M&M Technology, Inc., No. 192 (March 19, 2003) Docket No. BDPE-2002-11-14-20 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. ) IN THE MATTER OF: ) Docket No. BDPE-2002-11-14-20 ) M&M Technology, Inc. ) Decided: March 19, 2003 ) Petitioner ) ) APPEARANCES Michael R. Hatcher, Esq., Holland & Knight LLP, for M&M Technology, Inc. Diane W. Gaffney, Esq., Denise Benjamin, Esq.; David A. Javdan, Esq., General Counsel, for Respondent Small Business Administration. DIGEST In finding whether an individual's income for the past two years showed he was not economically disadvantaged, the SBA must include any bonuses he received. In finding whether an individual's income for the past two years showed he was not economically disadvantaged, the SBA must consider the individual's personal income for the past two years, rather than speculate upon what his average income might be in the future. The SBA reasonably considered the individual's income from past employment, even though he left that employment. In finding whether the net worth of an individual exceeds the $250,000 regulatory threshold, the SBA must consider the account value of any life insurance policy, less any outstanding loans that reduce its current value. The SBA erroneously considered a life insurance policy's account value without subtracting an outstanding loan. In determining whether an applicant's owner is economically disadvantaged, the SBA may consider failure to meet any one of the three factors enumerated in the regulation to automatically preclude a finding of economic disadvantage. Even though it incorrectly found the owner's personal net worth exceeded the $250,000 regulatory threshold, the SBA reasonably determined that applicant's owner was not economically disadvantaged, based on his personal income for the past two years. FINAL DECISION ARKOW, Administrative Law Judge: M&M Technology, Inc. (Petitioner), appeals a determination by the Respondent Small Business Administration (SBA) denying it entry into the 8(a) program. [1] The SBA determined Petitioner ineligible for the 8(a) program because its owner is not economically disadvantaged due to (1) his personal income for the preceding two years, which placed him among the top two percent of all U.S. taxpayers; and (2) his net worth, which exceeded $250,000. Petitioner claims the SBA Determination is arbitrary, capricious, and contrary to law. I disagree and find the SBA determination is reasonable. Jurisdiction There is jurisdiction to decide this appeal. See 15 U.S.C. Section 637(a)(9)(A), (B)(i); 13 C.F.R. Section 134.102(j)(1). [2] The appeal is timely. See 13 C.F.R. Section 134.202(a)(1). Issue Whether the SBA Determination denying Petitioner admission into the 8(a) program is arbitrary, capricious, or contrary to law. See 15 U.S.C. Section 637(a)(9)(C); 13 C.F.R. Section 134.406(b). Procedural History On April 30, 2002, Petitioner applied for admission into the 8(a) program. Administrative Record (AR), Ex. 15, at 1-4. Its owner claimed that he is socially and economically disadvantaged and that he owns, controls, and manages Petitioner. Id. at 2-3. On July 24, 2002, the SBA initially declined the application. AR, Ex. 7. 1Petitioner requested the SBA reconsider its decline. AR, Ex. 4. On September 18, 2002, the SBA reconsidered its initial decline and again declined the application. AR, Ex. 1 (SBA Determination). On November 14, 2002, Petitioner appealed the SBA Determination. Appeal Petition (App. Pet.). SBA Determination In declining Petitioner's application for participation in the 8(a) program, the SBA determined that Petitioner met all of the requirements for admission into the 8(a) program, except that its owner was not economically disadvantaged. The SBA found that Petitioner's owner's average adjusted gross income, as shown on his 2000 and 2001 personal tax returns, placed him among the top two percent of all U.S. taxpayers; and individuals with such high personal income cannot be economically disadvantaged. AR, Ex. 1, at 1. Further, the SBA recognized that Petitioner's owner had received all of his 2000 and 2001 wages from his former employer, Quality Technology, Inc. (Quality Technology), and that his 2002 income would be significantly less. However, the SBA concluded its 8(a) regulations require it to consider only income for the preceding two years in assessing economic disadvantage. Id. at 2. The SBA also determined that the personal net worth of Petitioner's owner exceeded $250,000, the SBA's regulatory limitation, which precludes a finding that he is economically disadvantaged. [3] Id. The SBA found that a "Stag" variable life insurance policy had a cash surrender value of $50,413 and treated that as a personal asset of the owner, thus increasing the owner's net worth by that amount. 