HUBZone Program: Oversight Has Improved But Some Weaknesses Remain
Published: 2017-03-02T00:00:00

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 designated as HUBZones. SBA certifies small business firms located in HUBZones to participate in the HUBZone program—that is, determines they are eligible for federal contracting preferences under the program, such as awards of sole-source and set-aside contracts. HUBZone areas lose their designations when they no longer meet applicable criteria on economic conditions and enter a 3-year transitional period (“redesignation”) during which HUBZone firms can continue to apply to and participate in the program. HUBZone firms had almost $6.6 billion in obligations on active federal contracts for calendar year 2015.
This testimony discusses, among other things, areas of weaknesses that GAO previously identified in reviews and fraud investigations of the program, related recommendations, and SBA's actions to address them. This statement is based on GAO's body of work issued between June 2008 and September 2016. GAO also met with SBA officials in February 2017 to discuss the status of open recommendations.
Since 2008, GAO has made 11 recommendations to improve the HUBZone program. SBA has implemented seven of these recommendations, not implemented two and is in the process of implementing the other two.
section_title: What GAO Found
paragraphs: The Small Business Administration (SBA) designates economically distressed areas as Historically Underutilized Business Zones (HUBZones), based on data such as unemployment and poverty rates. Since 2008, GAO has issued several products that identified weaknesses in the HUBZone program and made recommendations to SBA to address them. While weaknesses remain, SBA has taken some steps to enhance program processes to varying extents. For example,
Certification process. In 2008, GAO found that SBA performed limited verification of the information firms reported on applications. In response to GAO's recommendation to develop and implement guidance for the certification process, SBA has taken steps to improve its processes to verify the eligibility of firms applying to the program. Since fiscal year 2009, SBA has required firms to provide supporting documentation for applications that the agency then reviews.
Susceptibility to fraud and abuse. In 2008 and 2009, GAO's investigations found 29 HUBZone firms in five metropolitan areas made fraudulent or inaccurate representations, which allowed them to get into or remain in the program. In response to GAO's recommendations to address potential fraud, SBA increased its documentation requirements. But in 2010, GAO still was able to obtain HUBZone certification using bogus addresses. Subsequently, according to SBA officials, in fiscal year 2010 SBA began conducting site visits to 10 percent of certified firms.
Recertification process. Firms wishing to remain in the program must recertify their continued eligibility to SBA every 3 years. However, in 2015, GAO found that SBA had not required firms seeking recertification to submit any information to verify continued eligibility and instead simply relied on their attestations of continued eligibility. GAO recommended that SBA reassess its recertification process and add additional controls. As of February 2017, SBA had not yet implemented this recommendation.
Communications with firms about designations. GAO found in 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 that SBA establish a better notification mechanism. In response, SBA revised its letters to newly certified firms to inform them of the consequences of redesignation, and as of February 2017, SBA was implementing additional steps to ensure that all currently certified firms would be notified of changes that could affect their program eligibility.

section_title: Letter
paragraphs: I am pleased to be here today to discuss our work on the Small Business  Administration’s (SBA) Historically Underutilized Business Zone  (HUBZone) program. As of October 2016, there were about 19,700  HUBZones and 4,804 certified firms participating in the program. For  calendar year 2015 (the most recent year that data were available), 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. In some  cases, a HUBZone-certified firm can receive an award through full and  open competition. Federal agencies are responsible for trying to meet an  annual statutory goal for awarding contracts to HUBZone firms (3 percent  of the total dollar amount of all prime contracts and subcontracts subject  to such goals). During fiscal year 2015, federal agencies collectively  awarded 1.8 percent of eligible contracts to HUBZone-certified firms.
