regardless of the reason for the SBA's
conclusion that Mr. Koester controls or has the power to control
ATC, this new reason for denial requires the SBA to afford ATC
the rights afforded on an initial denial.  13 C.F.R. 
Section 124.206(c)(1). 

     Neither part 124 nor part 134 suggests a remedy for a
failure by the SBA to afford an 8(a) applicant an opportunity to
address new matters the SBA raises when denying a request for
reconsideration.  On one hand, a failure of the SBA to afford an
applicant an opportunity to address new matters could be
considered arbitrary, capricious, or contrary to law.  On the
other, the matter can be remanded to the SBA with instructions to
adhere to Section 124.206(c)(1), affording ATC an opportunity to
respond to the new matter and allowing the SBA an opportunity to
evaluate that matter.  The latter approach, which I choose to
exercise in this case, will afford the parties a just
determination in these proceedings and is allowed under a liberal
interpretation of the rules governing these proceedings.  See
13 C.F.R. Section 134.4(b).  By taking this approach I will also
avoid a piecemeal review of the other substantial issue involving
the SBA's "policy" for evaluating the full-time management of an
8(a) applicant.

     There is considerable support preferring remand as a remedy
for resolving this type of issue.  See, e.g., Matter of Encap
Systems Corporation, SBA No. 515 (1995); Matter of The Boston
Group, SBA No. 487 (1994); Matter of JTI Systems, Inc., SBA No.
463 (1994); Matter of Mega Analytical Research Services, Inc.,
SBA No. 374 (1991); cf., Matter of Paragon Systems, Inc., SBA No.
440 (1993) (where a new reason was raised by SBA, but further
reconsideration opportunities would delay ultimate disposition
and matter could be decided on facts in the record without a need
to remand).  The rationale for these decisions is that until the
SBA makes a final determination concerning an applicant's ability
to satisfy all of the SBA's requirements for admission into the
8(a) Program, the record is simply not complete.  Thus, a review
to decide if it is arbitrary, capricious, or contrary to law is
premature.  To conduct a review would thwart the obvious purpose
of the regulations: to give applicants sufficient notice and an
opportunity to respond to new conclusions of the SBA in reaching
a final decision on an 8(a) application.

     Further, in the interest of fairness, the SBA should be
given an opportunity to consider and address my observations
regarding the SBA's unpublished "policy" requiring a
disadvantaged individual to be at the firm's principal place of
business and how the June 7, 1995 change in the regulation
affects its decision before I evaluate these issues and decide
whether the SBA's conclusions are arbitrary or capricious.  It
would also waste valuable judicial resources to require review of
cases on a piecemeal basis.  Mega, supra, at 18-19. 

                           Conclusion

     The matter is REMANDED to the SBA for further consideration
and a determination of ATC's eligibility that is not inconsistent
with this Decision and Order.[8]  The SBA shall follow the
procedures mandated by 13 C.F.R. Section 124.206(c)(1) requiring
the SBA to treat the decline as an initial decline and afford ATC
all of the rights it received on the initial decline.  The SBA
may consider the evidence submitted in this appeal and determine
if that evidence is sufficient to satisfy its eligibility
require-ments or it may request additional material from ATC. 
The determination whether to admit ATC to the 8(a) Program based
on the appeal evidence or follow the Section 124.206(c)(1)
procedures shall be made within 10 days of the date of this
order.  The SBA shall immediately report the results of that
determination to the Administrative Law Judge.

     I retain jurisdiction of the matter until I review the final
determination of the SBA.  See 13 C.F.R. Section
124.210(h)(2).[9]

                              _________________________
                              Richard S. Arkow
                              Administrative Law Judge

____________________
 [1] Small Business Act of 1958, Section 8(a), 15 U.S.C. Section
637(a) and 13 C.F.R. part 124.  "The 8(a) Program is intended to
be used exclusively for business development purposes to help
small businesses owned and controlled by socially and
economically disadvantaged individuals. . . ."  13 C.F.R. Section
124.1(a).

 [2] 13 C.F.R. Section 124.104.

 [3] This appeal was filed prior to the revision of part 134 of
the Code of Federal Regulations, which applies to all appeals
filed on or after February 28, 1996.  See 13 C.F.R. part 134
(1996).  

 [4] As this was the first time the SBA raised the issue of
control, ATC was never given the opportunity to present evidence
on this new conclusion.

 [5] In view of my decision to remand, I need not decide these
issues now.  They are raised only to illustrate what I might have
to address when the merits of the appeal are weighed.

 [6] 60 Fed. Reg. 29,975 (1995).

 [7] Id.

 [8] 13 C.F.R. Section 124.210(h)(2).

 [9] I defer ruling on the Order to Show Cause Why Sanctions
Should Not be Imposed (January 31, 1996) until this matter is
returned to me.