Performance Audit Report 

Improved Examination Quality Can Strengthen 


SBA's Oversight of Small Business Investment Companies 


September 30, 2013 Report Number 13-22 
u.s. Small Business Administration 

Office of Inspector General 

Washington, D.C. 20416 

FINAL REPORT TRANSMITTAL 

REPORT NUMBER: 13-22 

DATE: 	 September 30,2013 

To: 	 Pravina Raghavan, Acting Associate Administrator, Office of Investments and Innovation 

SUBJECT: 	 Improved Examination Quality Can Strengthen SBA's Oversight of Small Business 

Investment Companies 

This final report presents the results of our audit of the Small Business Administration's (SBA) 


examinations of Small Business Investment Companies (SBICs). Our initial objectives were to determine 


the extent to which the SBA (1) conducted SBIC examinations in accordance with the law, rules and 


regulations, and SBA policies and procedures, (2) used SBIC examinations to mitigate the risk of financial 


loss, and (3) managed the SBIC examination process effectively and efficiently. During our initial survey 


work, we identified deficiencies in the management of the SBIC examination process, which caused us to 


focus our work on objective three. As a result, we developed a reporting objective to identify key 


challenges the Office of Investments and Innovation (011) faced in executing its SBIC examination 


function. 


We conducted this audit in accordance with generally accepted government auditing standards. 


Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence 


to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe 


that the evidence obtained provides a reasonable basis for our findings and conclusions based on our 


audit objective. 


We request that you provide your management decision for each recommendation on the attached 


SBA form 1824, Recommendation Action Sheet, by October 3D, 2013. Your decision should identify the 


specific actions taken or planned for each recommendation and the target dates for completion. 


We appreciate the courtesies and cooperation of the SBA extended to the staff during this audit. 


Please direct any questions to me at (202) 205-6586 or Terry Settle, Director, Credit Programs Group at 


(703) 487-9940. 

*** 

/s/ 

Robert A. Westbrooks 

Deputy Inspector General 
What DIG Audited However, we found that improvements of SBA processes 

Small Business Investment Companies (SBICs) are private 

investment firms licensed by the Small Business 

Administration (SBA), pursuant to authority granted by 

the Small Business Investment Act of 1958 (Act). The 

SBIC program bridges the gap for entrepreneurs who 

need capital and are unable to obtain it through 

traditional sources of financing. The SBIC program 

provides SBA-guaranteed leverage to SBICs that, in turn, 

make loans and equity investments in qualifying small 

businesses. As of March 31, 2013, there were 296 SBICs 

in active operation. Of those 296 SBICs, 252 were 

indebted to the SBA for more than $9.3 billion. 

The SBA is required to examine all SBICs at least every 

two years to assess (1) whether licensees are complying 

with the Small Business Investment Act of 1958 and 

implementing regulations, (2) the financial condition of 

licensees and SBA's financial vulnerabilities, and (3) the 

accuracy of information submitted to the SBA. These 

examinations are conducted by the Office of SBIC 

Examinations (OSE) within the Office of Investments and 

Innovation (011). 

Our initial objectives were to determine the extent to 

which the SBA (1) conducted SBIC examinations in 

accordance with the law, rules and regulations, and SBA 

policies and procedures, (2) used SBIC examinations to 

mitigate the risk of financial loss, and (3) managed the 

SBIC examination process effectively and efficiently. 

During our initial survey work, we identified deficiencies 

in the management of the SBIC examination process, 

which caused us to focus our work on objective three. As 

a result, we developed a reporting objective to identify 

key challenges the 011 faced in executing its SBIC 

examination function. 

What DIG Found 

We determined that while the SBIC examination function 

generally addressed the requirements of the Act and 

Agency policy, improvements can be made. Our review 

found that examinations were conducted at least every 

two years as required by the Act. Further, our review 

indicated that SBICs were generally checked for 

regulatory violations as prescribed by the Act and Agency 

policy. 

could enhance the extent to which the Office of SBIC 

Examinations identifies business conditions and practices 

prohibited by the Act and Agency policy. 

The SBA's focus on the frequency of examinations as a 

strategy for reducing risk did not include a compensating 

control to ensure that examinations conducted would 

result in accurate assessments of regulatory compliance. 

With a greater emphasis on quantity, the OSE runs the 

risk that the review of an SBIC may be inaccurate or 

incomplete. To this point, the significant decrease in 

examination reports with findings may indicate that the 

quality of these assessments has suffered. 

Outdated guidance and incomplete examination 

checklists also affected the quality of the SBIC 

examination process. The examiners were impacted by 

challenges in the areas of strategic planning and the 

absence of training and technology upgrades to help 

keep pace with the changing industry requirements. 

Further challenges included poor communication and 

insufficient funding. These challenges, coupled with the 

emphasis on quantity, have resulted in examiners not 

identifying all findings. 

DIG Recommendations 

We recommended that the Acting Associate 

Administrator for the Office of Investments and 

Innovation: 

(1) 	 Create and execute a plan to improve the internal 

operations of the examination function. 

(2) 	 Update and improve the existing examination 

checklist. 

(3) 	 Assess the costs of the examinations function and 

prepare cost-benefit analyses for several funding 

options, to cover all examination costs. 

Management Response and Actions Taken 

The SBA agreed with Recommendations 2 and 3 and 

disagreed with Recommendation 1. During the course of 

this audit, the SBA updated and submitted for clearance, 

SOP 10 09, SBle Examinations Guidelines. This update 

will address many of the concerns raised by the OIG as 

outlined in this report. 
Table of Contents 

Introduction ............................................................................................................................................1 


Background .............................................................................................................................................2 


Nature of Limited or Omitted Information ............................................................................................... 3 


Review of Internal Controls .....................................................................................................................4 


Results ....................................................................................................................................................4 


Conclusion............................................................................................................................................. 11 


Recommendations ................................................................................................................................ 12 


Agency Comments and OIG Response ................................................................................................... 13 


Appendix I: Scope and Methodology..................................................................................................... 17 


Appendix II: The SBIC Program- Nine Major Findings & Category One Violations .................................... 19 


Appendix III: Agency Comments ........................................................................................................... 21 

Introduction 

This report presents the results of our audit of the Small Business Administration's (SBA) 

examinations of Small Business Investment Companies (SBICs). Our initial objectives were to 

determine the extent to which the SBA (1) conducted SBIC examinations in accordance with the 

law, rules and regulations, and SBA policies and procedures, (2) used SBIC examinations to 

mitigate the risk of financial loss, and (3) managed the SBIC examination process effectively and 

efficiently. During our initial survey work, we identified deficiencies in the management of the 

SBIC examination process, which caused us to focus our work on objective three. As a result, we 

developed a reporting objective to identify key challenges the Office of Investments and 

Innovation (011) faced in executing its SBIC examination function. 

To answer our reporting objective, we reviewed the Small Business Investment Act of 1958, 

Part 107 of Title 13 Code of Federal Regulations, and applicable Standard Operating Procedures 

(SOPs). We also reviewed SBA's 2011- 2016 Strategic Plan and the Agency's Small Business 

Investment Company Program Annual Report for FY 2012. We obtained and analyzed historical 

performance and cost data related to the examination function. 

We judgmentally selected a sample of 3 examinations from a universe of 141 examinations 

performed by the Atlanta Field Office between October 1, 2010, and August 10, 2012. The SBICs 

examined by the Atlanta office represented approximately $4.24 billion in indebtedness to the 

SBA. Using an Office of Inspector General (OIG) review methodology-that we prepared based 

on applicable SOPs-we reviewed Atlanta office examination files to assess whether the 

examinations covered the required laws, regulations, policies, and procedures. 

We interviewed the three regional managers and 6 of the 17 examiners responsible for 

evaluating SBICs. We interviewed representatives of four leveraged SBICs. We also interviewed 

senior officials in the 011 at SBA Headquarters in Washington, DC. Finally, we interviewed 

budgetary officials in the Office of Investment and Innovation. See Appendix I for full details of 

our methodology and list of sampled SBIC examinations. 

Our review focused on SBA's Office of SBIC Examinations (OSE), the office that has functional 

responsibility for examining licensees for statutory and regulatory compliance in this multibillion dollar investment program. 

We conducted this audit in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain sufficient, appropriate 

evidence to provide a reasonable basis for our findings and conclusions based on our audit 

objectives. We believe that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objective. 