2Id. at 2. Facts Petitioner's 8(a) program application stated it is owned, controlled, and managed by a socially and economically disadvantaged Black American. Id. at 2-3. To establish its owner's economic disadvantage, the application included the owner's joint federal individual income tax returns for calendar years 2000 and 2001, as well as his wage and tax statements. AR, Ex. 9, 6. The tax returns showed the owner's joint adjusted gross income [4] was $1,000,606 in 2000 and $2,058,582 in 2001. AR, Ex. 9, at 1; 6, at 1. The SBA's analysis found the owner's share of the joint adjusted gross income was $524,414 in 2000 and $380,670 in 2001, for a two-year average of $452,542. AR, Ex. 3, at 4-5. His wage and tax statements [5] show the owner earned $523,063 in 2000 and $375,750 in 2001. AR, Ex. 3, at 4; 9, at 18; 6, at 29. All of his wages for both years were received from Quality Technology. Id. Petitioner's owner left the employ of Quality Technology in August 2001. AR, Ex. 4, at 4. IRS statistics for 2000 show that, among 129,271,972 individual tax returns filed, 2,771,875 reported adjusted gross income of $200,000 or more. AR, Ex. 10. To establish its owner's net worth, Petitioner's submission included his Personal Financial Statement (SBA Form 413) and a "Stag" variable life confirmation statement issued by Hartford Life Insurance Company. AR, Ex. 3, at 4; 4, at 2, 68. The SBA's analysis of the financial statement found Petitioner's owner had a net worth of $252,582. AR, Ex. 3, at 4. Among the owner's assets, the SBA found that the "Stag" insurance policy had a cash surrender value of $50,413. The confirmation statement from the insurance company shows an account value total of $50,413 and a loan account total of $10,224, representing a loan against the total account value. AR, Ex. 4, at 68. The difference is $40,189. Petitioner's Position Petitioner contends the SBA Determination that its owner is not economically disadvantaged is arbitrary, capricious, and contrary to law. In support of its contention, Petitioner argues that the SBA failed to follow 13 C.F.R. Section 124.104(a), which requires it to make a determination of economic disadvantage based on whether its owner's ability to compete in the free enterprise system has been impaired due to diminished capital and credit opportunities as compared to others in the same or similar line of business who are not socially disadvantaged. Rather, despite uncontroverted evidence demonstrating a current diminished ability to compete and a lack of access to capital and credit, the SBA based its determination on the owner's income over a two-year period, which is only one of several factors the SBA must consider. In so doing, the SBA effectively changed its regulation, in violation of the Administrative Procedure Act, to make personal income an automatic disqualifier on a par with the $250,000 net worth limitation. As a result, the SBA did not consider that the owner's income is now within acceptable limits, his significant income from Quality Technology having been a temporary spike because it (a) included extraordinary bonuses to aid his employer's tax strategy and (b) ended in August 2001. App. Pet. at 3-4. Petitioner also argues that the SBA relied on erroneous and unsupported assumptions to artificially inflate its owner's net worth. Among its arguments, Petitioner contends that the SBA failed to reduce the account value total of the "Stag" insurance policy by the $10,224 outstanding loan on the policy. Thus, the policy's current value was $40,189, not $50,413. If properly calculated, the owner's net worth would not exceed the regulatory threshold of $250,000. Id. at 4. Respondent's Position The SBA contends its determination is not arbitrary, capricious, or contrary to law. In support of its contention, the SBA argues that it (1) properly used the owner's adjusted gross income as reported on his tax returns [6] and (2) properly calculated the owner's net worth. [7] Response at 5-10. Discussion I. Standard of Review The SBA Determination must be sustained unless a review of the written administrative record demonstrates the SBA acted arbitrarily, capriciously, or contrary to law in concluding that Petitioner's owner is not economically disadvantaged. See 13 C.F.R. Section 134.406(a), (b). My review of the administrative record is narrow and does not permit me to substitute my own judgment for that of the SBA. I must examine whether the SBA