Small Business Administration: Additional Actions Are Needed to Certify and Monitor HUBZone Businesses and Assess Program Results
Released: 2008-07-17T00:00:00

Letter

Background

The purpose of the HUBZone program, which was established by the HUBZone Act of 1997, is to stimulate economic development, through increased employment and capital investment, by providing federal contracting preferences to small businesses in economically distressed communities or HUBZone areas. The types of areas in which HUBZones may be located are defined by law and consist of the following: Qualified census tracts. A qualified census tract has the meaning given the term by Congress for the low-income-housing tax credit program. The list of qualified census tracts is maintained and updated by the Department of Housing and Urban Development (HUD). As currently defined, qualified census tracts have either 50 percent or more of their households with incomes below 60 percent of the area median gross income or have a poverty rate of at least 25 percent. The population of all census tracts that satisfy one or both of these criteria cannot exceed 20 percent of the area population.

Qualified nonmetropolitan counties. Qualified nonmetropolitan counties are those that, based on decennial census data, are not located in a metropolitan statistical area and in which 1. the median household income is less than 80 percent of the nonmetropolitan state median household income; 2. the unemployment rate is not less than 140 percent of the average unemployment rate for either the nation or the state (whichever is lower); or 3. a difficult development area is located.

Qualified Indian reservations. A HUBZone qualified Indian reservation has the same meaning as the term “Indian Country” as defined in another federal statute, with some exceptions. These are all lands within the limits of any Indian reservation, all dependent Indian communities within U.S. borders, and all Indian allotments. In addition, portions of the State of Oklahoma qualify because they meet the Internal Revenue Service’s definition of “former Indian reservations in Oklahoma.”

Redesignated areas. These are census tracts or nonmetropolitan counties that no longer meet the economic criteria but remain eligible until after the release of the 2010 decennial census data.

Base closure areas. Areas within the external boundaries of former military bases that were closed by the Base Realignment and Closure Act (BRAC) qualify for HUBZone status for a 5-year period from the date of formal closure.

In order for a firm to be certified to participate in the HUBZone program, it must meet the following four criteria: the company must be small by SBA size standards; the company must be at least 51 percent owned and controlled by U.S. citizens; the company’s principal office—the location where the greatest number of employees perform their work—must be located in a HUBZone; and at least 35 percent of the company’s full-time (or full-time equivalent) employees must reside in a HUBZone.

As of February 2008, 12,986 certified firms participated in the HUBZone program. More than 4,200 HUBZone firms obtained approximately $8.1 billion in federal contracts in fiscal year 2007. The annual federal contracting goal for HUBZone small businesses is 3 percent of all prime contract awards—contracts that are awarded directly by an agency.

SBA Relies on Federal Law to Identify HUBZone Areas but Its Map Is Inaccurate

Our June 2008 report found that a series of statutory changes have resulted in an increase in the number and types of HUBZone areas. These changes could diffuse (or limit) the economic benefits of the program. Further, while SBA relies on federal law to identify qualified HUBZone areas, its HUBZone map is inaccurate.

Recent Legislation Increased the Number and Types of HUBZone Areas

In recent years, amendments to the HUBZone Act and other statutes have increased the number and types of HUBZone areas. The original HUBZone Act of 1997 defined a HUBZone as any area within a qualified census tract, a qualified nonmetropolitan county, or lands within the boundaries of a federally recognized Indian reservation. However, subsequent legislation revised the definitions of the original categories and expanded the HUBZone definition to include new types of qualified areas (see fig. 1). Subsequent to the various statutory changes, the number of HUBZone areas grew from 7,895 in calendar year 1999 to 14,364 in 2006. SBA’s data show that, as of 2006, there were 12,218 qualified census tracts; 1,301 nonmetropolitan counties; 651 Indian Country areas; 82 BRAC areas; and 112 difficult development areas.

In expanding the types of HUBZone areas, the definition of economic distress has been broadened to include measures that were not in place in the initial statute. For example, a 2000 statute amended the HUBZone area definition to allow census tracts or nonmetroplitan counties that ceased to be qualified to remain qualified for a further 3-year period as “redesignated areas.” A 2004 statute permitted these same areas to remain qualified until the release date of the 2010 census data. Further, in 2005, Congress expanded the definition of a qualified nonmetropolitan county to include difficult development areas outside the continental U.S.—areas with high construction, land, and utility costs relative to area income—and such counties could include areas not normally considered economically distressed. As a result, the expanded HUBZone criteria now allow for HUBZone areas that are less economically distressed than the areas initially designated. HUBZone program officials stated that the expansion can diffuse the impact or potential impact of the program on existing HUBZone areas. We recognize that establishing new HUBZone areas can potentially provide economic benefits for these areas by helping them attract firms that make investments and employ HUBZone residents. However, such an expansion could result in less targeting of areas of greatest economic distress.

