Small Business Contracting: Opportunities Exist to Further Improve HUBZone Oversight
Released: 2015-02-12T00:00:00

Letter

Background

There are four types of HUBZones. Initially, the HUBZone Act of 1997 (which established the HUBZone program) identified qualifying areas as qualified census tracts, which are determined by the area’s poverty rate or household income; qualified nonmetropolitan counties, which are determined by the area’s unemployment rate or median household income; and lands within the external boundaries of an Indian reservation, based on the areas meeting certain criteria.

In subsequent years, Congress expanded the criteria for HUBZones to add bases closed under various base closure acts and include counties in difficult development areas outside of the continental United States as part of the qualified nonmetropolitan counties.

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—located in a HUBZone; and have at least 35 percent of its employees reside in a HUBZone.

HUBZone Designations Can Change Relatively Frequently but SBA Communications May Not Reach All Affected Firms

HUBZone designations can change with some frequency. However, SBA’s communications to firms about programmatic changes, including changes to the HUBZone map (area designations), generally have not been targeted or specific to individual firms that would be affected by the changes.

Designations for HUBZone Areas Regularly Change

SBA updates the HUBZone designations regularly 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. SBA reassesses the status of nonmetropolitan counties more frequently than it reassesses the status of census tracts. For example, SBA updates the nonmetropolitan county designations each January to incorporate median household income data generated from ACS and each May to incorporate updated unemployment rates from BLS. In contrast, SBA historically has reassessed the status of qualified census tracts at multiyear intervals, such as every 5 years, using the census tract designations that the Department of Housing and Urban Development (HUD) uses for another program. See appendix II for more information about the specific criteria for each type of HUBZone area.

In 2001, Congress extended the eligibility of census tracts and nonmetropolitan counties that lost HUBZone eligibility because of changes in income levels or poverty or unemployment rates. These areas—labeled redesignated areas—remain eligible for 3 years after “the date on which the census tract or nonmetropolitan county ceased to be so qualified.” During the 3-year period, firms in those areas can continue to apply to and participate in the program and receive contracting preferences. In 2004, Congress revised the definition of redesignated areas to allow areas to retain eligibility for 3 years or until the public release of data from the 2010 decennial census, whichever was later. Consequently, all of the areas that were redesignated between 2001 and October 2008 received an extension of their 3-year redesignation period. With the release of 2010 Census data in October 2011, a large number of previously redesignated HUBZone areas that had received the extensions lost their designation, including 333 nonmetropolitan counties. In total, 2,396 of the more than 8,000 HUBZone certified firms at the beginning of fiscal year 2012 were decertified when these changes took effect because their principal office was no longer located in a HUBZone. (We discuss decertification in more detail later in this report.) The redesignations for 3,417 HUBZones will expire in 2015, largely because of the end of the approximately 3,400 census tracts that were redesignated in 2012. Finally, redesignated areas also may requalify for the program during their extended eligibility period. For example, after receiving the most recent unemployment data from BLS, SBA may change a nonmetropolitan county’s designation from redesignated to qualified.

Qualified and redesignated areas generally are spread throughout the United States (see fig. 1). The map suggests that more qualified HUBZones are in the West and Southwest, but that is in part reflective of the larger geographic size of the nonmetropolitan counties in those regions. The map also suggests a higher concentration of areas within redesignated HUBZones in the East Coast and Midwest. For information about the characteristics of the HUBZones and differences in economic conditions (for example, as indicated by poverty and unemployment rates) among redesignated, qualified, and nonqualified areas, see appendix II.

According to our analysis, 83 percent of certified firms are located in a qualified area (see table 1). Most of the firms (578) that are located in a redesignated HUBZone are located in areas that will have their designations expire in 2015. When the redesignation status of an area expires, HUBZone firms in that area lose their program certification unless they relocate their principal office or, in some cases, their employees move to another HUBZone.

SBA’s Communications about HUBZone Program Changes May Not Have Reached All Affected Firms

Generally, SBA relies on information posted on its website to communicate with interested parties about the HUBZone program. For instance, the HUBZone website includes links to the HUBZone map, frequently asked questions, and guidance to help firms apply for and maintain their certification. Firms can use the map of HUBZone areas to determine if an address or a particular area is designated as a HUBZone. More specifically, the website contains links to underlying data tables for the HUBZone map, and provides a potential applicant or program participant the ability to determine if a specific address is in a qualified HUBZone. Firms also can access a help desk by e-mail to get status information, help in resolving technical difficulties, or individualized assistance; obtain eligibility assistance through a twice-weekly interactive forum; and request a 15-minute appointment with a HUBZone analyst to discuss topics such as HUBZone policies and procedures, initial documents, or HUBZone applications. However, according to SBA officials, firms are primarily responsible for keeping themselves informed about the program so that they can remain eligible.

SBA’s Review of the Accuracy of HUBZone Maps

In our June 2008 report, we found that SBA’s HUBZone map contained ineligible areas and had not been updated to include 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 ensure that the map would be updated with the most recently available data on a more frequent basis.

In response to our recommendation, SBA modified its contract with its mapping vendor to enable more frequent updating of the HUBZone map (annually). SBA officials stated that the accuracy of the map is checked twice after each upgrade, first by the mapping vendor and second by an SBA employee.

SBA Notifications about Program Changes May Not Reach All Affected Firms

SBA’s communications to firms about programmatic changes, including changes to the HUBZone map (area designations), generally have not been targeted or specific to individual firms and may not have reached all affected firms. Since February 2013, SBA has used a broadcast e-mail (which simultaneously sends the same message to multiple recipients) to distribute information about the program, including changes to the HUBZone maps. According to SBA officials, the e-mail list initially included all certified firms, but firms certified since the list was created have not been automatically added to the list. They and other interested parties must sign up (subscribe) to receive the e-mails through SBA’s website, and as a result not all certified firms may have done so.

