HUBZone Program: Opportunities Exist to Further Improve Oversight
Published: 2016-09-07T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The purpose of the HUBZone program is to stimulate economic development in economically distressed areas. SBA certified HUBZone firms are eligible for federal contracting benefits, including limited competition awards such as sole-source and set-aside contracts. Small firms in SBA's HUBZone program had almost $6.6 billion in obligations on active federal contracts for calendar year 2015.
This testimony includes a discussion of (1) how SBA communicates changes in HUBZone designations to firms, including how SBA addressed GAO's 2015 recommendation to improve this process, and (2) SBA's certification and recertification processes for firms, including how SBA addressed GAO's 2015 recommendation to improve recertification.
GAO relied on the work supporting its February 2015 report on SBA's oversight of the program ( GAO-15-234 ) and its March 2016 report on actions taken in response to GAO recommendations ( GAO-16-4232R ), as well as July and August 2016 interviews with SBA officials on efforts the agency had undertaken to implement GAO's recommendations.
section_title: What GAO Found
paragraphs: As of August 2016, the Small Business Administration (SBA) had taken steps to better inform firms about changes in the designations of Historically Underutilized Business Zones (HUBZones) but had not yet fully implemented GAO's February 2015 recommendation to improve this process.
SBA primarily designates economically distressed areas as HUBZones, based on demographic data such as unemployment and poverty rates. The designations include certain census tracts and counties and are subject to periodic changes as economic conditions change. HUBZones that lose qualifying status due to changes in economic conditions become “redesignated” and undergo a 3-year transition period. After the 3-year period, HUBZone certified firms in these areas can no longer apply to and participate in the program and receive contracting preferences.
GAO found in February 2015 that SBA's communications to firms about programmatic changes (including redesignation) generally were not specific to affected firms and thus some firms might not have been informed they would lose eligibility. GAO recommended SBA better ensure firms were notified of changes that might affect program participation.
In response, SBA revised its approval letters to newly certified firms to include information about the consequences of redesignation (if applicable). But as of August 2016, SBA had not yet implemented changes to help ensure all currently certified firms would be notified of changes that could affect their program eligibility. SBA officials recently told GAO the agency intended to develop a technology solution by spring 2017 to help address GAO's recommendations.
While SBA made changes to its certification and recertification processes, SBA had not fully addressed GAO's recommendation on recertification of firms. To receive initial certification, SBA requires all firms to provide documentation to show they meet the eligibility requirements. SBA also conducts site visits at selected firms (for example, based on the amount of federal contracts received). According to HUBZone regulations, firms wishing to remain in the program without any interruption must recertify their continued eligibility to SBA within 30 days after the third anniversary of their certification date and each subsequent 3-year period. But in 2015, GAO found SBA did not require firms seeking recertification to submit any information to verify continued eligibility and instead relied on firms' attestations of continued eligibility. GAO also found SBA had a backlog for recertifying firms. GAO recommended in February 2015 that SBA implement additional controls for recertification, including criteria for requesting and verifying firm information, and ensuring sufficient staffing for the process so that significant backlogs would not recur. As of August 2016, SBA had plans to eliminate the backlog, but had not issued guidance on requesting supporting documents. SBA officials stated that any potential risk of fraud during recertification would be mitigated by SBA's site visits of firms. But as GAO stated in 2015 and reiterated in 2016, SBA only conducts site visits to about 10 percent of certified firms on an annual basis and characteristics of firms often can change, therefore relying on site visits is not adequate to mitigate this risk.

section_title: Letter
paragraphs: Thank you for the opportunity to discuss our work on the Historically  Underutilized Business Zone (HUBZone) program of the Small Business  Administration (SBA). As of December 31, 2015, there were about 16,500  designated HUBZones and 4,600 certified firms in the program. For  calendar year 2015, firms in the program had almost $6.6 billion in  obligations on active federal contracts directly awarded to bidders.