SBA’s Web Map Inaccurately Identifies Eligible Areas

SBA program staff employ no discretion in identifying HUBZone areas because they are defined by federal statute; however, they have not always designated these areas correctly on their Web map. To identify and map HUBZone areas, SBA relies on a mapping contractor and data from other executive agencies (see fig. 2). Essentially, the map is SBA’s primary interface with small businesses to determine if they are located in a HUBZone and can apply for HUBZone certification.

During the course of our review, we identified two problems with SBA’s HUBZone map. First, the map includes some areas that do not meet the statutory definition of a HUBZone area. As noted previously, counties containing difficult development areas are only eligible in their entirety for the HUBZone program if they are not located in a metropolitan statistical area. However, we found that SBA’s HUBZone map includes 50 metropolitan counties as difficult development areas that do not meet this or any other criterion for inclusion as a HUBZone area. As a result of these errors, ineligible firms have obtained HUBZone certification and received federal contracts. As of December 2007, 344 certified HUBZone firms were located in ineligible areas in these 50 counties. Further, from October 2006 through March 2008, federal agencies obligated about $5 million through HUBZone set-aside contracts to 12 firms located in these ineligible areas.

Second, while SBA’s policy is to have its contractor update the HUBZone map as needed, the map has not been updated since August 2006. Since that time, additional data such as unemployment rates from the Bureau of Labor Statistics (BLS) have become available. Although SBA officials told us that they have been working to have the contractor update the mapping system, no subcontract was in place as of May 2008. While an analysis of the 2008 list of qualified census tracts showed that the number of tracts had not changed since the map was last updated, our analysis of 2007 BLS unemployment data indicated that 27 additional nonmetropolitan counties should have been identified on the map, allowing qualified firms in these areas to participate in the program. Because firms are not likely to receive information on the HUBZone status of areas from other sources, firms in the 27 areas would have believed from the map that they were ineligible to participate in the program and could not benefit from contracting incentives that certification provides.

In our June 2008 report, we recommended that SBA take immediate steps to correct and update the map and implement procedures to ensure that it is updated with the most recently available data on a more frequent basis. In response to our recommendation, SBA indicated that it plans to issue a new contract to administer the HUBZone map and anticipates that the maps will be updated and available no later than August 29, 2008. Further, SBA stated that, during the process of issuing the new contract, the HUBZone program would issue new internal procedures to ensure that the map is updated continually.

SBA Has Limited Controls to Ensure That Only Eligible Firms Participate in the HUBZone Program

Our June 2008 report also found that the policies and procedures upon which SBA relies to certify and monitor firms provide limited assurance that only eligible firms participate in the HUBZone program. While internal control standards for federal agencies state that agencies should document and verify information that they collect on their programs, SBA obtains supporting documentation from firms in limited instances. In addition, SBA does not follow its own policy of recertifying all firms every 3 years, and has not met its informal goal of 60 days for removing firms deemed ineligible from its list of certified firms.

SBA Largely Relies on Self- Reported Data for HUBZone Certifications and Recertifications, Increasing the Risk That Ineligible Firms Can Participate

Firms apply for HUBZone certification using an online application system, which according to HUBZone program officials employs automated logic steps to screen out ineligible firms based on the information entered on the application. For example, firms enter information such as their total number of employees and number of employees that reside in a HUBZone. Based on this information, the system then calculates whether the number of employees residing in a HUBZone equals 35 percent or more of total employees, the required level for HUBZone eligibility. HUBZone program staff then review the applications to determine if more information is required. While SBA’s policy states that supporting documentation normally is not required, it notes that agency staff may request and consider such documentation, as necessary. No specific guidance or criteria are provided to program staff for this purpose; rather, the policy allows staff to determine what circumstances warrant a request for supporting documentation. In determining whether additional information is required, HUBZone program officials stated that they generally consult sources such as firms’ or state governments’ Web sites that contain information on firms incorporated in the state. SBA ultimately approves the majority of applications submitted. For example, in fiscal year 2007, SBA approved about 78 percent of the applications submitted.

To ensure the continued eligibility of certified HUBZone firms, SBA requires firms to resubmit an application. That is, to be recertified, firms re-enter information in the online application system, and HUBZone program officials review it. In 2004, SBA changed the recertification period from an annual recertification to every 3 years. According to HUBZone program officials, they generally limit their reviews to comparing resubmitted information to the original application. The officials added that significant changes from the initial application can trigger a request for additional information or documentation. If concerns about eligibility are raised during the recertification process, SBA will propose decertification or removal from the list of eligible HUBZone firms. Firms that are proposed for decertification can challenge that proposed outcome through a due-process mechanism. SBA ultimately decertifies firms that do not challenge the proposed decertification and those that cannot provide additional evidence that they continue to meet the eligibility requirements. For example, SBA began 6,798 recertifications in fiscal years 2005, 2006, and 2007 and either had proposed to decertify or completed decertification of 5,201 of the firms (about 77 percent) as of January 22, 2008 (the date of the data set). Although SBA does not systematically track the reasons why firms are decertified, HUBZone program officials noted that many firms do not respond to SBA’s request for updated information.