Through fiscal year 2014, SBA sent 13 e-mails through the system, covering topics such as changes made to the maps or the expiration of redesignated nonmetropolitan counties. Of the 13 e-mails, 9 focused on map-related issues. For example, a September 2014 e-mail notified subscribers that redesignations for 102 nonmetropolitan counties would expire on October 1, 2014. SBA also noted that there were 109 firms with principal offices in a county with expiring status. The e-mail included a link to the HUBZone map and a spreadsheet that showed the status of every county in January and May 2014, and encouraged firms to check their area’s status. However, the e-mail did not identify the firms with principal offices in the counties that would lose redesignated status or identify the specific counties.

Furthermore, according to SBA officials, SBA began using a revised certification letter in October 2014 that includes links to the program’s website and regulations, but unlike the previous certification letter that SBA sent to firms it does not include information on whether the firm is in a redesignated area or when that status will expire. According to HUBZone program policy, the approval letter should include language notifying the newly qualified firm of the possible expiration of the HUBZone. According to SBA officials, the only time that a firm would be directly notified that it was located in a redesignated area would be when it received a notice of proposed decertification after the status of the area expired. (We discuss the certification process later in the report.) Federal internal control standards require that management ensure there are adequate means of communicating with, and obtaining information from, external stakeholders that may have a significant impact on the agency achieving its goals.

In a May 2008 report, SBA’s Office of Advocacy stated that although HUBZone staff had been described as helpful and informative, there did not seem to be any systematic outreach or promotion of the program beyond responding to inquiries. In October 2014, SBA announced the development of a new initiative (Destination: HUB) that is intended to promote and support HUBZone firms in federal contracting opportunities. The initiative will consist of three major components; first, an in-depth examination of successes and needs in the program; second, an analysis of best practices for successful public-private partnerships; and third, the launch of a broad grassroots educational initiative at the regional and national levels.

SBA officials said that SBA does not include a list of firms in the e-mails it sends because it wants every firm to be proactive and check its eligibility status. According to SBA officials, SBA’s responsibility is to evaluate a firm’s initial compliance and its ongoing eligibility (through recertifications, program examinations, and protests); firms have a responsibility to ensure that they remain eligible for the program. But the combination of relatively frequent changes to HUBZone designations, SBA’s generally nonspecific communications to firms as illustrated by its certification letter, and the incomplete addressee list for the broadcast e-mails have increased the possibility that not all certified firms affected by such changes receive information about the changes or are made aware in a timely fashion of any effects on their program eligibility. We recognize that small businesses participating in the HUBZone program should be responsible for determining their eligibility, and they appear to have the ability to contact SBA to receive information specific to their situation. However, given the information SBA has at its disposal and the large number of HUBZone firms, SBA is in a position to better inform firms of changes affecting program eligibility.

SBA Has Improved Its Certification Reviews but Actions Related to Recertification Were Limited

Revised Certification Process Includes a Full Document Review, Which Helps to Ensure That Only Eligible Firms Participate in the Program

SBA revised its certification process in response to our June 2008 recommendation, and now requires firms to provide documentation and reviews this documentation to determine their eligibility for the HUBZone program. As we reported in 2008, at that time 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. We recommended that SBA develop and implement guidance to more routinely and consistently obtain supporting documentation upon application. The agency agreed with our recommendation and, according to SBA officials, since fiscal year 2009 SBA has required all firms to provide supporting documentation for information they enter in SBA’s online application system. SBA then performs a full-document review on all applications as part of its initial certification process.

The current initial certification process comprises multiple steps (see fig. 2). For instance, after firms verify that the information they entered was complete and accurate, administrative staff request supporting documents from the applicant, including a lease agreement, map of employees’ home addresses, personal and business tax returns, and payroll records. According to SBA officials, one staff reviews and analyzes the documents provided and makes a recommendation for the application and a second staff reviews the analysis and recommendation. Once a recommendation has been made, the HUBZone program director performs a final review before making a final determination. At the end of the process, SBA sends a signed letter to the applicant stating either that the firm is certified, or the basis for denial if the firm did not qualify. See appendix IV for summary statistics related to SBA’s review of initial applications.

Our review of 39 application files SBA received from October 1, 2012, through September 30, 2013, indicates that SBA conducts full documentation review of the applications submitted by firms seeking certification. For the 29 applications that were approved or denied, SBA staff prepared an analysis to support their recommendation to approve or deny the application. For 18 of the 29 applications, SBA staff followed up with the applicant to obtain additional documentation; 12 of these applicants provided the documents and were approved, and the remaining 6 were denied because they did not. Our review of the approval and denial letters relating to the 29 application files confirmed that the final determination and the effective dates entered into the system were the same.

We also found that SBA has not updated its SOP since 2009 when it began making changes to its certification processes, but expects to do so by the end of March 2015. Based on SBA’s response to a recent OIG recommendation, the agency had planned to complete the update by September 2014. The current SOP was last updated in November 2007 and therefore does not contain information about the full document review. According to SBA officials, to guide staff reviewing HUBZone certification packages, SBA currently uses guidance it developed that is specific to addressing situations that may arise during certification reviews. For example, the guidance discusses how to designate an employee of a HUBZone firm as located at a principal office when a person works an equal amount of time in a principal office and a secondary office. The guidance also includes language that should be included in a final e-mail request to the applicant firm when the analyst determines that SBA needs to obtain clarification, additional documents, or both to complete its review of the application package. According to SBA officials, SBA had delayed updating the SOP because the agency intended to revise the HUBZone regulations first and then incorporate those changes into the SOP.

