Financial Institutions Law Alert

An updated alert was published on May 13, 2020. 

Updated as of May 7, 2020

The SBA has extended the deadline to return PPP funds by one week to May 14, 2020. Recipients of the funds do not need to request an extension. The SBA stated that it will provide “additional guidance on how it will review the certification prior to May 14, 2020.” The SBA did not state whether the new guidance would be released in the form of FAQs or other format. RIAs should review and consider this anticipated new guidance in conjunction with their own individual circumstances in coming to a decision.

Most registered investment advisers, if not all, are very aware that the federal government, through the U.S. Small Business Administration (SBA), implemented a $659 billion relief package that provides small businesses with fewer than 500 employees, sole proprietors, independent contractors, and self-employed individuals with funds in the form of forgivable loans during the COVID-19 crisis (the Paycheck Protection Program or “PPP”). In order for the loan to be forgiven, the proceeds need to be used to cover payroll costs, rent, mortgage interest, and utility costs for an 8 week period and all full-time employees must be retained by the adviser. The SBA has capped loans at $10 million. More details on the PPP can be found here.

Perhaps unsurprisingly, many advisers quickly applied and received PPP funds because they met the small business qualifications under the PPP to do so. For the reasons set forth below, advisers who accepted PPP funds should carefully consider whether to return said funds to the federal government.

Recent Guidance Set Forth by the SBA

Since April 16, 2020 when the PPP exhausted its initial $349 billion in funding, the SBA, the Treasury Department, and the public at large have been scrutinizing companies that applied for and received funding. Of course, the big, well-known names are making headlines. For example, Shake Shack,  Ruth Chris Steakhouse, and large restaurant groups, who have been some of the hardest hit, have publically announced they will be giving their loans back. But, as the dust settles, the Treasury Department has made clear that the scrutiny will continue.

The SBA and Treasury Department released further guidance encouraging some borrowers to give the money back. If they do so by May 7, 2020, the federal government has promised they will not hold companies liable for originally applying for and accepting the loan. The Treasury Department has further warned that they will investigate companies who did not properly certify on their PPP application in good faith that “current economic uncertainty [made the] loan request necessary to support the ongoing operations” of the company. Thus, advisers who cannot make this certification in good faith, but who have accepted PPP funds, should consider returning PPP funds by May 7 to avoid significant legal consequences and potential public censure by the federal government or otherwise.

Disclosure of the PPP Loan on Form ADVs

On April 27, 2020, the Securities and Exchange Commission issued FAQs specific to advisers experiencing Covid-19 issues. In these FAQs, the SEC addressed whether an adviser who has received a PPP loan has to disclose the loan to its clients through an ADV filing. While the SEC does not directly answer this question in the affirmative, its guidance indicates that advisers are strongly urged to make the disclosure, and we agree. First, the SEC points out that advisers have a fiduciary duty requiring them to “make full and fair disclosure” to clients of “all material facts.” The SEC further states that “if the circumstances leading [the adviser] to seek a PPP loan or other type of financial assistance constitute material facts relating to [the adviser’s] advisory relationship with clients, it is the staff’s view that [the adviser] should provide disclosure of, for example, the nature, amount and effects of such assistance.” While the SEC lists two specific examples of situations requiring ADV disclosures (paying advisory personnel salaries and meeting contractual commitments to clients), we believe there are very few scenarios, if any, in which the acceptance of the PPP loan would  be immaterial and not disclosable  in an adviser’s ADV. Given that the PPP loan requires certification that the loan is necessary to support ongoing operations and can only be used for limited crucial expenses associated with the adviser, such as rent payments and utilities, the SEC would likely deem the acceptance of PPP funds as a material fact for purposes of the ADV.  The reason why is because acceptance of the PPP funds is relevant to the financial condition of the adviser. If an adviser returns the PPP loan by the May 7 deadline, ADV reporting would likely be unnecessary.

An Adviser’s Business may, for the Most Part, be Unaffected

While the PPP loan is geared to those businesses that have 500 employees or less, not all those eligible in theory may ultimately qualify, despite whether funding is ultimately granted or not. It is likely that the SBA and Treasury Department would agree that the goal of the PPP loan was not to put advisers back in the same position they were in during the bull market, but to keep businesses suffering from Covid-19 related issues afloat in the near term.

Most advisers are in a situation that they may be able to survive financially for some time. Their business, excluding the impact of the market decline, is mostly unaffected in comparison to other industries. Most rational clients have, at this point, decided to stay put with their current adviser and have acknowledged the unprecedented events that have affected their portfolios. We do not foresee clients flocking from their current advisers to others in the near term. Thus, advisers are still collecting fees from client portfolios. Although those fees may be lower than during the bull market over the last several years (and most advisers have been planning for at least some market correction), advisers should really consider (1) whether there is current economic uncertainty in their business; (2) whether PPP loans are necessary to sustain their business for the next several months; and (3) whether their ongoing operations could be permanently affected by the crisis. If the answer to any of these factors is “no,” but PPP funds have already been collected, advisers should consider returning PPP funds by May 7.

Good Will with Customers

Many brands have experienced public dismay over accepting apparently unneeded PPP loans. Mark Cuban, celebrity billionaire entrepreneur, warned successful businesses like Shake Shack that they were “killing” their brand by applying for and accepting PPP loans. Although Mark Cuban is unlikely to know or comment about a small business advisory firm, the public backlash may be some indication of an adviser’s clients’ reactions. Advisers should be worried about their clients’ opinions. Most clients have seen a significant drop in their portfolios given market volatility and current conditions. However, these clients continue to pay advisory fees despite little or no active management in their accounts and may even have foregone applying for the PPP loan for their own small businesses. Thus, advisers should really consider whether putting themselves in a potentially better position than their clients is the best move from a business relations standpoint.

In response to Shake Shack’s return of their $10 million PPP loan, Mark Cuban further commented, “Shake Shack didn’t give the money back because they didn’t want the money. They saw what the public outcry was.” Similarly, advisers who accepted PPP funds could experience their own client outcry upon receiving updated ADV disclosures. The cost of losing one client over time could outweigh the funds received from the PPP loan.

In conclusion, with regard to the PPP loan, advisers should consider:

1) Whether they can certify in good faith that the PPP loan was necessary to withstand the current economic uncertainty and to support the ongoing operations. In making this determination, advisers should consider:

a.  Whether their business has been truly negatively affected during the crisis;

b.  Whether their business will be unable to recover in the near future causing significant financial strain; and

c.  Whether operations are difficult or impossible without the funds.

2) Whether acceptance of the PPP loan will likely lead to scrutiny by the federal government or the public at large; and

3) Whether disclosure of the PPP loan on their ADVs will have a future and potentially long-term adverse impact on their retention of clients or revenue.

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