considered all of the facts presented, as well as the laws and regulations that guide the decision-making process. Then, I must determine that the SBA made a clear error of judgment in its decision before I can find the SBA acted arbitrarily, capriciously, or contrary to law. See Motor Vehicle Mfrs. Ass'n of the United States, Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983). A clear error of judgment can be found if the SBA (1) fails to properly apply the law and regulations to the facts of the case, (2) fails to consider an important aspect of the problem, (3) offers an explanation for its determination that runs contrary to the evidence, or (4) provides an implausible explanation that is more than a difference between my views and those of the SBA. In sum, the SBA must articulate a reasonable explanation for its action, including a rational connection between the facts found and its determination. See id. As long as the SBA Determination is reasonable, it must be upheld on appeal. 13 C.F.R. Section 134.406(b). II. Economic Disadvantage To be accepted into the 8(a) program, the individual who owns, controls, and manages Petitioner must be socially and economically disadvantaged. See 13 C.F.R. Sections 124.101-124.106. As a Black American, Petitioner's owner is presumed to be socially disadvantaged. See 13 C.F.R. Section 124.103(b). The SBA determined the owner met all of these criteria except he is not economically disadvantaged because of excessive personal income and excessive net worth. Accordingly, the issue in this case is whether the SBA's determination that he is not economically disadvantaged is arbitrary, capricious, or contrary to law. "Economically disadvantaged individuals are socially disadvantaged individuals whose ability to compete in the free enterprise system has been impaired due to diminished capital and credit opportunities as compared to others in the same or similar line of business who are not socially disadvantaged." 13 C.F.R. Section 124.104(a). In considering diminished capital and credit opportunities, the SBA examines three factors relating to the personal financial condition of the individual claiming disadvantaged status (Petitioner's owner). They are (1) the individual's personal income for the past two years, including bonuses; (2) the individual's personal net worth; and (3) the fair market value of all the individual's assets. See 13 C.F.R. Section 124.104(c). A finding of lack of economic disadvantage, under any one of these three factors, precludes a determination of economic disadvantage. Matter of The Corvus Group, Inc., SBA No. BDP-184, at 6 (2002). The regulations specifically provide that an 8(a) applicant's net worth must not exceed $250,000, 13 C.F.R. Section 124.104(c)(2), but do not specify a limit on how much personal income an applicant may earn over a two-year period. III. SBA's Evaluation of Petitioner's Evidence A. Excessive Personal Income The SBA determined Petitioner's owner has excessive personal income because his average adjusted gross income for the past two years places him in the top two percent of all U.S. taxpayers. The SBA's conclusion rests on statistics published by the IRS. Using the most recent IRS statistics for the year 2000, [8] the SBA divided the number of individual returns showing adjusted gross income of $200,000 or more by the total number of individual returns. The result is the percentage of returns showing adjusted gross income of $200,000 or more. For the year 2000, the percentage is 2.1% (2,771,875 divided by 129,271,972). Thus, the SBA correctly concluded that an adjusted gross income in excess of $200,000 placed a taxpayer among the top two percent of all individual U.S. taxpayers. The SBA determined that Petitioner's owner's adjusted gross income was $524,414 in 2000 and $380,670 for 2001, for an average of $462,542. It also determined that the owner's wages were $523,063 in 2000 and $375,750 in 2001, for an average of $449,407. Using the owner's average wages, as well as his adjusted gross income, the SBA concluded that the owner's average income for the past two years was well over $200,000, which placed him among the top two percent of all U.S. taxpayers. Petitioner does not dispute these calculations. Both the SBA's methodology and its calculations are reasonable and correct. Petitioner claims no error in SBA's methodology, using IRS statistics of adjusted gross income to assess excessive income. Ample precedent holds that the SBA reasonably determined that personal income ranking among the top percentiles of individual U.S. taxpayers indicates the absence of