HUBZone trade association representatives told us that SBA has not always clearly communicated information about its review process to program applicants. They stated that the lack of clarity about SBA’s certification review process likely could be solved through more education and communication. For example, they noted that after SBA changed the definition of an employee in May 2010 from an individual who was required to work 30 hours per week to an individual who worked 40 hours per month, the agency required that applicant firms provide documentation verifying that the employee worked during the previous month. However, according to the representatives, SBA then changed its interpretation to require that the employee worked during the period during which the application was submitted but did not communicate the change to the industry. According to SBA officials, SBA discusses the period that an employee must work in its frequently asked questions. While SBA defined an employee in its frequently asked questions, we did not find information related to the period that an employee must work to meet the eligibility requirement.

SBA officials told us that the agency again reviews the eligibility of some firms—generally, already certified firms—by conducting site visits to a select number of firms every year. In June 2008, we reported that SBA rarely conducted site visits during program examinations to verify a firm’s information and recommended that the agency conduct more frequent site visits. In response to that recommendation, according to SBA officials, SBA now conducts site visits on 10 percent of its portfolio of certified firms every year. According to the officials, the site visits are based on established criteria (such as the amount of HUBZone contract awards the firm has received) or done on an as-needed basis in connection with the review of an initial certification application or after receipt of a protest. SBA officials told us that SBA uses a pass/fail system to describe the outcome of a site visit. In fiscal years 2013 and 2014, the officials told us that SBA selected 511 and 550 firms, respectively, for site visits. In fiscal 2013, SBA noted that 81 percent of the firms passed the site visit and 19 percent failed. For fiscal year 2014, SBA noted that 88 percent of the firms passed and 12 percent failed. According to SBA officials, SBA sends a notice of proposed decertification to firms that fail a site visit. (We discuss decertification in the next section.)

SBA May Propose Firms for Decertification If Eligibility Requirements Are Not Met

Once a firm is approved for participation in the HUBZone program, SBA may decertify the firm if SBA determines that the firm is no longer eligible for the program or if SBA is unable to verify the firm’s continuing eligibility. For example, firms in redesignated areas are proposed for decertification and are provided an opportunity to establish continued eligibility following the expiration of the area’s redesignated status. For instance, a firm could prove its continued eligibility by showing that it had relocated its principal office to a qualified HUBZone area. These firms are ultimately decertified if they do not respond to the notice of proposed decertification by indicating that they are still eligible. According to SBA officials, the decertification process typically consists of three steps.

SBA e-mails a notice of proposed decertification to the firm and allows the firm 30 days to respond. If the firm does not respond, SBA sends the notice of proposed decertification to the firm by certified mail. If the firm does not respond to the certified notice within 30 days, SBA then decertifies the firm on the following day.

Decertification also can occur in two other ways. A firm voluntarily can decertify if the firm determines that it no longer meets the program’s eligibility requirements. SBA also can immediately decertify a firm during the protest process if, according to SBA officials, SBA determines that the firm did not meet the eligibility requirements at the time of bid and award, or at the time of protest if the contract had not yet been awarded. From fiscal year 2010 through fiscal year 2013, SBA reported 124 protests of HUBZone contracts, of which 46 (37 percent) were dismissed, 41 (33 percent) were sustained, and 37 (30 percent) were denied.

SBA noted that it decertified 4,660 firms from fiscal year 2010 through fiscal year 2013. The vast majority of decertifications occurred from fiscal years 2010 through 2012. According to SBA officials, in fiscal year 2009, before conducting a legacy portfolio review, SBA asked firms to confirm their compliance with the program requirements or to voluntarily withdraw from the program. The officials told us there were approximately 14,000 HUBZone firms that needed to validate their compliance with the program eligibility requirements. At that time, SBA notified the firms that the agency planned to conduct a full document review in 2009 or early 2010 to confirm compliance. According to SBA officials, many firms voluntarily withdrew from the program as a part of this effort. As shown in figure 3, our analysis of SBA data (for applications received from fiscal year 2010 through fiscal year 2013 for firms that were later decertified) showed that firms most frequently were decertified because their principal offices were not located in a HUBZone.SBA also decertified about 2 percent of firms that applied to the program during that period because they did not meet the 35 percent employee residency requirement.

Representatives from the HUBZone trade association noted that the employee residency requirement of 35 percent can make it difficult for a firm to stay in compliance with the program’s regulations. For example, according to the representatives, initiating and obtaining a contract may take a long time and maintaining many employees on the payroll without a contract can become a major overhead expense for firms. Furthermore, for smaller firms, losing one or two employees could result in noncompliance with the residency requirement. If firms do not maintain enough HUBZone-resident employees on payroll, they eventually lose their certification.

SBA Recertification Process Again Has Become Backlogged and Does Not Require Supporting Documentation

Recurring Backlog of Recertifications

HUBZone recertifications once again have become backlogged. According to HUBZone regulations, firms wishing to remain in the program without any interruption must recertify their continued eligibility to SBA within 30 calendar days after the third anniversary of their date of certification and each subsequent 3-year period. In June 2008, we reported that many firms were in the program for more than 3 years without being recertified. We recommended that SBA establish a specific time frame for eliminating the backlog of recertifications and take the necessary steps to ensure that recertifications were completed in a more timely fashion in the future. In March 2009, we determined that SBA eliminated the backlog of recertifications by hiring contract staff, but had yet to implement necessary procedures to ensure that future recertifications were completed in a timely fashion. At that time, SBA officials stated that their ongoing business process reengineering would include an assessment of the recertification process. Subsequently, in July 2012 SBA provided data illustrating that the backlog had not reoccurred and that they had recently obtained approval to replace those contract staff with 10 full-time equivalent (FTE) staff who would perform all future recertifications. We believed at that time that these steps would address the intent of our recommendation. However, SBA did not hire the 10 staff that were to replace the contract staff because, according to SBA officials, part of its funding authority was rescinded in 2013. As a result, according to SBA officials, as of September 2014 they faced a 1-year backlog for recertifying firms—that is, the agency was still recertifying firms that had their 3-year anniversaries in 2013.