1 
Background 

Small Business Investment Companies (SBICs) are private investment firms licensed by the Small 

Business Administration (SBA) pursuant to authority granted by the Small Business Investment 

Act of 1958 (Act). The SBIC program bridges the gap for entrepreneurs who need capital and are 

unable to obtain it through traditional sources of financing. The SBIC program provides 

SBA-guaranteed leverage1 to business investment firms that in turn make loans and equity 

investments in qualifying small businesses. 

The SBIC Program has primarily used two approaches to provide funding: 2 the Debenture 

Securities Program and the Participating Securities Program. Investment funds have been 

licensed as Standard Debenture licensees since the program was founded in 1958. Debenture 

licensees provide later stage or expansion capital to cash-flow positive or nearly cash-flow 

positive companies and are eligible for SBA leverage capped at $150 million.3 Debentures have 

a repayment term of 10 years and provide for semi-annual interest payments and a lump-sum 

principal payment at maturity. 

Conversely, the SBA's Participating Securities Program began in 1994 to better match how SBICs 

were funded with the equity needs of entrepreneurs. Participating securities have lO-year 

maturities and prioritized payments (interest) paid only to the extent that an SBIC has positive 

earnings. Depending on whether an SBIC was a corporation or a partnership, SBICs issued 

participating securities as preferred stock, income bonds, or a preferred limited partnership 

interests. The SBA eliminated the Participating Securities Program in 2004 due to projected 

losses in excess of $2.7 billion. 

The SBIC program is managed within the SBA by the Office of Investments and Innovation, which 

is responsible for licensing, overseeing the regulatory compliance of, assessing the financial 

condition of, guaranteeing leverage to, and liquidating SBICs. As of March 31, 2013, there were 

296 SBICs in active operation, 252 of which were indebted to the SBA for more than $9.3 billion 

in SBA-guaranteed leverage.4 The SBA charges upfront and annual fees on the leverage that 

SBICs draw. These fees are used, in part, to offset losses; however, the vast majority of SBICs 

fully repay their SBA-guaranteed leverage. 

In fiscal year 2012, SBICs provided $3.1 billion in financing to over 1,000 small businesses. 

The SBA maintains that the SBIC Program operates on a zero subsidy basis and, historically, at no 

cost to taxpayers. This aspect of the program has not been audited by the OIG. In its 2011-2016 

Strategic Plan, the SBA reported that it intended to double the amount of long-term capital 

deployed in the SBIC Program from the average of $750 million to $1.5 billion per year by Fiscal 

Year (FY) 2016. As of June 3D, 2013, the SBA reported that it had issued an average of 

$1. 7 billion in debenture leverage commitments, and therefore exceeded its goal. 

1 Leverage means financial assistance provided to an SBIC licensee by the SBA. 

The SBA also provides capital under its "Other Funds" category. These are referred to as Specialized SBICs. 

3 For everyone dollar an SBIC raises from a private investor, the SBA will typically provide two dollars of debt capital or 

leverage, subject to a cap of $150 million. 

4 Some SBICs do not receive SBA-guaranteed leverage or financial assistance. These "non-leveraged" investment funds 

nonetheless play an important role in both attracting private capital and investing in small businesses in need of financing. 

These non-leveraged funds have typically been attractive to bank investors, for whom investments in SBICs presumptively 

qualify towards Community Reinvestment Act Credit. As of FYE 2012, there were 44 Non-Leveraged SBICs in the program. 

2 

2 
The Act and SOPs require the SBA to examine all SBICs at least every two years to ensure they 

are performing well financially, and are complying with the legal requirements governing the 

SBIC Program. The Act further directs the SBA to determine if seven specific violations exist 

within the operations of SBICs. Agency policy requires examiners to determine if two additional 

violations exist. The nine violations are listed and explained in detail in Appendix II. The Office 

of SBIC Examinations (OSE), within the Office of Investments and Innovation (Oil), is tasked with 

examining SBICs for potential violations. The violations identified by the OSE can result in SBICs 

being transferred to the Oil's Office of SBIC Liquidation for recovery of funds paid by the SBA. 

The Oil's Office of SBIC Operations, which is responsible for the daily oversight and continuous 

monitoring of SBICs, also identifies program violations and other non-compliance issues. 

The Office of SBIC Examinations 

The Office of SBIC Examinations, according to Standard Operating Procedure (SOP) 10 08, 

Examination Guidelines, is responsible for (1) determining whether licensees are complying with 

the Small Business Investment Act of 1958 and implementing regulations, (2) assessing the 

financial condition of licensees and SBA's financial vulnerabilities, and (3) ensuring the accuracy 

of information submitted to the SBA. 

The SBA's statutory authority to conduct examinations allows the Agency to collect fees to cover 

the costs of performing these examinations. Examination fees are based upon the SBICs' assets 

at cost, with adjustments in the form of discounts or add-ons for outstanding examination 

findings, responsiveness, type of organization, and locations of files. 

The OSE is headed by a Director in Washington, D.C. who plans, directs, and coordinates the 

SBA's program for examining SBICs through three examination managers and 16 examiners 

assigned to regional offices located in Atlanta, Georgia; New York, New York; and San Francisco, 

California. An additional examiner located in West Virginia reports to the Director. Examination 

managers supervise the workflow and daily activities of examiners who schedule and perform 

examinations using a checklist to guide efforts and capture results. They also review the 

examiner's work papers and draft reports. The managers also report examination results and 

findings to the Office of SBIC Operations. Although OSE examiners identify findings, the Office 

of SBIC Operations has the final decision about the validity of those findings and the extent to 

which they will be included in the final reports issued to the SBICs for corrective action. Findings 

are classified as Category One, which represents the nine more serious violations, or Category 

Two, which covers all other less serious non-compliances that may appear under /lather 

Matters" in the examination report. 5 During fiscal year 2012, the SBA issued 233 examination 

reports, identifying 17 Category One findings and 16 Category Two findings. 

Nature of Limited or Omitted Information 

We did not limit or omit information from this report. 

5 See Category One violations in detail in Appendix II. 

3 
Review of Internal Controls 

The SBA's internal control systems SOP6 provides guidance on the implementation and 

maintenance of effective systems of internal control as required by OMB. 7 According to OMB, 

effective systems of internal control improve the accountability and effectiveness of Federal 

programs and operations by establishing, assessing, correcting, and reporting on internal 

controls. 

To assess internal controls during the survey phase of the audit, we assessed the control 

environment in which the Office of SBIC Examinations functioned and reviewed the activities 

and processes used to execute the office's responsibilities. We also completed a logic model to 

record concerns in the areas of inputs, activities, outputs, and outcomes for the SBIC 

Examinations function. We found weaknesses in the management of the SBIC examination 

process, including challenges in the areas of SBIC examination quality, guidance, planning, 

training, technology, communication, and funding. Cumulatively, the weaknesses we identified 

diminished the SBA's ability to identify regulatory violations and other non-compliance issues in 

the operations of SBICs. 

Results 

We determined that while the SBIC examination function generally addressed the requirements 

of the Act and Agency policy, improvements can be made. Our review found that examinations 

were conducted at least every two years as required by the Act. Further, our review indicated 

that SBICs were generally checked for regulatory violations as prescribed by the Act and Agency 

policy. However, we found that improvements could enhance the extent to which the Office of 

SBIC Examinations identifies business conditions and practices prohibited by the Act and Agency 

policy. 

Improved Examination Quality Can Strengthen SBA's Regulatory Oversight of SBICs 

The SBA's reliance on the frequency of examinations as a strategy for reducing risk did not 

include a compensating control to ensure that examinations conducted would result in accurate 

assessments of regulatory compliance. With a greater emphasis on quantity, the OSE runs the 

risk that the review of an SBIC may be inaccurate or incomplete. 

Outdated guidance and incomplete examination checklists also affected the quality of the SBIC 

examination process. The examiners were impacted by challenges in the areas of strategic 

planning and the absence of training and technology upgrades to help keep pace with the 

changing industry requirements. Further challenges included poor communication and 

insufficient funding. These challenges coupled with the emphasis on quantity have resulted in 

examiners not identifying all findings. 

While Examination Cycle Time Has Decreased, Reports with Findings Have Also Decreased 

Our analysis found that the SBA required examinations to be completed more frequently than 

statutorily mandated, which reduced the average examination cycle time. At the same time, the 

6 SOP 00 02, Internal Control Systems. 


7 US Office of Management and Budget (OMB) Circular A-123, Management's Responsibility for Internal control, 2004. 


4 

• • 

percentage of reports with findings also decreased. The SBA claimed the reduction in findings 

occurred due to more frequent examinations and stronger standards for entry into the program. 