In this statement, I will discuss the evolution of the HUBZone program  over the past decade, based on prior GAO performance audits and fraud  investigations. Specifically, this testimony (1) discusses areas of  weaknesses we have identified in prior reports, including fraud  investigations, and SBA’s actions to address them; and (2) examines  2012 and 2015 data on the economic characteristics of HUBZones.  Generally, our prior work addressed SBA’s efforts to better ensure that  only eligible small businesses participate in the HUBZone program,  including efforts to address fraud; how SBA communicates about  HUBZone area designations to HUBZone firms; and the economic  characteristics of HUBZones, including those slated to lose their  designations. In preparing this statement, we relied on our body of work  issued between June 2008 and September 2016. In addition, in  February 2017 we met with SBA officials to discuss the status of open  recommendations. As part of our fraud investigations, we created bogus  firms with fictitious owners and employees and submitted applications for  HUBZone certification to SBA. In addition, we selected HUBZone firms  based on certain criteria, such as receipt of HUBZone contracts, and  investigated them to determine whether they met key program eligibility  requirements.
The work on which this statement is based was performed in accordance  with generally accepted government auditing standards or quality  standards for investigations as set forth by the President’s Council on  Integrity and Efficiency, as appropriate. 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. More detailed information on the scope and methodology  used can be found in each of the reports cited throughout this statement.
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  generally by area poverty rate or household income; (2) qualified  nonmetropolitan counties, which are determined generally 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. The number of HUBZones increased from about 8,000 in  2000 to more than 14,000 in 2006.
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. Census  tracts and nonmetropolitan counties 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. For instance, about 3,400 HUBZones  redesignated in 2012 lost their designations in 2015. Another  approximately 2,500 census tracts and nonmetropolitan counties are  scheduled to lose their designation by January 2020. After the 3 years,  firms in these areas lose their certified status and the associated federal  contracting award preferences.
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 Has Made Some Improvements in Response to Identified Weaknesses
paragraphs: Since 2008, GAO has reported on weaknesses in the HUBZone program  and SBA’s efforts to address those vulnerabilities. GAO made 11  recommendations intended to address identified problems associated  with the program’s certification and recertification processes,  communication with firms, and the program’s susceptibility to fraud and  abuse (see app. I for a summary and status of our recommendations).  The following sections discuss the weaknesses we previously identified  and the program revisions and improvements SBA subsequently  implemented in response to our recommendations.
subsections: section_title: Certification Process
paragraphs: We reported in June 2008 that, for its certification process, SBA relied on  data that firms entered in the online application system and performed  limited verification of the self-reported information. Although agency staff  had the discretion to request additional supporting documentation, SBA  did not have specific guidance or criteria for such requests. Consequently  we recommended that SBA develop and implement guidance to more  routinely and consistently obtain supporting documentation upon  application.
In response to that recommendation, SBA revised its certification  process, and since 2009 has required firms to provide documentation,  which SBA officials review to determine the firms’ eligibility for the  HUBZone program. SBA then performs a full-document review on all  applications as part of its initial certification process to determine firms’  eligibility for the program. However, we also found in 2015 that the  revised process SBA implemented resulted in delays in processing  applications—81 percent of the 4,809 initial applications submitted  between fiscal year 2009 and 2013 that we reviewed exceeded SBA’s  processing goal of 90 days. Additional recommendations from our June  2008 report are discussed below.
section_title: Susceptibility to Fraud and Abuse
paragraphs: We previously found that SBA’s challenges with its certification process  made the HUBZone program vulnerable to fraud and abuse. For  example, in July 2008 we testified that 10 HUBZone firms in the  Washington, D.C., area had made fraudulent or inaccurate  representations to get into or remain in the HUBZone program, and in a  March 2009 report we found that another 19 firms in four other  metropolitan areas had made fraudulent representations.
We also reported in June 2010 that although SBA had increased  documentation requirements for the application process, SBA still was not  adequately authenticating self-reported information. We demonstrated  this by obtaining HUBZone certification for three bogus firms using the  addresses of the Alamo in Texas, a public storage facility in Florida, and a  city hall in Texas as principal office locations.