SBA’s current backlog indicates that it does not have processes in place to ensure that recertifications are completed in a timely fashion. SBA’s current process for recertifying firms involves manual sorting of data from HCTS to identify firms whose 3-year anniversary is upcoming. Based on our analysis of SBA information for the most recent notification of firms, SBA notified almost 53 percent (375) of the firms past the deadline (that is, more than 30 days past the firms’ 3-year anniversary). We identified three firms that were last recertified in 2009. Similarly, one firm with which we spoke said it received the SBA notification 3 or more months after the 3-year anniversary.

According to SBA officials, the recertification backlog is due in part to limitations with HCTS and resource constraints. According to SBA officials, the recertification module in HCTS was designed to electronically review and approve recertification applications submitted online and alert SBA when it identified significant differences in the information firms submitted for recertification, but has not worked as intended. As a result, the officials said that SBA has to manually identify firms that are due for recertification and only does so twice a year. According to agency officials, SBA began processing recertifications in batches in fiscal year 2013 because the agency lacked sufficient staff to do it more often. As a result of this batching schedule, in some instances SBA has been notifying firms almost 6 months after their 3-year anniversary date. The officials also told us that they have chosen not to allow firms to initiate the recertification process, which would enable firms to recertify in a more timely way. They said that having a process in which firms would submit e-mails within 30 calendar days after their 3-year anniversary date would be inefficient due to the additional steps required. For instance, officials said that they would have to manually sort through the e-mails and remove any firms that were not due for recertification.

According to agency officials, SBA has requested funding in its fiscal year 2016 budget to enhance the current system. With this funding, SBA plans to investigate fixes for the recertification process. For example, these fixes may allow firms to submit recertification applications on their anniversary date and HCTS internal logic would ascertain compliance. For those that were noncompliant, the system could be configured to notify program staff that the recertification had to be reviewed or decertification proposed. However, it is not clear whether SBA will receive additional funding in fiscal year 2016 or changes can be made to HCTS that would allow the system to ascertain compliance with the program requirements. In the interim, SBA officials noted that the agency’s goal in 2015 is to notify firms and process the recertifications on a monthly basis.

While SBA’s intention is to conduct more timely recertifications, its limited efforts since 2008 to prevent backlogs have not been successful. Until SBA makes it a priority to address ongoing challenges with its recertification process and can develop an effective approach to recertify firms in a timely manner, the agency will continue to face reoccurring backlogs and risks associated with ineligible firms participating in the program.

SBA Relies on Firms’ Attestations of Continued Eligibility

SBA relies on firms’ attestations of continued eligibility and generally does not request supporting documentation during recertification. SBA officials told us that SBA currently only requires that firms submit a notarized recertification form stating that their eligibility information is accurate. However, internal control standards for the federal government call for ongoing monitoring of program activity and indicate that federal agencies should have control activities in place, such as verification, to ensure compliance with program requirements. According to SBA officials, they do not believe they need to request supporting documentation from recertifying firms because all firms currently in the program have undergone a full document review, either when the firm initially applied or through the full document review SBA completed of its legacy portfolio review in fiscal year 2012, as previously discussed. While SBA officials noted that they have the authority to ask for supporting documentation when recertifying a firm, they have not done so. The SOP notes that agency staff may request and consider additional information, but it does not specify what circumstances warrant a request for supporting documentation. As previously noted, SBA officials said that the recertification process is affected by resource constraints. But as a result, SBA lacks reasonable assurance that only qualified firms are allowed to continue in the HUBZone program and receive preferential contracting treatment.

Moreover, while SBA’s review of its legacy portfolio represented a comprehensive effort, it was a one-time review and took place between fiscal years 2010 and 2012. The characteristics of firms and the status of HUBZone areas—the bases for program eligibility—can often change, and need to be monitored. For example, the size of a firm and the residency location of its employees can change in 3 years. In addition, monitoring processes can take resource constraints into account. In March 2009, we found 10 of 19 firms we examined to be egregiously out of compliance with HUBZone program requirements and recommended that SBA consider incorporating a risk-based mechanism for conducting unannounced site visits as part of the screening and monitoring process. Such a risk-based approach could be applied to SBA’s recertification process to review and verify information from firms that appear to pose the most risk to the program.

Conclusions

Since we reported on the HUBZone program in 2008, SBA has implemented a number of actions both to better ensure that only eligible firms participate in the HUBZone program and address weaknesses with internal controls that we and the OIG identified. The frequency of changes to HUBZone designations present challenges for both firms and SBA. While SBA uses a number of mechanisms to communicate with firms about changes to HUBZone designations, these methods are insufficient as they are at a general level and not all firms may receive them. The communications are not specific to firms or HUBZone areas (for example, broadcast e-mails). Additionally, not all certified firms may be on the broadcast e-mail subscription list. As a result, not all firms may be aware of changes that would affect their continuing program eligibility.

SBA has strengthened its internal controls for initial HUBZone certifications but missed opportunities to address weaknesses in controls related to the recertification of firms. The current recertification process has a number of issues that continue to limit its effectiveness. First, SBA again has a significant backlog in processing recertifications and has not implemented a sustainable process. Second, SBA requires firms to wait until being notified before beginning recertification, but routinely notifies firms too late for the firms to meet the deadline established in HUBZone regulations. Finally, the current recertification process requires no supporting documentation—in effect, firms self-certify. SBA officials noted that resource constraints prevent a full documentation review of all recertifications and that staff can request supporting documentation (but SBA does not have guidance on when staff should request or verify documentation). While the backlog and inability of firms to start the process are concerns, the greater issue is the lack of ongoing eligibility review and verification during recertification.