For example, in its Fiscal Year (FY) 2012 Annual Report, the SBA noted that it conducted more 

frequent examinations and had fewer reports with findings, thereby indicating that regulatory 

compliance had improved. Additionally, a senior 011 official stated that the number of findings 

had decreased due to the better quality of SBICs and training received by SBICs regarding 

policies and procedures. However, we identified other factors that could have contributed to 

the decline in findings. 

The Act requires the SBA to examine each licensee at least every two years,8 but SBA policy 

requires examinations that are more frequent. 9 For example, as of August 2012, examinations 

for leveraged SBICs were occurring at l1.9-month intervals, while examinations for nonleveraged SBICs were occurring at 15.2-month intervals, as reflected in Figure 1. 

Figure 1 SBIC Examinations Cycle Time (in Months) 

30 25.6 

_____23.2 23.2 


25 
 21.2 III 

..c

... 

c 20 0 15.6 15.2 2 

15 -

0 

... _ Non-Leveraged • • • . . : • cu 14 14.3 ..c 14.5 10 13.9 12.9 • E 11.7 11.9 Leveraged :::s 

z 5 


0 


FY06 FY07 FY08 FY09 FY10 FY11 FY12 


Fiscal Year 


Source: Generated by OIG with data obtained from the all. 

As the time between examinations has generally decreased over the past six years, the 

percentage of findings has also decreased. Specifically, since 2006, the average time between 

examinations decreased by greater than 15 percent for leveraged SBICs and 40 percent for 

non-leveraged SBICs. The percentage of reports that yielded findings of regulatory violations for 

both leveraged and non-leveraged SBICs combined, decreased by nearly 67 percent, from 26.9 

percent to 9 percent, during this same period, as shown in Figure 2. 

8 Section 310(b) 


9 SOP 1008 requires leverage SBICs be examined annually and non-leveraged on an 18-24 month cycle. 


5 

Figure 2 Percentage of Total Reports with Findings 

30.0% 

cu 20.0% tID 


III


... 

C 

cu 

... 

u 10.0% cu 

c.. 

0.0% 

FY06 FY07 FY08 FY09 

Fiscal Year 

FY10 FY11 FY12 

Source: Generated by OIG with data obtained from the 011. 

SBA Management stated that the decrease in findings was due to an improvement in the quality 

of SBICs as a result of more frequent examinations and more stringent licensing requirements. 

However, we determined that there are specific challenges faced by examiners that are 

contributing towards the decline in findings as discussed below. 

Quality Suffered in Response to Risk Reduction Strategy of Increasing Examination Frequency 

The Office of Examinations' strategy of focusing on examination frequency was reflected in the 

annual guidance distributed to examination managers. This guidance emphasized the number 

of examinations to be completed. Further, individual performance standards clearly stressed 

volume. Specifically, the performance standards showed a direct relationship between the 

number of examinations performed and the performance ratings of examiners and examination 

managers. For example, a GS-ll examiner was expected to complete a minimum of 12 

examinations in order to receive a rating of 3. To receive a rating of 4, the examiner had to 

complete a minimum of 13 examinations. A rating of 5 required the completion of a minimum 

of 14 examinations. Quality was not a measurable benchmark in terms of employee 

performance. In fact, emphasis was placed on the quality of the written product as opposed to 

the quality of the examination process itself. 

Importantly, in interviews conducted with examination managers, examiners, and SBICs, the 

issue of time allowed to conduct examinations was a concern. Specifically, four examiners told 

us that the quality of the exams could be improved if more time was allotted. They stated more 

thorough examinations could be performed and more findings possibly produced. 

One examiner told us that their manager pushed for a IIno findings" report due to time 

constraints. An examination manager stated that due to the broad scope of the examination, 

the examiner does not have sufficient time to identify some of the more complex findings. 

Another examination manager and examiner said that additional time would permit more 

detailed reviews. Additionally, one senior 011 official stated that examiners missed violationssuch as improper management fees-that had been recurring for several years. Liquidations 

staff eventually discovered the violations only after the licensee was transferred to liquidation. 

Another senior 011 official stated that examiners missed violations such as conflicts of interest, 

inaccurate valuations and overline investments. 

6 
Outdated Guidance and a Deficient Examination Checklist Affect Examination Quality 

At the time of our audit, SBA guidance for examining SBICs was outdated and did not ensure 

that major regulatory violations were addressed. The SBA's SOP 10 08, SBIC Examinations 

Guidelines, which defined the purpose of examinations, had not been updated since its issuance 

in 1997. The SBA's SOP 10 09, SBA Internal Examination Guidelines also had not been updated 

since 1998. This SOP instructed the examiners to focus on nine Category One violations, as 

follows: 

(1) Unlawful Activities Not Contemplated by the Act, 

(2) Relending, Foreign, Passive or other Prohibited Investments, Including Prohibited Real 

Estate Financings, 

(3) Prohibited Conflicts of Interest, 

(4) Overline Investments 

(5) Short Term Financing, 

(6) Excessive Cost of Money, 

(7) Control ofSmall Business, 

(8) Inappropriate Distributions, 

(9) Impairment and Valuation Issues 

The Office of SBIC Examinations created a checklist in 2001 for examiners to perform their work. 

Our review of the six-page checklist found that it did not align with the nine Category One 

violations. The checklist contained 41 specific actions for examiners to complete. However, the 

focus of the checklist was unclear and violations were not explicitly listed. For example, to 

address Conflicts of Interest, SOP 10 09 required examiners to review the terms of financings, 

review the disposition of assets, obtain credit reports, obtain confirmations from portfolio 

concerns, and consider visiting small business that appear to be in a conflict of interest situation. 

However, the only SOP action mentioned on the checklist was IIreview disposition of assets," 

and the checklist did not mention IIConflict of Interest." Similarly, the checklist did not explicitly 

list the following Category One violations and did not contain all the elements necessary to 

examine the violations as stated in the SOP: 

• 	 Activities Not Contemplated by the Act 

• 	 Prohibited Control of a Small Business 

• 	 Short Term Financings 

• 	 Overline Investments 

• 	 Relending, Foreign, Passive or Other Prohibited Investments, including 

Prohibited Real Estate Financing; and 

• 	 Excessive Cost of Money 

Furthermore, we observed that although the steps required in the SOP to identify 

IIlnappropriate Distributions" were in the checklist, this violation was not titled anywhere within 

the checklist. 

Six of the nine managers and examiners we interviewed told us that the checklist was outdated 

and did not reflect the current environment for identifying findings. Several examiners 

confirmed our analysis that the nine Category One violations were not specifically covered by 

the checklist. One examiner said these violations should be explicitly stated in the checklist for 

7 

new and inexperienced examiners. The guidance governing the examinations process has not 

been updated since 1998 and the checklist since 2001. The outdated policies and procedures, 

according to staff, did not reflect the changes that have occurred in the program. For example, 

according to an examination manager, examiners no longer review the prohibited control of a 

small business and short-term financing, which are two of the nine Category One violations, 

because of the rarity of these violations. During the course of the audit, senior officials in the 

011 stated they recognize that the SOPs should be updated and were in the process of making 

revisions to SOP 1009. However, they said the checklist was not an issue because everything 

was covered and there was consistency across the offices in conducting examinations. 

Given the gaps in the checklist, statutory and regulatory violations and other non-compliance 

issues may not be identified and the SBA's ability to assess the financial condition of licensees 

and SBA's financial vulnerability may be hindered. In addition, the SBA's ability to ensure the 

accuracy of information that licensees submit to the Agency might be impaired. Furthermore, 

the checklist gaps could result in a lack of consistency in the approach that SBIC examiners use 

and the conclusions that they reach. 

Additionally, incongruence between SOPs and the checklist increases opportunities for 

unidentified violations that impact the quality of examinations. For example, one senior 011 

official stated that examiners missed violations such as improper management fees that had 

been recurring for several years. Liquidations staff eventually discovered the violations only 

after the licensee was transferred to liquidation. Another senior 011 official stated that 

examiners missed violations such as conflicts of interest, inaccurate valuations and overline 

investments. 

Challenges That Impacted Examiner Effectiveness 

We found that although the SBA had a strategic plan which included goals, strategies, and 

performance measures for the Oil, neither the 011 nor the OSE had its own plan to provide 

direction at the operational level. We also found that examination staff was not receiving the 

training necessary to develop and maintain the skills needed to keep pace with industry 

changes, including private equity and venture capital. Furthermore, while the SBA planned to 

invest in technology for the 011 to reduce program risks, the SBIC examination activity was not 

included in the strategy. We also identified communication challenges that represent missed 

opportunities for a more effective SBIC examination process. Finally, while the SBA has 

continued to exercise its statutory authority to collect examination fees, we determined the fees 

were not sufficient to keep pace with rising costs. 

