Investment Adviser’s Duty to Disclose Precarious Financial Condition

April 19, 2020

With the recent decline in the markets due to COVID-19, it is likely that many investment adviser firms relying upon asset-based fees are also facing a significant decline in the investment advisory fee revenue which can have compliance implications depending upon the circumstances.

To the extent that your investment adviser firm is facing financial challenges due to this rapid decline in investment advisory fee revenue, you need to be aware of your investment adviser firm’s fiduciary duty to disclose material facts such as any financial condition that is likely to impair your investment adviser firm’s ability to meet its contractual obligations to its investment advisory clients.

As described in Item 18.B of the Form ADV Part 2A, an investment adviser firm (with discretion, custody or pre-payment of fees) is required to disclose a precarious financial condition to its investment advisory clients:

If you have discretionary authority or custody of client funds or securities, or you require or solicit prepayment of more than $1,200 in fees per client, six months or more in advance, disclose any financial condition that is reasonably likely to impair your ability to meet contractual commitments to clients.

To view the entire Part 2A instructions, see the following link – https://www.sec.gov/about/forms/formadv-part2.pdf.  Item 18 is on page 14 (emphasis added).

The need to disclose a precarious financial condition under Item 18.B of the Form ADV Part 2A is a facts-and-circumstances based analysis.  RIA Compliance Consultants recommends an investment adviser firm facing financial challenges consult with its accountant for an opinion on the investment adviser firm’s financial condition and whether the investment adviser firm has the ability to meet contractual commitments to its investment advisory clients.

If your investment adviser firm is state registered, then your investment adviser firm may also be subject to a net worth requirement set by your home state’s securities regulator.

Within the investment advisory trade press, there have been several articles discussing whether merely applying for or receiving loan proceeds from the Paycheck Protection Program (“PPP”) by itself requires disclosure to investment advisory clients. (The PPP is a loan designed to provide a direct incentive for a small business to keep its workers on the payroll. The small business must certify that the current economic uncertainty makes this loan request necessary to support its ongoing operations.  The Small Business Administration will forgive loans if all employees are kept on the payroll for eight weeks and the money is used for payroll, rent, mortgage interest, or utilities.)  Unfortunately, the U.S. Securities and Exchange Commission (“SEC”) has not yet published any specific guidance with respect to whether a PPP loan automatically triggers a reporting event for an investment adviser firm.

For a detailed analysis about whether loan forgiveness under the PPP constitutes a compromise with a creditor for purposes of the Form U4, please click here.  To listen to our complimentary investment adviser compliance training webinar, Compliance Tips for COVID-19, please click here.

Posted by Bryan Hill
Labels: COVID-19, Financial Statements, Form ADV