Recommendations for Executive Action

To improve SBA’s administration and oversight of the HUBZone program and reduce the risk that firms that no longer meet program eligibility criteria receive HUBZone contracts, the Administrator of SBA should take the following two actions:

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.

Agency Comments

We sent a draft of this report to SBA for its review and comment. In response, SBA provided written comments, which are reproduced in appendix VI. SBA agreed with our recommendations and outlined steps it has taken or plans to take to address them. SBA stated that it has been analyzing existing resources to implement our recommendation on notifying firms of changes that could affect their participation in the program. SBA also said that by July 2015, it plans to implement an enhanced mechanism to better inform all certified and newly certified firms of HUBZone designation changes or, at least, explain how being in a redesignated area could affect program participation. In response to our recommendation on assessing the recertification process and implementing additional controls, SBA stated that it will assess the current process. In addition, SBA stated that by September 30, 2015, it plans to identify improvements to reduce the risk of fraud, waste, and abuse.

If you or your staff have any questions concerning this report, please contact me 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 report. GAO staff who made major contributions to this report are listed in appendix VII.

Appendix I: Objectives, Scope, and Methodology

This report examines the Historically Underutilized Business Zone (HUBZone) program of the Small Business Administration (SBA). More specifically, the report (1) describes HUBZone designations and how SBA communicates with interested parties about the program, and (2) examines SBA’s certification and recertification processes for firms, including the extent to which SBA has implemented procedures to address recommendations previously made to improve these processes. In addition, we present information about selected characteristics of HUBZones, effects of hypothetical changes to criteria on HUBZone designations, HUBZone application processing, and selected characteristics of HUBZone firms in appendixes II, III, IV, and V, respectively.

To address both objectives, including how SBA notifies and communicates with interested parties about the HUBZone program, we reviewed previous GAO and SBA Office of Inspector General (OIG) reports; applicable statutes and regulations; and SBA documents, including Standard Operating Procedures, internal policy guidance for staff, process work guidelines, checklist of required documents, criteria used to select firms to undergo site visits, outreach and communication materials, goaling report, Congressional Budget and Performance report, and a new initiative that SBA created intended to boost HUBZones in the federal marketplace. We interviewed SBA staff and representatives from the HUBZone Contractors National Council—the HUBZone trade association.

We also interviewed representatives from local economic development agencies and from HUBZone firms. We selected a purposive sample of16 HUBZone firms. To ensure a range of HUBZone firms, our sample included 8 firms that were currently certified, 4 firms that had been denied entry into the program, and 4 firms that were once certified but had been decertified. Of the 16 firms, we interviewed 8, the findings from which cannot be generalized to the overall population of firms that have applied to the HUBZone program. To identify the firms, we relied on a multistage sampling approach:

To select firms that were certified, we first selected four states, one from each of the four regions of the United States—West, Midwest, Northeast, and South. We used 2013 unemployment rates from the Bureau of Labor Statistics to select two states with higher unemployment rates and two states with unemployment rates lower than the U.S. average rate. To ensure a mix of rural and urban states, we used 2010 Census data and calculated the percentage of each state that was rural and picked some states that had higher concentrations of rural areas. We also picked some states that had a large number of HUBZone certified firms, according to the Dynamic Small Business Search (DSBS) database, to ensure we had a sufficient number of firms from which to select firms to interview.

We selected one county from each of the four states based on the number of certified firms located in each county that had been awarded federal contracts and firms that had not been awarded contracts in fiscal years 2010 through 2013 based on Federal Procurement Data System-Next Generation (FPDS-NG) data. We also considered the number of contracts awarded to the firms and the dollar amount of the contracts in fiscal year 2013 based on FPDS-NG data. In addition, we selected the county from each state that had a mix of certified firms with and without contracts and that had a high number of contracts awarded to firms in the county in fiscal year 2013, as compared with other counties in the state. For one state, we selected the county with the second-highest number of contracts because it represented a redesignated nonmetropolitan area.

Within the selected counties, we selected four certified firms that had been certified in 2009 or later and had been awarded the most contracts among firms in the county from fiscal years 2010 through 2013. Based on the oldest certification date, we also selected four firms that had not received any contracts.

Finally, we used applicant data from SBA’s HUBZone Certification Tracking System (HCTS) to select four firms that were denied entry into the program and four firms that were decertified. We used the same four U.S. regions and randomly selected two firms from each region, one for each of the two categories.

To examine how SBA designates HUBZones, selected characteristics of the areas, and how potential changes to designation criteria would affect HUBZones and firms, we reviewed applicable statutes and regulations, such as the HUBZone Act of 1997. We also reviewed prior GAO, Congressional Research Service, and SBA OIG reports on the HUBZone program. We accessed the list of qualified and redesignated areas from SBA’s HUBZone website and plotted them using Mapinfo. We also downloaded the list of certified firms as of June 16, 2014, and plotted those firms into their corresponding HUBZones. According to SBA officials, firms may have more than one profile and address in DSBS and there is no way within the system to identify which address represents a principal office. Consequently, the numbers we report are based on the addresses in the DSBS profiles. We were unable to plot 573 firms in a HUBZone. For the firms we could plot, we matched these certified firms with federal procurement data from FPDS-NG to identify the number and amount of contracts that the firms received from fiscal year 2010 to fiscal year 2013. We used these data sources to identify characteristics of the different HUBZone types, such as the number of firms in the different HUBZone types as well as the contract dollars those firms received. To identify economic characteristics of the different HUBZone types, we reviewed selected economic indicators, such as the poverty and unemployment rates, and the median housing income and housing value for the different HUBZone types. We used data from the Census Bureau’s American Community Survey (ACS) and unemployment data from the Bureau of Labor Statistics (BLS). After reviewing related documentation or interviewing knowledgeable agency officials, we deemed the DSBS, FPDS-NG, Census Bureau, BLS, and SBA data sufficiently reliable for the purposes of describing the characteristics of HUBZones, participating firms, and their contracting. To determine the impact of hypothetical changes to HUBZone criteria, we reviewed county-level unemployment data from BLS. We applied different criteria to the data to determine the impact that the changes would have on the number of eligible counties, by state. For example, we used a 5- and 10-year average unemployment rate instead of the 1-year rate that SBA currently uses to determine the eligibility for nonmetropolitan counties. To determine the impact of the statutory 20 percent cap imposed on census tracts as part of the Low- Income Housing Tax Credit (LIHTC) program, we analyzed 2014 data from the Department of Housing and Urban Development (HUD) and applied the algorithm that HUD uses to determine if a census tract qualifies, and then stopped applying the criteria prior to the imposition of the 20 percent cap. We compared the number of areas that would qualify under both scenarios.