economic disadvantage. See The Corvus Group, SBA No. BDP-184, at 6; Matter of Tower Communications, SBA No. MSB-587, at 6-7 (1997) (citing cases applying this rationale). Thus, the SBA reasonably may conclude that average income placing one among the top two percent of all individual U.S. taxpayers is excessive, for purposes of determining economic disadvantage. Petitioner argues, however, that its owner's average income for the past two years distorts his current economic condition because (a) Quality Technology, his chief source of income for the past two years, paid him extraordinary bonuses both years and (b) he no longer works there. Petitioner argues that, because the owner's income has been substantially reduced, the SBA should have considered this changed circumstance in assessing its owner's personal income because the SBA should examine his current, rather than earlier, financial condition. These arguments are without merit. First, personal income includes bonuses. See 13 C.F.R. Section 124.104(c). Second, the SBA can only consider personal income for the past two years. The SBA cannot resolve questions of eligibility by speculating upon what the owner's average income might be in the future. [9] See The Corvus Group, SBA No. BDP-184, at 6. For these reasons, the SBA reasonably concluded that the income of Petitioner's owner for the past two years is excessive and that he is not economically disadvantaged. B. Excessive Net Worth The SBA also concluded that Petitioner's owner's net worth is $252,582, which exceeds the SBA's $250,000 threshold. [10] Among its net worth calculations, the SBA included the cash surrender value of the owner's "Stag" variable life insurance policy, an asset the SBA valued at $50,413. Petitioner contends that the SBA failed to recognize that a $10,224 loan outstanding on the "Stag" insurance policy reduces the $50,413 account value to $40,189. This difference brings the owner's net worth below the regulatory threshold of $250,000. The estimated current value of a life insurance policy must be listed as an asset on a personal financial (net worth) statement. See Thomas D. Hubbard & Dennis S. Neier, Personal Financial Statements, in Accountant's Handbook Paragraph 35.2, at 35-2-35-3 & ex. 35.2 (D.R. Carmichael et al. eds., 8th ed. 1996). Thus, the SBA correctly included it in its calculations. However, the estimated current value of a life insurance policy is its cash surrender value, reduced by any outstanding loans against the policy. Id. Paragraph 35.3(g), at 35-8. The SBA failed to account for the outstanding loan of $10,224 on the policy. The loan is reflected on a monthly confirmation statement from "Stag" that the Petitioner provided at the SBA's request. Thus, the current value of the insurance policy is $40,189 ($50,413 minus $10,224), not $50,413. The SBA's failure to properly account for the outstanding loan inflated the owner's personal net worth by $10,224. Properly calculated, then, the owner's net worth would be $242,358, not $252,582. Accordingly, the SBA erred in its determination that the net worth of Petitioner's owner exceeded $250,000. [11] IV. No Error of Judgment Because excessive income for the past two years alone precludes a finding of economic disadvantage, the SBA's erroneous determination that its owner's net worth exceeds the $250,000 threshold does not prejudice Petitioner. Nor is it necessary to remand the case to the SBA to reevaluate its net worth determination because of the ultimate determination that Petitioner's owner is not economically disadvantaged. See generally 13 C.F.R. Section 134.406(e). Petitioner argues that, by using excessive personal income for the past two years as an automatic disqualifier for admission, regardless of any other circumstances, the SBA effectively changed its regulation, in violation of the Administrative Procedure Act, to make personal income, like the net worth limitation, an automatic disqualifier. This argument is without merit. The regulation is clear: "In considering diminished capital and credit opportunities, SBA will examine factors relating to the personal financial condition of any individual claiming disadvantaged status, including personal income for the past two years . . . , personal net worth, and the fair market value of all assets . . . ." 13 C.F.R. Section 124.104(c). Concerning those enumerated factors, it provides that the personal net worth of an individual claiming disadvantaged status for 8(a) purposes must be less than $250,000. 