Internal control standards for federal agencies and programs require that agencies collect and maintain documentation and verify information to support their programs. However, SBA verifies the information it receives from firms in limited instances. For example, our review of the 125 applications that were submitted in September 2007 shows that HUBZone program staff requested additional information but not supporting documentation for 10 (8 percent) of the applications; requested supporting documentation for 45 (36 percent) of the applications; and conducted one site visit.

According to HUBZone program officials, they did not more routinely verify the information because they generally relied on their automated processes and status protest process. For instance, they said they did not request documentation to support each firm’s application because the application system employs automated logic steps to screen out ineligible firms. For example, the application system calculates the percentage of a firm’s employees that reside in a HUBZone and screens out firms that do not meet the 35 percent requirement. But the automated application system would not necessarily screen out applicants that submit false information to obtain a HUBZone certification.

Rather than obtaining supporting documentation during certification and recertification on a more regular basis, SBA waits until it conducts program examinations of a small percentage of firms to consistently request supporting documentation. Since fiscal year 2004, SBA’s policy has been to conduct program examinations on 5 percent of firms each year. From fiscal years 2004 through 2006, nearly two-thirds of firms SBA examined were decertified, and in fiscal year 2007, 430 of 715 firms (about 60 percent) were decertified or proposed for decertification. The number of firms decertified includes firms that the agency determined were ineligible and were decertified, and firms that requested to be decertified. Because SBA limits its program examinations to 5 percent of firms each year, firms can be in the program for years without being examined. For example, we found that 2,637 of the 3,348 firms (approximately 79 percent) that had been in the program for 6 years or more had not been examined. In addition to performing program examinations on a limited number of firms, HUBZone program officials rarely conduct site visits during program examinations to verify a firm’s information.

In our report, we recommended that SBA 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. In response to this recommendation, SBA stated it was formulating procedures that would provide sharper guidance about when supporting documentation and site visits would be required, and plans to identify potential areas of concern during certification that would mandate additional documentation and site visits.

Because SBA Has a Backlog of Recertifications, Some Firms Went Unmonitored for Longer Periods

As noted previously, since 2004 SBA’s policies have required the agency to recertify all HUBZone firms every 3 years. Recertification presents another opportunity for SBA to review information from firms and thus help monitor program activity. However, SBA has failed to recertify 4,655 of the 11,370 firms (more than 40 percent) that have been in the program for more than 3 years. Of the 4,655 firms that should have been recertified, 689 have been in the program for more than 6 years. According to HUBZone program officials, the agency lacked sufficient staff to complete the recertifications. However, the agency hired a contractor in December 2007 to help conduct recertifications, using the same process that SBA staff currently use. Although SBA has acquired these additional resources, the agency lacks specific timeframes for eliminating the backlog. As a result of the backlog, the periods during which some firms go unmonitored and reviewed for eligibility are longer than SBA policy allows, increasing the risk that ineligible firms may be participating in the program.

In our recent report, we recommended that SBA establish a specific time frame for eliminating the backlog of recertifications and take the necessary steps to ensure that recertifications are completed in a more timely fashion in the future. In its response to this recommendation, SBA noted that the HUBZone program had obtained additional staff and that the backlog of pending recertifications would be completed by September 30, 2008. Further, to ensure that recertifications will be handled in a more timely manner, SBA stated that the HUBZone program has made dedicated staffing changes and will issue explicit changes to procedures.

SBA Lacks a Formal Policy on Timeframes for Decertifying Firms, Which Provides Ineligible Firms with an Opportunity to Obtain Contracts

While SBA policies for the HUBZone program include procedures for certifications, recertifications, and program examinations, they do not specify a timeframe for processing decertifications—the determinations subsequent to recertification reviews or examinations that firms are no longer eligible to participate in the HUBZone program. Although SBA does not have written guidance for the decertification timeframe, the HUBZone program office negotiated an informal (unwritten) goal of 60 days with the SBA Inspector General (IG) in 2006. In recent years, SBA ultimately decertified the vast majority of firms proposed for decertification, but has not met its 60-day goal consistently (see table 1). From fiscal years 2004 through 2007, SBA failed to resolve proposed decertifications within its goal of 60 days for more than 3,200 firms. While SBA’s timeliness has improved, in 2007, more than 400 (or about 33 percent) were not resolved in a timely manner. As a consequence of generally not meeting its 60-day goal, lags in the processing of decertifications have increased the risk of ineligible firms participating in the program.