To examine SBA’s certification and recertification processes for firms and the extent to which SBA addressed previous recommendations, we reviewed SBA’s certification and recertification processes for certifying firms, including its policies and procedures for certifying and monitoring firms. To test whether SBA had implemented procedures to help ensure that only eligible firms participate in the program, we reviewed a purposive sample of 39 application case files. To select these files, we used data from HCTS to identify the universe of applications SBA received from October 1, 2012, to September 30, 2013. We grouped these files into four outcome categories—approved, denied, withdrawn, and decertified and randomly selected 10 from each category. We reviewed these case files and collected information using a data collection instrument (DCI) to gather information such as whether SBA staff prepared an analysis summary; analyzed information, including supporting documentation, to determine if the applicants met the program eligibility requirements; sent follow-up communications to request additional documentation; and performed a second review before making a final determination on the application. We also determined the date on which the application was received and the date of final determination. The findings from this limited review of 39 case files cannot be generalized to the overall population of applications received in fiscal year 2013.

We developed the DCI after reviewing SBA’s regulations, its description of the HUBZone current certification process, and the HUBZone policy guidance, document request checklist, and process work guidelines. Two GAO team members independently entered information from one sample case file using the DCI and compared the results. After the two team members agreed on the final fields to be used in the DCI, they entered information from the case files into the DCI. A third staff member verified the accuracy of the entries.

Using HCTS data, we analyzed data about firms for which applications were received from fiscal years 2008 through 2013, by year of receipt, to determine (1) the number of applications approved, denied, or withdrawn; (2) the number of firms that had been recertified; (3) the number that had been decertified; (4) the length of time it took SBA to approve applications; and (5) the reasons firms were decertified. We also analyzed HCTS data to examine the characteristics of HUBZone applicant firms, including the industry codes and number of employees. A copy of the HCTS data was originally provided to GAO in Oracle format and was the most current version as of July 2014. These data were then read in using SAS software to allow for analysis. Before conducting the analysis, a GAO data analyst reviewed the data for inconsistencies and completeness. As a part of this work, inconsistencies related to the effective dates of different processes were discovered. We determined that the data were sufficiently reliable for the analysis we report by reviewing related documentation, interviewing knowledgeable officials, and electronic testing of the data, but there were internal inconsistencies that limited our reporting. Specifically, in some cases, there were conflicting outcomes or dates that appeared to be out of sequence or illogical. In particular, the dates associated with events in the certification review processes were found to be unreliable. To clarify, GAO met with SBA and learned that the inconsistencies were related to manual data entry processes that were required since fiscal year 2006 because of deficiencies discovered in the software related to the recertification module in HCTS. We concluded that while the actual outcomes were reliable enough to report, the data that relied on the effective dates of these outcomes were not sufficiently reliable to report.

To identify the eligibility-related reasons for decertification, we analyzed the reason field contained in HCTS for applications received from 2010 to 2013 that were later decertified. Because a large percentage of these applications had “other” for their recorded reason, we conducted a review of the comments field to code for the possible other reasons. To conduct that review, the GAO data analyst did a string search of the text using keywords such as “35 percent” and “principal office” and identified one additional category and added additional cases to existing reasons. An analyst reviewed a subset of the coding to ensure accuracy.

To determine whether SBA implemented procedures to help ensure that only eligible firms continue to participate in the program, we assessed SBA’s recertification process. We reviewed SBA’s regulations on recertification and information from HCTS relating to firms’ certification anniversary dates and SBA’s e-mail notification for firms to recertify. We assessed the reliability of the data on these processes by interviewing officials knowledgeable about the data and performing electronic data testing to detect errors in completeness and reasonableness. We determined that they were sufficiently reliable for the purpose of identifying the amount of time between a firm’s prior certification and SBA’s notice about recertification. We compared SBA’s certification and recertification processes with federal internal control standards for collecting documentation and verifying information.

We conducted this performance audit from April 2014 to February 2015 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.

Appendix II: Characteristics of HUBZones

There are four different types of qualified HUBZone areas as defined by federal statute.

Qualified census tracts. The qualified census tracts are the same as those determined by HUD for the LIHTC program. The current criteria are any census tract that is designated by HUD and, for the most recent year for which census data are available on household income in such tract, has (1) at least 50 percent of households with income below 60 percent of the median gross income of the MSA (in metropolitan census tracts) or for all nonmetropolitan areas of the state (in nonmetropolitan census tracts) or (2) a poverty rate of at least 25 percent. The LIHTC program limits the amount of qualified census tracts in any MSA or PMSA so that they together do not contain more than 20 percent of the total population of the MSA or PMSA. As such, it is possible for a tract to meet one or both of the criteria, but not be designated as a qualified census tract.