Strategic Planning 

An 011 senior official told us that the Oil's goals are generally guided by the SBA's strategic plan. 

Neither the 011 nor the OSE had their own plan. The senior official stated that SBIC 

examinations are an Agency goal because they are a statutory requirement. The senior official 

further stated that the 011 creates goals at the director level annually, but does not formally 

track these goals. 

According to the Office of Management and Budget (OMB), a strategic plan is a valuable tool for 

communicating to agency managers, employees, and other stakeholders a vision for the future. 

8 
It should be used to align resources and guide decision-making to accomplish established 

priorities and improve outcomes. Further, it should inform agency decision-makers about the 

need for major new acquisitions, information technology, human capital development, 

evaluations, and other investments.lO 

Although functional offices within the Agency were not required to develop a plan, in the 

absence of a plan for the Oil, we observed the following: 

• 	 Managers and employees are not aware of the vision for the Office of SBIC 

Examinations 

• 	 Inconsistency, in terms of examination focus across offices 

• 	 Lack of priority regarding technology and training needs 

The 011 could use the Agency's strategic plan as a framework to develop its own plan to measure 

the performance of its components, to include the OSE. For example, the Agency outlined 

various approaches and strategies in its strategic plan to improve its performance. These 

strategies included providing employees with business, technical and analytical training; linking 

employees' annual performance plans to results oriented organizational goals; deploying 

technologies to enable employees to quickly and efficiently perform daily duties; and lastly, 

improving employee engagement and utilization. 

Training Challenges 

Insufficient training impedes examination staff in developing and maintaining the necessary 

skills to keep pace with changes in the industry. Managers expressed concerns regarding the 

need for more training. For example, one manager expressed concern regarding the extent to 

which the staff had the appropriate skills and education to perform the work. Another manager 

believed that training in Forensic Accounting could benefit the examination process. Examiners 

could also benefit from training in the area of private equity, according to a seasoned examiner. 

Guidelines for SBIC Examinations require that examiners be able to demonstrate proficiency in 

financial analysis and accounting principles, standards, and techniques. Further, examiners are 

also required to have a thorough knowledge of regulatory and statutory requirements 

pertaining to the SBIC program and the examination process; however, management did not 

provide ongoing training to maintain proficiency in these areas. For example, examiners did not 

receive a formal introduction to the private equity industry through training. Therefore, 

examiners were not aware of what was new in the financial risk arena, which changes 

frequently. One examiner stated that SBICs are much more sophisticated than when the 

examiner initially began his or her career in 2000. As such, the examiner feels that the staff 

needs to participate in targeted training to help them keep up with changes in the field and the 

business and technological advancements of the SBICs. 

Technology Challenges 

Another area of concern was related to technology. As previously discussed, examinations are 

used to implement the SBA's statutory mandate to review SBICs for violations of the Act, and 

compliance with Agency and program requirements. In its strategic plan, the SBA acknowledged 

10 0MB A-ll, Preparation, Submission, and Execution of the Budget. 

9 
the need to invest in technology to create tools to collect financial data and monitor risk and 

performance to reduce investment program risk. However, the SBIC examination activity was 

not included in the description of measures to reduce risk. 

The Clinger-Cohen Act of 1996 requires agencies to establish goals for improving the efficiency 

and effectiveness of agency operations through the effective use of information technology.ll 

Management and staff from the 011 expressed the need for, and benefit of, technology such as 

electronic work papers (e.g. Team Mate). For example, files that were once shipped between 

offices and exposed to loss or damage could be scanned for review by appropriate examination 

staff. An examiner told us that electronic work papers would be a significant asset to the 

examination process and would be a good way to incorporate standardization into the process 

while bringing the three offices in line with one another. 

The former Associate Administrator for the 011 acknowledged the need for improved 

technology, but stated that due to budgetary priorities, it was not feasible anytime soon. 

Additionally, SBIC representatives expressed their concerns about SBA's technology, in terms of 

efficiency and security. For example, an SBIC official expressed the need for updated technology 

for examinations, such as audit software similar to financial auditing organizations. 

Another SBIC official expressed concerns about data security because of limited technology. 

The official also stated that he wanted to provide all required documents through a cloud 

storage device and was surprised that examiners did not have a paperless method for collecting 

data. 

Communications Challenges 

Communication is critical to the OSE because the office has staff in multiple locations. 

According to OMB A-123, lIinformation should be communicated to relevant personnel at all 

levels within an organization. The information should be relevant, reliable, and timely." 

We identified challenges that impacted the effectiveness of the OSE's communications. For 

example: 

• 	 Examiners' Input on New Processes: The OSE in Washington, DC, disseminated 

information to field staff about policy changes via email through examination managers. 

The lack of direct or in-person communication with examiners limited the opportunity 

for examiners to provide input. Our interviews with examiners reflected that this 

impacted employee morale. 

• 	 Lack of Knowledge Sharing: The ability for examination staff to share knowledge is 

constrained. We found that there is limited communication from headquarters to the 

field and among SBIC examination field offices. In addition, an 011 official said that the 

011 no longer holds regional or national meetings due to budget constraints. Staff told 

us that when these types of meetings occurred in the past, they used them as an 

opportunity to share ideas, information, and trends. We identified a lack of 

communication, both vertically and horizontally, which could have impaired consistency 

in operations, limited knowledge transfer, and negatively impacted synergy among 

11 US Office of Management and Budget (OMB) Circular A-123, Management's Responsibility for Internal control, 2004, p. 11. 

10 
peers in the examination function. As the SBICs get more sophisticated, knowledge 

sharing becomes even more important. One examiner told us it would be beneficial, for 

example, to hear about specific issues that other examiners have encountered. 

Funding Challenges 

Resources are critical to carrying out the mission of the OSE. Congress provided for a source of 

funding for the SBIC examinations activity in the Act. The Act authorized the SBA to collect fees 

from SBICs to cover costs associated with the examination function. Importantly, we reviewed 

the CFR and confirmed with SBA officials that examination fees have not changed since 1998. 12 

While the SBA has continued to exercise its statutory authority to collect fees, we determined 

the actual fees collected were not sufficient to keep pace with rising costs. 

a. 	 Based on 2012 figures, inflation has increased by 37 percent since 1998. 13 Therefore, all 

else being equal, an SBIC that paid $5,000 for an examination in 1998 should pay 

approximately $7,100 for the same examination today. 

b. 	 Federal government salaries, benefits, travel, and related costs have continually 

increased since 1998 and therefore, it is reasonable to expect examinations fees would 

increase to mitigate the costs associated with the examination function as allowed by 

the Act. An 011 senior budget official believed that SBICs were already incurring enough 

of a financial burden without paying additional examination fees. 

Despite inflation and government-wide budget cuts, SBA management has chosen not to 

increase examination fees, which may have impaired OSE's ability to meet the intended purpose 

of examinations. Without proper training and technology examiners may not effectively identify 

all regulatory violations as intended by the Act. For example, 011 program officials stated that 

budgetary constraints affected their ability to provide examination staff with training and 

technology necessary to keep pace with the challenges of a complex and ever-evolving venture 

capital industry. 

In FY 2012, the SBA collected $1.84 million in fees, which offset just over half or 54 percent of 

the $3.4 million in examination costs for that year. Further, SBA staff confirmed our analysis 

that the cost of conducting examinations far exceeds the examination fees they collect. 

For FY 2013, the OSE implemented a mandated budget cut that limited examination-related 

travel. 14 By implementing the mandated budget cuts, the OSE reduced its FY 2013 travel 

budget from $228,737 to $160,000. If fees do not cover the cost of examinations, the SBA 

should consider exercising its statutory authority to increase them. 

Conclusion 

The Office of SBIC Examinations, while meeting statutory requirements, could significantly 

enhance its oversight of SBICS by improving its examination process, a risk-mitigation function 

essential to the SBIC program. The policy to focus on quantity is not sufficient to ensure that 

12 13 CFR 107.692, Examination Fees. 


13 Source: US Department of Labor, Bureau of Labor Statistics Inflation Calculator. 


140MB M-12-12, Promoting Efficient Spending to Support Agency Operations, May 11, 2012. 


11 

examiners are able to identify and address violations by SBICs. Also, outdated guidance and 

incomplete examination checklists further impacted the quality of the examination process. 