When we revisited this issue in 2015, SBA officials told us that the agency  conducted site visits on 10 percent of its portfolio of certified firms  annually to help address these vulnerabilities. SBA selects the firms to  receive site visits based on established criteria (such as the amount of  HUBZone contract awards the firm has received) or on an as-needed  basis in connection with the review of an initial certification application or  after receipt of a protest.
section_title: Recertification Process
paragraphs: In 2008 and 2015, we identified a number of concerns with SBA’s  HUBZone recertification process. Generally, SBA relied on self-reported  information to make its recertification decisions and had a backlog of  firms waiting to be recertified. As a result, SBA lacked reasonable  assurance that only qualified firms were allowed to continue in the  program and receive preferential contracting treatment.
subsections: section_title: Lack of Supporting Documentation
paragraphs: In February 2015, we reported that SBA relied on firms’ attestations of  continued eligibility and generally did not request supporting  documentation as part of the recertification process. 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. However, as we found, the characteristics of firms  and the status of HUBZone areas—the bases for program eligibility— often can change and need to be monitored. As a result, we concluded  that SBA lacked reasonable assurance that only qualified firms were  allowed to continue in the HUBZone program and receive preferential  contracting treatment. 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.
In March 2016, we found that SBA had not yet implemented additional  controls (such as guidance for when to request supporting documents) for  the recertification process because SBA officials believed 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 stated  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.  We concluded that a lack of risk-based criteria and guidance for staff to  request and verify firm information during the recertification process  increased the risk that ineligible firms could obtain HUBZone contracts.  We also reiterated that the characteristics of firms and the status of  HUBZone areas—the bases for program eligibility—often can change,  and needed to be monitored.
As of February 2017, SBA officials told us that the agency had begun  implementing a technology-based solution to address some of the  ongoing challenges with the recertification process. The officials expected  that the new solution would help them better assess firms and implement  risk-based controls by the end of calendar year 2017.
section_title: Backlog
paragraphs: In 2008 and again in 2015, we found that the recertification process was  backlogged—that is, firms were not being recertified within the 3-year  time frame. In 2015, we reported that 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. Consequently, in 2015 we  again recommended that SBA take steps to ensure 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 to firms (to respond to and attest that  they continued to meet the eligibility requirements for the program).  According to SBA officials, as of February 2017 this change has not yet  eliminated the backlog.
section_title: SBA’s Communications with Firms about Designations
paragraphs: In 2008 and 2015, we reported on challenges some firms had faced or  might have faced in understanding their eligibility status for the program.  Generally, SBA relied on information posted on its website to  communicate with interested parties about the HUBZone program.
subsections: section_title: Accuracy of HUBZone Maps
paragraphs: SBA’s HUBZone website includes links to the HUBZone map, which firms  can use to determine if an address or a particular area is designated as a  HUBZone. In our June 2008 report, we found that SBA’s HUBZone map  contained ineligible areas and had not been updated to include currently  eligible areas. As a result, ineligible small businesses had participated in  the program, and eligible businesses had not been able to participate.  Consequently, we recommended that SBA take steps to correct and  update the map used to identify HUBZone areas and implement  procedures to help ensure that the map would be updated with the most  recently available data on a more frequent basis. In response to our  recommendation, SBA subsequently contracted with its mapping vendor  in 2008 to enable more frequent updating of the HUBZone map (at least  annually). According to SBA officials, the accuracy of the map is checked  twice after each upgrade, first by the mapping vendor and then by an  SBA employee.
section_title: Notification to Firms
paragraphs: We subsequently reported in February 2015 that while HUBZone  designations can change with some frequency, 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. At that time SBA used a broadcast e-mail (which  simultaneously sends the same message to multiple recipients) to  distribute program information. In 2015, SBA’s e-mail addressee list had  not been updated to include firms certified since the list was created in  2013. While firms could sign up through SBA’s website to receive the e- mails, 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 our recommendation, SBA improved its notifications to  newly certified firms but not to other certified firms. For example, SBA’s  certification letter to firms with principal offices in a redesignated area  specifically states 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 better ensure that all currently certified firms  would be 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 February 2017, SBA had begun to improve its notifications to all  firms. According to SBA officials, the agency has started sending program  notices to all the firms in its portfolio. They told us that for its most recent  notice in February 2017, the agency copied all the e-mail addresses in its  HUBZone database and placed them in the e-mail distribution system.  According to SBA officials, SBA intends to repeat this effort with  subsequent notices. We will continue to monitor SBA’s implementation of  this activity.
