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

Letter

Background

The HUBZone Act of 1997 (which established the HUBZone program) identified HUBZones as (1) qualified census tracts, which are determined by area poverty rate or household income; (2) qualified nonmetropolitan counties, which are determined by area unemployment rate or median household income; and (3) lands meeting certain criteria within the boundaries of an Indian reservation. Congress subsequently expanded the criteria for HUBZones to add former military bases and counties in difficult development areas outside the continental United States.

To be certified to participate in the HUBZone program, a firm must meet the following criteria: when combined with its affiliates, be small by SBA size standards; be at least 51 percent owned and controlled by U.S. citizens; have its principal office—the location where the greatest number of employees perform their work—in a HUBZone; and have at least 35 percent of its employees reside in a HUBZone.

SBA recertifies firms (that is, determines that firms continue to meet HUBZone eligibility requirements to participate in the program) every 3 years.

SBA Improved Communications to Firms about Changes to HUBZone Designations but Had Not Fully Implemented GAO’s Recommendation

As of August 2016, SBA had taken some actions to address but had not yet fully implemented our recommendation on better informing firms about programmatic changes that could affect their eligibility. In our February 2015 report, we described how HUBZone designations can change with some frequency. SBA generally updates HUBZone designations at least twice a year based on whether they meet statutory criteria (such as having certain income levels or poverty or unemployment rates). SBA generally uses data from other federal agencies to determine if areas still qualify for the HUBZone program. As a result of the updates, additional areas are designated for inclusion while other areas lose their designation. Areas that lose their designation begin a 3-year “redesignation” period during which firms in those areas can continue to apply to and participate in the program and receive contracting preferences. After the 3 years, firms in these areas lose their HUBZone certified firm status and the associated federal contracting award preferences. In 2015, we reported that 17 percent (871) of firms certified at the time were located in a redesignated area.

However, we found that SBA’s communications to firms about programmatic changes (including redesignation) generally had not been targeted or specific to firms that would be affected by the changes. In 2015, we found that SBA used a broadcast e-mail (which simultaneously sends the same message to multiple recipients) to distribute program information. According to SBA officials, the e-mail list initially included all certified firms, but firms certified since the list was created in 2013 and up to the time period covered by our 2015 report had not been automatically added to the list. Firms had to sign up through SBA’s website to receive the e-mails. As a result, not all certified firms may have done so.

Consequently, we recommended that SBA establish a mechanism to better ensure that firms are notified of changes to HUBZone designations that may affect their participation in the program. This recommendation was intended to address communications to all certified firms, whether newly certified or in the program for years.

In response to the recommendation, SBA has improved notifications to newly certified firms. As we reported in March 2016, SBA revised its certification letters to firms. If SBA identifies during an application review that a firm’s principal office is in a redesignated area, it indicates in the certification letter that the firm is in a redesignated area, explains the implications of the designation, and notes when the redesignated status will expire. However, we found in March 2016 that SBA had not yet implemented changes to ensure that all currently certified firms are notified of changes that could affect their program eligibility. It is important that all certified firms potentially affected by such changes receive information about the changes or are made aware in a timely fashion of any effects on their program eligibility.

As of August 2016, SBA had plans to improve its notifications to all firms. SBA recently hired an employee whose responsibilities include helping SBA update its e-mail distribution list. As part of this effort, according to SBA officials, SBA plans to collect all the e-mail addresses for certified firms from its Dynamic Small Business Search database to create a new distribution list. SBA plans to begin adding newly certified firms to the list quarterly. Additionally, SBA officials told us that the agency intends to develop a technology solution similar to SBA One—a database now used to process loan applications—to include the HUBZone program to help collect information and documents from existing firms and address this recommendation. SBA expects to implement this solution by spring 2017.

SBA Has Taken Some Steps to Address GAO’s Recommendation to Strengthen the Recertification Process

We found in February 2015 that SBA had addressed weaknesses in its certification process that we previously identified. However, as of August 2016, SBA had not yet taken steps to fully address our recommendation related to the HUBZone firm recertification process. In February 2015, we reported that SBA had changed its certification process to require all applicant firms to provide documentation supporting their eligibility and to require agency staff to perform a full document review to determine firms’ eligibility for the program. Additionally, SBA had conducted site visits on 10 percent of its portfolio of certified firms every year in response to a prior GAO June 2008 recommendation. However, we also found deficiencies relating to the recertification process.

First, in 2008 and again in 2015, we found that the recertification process had become backlogged—that is, firms were not being recertified within the 3-year time frame. As of September 2014, SBA was recertifying firms that had been first certified 4 years previously. While SBA initially eliminated the backlog following our 2008 report, according to SBA officials the backlog recurred due to limitations with the program’s computer system and resource constraints.

Second, in 2015 we found that SBA relied on firms’ attestations of continued eligibility and generally did not request supporting documentation. SBA only required firms to submit a notarized recertification form stating that their eligibility information was accurate. SBA officials did not believe they needed to request supporting documentation from recertifying firms because all firms in the program had undergone a full document review, either at initial application or during SBA’s review of its legacy portfolio in fiscal years 2010–2012.

As a result, we concluded in 2015 that SBA lacked reasonable assurance that only qualified firms were allowed to continue in the HUBZone program and receive preferential contracting treatment.