Although the OSE has implemented a systematic method for prioritizing its examinations, a 

number of other challenges adversely impacted its ability to fully achieve the goal of assessing 

(1) compliance with the Act and implementing regulations, (2) the financial condition of 

licensees and SBA's financial vulnerabilities, and (3) the accuracy of information SBICs submit to 

the SBA. These challenges include the lack of an organizational level strategic plan, inadequate 

training, outdated technology, poor communication, and limited funding. This has resulted in 

inconsistent examinations and examiners not identifying all findings. 

To improve and sustain the performance of the SBIC examination function, the SBA will need to 

evaluate the operations of the SBIC examination function. This evaluation should help to 

identify approaches toward overcoming the challenges that the OIG has identified in the areas 

of quality assurance, guidance, planning, training, technology, communication, and funding. 

During the course of this audit, the SBA updated and submitted for clearance, SOP 10 09, SBle 

Examinations Guidelines. This update will address many of the concerns raised by the OIG in this 

report and we commend the Agency for this progress. 

Recommendations 

We recommend that the Acting Associate Administrator for the Office of Investments and 

Innovation: 

1. 	 Create and execute a plan to improve the internal operations of the examination 

function. The plan should include quality driven goals and performance indicators that 

the 011 will use to monitor, assess, and balance the quantity and quality of the SBIC 

examination function and its operations. It should also include a plan for better 

communication. 

2. 	 Update and improve the existing examination checklist to: (1) better align with and 

reference SOP guidance for examinations; (b) ensure focus on Category One violations, 

and (3) ensure consistency across the three SBIC examination offices. 

3. 	 Assess the costs of the examination function and prepare cost-benefit analyses for 

several funding options, including a potential increase in examination fees, in order to 

improve training and technology, and cover other examination costs. 

12 

Agency Comments and OIG Response 

On August 23, 2013, we provided a draft of this report to the Acting Associate Administrator for 

Investment and Innovation for comment. On September 23, 2013, the Agency submitted a formal 

response, which is included in its entirety, less Exhibits, in Appendix III. 

Summary of Management Comments 

The SBA agreed with two of the three recommendations in the report and disagreed with one. 

Management stated that Recommendation 1 was based on discrepancies and/or inaccuracies within the 

report. Management stated that it has historically and actively managed optimal internal operations, 

strived for quantity and quality in its processes, and promoted open communication. In response to 

Recommendations 2 and 3, the SBA agreed to (1) update and improve the existing examination checklist 

and (2) assess the costs of the examination function and prepare cost-benefit analyses for several 

funding options, including a potential increase in examination fees, in order to improve training and 

technology, and cover other examination costs. 

The SBA stated that the title of the report was misleading as it asserted that examination quality was 

lacking and the oversight of SBICs was not as strong as it should be. The SBA claimed that the OIG's 

conclusion regarding the emphasis on quantity and the lack of compensating controls to ensure the 

accuracy of examinations was inaccurate. The SBA stated there was no documentation indicating there 

was a quality issue with examinations or that time constraints were causing a reduction in quality. 

The SBA provided email exhibits to refute the OIG's conclusion. The emails provided examples of 

directives to SBIC Examination Managers including factors, such as quality, to be met when conducting 

examinations. The SBA also provided observations demonstrating why the significant decrease in 

examination reports with findings may have resulted from factors other than decreased examination 

quality. These observations included two recent regulatory changes, a more rigorous licensing process 

and a more thorough and transparent examination process. The SBA stated that the number of 

examinations completed by an examiner is only one component in deriving an examiner's numerical 

performance rating. Management provided an October 2, 2012, email directing examination managers 

to consider other factors, such as quality, in determining the examiners' numerical ratings for fiscal year 

2013. 

The SBA noted that it has been revising and updating SOP 10 08 and a revised SOP 10 09 is pending 

publication. The SBA stated that the examination checklist would be updated to better correspond and 

correlate with the revised SOP. Furthermore, the SBA stated that it would schedule an annual review of 

the checklist and enhance and update it as necessary. 

The SBA provided email exhibits to demonstrate that (1) there was communication as to the goals 

strategies and conditions within the Office of SBIC Examinations, (2) it endeavored to provide training to 

its staff, and (3) requested technological upgrades. The SBA acknowledged that due to resource 

limitations, none of the training requests were approved and the technology requests were not funded. 

The SBA noted that the Director of Examinations is in constant communication with the examination 

managers and requests status reports to ensure that all offices have opportunities to raise issues and 

concerns. The SBA provided email communications to demonstrate the communications that occurred. 

13 
The SBA claimed we did not provide support for our conclusion that examiners did not identify all 

findings. The SBA stated that neither prior nor current examination reports were flagged nor referenced 

for overlooking or missing finding, misstating regulations, failing to follow SOPs, nor failing in form or 

content to have shortcomings. 

OIG Response 

We continue to support our conclusion and the title of our audit report that improved examination 

quality can strengthen SBA's oversight of Small Business Investment Companies. This title is supported 

by sufficient and appropriate evidence obtained during the audit. The evidence was collected based on 

our review of examination guidance and the actual performance standards of examiners. Furthermore, 

we based our conclusion and title on evidence obtained during interviews with senior 011 officials, 

examination managers, examiners, and SBICs who raised concerns about the quality of examinations. 

We continue to support our conclusion that the SBA's focus on the frequency of examinations as a 

strategy for reducing risk did not include a compensating control to ensure that examinations conducted 

would result in accurate assessment of regulatory compliance. Strong testimonial evidence was 

obtained during this audit in support of this conclusion. Specifically, we interviewed examination 

managers, examiners, and SBIC officials who all indicated the quality of examinations could be improved 

if more time was allotted. We have revised our report to include additional examples in support of our 

conclusion based on these interviews. We agree that the emails provided by the SBA demonstrate 

there were communications between the Director of Examinations and examination managers with 

regard to the quality of examinations. However, our audit evidence demonstrates that these 

communications were not sufficient to overcome the time constraints and emphasis on quantity felt by 

the examiners and examination managers. 

We continue to support our conclusion that the significant decrease in examination reports with findings 

may indicate that the quality of examinations has suffered. Our report recognizes that the SBA indicated 

many factors could have contributed to the decline in reports with findings. Our report simply points 

out other factors that could have contributed to the decline, such as the focus on the examination 

frequency, outdated guidance, and an insufficient examination checklist. These conclusions are 

supported by evidence we obtained from reviewing examination guidance, the examination checklist, 

and the actual performance standards of examiners. Furthermore, we based our conclusion on evidence 

obtained during interviews with examination managers and examiners who indicated the time allowed 

to conduct examinations was a concern and impacted their ability to produce findings. However, to 

address SBA's comments regarding the decrease in the number of reports with findings, we have revised 

the wording in our report to clarify the factors identified by the OIG could have IIcontributed to" rather 

than IIcaused" the decline in findings. 

In response to SBA's comment that the number of examinations completed by an examiner is only one 

component in deriving an examiner's numerical performance rating, we reviewed the actual 

performance standards that demonstrated quality was not a measurable benchmark. While the emails 

provided by the SBA demonstrate guidance to the examination managers for assessing examination 

quality, the performance standards themselves should be revised to fully address our finding. 

We commend the SBA on their actions to revise the SOPs and update the examination checklist. 

We appreciate the efforts of the Director of Examinations to communicate the goals and strategies to 

her examination managers. However, as noted in our audit report, we observed that managers and 

14 

employees were not aware of the vision of OSE and that there were inconsistencies in the examinations 

across offices. Furthermore, we found that the goals established by the Director of Examinations were 

not formally tracked. As a result, we continue to support our position that the Agency should develop a 

plan to improve its communication of its strategies and goals for the OSE. We appreciate the efforts of 

the Director of Examinations to communicate with her managers via email and phone. However, the 

evidence in our audit report demonstrates that the email and phone communication alone was not 

sufficient to allow examiners to provide input for examination processes. Additionally, it limited 

knowledge sharing across offices. We have revised our audit report better explain the communication 

deficiency we identified. 

We continue to support our conclusion that examiners did not identify all findings as is supported by the 

strong testimonial evidence from two Senior 011 officials who provided examples of SBIC violations that 

were missed during the examination process. These missed violations included improper management 

fees, conflicts of interest, inaccurate valuations, and overline investments. While this evidence was 

included in our audit report in the section that discussed the outdated guidance, we have modified our 

report to clarify that this evidence also supports our conclusion that the examiners did not identify all 

findings. 

Recommendation 1 - Create and execute a plan to improve the internal operations of the examination 

function. The plan should include quality driven goals and performance indicators that the 011 will use 

to monitor, assess, and balance the quantity and quality of the SBIC examination function and its 

operations. It should also include a plan for better communication. 