In our June 2008 report, we recommended that SBA formalize and adhere to a specific time frame for processing firms proposed for decertification in the future. In response, SBA noted that it would issue new procedures to clarify and formalize the decertification process and its timelines. SBA stated that the new decertification procedures would establish a 60 calendar day deadline to complete any proposed decertification.

SBA Has Not Implemented Plans to Assess the Effectiveness of the HUBZone Program and Most Agencies Have Not Met Contracting Goals

Our June 2008 report also found that SBA has taken limited steps to assess the effectiveness of the HUBZone program. SBA’s three performance measures for the HUBZone program do not directly measure the effect of the program on communities. Moreover, federal agencies did not meet the government-wide contracting goal for the HUBZone program in fiscal years 2003 through 2006 (the most recent years for which goaling data are available).

SBA Has Limited Performance Measures and Has Not Implemented Plans to Evaluate the Effectiveness of the Program

While SBA has some measures in place to assess the performance of the HUBZone program, the agency has not implemented its plans to conduct an evaluation of the program’s benefits. According to the Government Performance and Results Act of 1993, federal agencies are required to identify results-oriented goals and measure performance toward the achievement of their goals. We previously have reported on the attributes of effective performance measures, and reported that for performance measures to be useful in assessing program performance, they should be linked or aligned with program goals and cover the activities that an entity is expected to perform to support the intent of the program.

According to SBA’s fiscal year 2007 Annual Performance Report, the three performance measures for the HUBZone program were: (1) the number of small businesses assisted (which SBA defines as the number of applications approved and the number of recertifications processed), (2) the annual value of federal contracts awarded to HUBZone firms, and (3) the number of program examinations completed. These measures provide some data on program activity and measure contract dollars awarded to HUBZone firms. However, they do not directly measure the program’s effect on firms (such as growth in employment or changes in capital investment) or directly measure the program’s effect on the communities in which the firms are located (for instance, changes in median household income or poverty levels).

Similarly, the Office of Management and Budget (OMB) noted in its 2005 Program Assessment Rating Tool (PART) that SBA needed to develop baseline measures for some of its HUBZone performance measures and encouraged SBA to focus on more outcome-oriented measures that better evaluate the results of the program. The PART assessment also documented plans that SBA had to conduct an analysis of the economic impact of the HUBZone program on a community-by-community basis using data from the 2000 and 2010 decennial census. However, SBA officials indicated that the agency has not devoted resources to implement either of these strategies for assessing the results of the program. Yet by not evaluating the HUBZone program’s benefits, SBA lacks key information that could help it better manage the program and inform the Congress of its results.

As part of our work, we conducted site visits to four HUBZone areas (Lawton, Oklahoma; Lowndes County, Georgia; and Long Beach and Los Angeles, California) to better understand to what extent stakeholders perceived that the HUBZone program generated benefits. For all four HUBZone areas, the perceived benefits of the program varied, with some firms indicating they have been able to win contracts and expand their firms and others indicating they had not realized any benefits from the program. Officials representing economic development entities varied in their knowledge of the program, with some stating they lacked information on the program’s effect that could help them inform small businesses of its potential benefits.

In our report, we recommended that SBA further develop measures and implement plans to assess the effectiveness of the HUBZone program. In its response to this recommendation, SBA stated that it would develop an assessment tool to measure the economic benefits that accrue to areas in the HUBZone program and that the HUBZone program would then issue periodic reports accompanied by the underlying data.

Most Federal Agencies Did Not Meet Their Contracting Goals for the HUBZone Program

Although contracting dollars awarded to HUBZone firms have increased since fiscal year 2003—when the statutory goal of awarding 3 percent of federally funded contract dollars to HUBZone firms went into effect— federal agencies collectively still have not met that goal. According to data from SBA’s goaling reports, for the four fiscal years from 2003 through 2006, the percentage of prime contracting dollars awarded to HUBZone firms increased, with the total for fiscal year 2006 at just above 2 percent (see table 2).

In fiscal year 2006, 8 of 24 federal agencies met their HUBZone goals. Of the 8 agencies, 4 had goals higher than the 3 percent requirement and were able to meet the higher goals. Of the 16 agencies not meeting their HUBZone goal, 10 awarded less than 2 percent of their small business- eligible contracting dollars to HUBZone firms.

Madam Chairwoman, this concludes my prepared statement. I would be happy to answer any questions at this time.

Contacts and Acknowledgments

For further information on this testimony, please contact William B. Shear at (202) 512-8678 or shearw@gao.gov. Individuals making key contributions to this testimony included Paige Smith (Assistant Director), Triana Bash, Tania Calhoun, Bruce Causseaux, Alison Gerry, Cindy Gilbert, Julia Kennon, Terence Lam, Tarek Mahmassani, John Mingus, Marc Molino, Barbara Roesmann, and Bill Woods.

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