section_title: Economic Distress Has Been More Severe in Designated HUBZone Areas Than in Redesignated Areas
paragraphs: Our June 2008 and February 2015 reports demonstrated that economic  distress (based on poverty and unemployment rate and median  household income) has been more severe in designated HUBZone areas  than in redesignated areas. For example, in June 2008, we found that  approximately 60 percent of qualified metropolitan census tracts had a  poverty rate of 30 percent or more, while approximately 4 percent of  redesignated metropolitan census tracts had a poverty rate of 30 percent  or more. Similarly, we found that about 46 percent of qualified  nonmetropolitan counties had a poverty rate of 20 percent or more, while  21 percent of redesignated nonmetropolitan counties had a poverty rate  of 20 percent or more.
In our February 2015 report, we analyzed indicators (including poverty  and unemployment rate and median household income as of 2012) to  illustrate the differences in economic conditions among HUBZone areas  (qualified and redesignated areas) and non-HUBZone areas (nonqualified  tracts or areas). We found that indicators for redesignated areas on  average fell below those of qualified areas, consistent with what we  reported in June 2008. We also found that indicators for redesignated  areas on average fell between those of qualified areas and nonqualified  areas.
For this statement, we updated our prior analysis of the economic  conditions of such areas (to include not only data as of 2012 but also as  of 2015, the most current available). Based on current analysis of poverty  and unemployment rate data, indicators for redesignated areas on  average again fell between those of qualified and non-qualified areas  (see fig. 1). For example, for census tracts in 2015 qualified tracts had poverty and unemployment rates of 34 percent  and 13 percent, respectively;  redesignated tracts had rates of 23 percent and 11 percent,  respectively; and nonqualified tracts had rates of 12 percent and 7 percent,  respectively.
A similar pattern existed for nonmetropolitan counties. Also, while the  poverty and unemployment rates for qualified and non-HUBZone  nonmetropolitan counties remained relatively unchanged between 2012  and 2015, the unemployment rate decreased in redesignated counties.
We also updated our analysis that included indicators for household  income and housing value for qualified, redesignated, and non-HUBZone  areas (by census tract). As shown in table 1, in both 2012 and 2015  qualified areas on average, had higher poverty and unemployment rates  and lower median household income and housing values then either  redesignated or non-HUBZone areas. On average, redesignated areas  had economic indicators between those of qualified and nonqualified  areas. Between 2012 and 2015 the poverty rate increased in qualified  census tracts while the average median housing income and housing  values decreased. In contrast, the average median household income  increased for both redesignated and non-HUBZone areas during that  period.
As we have stated since our June 2008 report, while allowing continued  eligibility for firms located in redesignated areas can benefit firms and  communities in such areas, allowing continued eligibility could also result  in diffusion—decreased targeting of areas with greatest economic  distress—by lessening the competitive advantage on which small  businesses may rely to thrive in economically distressed communities.  Therefore, while allowing redesignated areas to remain eligible can  generate economic benefits for such areas, the inclusion of such areas in  the HUBZone program could limit the benefits that qualified areas with  more depressed economic conditions might realize. In taking into account  the potential impacts of actions that can expand or reduce the number of  HUBZones and redesignated areas, our June 2008 report included a  recommendation to SBA to further develop measures and implement  plans to assess the effectiveness of the HUBZone program that take into  account factors such as the economic characteristics of the HUBZone  area. Although SBA took initial steps to develop such an assessment, the  agency has not implemented our recommendation.
