The U.S. Securities and Exchange Commission (“SEC”) recently provided guidance on the disclosure obligations of an investment adviser firm when receiving a Paycheck Protection Plan (“PPP”) loan guaranteed by the U.S. Small Business Administration in conjunction with the relief afforded from the CARES Act during the COVID-19 pandemic.
A PPP loan is designed to provide a direct incentive for a small business such as an investment adviser firm to keep its employees on the payroll. In order to receive a PPP loan, the small business must certify that the current economic uncertainty makes this loan request necessary to support its ongoing operations. The U.S. Small Business Administration will forgive repayment of such PPP loan if all employees are kept on the payroll for eight weeks and the proceeds are used for payroll, rent, mortgage interest, or utilities.
In response to inquiries by investment advisers, SEC’s Division of Investment Management recently posted a specific PPP loan disclosure question/answer on its Coronavirus (COVID-19) Response FAQs webpage:
Q. 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?
A. 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). (Posted April 27, 2020)
See Question II.4. at https://www.sec.gov/investment/covid-19-response-faq .
If your investment adviser firm is state registered, you should contact your state securities regulator for guidance on whether the PPP loan should be disclosed. It is our understanding that certain state securities regulators consider the receipt of a PPP loan in itself as a disclosure event for an investment adviser.
As explained above and in our 4/19/20 blog article, your investment adviser firm has a fiduciary duty to disclose material facts such as any financial condition or circumstances underlying a PPP loan that is likely to impair your investment adviser firm’s ability to meet its contractual obligations to its investment advisory clients.
Item 18.B of the Form ADV Part 2A outlines the following disclosure obligation:
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.
An investment adviser firm facing financial challenges should 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. To the extent that an investment adviser firm determines that it has the ability to meet its contractual obligations to its investment advisory clients and consequently will not be making a disclosure regarding its receipt of a PPP loan, this financial analysis should be carefully documented. We anticipate that the SEC will scrutinize an investment adviser firm which applied for or received a PPP loan but did not disclose the PPP loan or an underlying precarious financial condition to its clients. As a result, it is advisable for a SEC registered investment adviser firm to disclose receipt of a PPP loan even if the investment adviser firm determines that its financial condition is not precarious.
RIA Compliance Consultants has prepared a sample disclosure for the Form ADV Part 2A with respect to the receipt of a PPP loan, which is available for purchase via our online store; however, such a disclosure may need to be expanded and customized depending upon the investment adviser firm’s financial circumstances underlying the PPP loan.