Consequently, we recommended that SBA reassess the recertification process and implement additional controls, such as developing criteria and guidance on using a risk-based approach to requesting and verifying firm information, allowing firms to initiate the recertification process, and ensuring that sufficient staff would be dedicated to the effort so that significant backlogs would not recur.

In response to the recommendation, SBA made some changes to its recertification process. For example, instead of manually identifying firms for recertification twice a year, SBA automated the notification process, enabling notices to be sent daily for firms to respond to and attest that they continued to meet the eligibility requirements for the program. According to SBA officials, this change should ultimately help eliminate the backlog by September 30, 2016.

However, as we discussed in our March 2016 report, SBA had not implemented additional controls (such as guidance for when to request supporting documents) for the recertification process because SBA officials believe that any potential risk of fraud would be mitigated by site visits to firms. The officials also cited resource limitations. Based on data that SBA provided, the agency visited about 10 percent of certified firms each year during fiscal years 2013–2015. SBA’s reliance on site visits alone would not mitigate the recertification weaknesses that were the basis for our recommendation. In recognition of SBA’s resource constraints, we said in our 2015 report and reiterated in 2016 that SBA could apply a risk-based approach to its recertification process to review and verify information from firms that appear to pose the most risk to the program. A lack of risk-based criteria and guidance for staff to request and verify firm information during the recertification process increases the risk that ineligible firms obtain HUBZone contracts. And as we stated in 2015 and reiterated in 2016, the characteristics of firms and the status of HUBZone areas—the bases for program eligibility—often can change, and need to be monitored.

SBA officials told us that the agency intends to implement a technology- based solution similar to SBA One to address some of the ongoing challenges with the recertification process by spring 2017. The officials expect that the new solution will help them better assess firms and implement risk-based controls.

Potential Changes to HUBZone Designation Criteria Could Affect Program Benefits Realized by Specific Communities

As we reported in February 2015, potential changes to HUBZone designation criteria could be designed to provide additional economic benefits to some communities. However, changes that benefit some communities also could, through competitive market processes, reduce activity by HUBZone firms in existing HUBZones. Likewise, if the potential changes significantly increased the number of HUBZones, new areas could realize economic benefits. However, such changes also could result in diffusion—decreased targeting of areas of greatest economic distress—by lessening the competitive advantage on which small businesses may rely to thrive in economically distressed communities.

An analysis we performed for our February 2015 report offers examples of the scope of the differences in economic conditions among HUBZone areas (qualified areas), redesignated areas, and non-HUBZone areas (nonqualified tracts or areas) . We analyzed the economic conditions of such areas as of 2012 and found that indicators for redesignated areas on average fell between those of qualified and non-qualified areas. For example, as shown in figure 1, qualified census tracts had poverty and unemployment rates of 32 percent and 14 percent, respectively; redesignated tracts had rates of 24 percent and 12 percent, respectively; and nonqualified tracts had rates of 11 and 8 percent, respectively. A similar pattern existed for nonmetropolitan counties. Therefore, while allowing redesignated areas with certified firms to remain eligible can generate economic benefits for such areas, such inclusion could limit the benefits realized by qualified areas with more depressed economic conditions.

In our 2015 report, we explored the potential impact of altering some of the criteria used to designate HUBZones. We examined changes to thresholds for unemployment rate and for the number of census tracts that could qualify for the program in a given metropolitan area. For example, one way a nonmetropolitan county can qualify as a HUBZone is based on its unemployment rate. More specifically, the unemployment rate must be 140 percent or more of the average unemployment rate for the United States or for the state in which the county is located, whichever is less. Under the current definition, two counties in different states with the same unemployment rate would not necessarily both qualify as HUBZones, depending on the unemployment rate of the state in which they are located. In general, every county in a state with an unemployment rate less than the U.S. average would qualify as a HUBZone if its unemployment rate was at least 140 percent of the state’s (even if it was less than the U.S. average). In contrast, counties in states with unemployment rates higher than the U.S. average must have an unemployment rate at least equal to 140 percent of the U.S. average to qualify as a HUBZone.

Our application of hypothetical changes to the unemployment rate generally resulted in approximately the same number of areas qualifying compared to the current definition with two exceptions —applying the lowest unemployment rate to all states resulted in approximately four times as many counties qualifying, while applying the highest unemployment rate resulted in approximately eight times fewer counties qualifying (see table 1).

Similarly, we analyzed the potential impact of removing the limit on the number of areas that could qualify as HUBZones pursuant to the definition of “qualified census tract” that was in effect at the time we issued our February 2015 report. We found that about 2,400 more census tracts would qualify as HUBZones if the 20 percent cap were not in place, an increase of 15 percent from the number of qualified tracts as of June 2014.

Chairman Chabot and Ranking Member Velázquez, this concludes my statement. I would be pleased to respond to any questions you or other Members of the Committee may have.

GAO Contact and Staff Acknowledgments

If you or your staff have any questions about this testimony, please contact William B. Shear, Director, Financial Markets and Community Investment, at (202) 512-8678 or shearw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. GAO staff who made key contributions to this testimony are Harry Medina (Assistant Director), Daniel Newman (Analyst-in-Charge), Pamela Davidson, John McGrail, and Barbara Roesmann.

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