Management's Comments 

Management did not concur with this recommendation. Management stated that this 

recommendation was founded on discrepancies within the report and that the program is 

managed properly to ensure optimum performance, including quality reports and open 

communication among staff members. 

OIG Response 

We continue to support this recommendation. As discussed above, we observed that managers 

and employees were not aware of the vision and goals of the OSE. Further, goals established at 

the director level were not tracked. Our recommendation was based on sufficient and 

appropriate evidence, including strong testimonial evidence from Senior 011 officials, 

examination managers, examiners, and SBICs. The management decision for this 

recommendation is considered unresolved and will remain open pending audit follow-up. 

Recommendation 2 - Update and improve the existing examination checklist to: (1) better align with 

and reference SOP guidance for examinations; (b) ensure focus on Category One violations, and (3) 

ensure consistency across the three SBIC examination offices. 

Management's Comments 

15 
Management concurred with this recommendation. Given that the new SOP 10 09 is being 

published, the checklist will be reviewed and updated to better correspond and correlate with 

the revised SOP. Additionally, the checklist will be reviewed annually to ensure that it is a 

dynamic document that is enhanced and updated as necessary. 

OIG Response 

Management's comments were responsive to the recommendation. The management decision 

for this recommendation is considered resolved and the recommendation will remain open 

pending final action. 

Recommendation 3 - Assess the costs of the examination function and prepare cost-benefit analyses for 

several funding options, including a potential increase in examination fees, in order to improve training 

and technology, and cover other examination costs. 

Management's Comments 

Management stated it fully supports this recommendation. 

OIG Response 

Management's comments were responsive to the recommendation. The management decision 

for this recommendation is considered resolved and the recommendation will remain open 

pending final action. 

16 

Appendix I: Scope and Methodology 

To determine if the SBA conducted SBIC examinations in accordance with the Law, rules and 

regulations, and SBA policies and procedures, we reviewed Section 310 of the Small Business 

Investment Act of 1958; Code of Federal Regulations, Chapter 13, Section 107; and Standard 

Operating Procedures (SOPs) 10 06, 10 08 and 10 09. 

We judgmentally selected the Office of SBIC Examinations' Atlanta Field Office and obtained the 

universe of 141 examinations performed by this regional office between October 1, 2010, and 

August 10, 2012. The SBICs examined by the Atlanta office represented approximately 

$4.24 billion in indebtedness to the SBA. Using a risk-based approach, we judgmentally selected 

a sample of three examinations conducted by three different examiners based on outstanding 

SBA leverage amount, date of examination, and number of findings. The SBICs covered by this 

sample received nearly $175 million in SBA-guaranteed funding. Using an OIG review 

methodology-that we prepared based on applicable Standard Operating Procedures-we 

reviewed Atlanta office examination files to assess whether the examinations covered the 

required laws and regulations. 

To determine if the SBA managed the SBIC examination process effectively and efficiently we 

reviewed SBA's 2011-2016 Strategic Plan and the Agency's Small Business Investment Company 

Program Annual Report for FY 2012. We obtained and analyzed historical performance and cost 

data related to the examination function from the Office of Investments and Innovations (011). 

We reviewed Agency regulations to assess the SBIC examination fee structure for the past 15 

years, adjusted the fees for inflation, and compared fees collected in FY 2012 to what fees 

would be based on inflation. We also compared fees collected in FY 2012 to the cost of 

performing examinations in FY 2012. We examined SBIC Program Overview reports and the 

performance standards of examination staff. We interviewed budgetary officials in the Office of 

the Chief Administrative Officer. We interviewed the former Associate Administrator and 

Deputy Associate Administrator for the Office of Investments and Innovations. We interviewed 

the Director, three regional examination managers, and 6 of the 17 SBIC examiners in Office of 

SBIC Examinations. Finally, we interviewed the representatives of four SBICs. 

Table 1 SBIC Examinations Reviewed by DIG 

SBIC Name & License No. Report Date SBA Leverage Number of Findings 

FOIAEx.4 2/23/2012 $14,600,000 6 

FOIAEx.4 ~ 12/2/2011 $20,775,000 1 

FOIAEx.4 6/29/2011 $139,590,000 4 

17 

Appendix I: Scope and Methodology 

Use of Computer Processed Data 

We obtained computer generated data from the Office of Investments and Innovation (011) for 

our judgmental sample of SBICs examined by the Atlanta Field office in FY 2012. We compared 

the data provided by 011 to the source documents for the three examination files reviewed at 

the Atlanta field Office. Specifically, we verified the licensee number, SBIC name, current 

regulatory private capital, current leverage from the SBA, the exam manager, the report date, 

and the scope of the examination. 

Prior Coverage 

No audits of the Office of Investment and Innovation, SBIC program have been conducted within 

the last 10 years. 

18 

Appendix II: The SBIC Program- Nine Major Findings & Category One Violations 

Activities Not Contemplated by the Act (Required by Small Business Investment Act of 1958) ­

13 CFR 107.500 requires SBICs to engage only in the activities contemplated by the Small 

Business Investment Act of 1958. liThe principle issues of concern in this area include SBICs 

financing a large business; financing provided by a Specialized SBIC (SSBIC) to a small business 

that is not owned, controlled, and managed by disadvantaged persons; and SBICs conducting 

operations of any business other than that for which it was licensed." 

Examiners should analyze the licensee's financing records and other documentation, including 

background information on the financed small business and the owners of the small business 

(SOP 10 09, pg. 13). 

Prohibited Conflicts of Interest (Required by Small Business Investment Act of 1958) ­

13 CFR 107.730 prohibits SBICs from self-dealing to the prejudice of a Small Business, the 

Licensee, its shareholders or partners, or SBA. Examples of prohibited actions include providing 

financing to associates or borrowing money from a small business financed by the SBIC. 

Examiners should review the terms of financings provided to portfolio concerns, and records 

pertaining to their principals, owners, and directors. Additionally, examiners should obtain 

credit reports on entities receiving financing as well as written confirmations from portfolio 

concerns (SOP 10 09, pg. 13). 

Prohibited Control of a Small Business (Required by Small Business Investment Act of 1958) ­

13 CFR 107.865 allows SBICs to exercise control over a small business for purposes connected to 

the investment through ownership of voting securities, management agreements, voting trusts, 

majority representation on the board of directors, or otherwise. However, the period of control 

is limited to seven years. 

Examiners should review the terms of financings made to small business concerns to include 

post-financing ownership, stock voting rights, shareholders agreements, and board membership 

or partner rights(SOP 10 09, pg. 14). 

Short Term Financings (Required by Small Business Investment Act of 1958) - 13 CFR 107.830 

requires SBICs to provide financings for a minimum duration of one year. 

Examiners should review the terms of the financing to determine whether they result in a 

prohibited short-term financing (SOP 10 09, pg.14). 

Overline Investments (Required by Small Business Investment Act of 1958) -13 CFR 107.740 

requires SBICs to diversify their portfolios. SBICs are prohibited from concentrating their assets 

in anyone small business or any affiliated group of small businesses. In general, SBICs are 

restricted to having a maximum of 30 percent of their regulatory capital in any small business. 

Examiners should compare the licensee's total outstanding financing and commitments to each 

small business with its appropriate overline limit (SOP 10 09, pg. 14). 

19 
Appendix II: The SBIC Program-Nine Major Findings & Category One Violations 

Relending, Foreign, Passive or Other Prohibited Investments, Including Prohibited Real Estate 

Financings (Required by Small Business Investment Act of 1958) - 13 CFR 107.720 classifies 

certain small businesses ineligible for financings. For example, financing to small businesses that 

are re-Ienders or re-investors, passive businesses, or real estate businesses are prohibited. 

Examiners should determine the nature of the business from the Dunn and Bradstreet credit 

report and determine the use of proceeds through visits with the small business owners(SOP 10 

09, pg. 14-15). 

Excessive Cost of Money (Required by Small Business Investment Act of 1958) - 13 CFR 107.855 

defines /lcost of money" as the interest and other consideration SBICs receive from small 

businesses. SBICs are restricted in the cost of money they can charge on loans and debt 

securities. 

Examiners should determine the rate of interest and any discount or fee charged on financings 

provided to portfolio concerns by examining the note and any other financing agreements (SOP 

10 09, pg. 15). 

Inappropriate Distributions, Including Improper Dividends and Excessive Expenditures 

(Required by SBA SOP 10 09) - Licensees are restricted in the types and amounts of capital and 

earnings distributions they may make. Any increases in management expenses including 

salaries, office expenses, travel, etc. must be SBA approved. 

