RIA Compliance and Practice Management Blog

RIA Compliance Considerations for Paycheck Protection Program Loans

Posted by RIA in a Box

May 4, 2020 8:48:59 AM

RIA PPP Loan DisclosureWith the advent of the CARES Act in response to the Coronavirus Disease 2019 (COVID 19), businesses throughout the United States are trying to figure out how to react in a number of ways, particularly financially. Part of that equation for a small business, including a registered investment advisers (RIA) firm, is determining whether to apply for the Paycheck Protection Program (PPP) established by the U.S. Small Business Administration.

In order to obtain a loan under the PPP, an eligible small business must (among meeting other requirements) certify on the application that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations” of the firm. This requirement has left many investment advisers wondering if this threshold – “necessary to support the ongoing operations”– means that the RIA firm must make a disclosure regarding its financial situation to its clients.

Note: RIA in a Box LLC is not a law firm and does not provide legal advice. We strongly advise that all RIA firms considering making use of the Paycheck Protection Program consult with legal counsel and an accounting professional to understand eligibility restrictions, the latest guidance, and other considerations. This overview is provided for general information purposes only and should not be relied upon to take any action.This post below is as May 4, 2020. As the SEC and other regulatory bodies issue additional guidance, we anticipate additional updates and/or modifications will be made to this solely educational overview. 

Download our Infographic Outlining the 5 Form CRS Requirements

Form U4 Disclosure

In regards to a potential disclosure on an individual adviser's Form U4, the Financial Industry Regulatory Authority (FINRA) answered this question directly, issuing a FAQ addressing the topic on April 13, 2020:

Question: The Paycheck Protection Program (PPP) allows eligible individuals and small businesses to obtain loans that can be used during the COVID-19 crisis. A PPP loan is eligible for forgiveness, provided the terms of the loan forgiveness are satisfied. If a registered person or a business they control obtains a PPP loan and the loan or part of the loan is forgiven, will the registered person be required to report that forgiveness in response to Question 14K on their Form U4 as a “compromise with a creditor?”

Answer: No, provided the PPP loan or part of the loan is forgiven consistent with the original terms of the loan. For purposes of Form U4 Question 14K, a compromise with one or more creditors “generally involves an agreement between a borrower and a creditor in which a creditor agrees to accept less than the full amount owed in full satisfaction of an outstanding debt, unless such an agreement is included in the original terms of the loan.” Because a PPP loan contemplates forgiveness of some or all of the loan as part of the original terms of the loan, such forgiveness will not involve a new agreement by the creditor, but will be an event consistent with the loan’s original terms. In those circumstances, the forgiveness of a PPP loan will not be a “compromise with creditors” for purposes of Form U4 Question 14K. Any forgiveness beyond the original terms of the loan would be considered a “compromise with creditors.”

Form ADV Disclosure

However, the FINRA FAQ addresses only a single RIA compliance consideration regarding PPP loans – Form U4 disclosure in the event of forgiveness. The fact that the loan need not be disclosed on Form U4 as a compromise with creditors does not necessarily mean that no other disclosure is called for. Indeed, the SEC released its own helpful guidance two weeks after FINRA’s FAQ. The SEC FAQ posted on April 27, 2020 addresses the broader question of whether taking a PPP loan warrants disclosure to clients: 

Question: I am a small advisory firm that meets the requirements of the Paycheck Protection Program (PPP) established by the U.S. Small Business Administration in connection with COVID-19. If I receive or have received a PPP loan, what are my regulatory reporting obligations under the Investment Advisers Act of 1940 to my firm’s clients?

Answer: As a fiduciary under federal law, you must make full and fair disclosure to your clients of all material facts relating to the advisory relationship. If the circumstances leading you to seek a PPP loan or other type of financial assistance constitute material facts relating to your advisory relationship with clients, it is the staff’s view that your firm should provide disclosure of, for example, the nature, amounts and effects of such assistance. If, for instance, you require such assistance to pay the salaries of your employees who are primarily responsible for performing advisory functions for your clients, it is the staff’s view that you would need to disclose this fact. In addition, if your firm is experiencing conditions that are reasonably likely to impair its ability to meet contractual commitments to its clients, you may be required to disclose this financial condition in response to Item 18 (Financial Information) of Part 2A of Form ADV (brochure), or as part of Part 2A, Appendix 1 of Form ADV (wrap fee program brochure).

This FAQ essentially parses the analysis into two parts:

  1. whether disclosure to clients is required and
  2. whether disclosure specifically on Form ADV Part 2A is required.

For the first prong of the assessment, the SEC's FAQ response makes clear that it is a materiality standard – is the loan a material fact relating to the RIA’s advisory relationship with clients? The SEC provides one example, stating that disclosure would be warranted if the PPP funds are needed to pay advisory personnel. While this falls short of a definitive rule for every situation, the FAQ suggests that an RIA firm should likely err on the side of disclosing to its clients the use of PPP loan proceeds. Any advisory firm that does not disclosed receipt of PPP loan assistance should be prepared to explain to regulators why this fact would not be material to its clients.

With respect to the second prong relating more specifically to disclosure on Item 18 of the Form ADV Part 2A firm brochure, the SEC references the specific language already set forth in Item 18, calling for disclosure “if your firm is experiencing conditions that are reasonably likely to impair its ability to meet contractual commitments to its clients.”  Again, the SEC's FAQ response can be construed as encouraging RIAs to make an Item 18 disclosure when in doubt. However, this standard appears to be somewhat different than the “materiality” threshold for disclosure to clients so RIA firms should be sure to take into account their specific facts and circumstances when assessing whether Item 18 disclosure is required. Disclosing the PPP loan assistance in Item 18 of Form ADV Part 2A and distributing the firm brochure to clients would seemingly also satisfy the notification to clients per the first prong.

PPP Loan Forgiveness

RIAs should also consider what happens if a PPP loan is forgiven under the program. Forgiveness of the loan alone would not necessarily mean that the firm is financially sound. However, an argument can be made that Form ADV Part 2A Item 18 disclosure is no longer needed if the firm is no longer experiencing those conditions that impaired its ability to meet client contractual commitments.

Net Capital Requirements for State-Registered RIA Firms

Lastly, RIA firms need to take heed of potential net capital requirements. While many regulators require only solvency, there are a number of states that have stricter net capital requirements, often up to five figures for investment advisers with discretionary trading authority. Advisory firms contemplating PPP participation need to consider the impact a loan would have on their net capital and must avoid violating applicable net capital requirements. RIA in a Box clients can contact their client service representative to discuss net capital requirements by state, but all RIAs are encouraged to work with an accounting professional to determine the potential financial statement treatment of the loan under the CARES Act.

Contact RIA in a Box to create your firm's Form CRS


Topics: RIA Operations, RIA Compliance

RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

RIA Compliance & Practice Management

Stay up to date on the latest RIA compliance, operations, and technology topics.

Hear from industry experts as they keep you up to date on the latest regulatory developments and practice management topics.

Subscribe to Email Updates

Recent Posts