Congress established the HUBZone program to stimulate economic  development in economically distressed communities. The program  provides federal contracting preferences to small businesses located in  HUBZone-designated areas that also employ residents of the areas. The  contracting preferences that a certified HUBZone firm (one that meets  program eligibility requirements) can receive include limited-competition  contracting awards such as sole-source and set-aside contracts. A  HUBZone-certified firm also can receive an award through full and open  competition if its price does not exceed the otherwise lowest responsive  and responsible offeror’s price by more than 10 percent. Federal  agencies are responsible for trying to meet an annual statutory goal for  awarding contracts to HUBZone firms (3 percent of all prime contracts  and subcontracts that are subject to the goaling process). During fiscal  year 2015, federal agencies collectively obligated 1.8 percent of eligible  contracts to HUBZone-certified firms.
My statement today is based on the key findings in our February 2015  report on SBA’s oversight of the HUBZone program and our March 2016  follow-up report on SBA responses to our 2015 recommendations.  Specifically, this testimony discusses (1) how SBA communicates  changes in HUBZone designations to firms, including how SBA  addressed our recommendation to improve this process; (2) SBA’s  certification and recertification processes for firms, including how SBA  addressed our recommendations to improve these processes; and ( 3)  how potential changes to designation criteria could affect HUBZones. In  preparing this statement, we relied on the work supporting our February  2015 and March 2016 reports, as well as July and August 2016 interviews  with SBA officials on efforts they had undertaken to implement our  recommendations. More detailed information on our scope and  methodology can be found in our February 2015 and March 2016  reports.
The work on which this testimony is based was performed 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 objectives.
subsections: section_title: Background
paragraphs: The HUBZone Act of 1997 (which established the HUBZone program)  identified HUBZones as (1) qualified census tracts, which are determined  by area poverty rate or household income; (2) qualified nonmetropolitan  counties, which are determined by area unemployment rate or median  household income; and (3) lands meeting certain criteria within the  boundaries of an Indian reservation. Congress subsequently expanded  the criteria for HUBZones to add former military bases and counties in  difficult development areas outside the continental United States.
To be certified to participate in the HUBZone program, a firm must meet  the following criteria: when combined with its affiliates, be small by SBA size standards; be at least 51 percent owned and controlled by U.S. citizens; have its principal office—the location where the greatest number of  employees perform their work—in a HUBZone; and have at least 35 percent of its employees reside in a HUBZone.
SBA recertifies firms (that is, determines that firms continue to meet  HUBZone eligibility requirements to participate in the program) every 3  years.
section_title: SBA Improved Communications to Firms about Changes to HUBZone Designations but Had Not Fully Implemented GAO’s Recommendation
paragraphs: As of August 2016, SBA had taken some actions to address but had not  yet fully implemented our recommendation on better informing firms about  programmatic changes that could affect their eligibility. In our February  2015 report, we described how HUBZone designations can change with  some frequency. SBA generally updates HUBZone designations at least  twice a year based on whether they meet statutory criteria (such as  having certain income levels or poverty or unemployment rates). SBA  generally uses data from other federal agencies to determine if areas still  qualify for the HUBZone program. As a result of the updates, additional  areas are designated for inclusion while other areas lose their  designation. Areas that lose their designation begin a 3-year  “redesignation” period during which firms in those areas can continue to  apply to and participate in the program and receive contracting  preferences. After the 3 years, firms in these areas lose their HUBZone  certified firm status and the associated federal contracting award  preferences. In 2015, we reported that 17 percent (871) of firms certified  at the time were located in a redesignated area.
However, we found that SBA’s communications to firms about  programmatic changes (including redesignation) generally had not been  targeted or specific to firms that would be affected by the changes. In  2015, we found that SBA used a broadcast e-mail (which simultaneously  sends the same message to multiple recipients) to distribute program  information. According to SBA officials, the e-mail list initially included all  certified firms, but firms certified since the list was created in 2013 and up  to the time period covered by our 2015 report had not been automatically  added to the list. Firms had to sign up through SBA’s website to receive  the e-mails. As a result, not all certified firms may have done so.
Consequently, we recommended that SBA establish a mechanism to  better ensure that firms are notified of changes to HUBZone designations  that may affect their participation in the program. This recommendation  was intended to address communications to all certified firms, whether  newly certified or in the program for years.