Examiners should analyze capital accounts (paid in and earned) for changes since the prior 

examination (SOP 10 09, pg. 15). 

Impairment and Valuation Issues (Required by SBA SOP 10 09) - SBICs must comply with the 

maximum permitted capital impairment percentages outlined in 13 CFR 107.1830. Additionally, 

licensees must prepare, document, and report the valuations of loans and investments in 

accordance with the valuation guidelines for SBICS issued by SBA (13 CFR 107.503). 

Examiners should review capital accounts, unrealized appreciation and depreciation of the 

portfolio, and calculate any capital impairment based on regulatory requirements. Additionally, 

examiners should determine if the portfolio valuations have been completed in accordance with 

the approved valuation policy and reported to SBA (SOP 10 09, pg. 15) 

20 

Appendix III: Agency Comments 

Date: September 23,2013 

To: Robert A. Westbrooks, 

Deputy Inspector General and Office of Inspector General 

From: Pravina Raghavan 

Acting Associate Administrator for Investment and Innovation 

Subject: Response to Performance Audit Report, "Improved Examination Quality Can Strengthen SBA's 

Oversight of Small Business Investment Companies" 

Dear Mr. Westbrooks: 

This memorandum is in response to your August 23fd, 2013, Performance Audit Report entitled, "Improved 

Examination Quality Can Strengthen SBA's Oversight of Small Business Investment Companies". We have 

reviewed and analyzed this report and welcome the opportunity to reply. 

As per the review between ourselves and your staff on the draft report on August n lld, 2013, there are a number of 

findings and conclusions with which we do not concur. We fail to find documentation within your report that 

justifies or supports some findings and, therefore, find fault with the resulting conclusions made within the report 

related to those findings. We will be highlighting the discrepancies and/or inaccuracies within the report and will 

reference official SBA emails (full texts attached as an addendum to this memorandum) that will serve as supporting 

documentation to our rebuttal. 

Although it is our belief that there are issues with the findings and conclusions within the report, we do agree, with 

noted comments, with recommendation 2 and 3 of the report. We disagree with recommendation I for the reason 

below. 

Recommendation I is based on what we believe are discrepancies and/or inaccuracies within the report. It is OIl's 

belief that we have historically and actively managed optimal internal operations, strive for quantity and quality in 

our processes, and promote open communication. We will be highlighting and supporting this perspective with our 

rebuttal below under Observations and Highlights. 

On Recommendation 2, please note that, independent of this Performance Audit Report, the Office of Examinations 

had already engaged in a project to update SOP's, resulting in SOP 1009 completed 31-July-20 13 and pending 

publication. As is the current practice, all offices require examiners to conduct examinations with all rules and 

regulations applied for possible violations. 

On Recommendation 3, we fully support this recommendation with the additional complementary statement that the 

statute indicates that the examination fees "shall be deposited in the account for salaries and expenses of the 

Administration, and are authorized to be appropriated solely to cover the costs of examinations and other program 

oversight activities." Besides covering direct examination functions and costs, program oversight activities could 

include technological upgrades to equipment (Laptops, Printers, etc), software acquisition (Team Mate), and 

improvements to the website which would benefit everybody. 

21 

Observations and Highlights - Executive Summary 

The title of the report, "Improved Examination Quality Can Strengthen SBA's Oversight of Small Business 

Investment Companies", asserts that examination quality is lacking and that the oversight of Small Business 

Investment Companies (SBIC's) is not as strong as it should be. Neither of these conclusions are supported nor 

documented within the report. Neither prior or current examination reports were flagged nor referenced for 

overlooking or missing findings, misstating regulations, failing to follow SOP's, nor failing in form or content to 

have shortcomings. We believe this title to be misleading and not in conformity with fact and request that the title 

be changed to one that is consistent with the findings, conclusions and recommendations that are supported by 

specific and demonstrable documentation within the report. 

In your cover letter to this report you highlight that "During our initial survey work, we identified significant 

deficiencies in the management of the SBIC examination process .... "(Paragraph 1, Sentence 3), but did not specify, 

highlight, or document the findings which support or lead to this statement. Additionally, in the Executive 

Summary, this statement is modified to state, "During our initial survey work, we identified deficiencies in the 

management of the SBIC examination process ... "(Paragraph 3, Sentence 2). We contend that there are no 

deficiencies, significant nor otherwise. The only reference to a deficiency we could find within the report was on 

page 6, at the bottom of the page, a section title "Outdated Guidance and a Deficient Examination Checklist Affect 

[sic] Examination Quality 

In paragraph 4, sentence 4, of the Executive Summary, SBA processes are highlighted for improvement that "could 

enhance the extent to which the Office of SBIC Examinations identifies business conditions and practices prohibited 

by the Act and Agency policy". The processes in question are not highlighted, opportunities to enhance the 

identification business conditions or practices prohibited by the Act and Agency policy are not referenced, nor is 

there documentation justifying this statement. 

Paragraph 5 of the Executive Summary, is inaccurate. 

Please see exhibit I, an email dated Tuesday, December 04,20127: l4am, Subject: FY'13 Goals, exhibit II, an email 

dated Thursday, October 14, 2010 8:58am, Subject: FY' 11 Goals, and exhibit V, email dated Monday, December 

10,20129:02 AM, Subject: RE: Performance for Team. These emails stipulate not just frequency or numerical 

goals but clearly and extensively state other factors that are to be met (Quality, Timeliness, Following Procedures, 

Working Papers, Need to follow SOP's, Communication Skills, etc). Additional emails between the Director of 

Examinations and Examination Managers, stipulating these points are available. These emails rebut the first two 

sentences of this paragraph, "The SBA's focus on the frequency of examinations as a strategy for reducing risk did 

not include a compensating control to ensure that examinations conducted would result in accurate assessments of 

regulatory compliance. With a greater emphasis on quantity, the OSE runs the risk that the review of an SBIC may 

be inaccurate or incomplete." 

Concerning the third sentence of this paragraph, "To this point, the significant decrease in examination reports with 

findings may indicate that the quality of these assessments has suffered.", this supposition can be refuted by at least 

five observations: 

1. Regulatory changes which may impact violations in the past few years are: 

04/0412012: Conflicts ofInterest and Investment ofIdle Funds 

(Allows certain associate investments for follow-on investments 

without violating conflict of interest. Also provides increased PDF I HTML I More 

flexibility on idle fund investment.) 107.730 & 530 

04/1412009: Leverage Eligibility and Portfolio Diversification 

Requirements (Increases leverage maximum and increases PDF I HTML I More 

overline maximum) 107.1160 &1810 

22 
2. 	 A more rigorous licensing process ensures that licensees are vetted and reviewed more 

thoroughly and therefore lead to higher quality of licensees and a reduction in violations. See 

exhibit "Leveraged Debenture SBICs Performance". 

3. 	 Setting higher standards in 2002, a rigorous MAQ that many in the industry say is as good as 

the private sector, larger, more sophisticated funds allowing for better quality managers. 

4. 	 A more thorough and transparent exam process has led to improvement in regulatory 

compliance by the licensees. 

5. 	 Thorough, comprehensive and high quality examinations as conducted by the Office of 

Examinations, promote an environment of diligence and care at the Licensee which promotes an 

environment where Licensees strive to eliminate and minimize operations and activities which 

could generate findings. Findings, if any, are reviewed with the licensee so as to educate them 

and endeavor to ensure that future examinations are finding free. 

Please note that we believe the role of the Office of Examinations is not to strive to find a minimal amount of 

findings per year or per examination, it is to work in partnership with the licensee to ensure they comply with the 

rules and regulations of the program. We believe that this strategy is working and this is another component in the 

reduction of findings. This should be considered a positive, not a negative event. 

Concerning paragraph 6, sentence 1, please note that the Office of Examinations, independent of this Performance 

Audit Report, has been working on revising and updating SOP 1008, SBIC Examinations Guidelines (11/25/97), and 

submitted the revision, SOP 1009 SBIC Examinations Guidelines, for comment by the Office of Inspector General 

on July, 2013. All exchanges between various areas, including the Office of Inspector General, were completed by 

31-July-20 13, and the new guidelines are pending publication (Exhibit III, Request from Director of Examinations 

to SBA Administrator for final approval of SOP 1009). 

The exam checklist is an internal confidential document used by the examiners as a guideline to enumerate areas 

that need to be reviewed and is to be used in conjunction with the SOP to ensure a comprehensive, accurate and 

thorough examination. The checklist is not intended to represent a comprehensive scope of an examination, and 

should not be the sole basis or substitute the SOP as the basis of an examination. Given that the new SOP 1009 is 

being published, the checklist will be reviewed and updated as well so as to better correspond and correlate with the 

revised SOP. Additionally, the Director of Examinations is scheduling processes to ensure annual review of the 

checklist to ensure that it is a dynamic document that is enhanced and updated as necessary. 