Qualified nonmetropolitan county. A qualified nonmetropolitan county is any county that was not located in an MSA at the time of the most recent census. To qualify, the (1) median household income for the county must be less than 80 percent of the nonmetropolitan state median household income, based on the most recent data available from the Bureau of the Census; or (2) the unemployment rate is not less than 140 percent of the average unemployment rate for the United States or for the state in which such county is located, whichever is less, based on the most recent data available from the Secretary of Labor. SBA uses a 5-year median income, as determined through the ACS. The most recent update reflected data from 2008- 2012. The unemployment rate is derived from data released annually by BLS and is typically sent to SBA during May, June, or July. Additionally, nonmetropolitan counties can qualify if they include a difficult development area, as designated by HUD, within Alaska, Hawaii, or any territory or possession of the United States outside of the 48 contiguous states.

Qualified Indian land. Lands within the boundaries of Indian reservations may qualify as a HUBZone area. The Bureau of Indian Affairs provides data delineating these areas.

Qualified base closure area. HUBZone eligibility is extended for 5 years to lands within the external boundaries of a military installation closed through a privatization process under the authority of various base closure laws. The military base’s HUBZone eligibility commences on the effective date of the law (Dec. 8, 2004) if the military base already was closed at that time, or on the date of formal closure if the military base was still operational at that time. According to SBA officials, no HUBZone firms are located in these areas because it is very difficult for firms to meet the 35 percent residency requirement. Additionally, the SBA officials noted that, according to statute, the areas are only eligible for 5 years from the date of base closure, and it may take several years before the area is able to receive business leases, leaving applicant firms with only 1 to 2 years of eligibility.

According to our analysis, about 2,600 of the approximately 5,200 certified firms were in a qualified or redesignated census tract, as of June 2014 (see table 2). Additionally, about 12 percent of the firms were located simultaneously in at least two types of HUBZones. Most commonly, firms were located in both a qualified census tract and qualified nonmetropolitan county (311 firms) or a qualified census tract and Indian land (107 firms). However, about 88 percent of HUBZones— including all the base realignment and closure areas—did not contain any certified firms (that we could geographically code).

In fiscal year 2013, certified firms received, on average, about $789,000 through HUBZone contracts. Firms in qualified census tracts received about $1 million in contracts, with those in redesignated areas receiving about $300,000 more, each. Firms in all redesignated areas were obligated almost $800 million in federal contracts in fiscal year 2013. Overall, 211 firms comprised the top 10 percent, in terms of the size of contracts received, while almost 4,300 comprised the bottom 10 percent.

As shown in figure 4, there are certified firms in all 50 states. In general, counties in the West had more certified firms, on average, than counties elsewhere in the United States.

As shown in table 3, California, New York, and Texas had the largest number of qualified areas. California, Oklahoma, Texas, and Virginia all had more than 200 certified firms, with California having the most (477).

Economic Characteristics of HUBZones

Our analysis of the economic conditions of qualified and redesignated areas as of 2012 found that redesignated areas had, on average, economic conditions between those of qualified and nonqualified areas. For example, as shown in figure 5, qualified census tracts had poverty and unemployment rates of 32 percent and 14 percent, respectively, while nonqualified census tracts had poverty and unemployment rates of 11 percent and 8 percent, respectively. In contrast, the poverty rate in redesignated census tracts was 24 percent while the unemployment rate was 12 percent.

As shown in figure 6, a similar pattern exists for qualified, redesignated, and nonqualified nonmetropolitan counties.

As shown in table 4, our analysis of various economic indicators for qualified, redesignated, and non-HUBZone areas found that qualified areas had, on average, higher poverty and unemployment rates, and lower median household income and housing values then either redesignated or non-HUBZone areas. Redesignated areas had, on average, economic indicators between those of qualified and not qualified areas.

As shown in figure 7, about 55 percent of qualified census tracts had poverty rates of 30 percent or more. In contrast, almost 76 percent of redesignated census tracts had poverty rates between 10 percent and 29.9 percent. Similarly, almost 72 percent of qualified census tracts had unemployment rates greater than 10 percent, whereas about 40 percent of redesignated areas and 70 percent of nonqualified areas had unemployment rates of less than 10 percent.

Similarly, our analysis of various nonmetropolitan counties found that redesignated areas had, on average, economic indicators between those of qualified and not qualified areas (see table 5). However, redesignated nonmetropolitan counties had a lower average median housing value than either qualified or not-qualified HUBZone counties.

As shown in figure 8, about 16 percent of qualified nonmetropolitan counties had poverty rates of at least 30 percent. In contrast, less than 1 percent of redesignated or nonqualified nonmetropolitan counties had a poverty rate of at least 30 percent. Similarly, 22 percent of qualified areas had an unemployment rate of at least 15 percent, while about 7 percent of redesignated counties and 1 percent of nonqualified counties had a similar level.

Appendix III: Impact of Hypothetical Changes to HUBZone Criteria on HUBZone Designations

We applied hypothetical changes to selected statutory criteria for designating HUBZones to illustrate how such changes could affect the number of eligible areas. As we reported in 2008, establishing new HUBZone areas could provide economic benefits to these new areas, but also could result in diffusion—decreased targeting of areas of greatest economic distress—by lessening the competitive advantage upon which small businesses may rely to thrive in economically distressed communities.

Impact of Adjustments in the Unemployment Rate Used

As discussed earlier in this report, one of the ways in which a nonmetropolitan county can qualify as a HUBZone is based on its unemployment rate. More specifically, the unemployment rate for the nonmetropolitan county must not be less than 140 percent of the average unemployment rate for the United States or for the state in which the county is located, whichever is less, based on the most recent data available from the Department of Labor.Adjustments could make this definition more uniform across all of the states.

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.

We analyzed the impact on the number of nonmetropolitan counties that could qualify under a variety of adjustments to the current definition.

Current definition. Under the current definition, 424 nonmetropolitan counties would qualify as a HUBZone.

Lowest state unemployment rate. If 140 percent of the lowest state unemployment rate (2.9 percent) was applied to all counties and states, almost 1,700 counties would qualify. Under this scenario, for example, Texas would go from 16 qualified nonmetropolitan counties to almost 150.