13 C.F.R. Section 124.104(c)(2). The SBA added that limitation in 1989. See 54 Fed. Reg. 12054, 12078 (Mar. 23, 1989) (proposed rule); 54 Fed. Reg. 34692, 34719 (Aug. 21, 1989). Nothing in the rule- making history suggests that the SBA intended to make the net worth limitation the only automatically disqualifying factor. Indeed, if the SBA is to consider "personal income for the past two years" as a factor in determining economic disadvantage, the SBA must also determine how much income disqualifies an individual from being found economically disadvantaged. The case law supports the conclusion that a finding of lack of economic disadvantage, under any one of the three factors (the previous two years' income, net worth, or the value of the owner's assets), precludes a determination of economic disadvantage. See, e.g., Matter of Autek Systems Corporation, SBA No. MSB-417, after remand, SBA No. MSB-420 (1992), aff'd sub nom. Autek Systems Corp. v. United States, 835 F. Supp. 13, 15 (D.D.C. 1993), aff'd, 43 F.3d 712 (D.C. Cir. 1994) (per curiam) (unpublished opinion). As in this case, although the owner's net worth did not exceed the regulatory threshold, the SBA found him not economically disadvantaged because of his personal income. See Autek Systems, SBA No. MSB-417, at 3, 10-11. The Administrative Law Judge ultimately affirmed the SBA Determination based on personal income alone. Autek Systems, SBA No. MSB-420, at 6-7. On judicial review, the district court found that "SBA did not abuse its discretion by considering [the owner's] income as the dispositive factor in determining whether [the applicant] could demonstrate economic [disadvantage]." Autek Systems, 835 F. Supp. at 15. See also SRS Technologies v. United States, 843 F. Supp. 740, 746-47 (1994) (finding that substantial assets may outweigh diminutive net worth). Accordingly, the SBA Determination is reasonable, and the SBA made no clear error of judgment in reaching the conclusion that Petitioner's owner is not economically disadvantaged. Conclusion Respondent Small Business Administration's determination denying Petitioner Petitioner's entry into the 8(a) program is NOT ARBITRARY, CAPRICIOUS, OR CONTRARY TO LAW. 15 U.S.C. Section 637(a)(9)(C); 13 C.F.R. Section 134.406(b). Subject to 13 C.F.R. Section 134.409(c), this is the final decision of the Small Business Administration. See 15 U.S.C. Section 637(a)(9)(D); 13 C.F.R. Section 134.409(a). RICHARD S. ARKOW Administrative Law Judge _________________________ 1 Small Business Act of 1958, Section 8(a), as amended, 15 U.S.C. Section 637(a); 13 C.F.R. Part 124. The purpose of section 8(a) is to "promote the business development of small business concerns owned and controlled by socially and economically disadvantaged individuals so that such concerns can compete on an equal basis in the American economy." 15 U.S.C. Section 631(f)(2)(A). 2 Effective September 16, 2002, the SBA amended its procedural regulations, 13 C.F.R. Part 134, and made conforming changes to 13 C.F.R., Parts 121 & 124. 67 Fed. Reg. 47244 (July 18, 2002). Because the SBA Determination from which Petitioner appeals was made after September 15, 2002, the amended regulations apply to this appeal. See 67 Fed. Reg. at 47244 ("Applicability Date"). All citations are to the regulations, as amended, which are available at www.sba.gov/oha/8aeligibility.html. 3 The SBA Determination did not state the exact amount of the owner's net worth, only that it was over $250,000. This unnecessarily increased the difficulty of addressing the SBA's conclusion. Only after the SBA filed and served the administrative record did it become apparent how the SBA calculated the net worth. Because Petitioner nonetheless addressed the relevant issues in the appeal, there was no prejudice. 4 Form 1040, U.S. Individual Income Tax Return, Line 33. 5 Form W-2, Wage and Tax Statement, Block 1 (Wages, tips, other compensation). 6 The response did not address issues regarding the owner's bonuses and the end of employment. 7 The response cited figures from the initial decline and did not address the argument regarding the "Stag" insurance policy's value. 8 The IRS has not published statistics for 2001. 9 If the owner's income falls within SBA's limits in the future, the applicant may reapply for admission 12 months after the SBA's final decision and, if it then meets the eligibility requirements, be admitted. See 13 C.F.R. Section 124.207. 10 Net worth for 8(a) purposes excludes the ownership interest in the applicant concern and the equity in the owner's primary personal residence. See 13 C.F.R. Section 124.104(c)(2). 11 Therefore, consideration of Petitioner's other arguments regarding net worth is unnecessary. Posted: March, 2003