Concerning paragraph 6, sentence 2, there is no reference, examples or specifics as to what challenges in the areas of 

strategic planning is being highlighted. On the contrary, by reviewing Exhibit I and II, it can be see that there is 

communication as to the goals, strategies and conditions within the Office of Examinations. 

The Office of Examinations, has endeavored to provide training to its' staff as they request it and SBA resources 

will allow. See exhibit VIII, email dated Monday, June 04,20129: 11 AM, Subject: FW: Training Needs SurveySBA Employees and exhibit IX, email dated Monday, April 15, 2013 12:37 PM. On the subject of technology 

upgrades, the Office of Examinations has made efforts to price and acquire software (TeamMate) and the supporting 

hardware numerous times over the years. See exhibit X, email dated Wednesday, March 19, 2003 11:47 AM, 

Subject RE: BUDGET, and exhibit XI, email dated Fri 10/21/20087:28 AM, Subject: TeamMate. Due to resource 

limitations, none of our requests were approved. Additionally, on a yearly basis, Managers have been requesting 

technological upgrades to equipment (PC's Laptops, Printers, etc), which are subject to budgetary constraints and 

are normally denied. This year, 2013, several new laptops have been approved and purchased for the examiners. 

See exhibit XIII, email dated Tuesday, August 13, 2013 11:35 AM, Subject RE: Request for upgraded laptops for 

examiners - Deborah D. Cotton - Justification for a laptop. Although technology requests were not funded, the 

Office of Examinations has endeavored to internally develop technological tools to compensate and automate some 

processes and activities. See exhibit XII, email dated Thursday, March 21,2013 8:50 AM, Subject <blank>. 

Concerning paragraph 6, the first portion of sentence 3, "Further challenges include poor communication ... ", please 

note that the Director of Examination is in constant email contact with the Regional Managers, and request status 

reports on a weekly basis so as to ensure that all offices have the opportunity to raise issues and/or concerns to the 

Director. Open exchanges between the Director and the Managers occur via emails, phone calls, and occasional 

conference calls are organized with the Director, Managers and Examiners. Please see exhibit IV, email dated 

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Wednesday, April 04,2012 7:03am, Subject: RE: FY 2012 GoalOwner goals and Authorizing Official Signature on 

TA, exhibit V, email dated Monday, December 10, 2012 9:02am, Subject: RE: Performance for Team, exhibit VI, 

email dated Thursday, March 21,2013 8:50AM, Subject: <blank>, and exhibit VII, email dated Wednesday, July 

27, 2011 7 :42AM, Subject: RE: SBIC Caseload Analysis among Regions, as examples of emails illustrating open 

and frank communications. Numerous other emails are available if further documentation is requested. 

Concerning paragraph 6, the second portion of sentence 3, " ... and insufficient funding", we support this statement. 

Concerning paragraph 6, sentence 4, the referenced challenges have been address above; the middle part of this 

sentence as been addressed in our response to paragraph 5 above. 

The latter part of paragraph 6, sentence 4, " ... have resulted in examiners not identifying all findings." Is not 

supported and not been documented, to the contrary, as noted earlier, neither prior or current examination reports 

were flagged nor referenced for overlooking or missing findings, misstating regulations, failing to follow SOP's, nor 

failing in form or content to have shortcomings. Additionally, paragraph 5, sentence 3, clearly states that the 

reduction in findings "may indicate" an issue (not proven) while this sentence presents it as if it were a proven fact. 

We find this highlighted portion to be unsupported by documentation or evidence that confirms this statement. 

Observations and Highlights - Body of Report 

Page 4, Paragraph 2, Sentence 3 and 4, please refer to our response to paragraphs 4,5 and 6 of the Executive 

Summary above, and the supporting documentation referenced. We find no supporting documentation or evidence 

for these statements and believe they are based on conjecture. Additionally, an inferred correlation between a 

reduction in the number of findings and the quality of examinations is a conclusion that does not follow from its 

premise. 

Page 4, Paragraph 3, Sentence 4, please refer to our response to paragraph 4 of the Executive Summary above. 

Page 4, Paragraph 4, please refer to our response to paragraph 5 of the Executive Summary above, and the 

supporting documentation referenced. Please note, there is more documentation available proving that the Office of 

Examinations does not solely rely on the frequency of examinations as a strategy for reducing risk. It is one of the 

factors, among multiple, which are utilized to manage and control risk and exposure to the SBA. Among others are 

a more thorough and transparent exam process has led to improvement in regulatory compliance by the licensees 

and thorough, comprehensive and high quality examinations to promote an environment of diligence and care at the 

Licensee which promotes an environment where Licensees strive to eliminate and minimize operations and activities 

which could generate findings and an effort to educate licensees. 

Page 4, Paragraph 5, please refer to our response to paragraph 6 of the Executive Summary above, and the 

supporting documentation referenced. Please note, there is no documentation that examiners have not identified all 

findings. This is based on a conjecture without supporting documentation. 

Page 5, Paragraph 1, last sentence, "However, we identified other factors that could have caused the decline in 

findings". This sentence makes clear that there is conjecture and uncertainty by the OIG on the reason for the 

decline in findings. This is consistent with the last sentence of paragraph 5 of the Executive Summary, yet in 

paragraph 6 of the Executive Summary 6, the reduction in findings over time is stated as a fact and is actually 

contra-indicated by this statement. 

Page 6, Paragraph 1, Sentence 2, a correlation between non-specified challenges and a decrease in findings is not 

supported by documentation, additionally, the premise" ... SBA' s emphasis on the quantity of SBIC examinations at 

the expense of more detailed reviews" is strongly refuted by our response to paragraph 6 of the Executive Summary 

above, and the supporting documentation referenced (Exhibit I and Exhibit II). 

Page 6, Paragraph 2, we strongly refute this paragraph. As can be seen from our response to paragraph 6 of the 

Executive Summary above, and the supporting documentation referenced (Exhibit I and Exhibit II, also Exhibit V, 

morc documcntation available if rcqucstcd), thc numbcr of cxams compctcd by an cxamincr is onc componcnt in thc 

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evaluation of an examiner and it was not an absolute evaluation but it was utilized to be "consider" for a certain 

numerical rating, not a requirement. Quoting from Exhibit 1: 

"We should also consider that the ratings include: 

• Quality and quantity ofthe exams. 

• Depth of the analysis performed by the examiner 

• Amount of time that the examiner spent on their review and on the issuance of the report. 

• Written material being grammatically correct, clear and accurate. 

• Effective communications skills. 

Also see, exhibit V, Element 3: Job Specific. 

Page 6, Paragraph 3, please note this paragraph is based on conjecture. There is no documentation indicating the 

there is a quality issue with examinations or that time constraints are causing a reduction in quality of examinations. 

On the issue of time allocated for examinations, experience past examinations (with and without findings) have 

shown that 3 weeks per examination is an optimal allocation per examination. Conversely, if technological resources 

were made available, there also could be time savings realized (assuming that training to utilize the technological 

resource was provided as well as support services). SBA resource constraints have imposed hiring limits on the 

number of examiners. Additional examiners would enable an increase in the time allotted for examinations but this 

increase in examiners would also require and increase in technological, travel and administrative resource allocated 

to the Office of Examinations. 

Please note, Although Page 6, Paragraph 3, sentence 4, is hearsay from one examiner, but if supporting statements 

from other sources and collaborating documentation can be presented, the Director of Examination would like to 

ensure that this not a continuing issue. 

Page 6, Paragraph 4, continuing to Page 8, Paragraph 3, please refer to our response to paragraph 6 of the Executive 

Summary above, and the supporting documentation referenced. On Page 8, Paragraph 3, please provide 

documentation validating the individual statements of the two senior 011 officials so as not be considered hearsay. 

Page 8, Paragraph 4, through Page 10, Paragraph 2, please refer to our response to paragraph 6 of the Executive 

Summary above, and the supporting documentation referenced. 

Page 10, Paragraph 3, Section titled "Communication Challenges", please refer to our response to paragraph 6 ofthe 

Executive Summary above, and the supporting documentation referenced. 

Page 11, Section titled "Conclusion" forward, based on our rebuttal, see all of the above, we find that a number of 

conclusions are without basis. 

Page 12, Section titled "Recommendations", response the recommendations are noted on the first page of this 

document. 

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