Highest state unemployment rate. If 140 percent of the highest state unemployment rate (9.8 percent) was applied to all counties and states, there would only be 54 qualified nonmetropolitan counties nationwide. Thirty-four states would not have any qualified nonmetropolitan counties, while Kentucky and Mississippi would have the most, with 9 each.

Applying U.S. average unemployment rate. If 140 percent of the U.S. average unemployment rate (7.4 percent) was applied uniformly to all counties and states, 301 nonmetropolitan counties would qualify.

Average of all state unemployment rates. If 140 percent of the average of all state unemployment rates (6.8 percent) was used, about 450 counties would qualify. Under this scenario, states with relatively high unemployment rates would have additional nonmetropolitan counties (such as Georgia, which would have 17 additional qualifying counties), while states with relatively low unemployment rates would have fewer qualifying counties (such as Virginia, which would have 20 fewer).

In addition to comparing all nonmetropolitan counties against the same unemployment rate, the qualifying criteria could be changed from the current standard (data from 1 year) to use a 5- or 10-year average unemployment rate to determine if a nonmetropolitan county qualified for the program. Such a change could minimize the wide variations that can occur by using the 1-year rates. For example, the average unemployment rates that equaled 140 percent of the U.S. unemployment rate ranged from 6.4 percent in 2006 and 2007 to 13.4 percent in 2010. Similarly, the difference between the states with the highest and lowest unemployment rates ranged from 6 percentage points in 2004 to about 14 percentage points in 2010. However, using a 5- or 10-year average unemployment rate would result in fewer counties qualifying as a HUBZone.

Using a 5-year unemployment rate. If a 5-year average unemployment rate were used, 345 nonmetropolitan counties would qualify. With the change from 1- to 5-year, additional counties in 6 states would become eligible, while the number of eligible counties in 21 states would decrease. The net number of affected counties would range from 6 added to 15 eliminated.

Using a 10-year unemployment rate. If a 10-year average unemployment rate were used, 377 nonmetropolitan counties would qualify. Under this adjustment, 10 states would have more counties eligible and 18 would have fewer. See figures 9 and 10 for a summary of the impact of each potential change on the number of qualified nonmetropolitan counties.

As shown in table 6, the impact of the hypothetical changes on the number of qualified nonmetropolitan counties in the individual states varies.

Impact of Removing Limit in Census Tracts

Currently, HUBZone-qualified census tracts are those census tracts designated by HUD. Statutory provisions governing the LIHTC program limit the amount of qualified census tracts in any MSA or PMSA to no more than 20 percent of the total population of the MSA or PMSA. Consequently, some census tracts that may qualify for the HUBZone program based on the area’s median household income or poverty rate might not be designated as qualified census tracts because of the population cap, and are therefore not included in the HUBZone program.

Our analysis of data HUD used for its 2014 designations found that about 2,400 more census tracts would qualify as HUBZone areas if the 20 percent cap were not in place, an increase of 15 percent from the current number of qualified tracts. Eight states or territories would have at least 20 percent more qualified areas if all eligible tracts were included.

Appendix IV: Summary Data Relating to HUBZone Application Processing

According to our analysis of data for applications received by SBA during fiscal years 2008-2013, the number of applications submitted by firms declined significantly from 2009 through 2011 (from a high of about 4,500 in 2009 to under 1,500 in 2013). Since 2009, the application approval rate also declined. For example, SBA approved about 32 percent of the approximately 4,000 applications submitted in 2010 (shortly after the new process was implemented), while it approved almost 53 percent of the approximately 3,000 applications submitted in 2008 under the previous process (see table 7 and fig. 11). In general, a higher percentage of applications have been withdrawn since SBA implemented the revised process—more than 50 percent of applications for every year except 2013. According to SBA officials, firms can withdraw an application or SBA can close it if it is believed that the firm will not meet program requirements.

According to SBA officials, SBA’s goal is to process an application within 90 days. Our analysis of SBA data found that it took SBA more than 90 days to process most of the applications approved since fiscal year 2008. As shown in table 8, of the applications SBA received in fiscal years 2008-2013, about 27 percent were processed in 90 or fewer days while 73 percent took more than 90 days to process. SBA reported that in fiscal years 2013 and 2014 it took an average of 103 and 123 days, respectively, to process any application regardless of outcome.

According to the officials, SBA has completed a review of its certification process and plans to implement changes to improve and more accurately reflect its processing time. For example, according to SBA officials, SBA has been considering requiring that the program analyst, instead of administrative staff, request supporting documentation from the applicant firms. Furthermore, the official explained that SBA has been considering changing when it starts calculating the processing time. Currently, SBA begins to calculate the processing time when a high-ranking official from the firm electronically validates the application. However, SBA cannot begin its review until it receives supporting documents from the firm, which can take weeks. Consequently, SBA has been considering changing the start date to when it receives the supporting documents.

Appendix V: Characteristics of HUBZone Certified Firms as of 2014

According to our analysis of SBA data for approved applications submitted during fiscal years 2008-2013, HUBZone firms vary in size and types of services and products provided.

Number of employees. The number of employees at HUBZone firms ranged from 1 to 496, with a median of 4 employees for all years except 2009 and 2010, in which the median was 5. Industries in which firms operated. Table 9 lists the top 10 industries based on the number and percentage of approved HUBZone firm applications.

Appendix VI: Comments from the Small Business Administration

Appendix VII: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact above, Harry Medina (Assistant Director), Daniel Newman (Analyst-in-Charge), Pamela Davidson, Cynthia Grant, Julia Kennon, Yola Lewis, John McGrail, John Mingus, Marc Molino, Caroline Neidhold, Gloria Proa and Barbara Roesmann made key contributions to this report.