In response to the recommendation, SBA has improved notifications to  newly certified firms. As we reported in March 2016, SBA revised its  certification letters to firms. If SBA identifies during an application review  that a firm’s principal office is in a redesignated area, it indicates in the  certification letter that the firm is in a redesignated area, explains the  implications of the designation, and notes when the redesignated status  will expire. However, we found in March 2016 that SBA had not yet  implemented changes to ensure that all currently certified firms are  notified of changes that could affect their program eligibility. It is  important that all certified firms potentially affected by such changes  receive information about the changes or are made aware in a timely  fashion of any effects on their program eligibility.
As of August 2016, SBA had plans to improve its notifications to all firms.  SBA recently hired an employee whose responsibilities include helping  SBA update its e-mail distribution list. As part of this effort, according to  SBA officials, SBA plans to collect all the e-mail addresses for certified  firms from its Dynamic Small Business Search database to create a new  distribution list. SBA plans to begin adding newly certified firms to the  list quarterly. Additionally, SBA officials told us that the agency intends to  develop a technology solution similar to SBA One—a database now used  to process loan applications—to include the HUBZone program to help  collect information and documents from existing firms and address this  recommendation. SBA expects to implement this solution by spring 2017.
section_title: SBA Has Taken Some Steps to Address GAO’s Recommendation to Strengthen the Recertification Process
paragraphs: We found in February 2015 that SBA had addressed weaknesses in its  certification process that we previously identified. However, as of August  2016, SBA had not yet taken steps to fully address our recommendation  related to the HUBZone firm recertification process. In February 2015, we  reported that SBA had changed its certification process to require all  applicant firms to provide documentation supporting their eligibility and to  require agency staff to perform a full document review to determine firms’  eligibility for the program. Additionally, SBA had conducted site visits on  10 percent of its portfolio of certified firms every year in response to a  prior GAO June 2008 recommendation. However, we also found  deficiencies relating to the recertification process.
First, in 2008 and again in 2015, we found that the recertification  process had become backlogged—that is, firms were not being  recertified within the 3-year time frame. As of September 2014, SBA  was recertifying firms that had been first certified 4 years previously.  While SBA initially eliminated the backlog following our 2008 report,  according to SBA officials the backlog recurred due to limitations with  the program’s computer system and resource constraints.
Second, in 2015 we found that SBA relied on firms’ attestations of  continued eligibility and generally did not request supporting  documentation. SBA only required firms to submit a notarized  recertification form stating that their eligibility information was  accurate. SBA officials did not believe they needed to request  supporting documentation from recertifying firms because all firms in  the program had undergone a full document review, either at initial  application or during SBA’s review of its legacy portfolio in fiscal years  2010–2012.
As a result, we concluded in 2015 that SBA lacked reasonable assurance  that only qualified firms were allowed to continue in the HUBZone  program and receive preferential contracting treatment.
Consequently, we recommended that SBA reassess the recertification  process and implement additional controls, such as developing criteria  and guidance on using a risk-based approach to requesting and verifying  firm information, allowing firms to initiate the recertification process, and  ensuring that sufficient staff would be dedicated to the effort so that  significant backlogs would not recur.
In response to the recommendation, SBA made some changes to its  recertification process. For example, instead of manually identifying firms  for recertification twice a year, SBA automated the notification process,  enabling notices to be sent daily for firms to respond to and attest that  they continued to meet the eligibility requirements for the program.  According to SBA officials, this change should ultimately help eliminate  the backlog by September 30, 2016.
However, as we discussed in our March 2016 report, SBA had not  implemented additional controls (such as guidance for when to request  supporting documents) for the recertification process because SBA  officials believe that any potential risk of fraud would be mitigated by site  visits to firms. The officials also cited resource limitations. Based on  data that SBA provided, the agency visited about 10 percent of certified  firms each year during fiscal years 2013–2015. SBA’s reliance on site  visits alone would not mitigate the recertification weaknesses that were  the basis for our recommendation. In recognition of SBA’s resource  constraints, we said in our 2015 report and reiterated in 2016 that SBA  could apply a risk-based approach to its recertification process to review  and verify information from firms that appear to pose the most risk to the  program. A lack of risk-based criteria and guidance for staff to request  and verify firm information during the recertification process increases the  risk that ineligible firms obtain HUBZone contracts. And as we stated in  2015 and reiterated in 2016, the characteristics of firms and the status of  HUBZone areas—the bases for program eligibility—often can change,  and need to be monitored.