We plan to continue to evaluate elements of the HUBZone program. The  Puerto Rico Oversight, Management, and Economic Stability Act contains  a provision for us to evaluate the application and utilization of SBA  contracting activities (including contracting activities relating to HUBZone  firms) in Puerto Rico. Our work will include an analysis of the impact of  SBA’s June 2016 decision to remove a statutory cap on the number of  qualified census tracts in metropolitan statistical areas in Puerto Rico (as  well as nationwide). According to SBA, the removal of the cap resulted  nationally in 2,015 additional census tracts qualifying as HUBZones at  that time. We anticipate issuing the report in June 2017.
Chairman Knight, Ranking Member Murphy, and members of the  Subcommittee, this concludes my statement. I would be pleased to  respond to any questions you may have.
subsections: 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, John Mingus, and  Barbara Roesmann.
section_title: Appendix I: Summary and Status of Previous GAO HUBZone Recommendations
paragraphs: The following table summarizes the status of our recommendations from  HUBZone performance audits and investigations as of February 2017.  We classify each recommendation as partially implemented (the agency took steps to implement the  recommendation but more work remains); open (the agency has not taken steps to implement the  closed, not implemented (the agency decided not to take action to  implement the recommendation).
The recommendations are listed by report.
GAO recommendations  Small Business Contracting: Opportunities Exist to Further Improve HUBZone Oversight: GAO-15-234, February 12, 2015  Establish a mechanism to better ensure that firms are notified of changes to HUBZone designations that  may affect their participation in the program, such as ensuring that all certified firms and newly certified firms  are signed up for the broadcast e-mail system or including more specific information in certification letters  about how location in a redesignated area can affect their participation in the program  Conduct an assessment of 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 will be dedicated to the effort so  that a significant backlog in recertifications does not recur.  HUBZONE Program: Fraud and Abuse Identified in Four Metropolitan Areas: GAO-09-440, March 25, 2009  Consider incorporating a risk-based mechanism for conducting unannounced site visits as part of the  screening and monitoring process.
Consider incorporating policies and procedures into SBA’s program examinations for evaluating if a  HUBZone firm is expending at least 50 percent of the personnel costs of a contract using its own  employees.
Ensure appropriate policies and procedures are in place for the prompt reporting and referral of fraud and  abuse to SBA’s Office of Inspector General as well as SBA’s Suspension and Debarment Official.
Take appropriate enforcement actions on the 19 HUBZone firms we found to violate HUBZone program  requirements to include, where applicable, immediate removal or decertification from the program, and  coordination with SBA’s Office of Inspector General as well as SBA’s Suspension and Debarment Official.
Closed-implemented  GAO recommendations  Small Business Administration: Additional Actions Are Needed to Certify and Monitor HUBZone Businesses and Assess  Program Results: GAO-08-643, June 17, 2008  Take immediate steps to correct and update the map that is used to identify HUBZone areas and implement  procedures to ensure that the map is updated with the most recently available data on a more frequent  basis.
Develop and implement guidance to more routinely and consistently obtain supporting documentation upon  application and conduct more frequent site visits, as appropriate, to ensure that firms applying for  certification are eligible.
Establish a specific time frame for eliminating the backlog of recertifications and ensure that this goal is met,  using either SBA or contract staff, and take the necessary steps to ensure that recertifications are  completed in a more timely fashion in the future.
Formalize and adhere to a specific time frame for processing firms proposed for decertification in the future.  Closed-implemented  Further develop measures and implement plans to assess the effectiveness of the HUBZone program that  take into account factors such as (1) the economic characteristics of the HUBZone area and (2) contracts  being counted under multiple socioeconomic subcategories.
Closed - not  Implemented  This is a work of the U.S. government and is not subject to copyright protection in the  United States. The published product may be reproduced and distributed in its entirety  without further permission from GAO. However, because this work may contain  copyrighted images or other material, permission from the copyright holder may be  necessary if you wish to reproduce this material separately.