SBA officials told us that the agency intends to implement a technology- based solution similar to SBA One to address some of the ongoing  challenges with the recertification process by spring 2017. The officials  expect that the new solution will help them better assess firms and  implement risk-based controls.
section_title: Potential Changes to HUBZone Designation Criteria Could Affect Program Benefits Realized by Specific Communities
paragraphs: As we reported in February 2015, potential changes to HUBZone  designation criteria could be designed to provide additional economic  benefits to some communities. However, changes that benefit some  communities also could, through competitive market processes, reduce  activity by HUBZone firms in existing HUBZones. Likewise, if the potential  changes significantly increased the number of HUBZones, new areas  could realize economic benefits. However, such changes also could result  in diffusion—decreased targeting of areas of greatest economic  distress—by lessening the competitive advantage on which small  businesses may rely to thrive in economically distressed communities.
An analysis we performed for our February 2015 report offers examples  of the scope of the differences in economic conditions among HUBZone  areas (qualified areas), redesignated areas, and non-HUBZone areas  (nonqualified tracts or areas) . We analyzed the economic conditions of  such areas as of 2012 and found that indicators for redesignated areas  on average fell between those of qualified and non-qualified areas. For  example, as shown in figure 1, qualified census tracts had poverty and  unemployment rates of 32 percent and 14 percent, respectively;  redesignated tracts had rates of 24 percent and 12 percent, respectively;  and nonqualified tracts had rates of 11 and 8 percent, respectively. A  similar pattern existed for nonmetropolitan counties. Therefore, while  allowing redesignated areas with certified firms to remain eligible can  generate economic benefits for such areas, such inclusion could limit the  benefits realized by qualified areas with more depressed economic  conditions.
In our 2015 report, we explored the potential impact of altering some of  the criteria used to designate HUBZones. We examined changes to  thresholds for unemployment rate and for the number of census tracts  that could qualify for the program in a given metropolitan area. For  example, one way a nonmetropolitan county can qualify as a HUBZone is  based on its unemployment rate. More specifically, the unemployment  rate must be 140 percent or more of the average unemployment rate for  the United States or for the state in which the county is located,  whichever is less. Under the current definition, two counties in different  states with the same unemployment rate would not necessarily both  qualify as HUBZones, depending on the unemployment rate of the state  in which they are located. In general, every county in a state with an  unemployment rate less than the U.S. average would qualify as a  HUBZone if its unemployment rate was at least 140 percent of the state’s  (even if it was less than the U.S. average). In contrast, counties in states  with unemployment rates higher than the U.S. average must have an  unemployment rate at least equal to 140 percent of the U.S. average to  qualify as a HUBZone.
Our application of hypothetical changes to the unemployment rate  generally resulted in approximately the same number of areas qualifying  compared to the current definition with two exceptions —applying the  lowest unemployment rate to all states resulted in approximately four  times as many counties qualifying, while applying the highest  unemployment rate resulted in approximately eight times fewer counties  qualifying (see table 1).
Similarly, we analyzed the potential impact of removing the limit on the  number of areas that could qualify as HUBZones pursuant to the  definition of “qualified census tract” that was in effect at the time we  issued our February 2015 report. We found that about 2,400 more  census tracts would qualify as HUBZones if the 20 percent cap were not  in place, an increase of 15 percent from the number of qualified tracts as  of June 2014.
Chairman Chabot and Ranking Member Velázquez, this concludes my  statement. I would be pleased to respond to any questions you or other  Members of the Committee may have.
section_title: GAO Contact and Staff Acknowledgments
paragraphs: If you or your staff have any questions about this testimony, please  contact William B. Shear, Director, Financial Markets and Community  Investment, at (202) 512-8678 or shearw@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found  on the last page of this statement. GAO staff who made key contributions  to this testimony are Harry Medina (Assistant Director), Daniel Newman  (Analyst-in-Charge), Pamela Davidson, John McGrail, and Barbara  Roesmann.
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