Last week, I found myself in a discussion about whether RIA firms are required to disclose to clients a successful PPP loan application. To be sure, one can imagine circumstances requiring disclosure, such as a firm’s conclusion that without the loan, the firm will be forced to lay off employees primarily responsible for serving its advisory clients. But what if the circumstances were different?
Shortly after this discussion, I observed commentary on the internet saying that the SEC required disclosure, presumably under all circumstances. Unfortunately, the commentary contained little analysis of the text in the SEC’s recent FAQ Response on the subject. A close review of the Response reveals that the disclosure question is more nuanced. There is nothing wrong with a firm deciding to disclose even if not required to do so. But for at least three reasons, I disagree that the recent Staff Response addressing the subject mandates disclosure under all circumstances.
The Paycheck Protection Program (PPP) is a loan designed to provide a direct incentive for small businesses to keep their workers on the payroll. The Small Business Administration (SBA) 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.
Under the SBA’s standard application form, or a private lender’s substantially similar form, applicants represent that, "current economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant".
Applying for a PPP loan is free to the applicant. Applicants had to and must act quickly to apply for the loan as loan applications are only accepted, and loans may only be made, through June 30, 2020. PPP loans have been accepted, approved and disbursed in the order of first-come first-served, until the money appropriated by Congress is depleted.
The principal of a PPP loan will be partially or fully forgiven based on what the loan proceeds were spent on, to what extent the employer maintained or rehired its employees and to what extent it maintained the wages of its employees.
Staff Responds to Frequently Asked Question About Disclosure Obligations
On April 27, 2020, staff of the SEC’s Division of Investment Management (Staff) posted the following response to a question about funds and advisers affected by COVID-19.
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).
Staff Response to Question II.4, April 27, 2020 (emphasis added). As made clear by the Staff at the end of the Response, a firm must disclose under Item 18 in ADV Part 2A conditions that are reasonably likely to impair its ability to meet contractual commitments to its clients. This article is focused on the separate question of whether receipt of a PPP loan mandates updating the ADV due to a material change in circumstances (apart from Item 18).
The Staff Response Does Not Support Mandated Disclosure in All Cases
The Staff prefaced its Response with the following disclaimer:
These responses represent the views of the staff of the Division. They are not a rule, regulation, or statement of the Securities and Exchange Commission (SEC). The SEC has neither approved nor disapproved this content. These responses, like all staff guidance, have no legal force or effect: they do not alter or amend applicable law, and they create no new or additional obligations for any person.
Does the Response require disclosure of a PPP loan in all cases? In my opinion, it does not.
First, leaving aside the Staff’s disclaimer confirming that the Response creates “no new or additional obligations for any person,” the text of the Response suggests that the answer to the disclosure question depends on the facts and circumstances surrounding a firm’s application and receipt of the loan. Keep in mind, the Staff could have omitted the word “if” and simply said: “As a fiduciary under federal law, you must make full and fair disclosure to your clients of all material facts relating to any PPP loan you received” —and left it at that. But the Staff took a different route and made disclosure contingent on several factors.
Second, in explaining that disclosure would be appropriate “If the circumstances leading you to seek a PPP loan . . . constitute material facts relating to your advisory relationship,” the Staff leaves open the possibility that the circumstances leading a firm to seek a PPP loan may not constitute material facts relating to the advisory relationship with clients. Thus, it may be that the loan application was prompted by circumstances that did not necessarily constitute material facts relating to the firm’s advisory relationship with clients
Third, the Response implies that even if PPP loan funds are required—but required for something other than paying employees who are “primarily responsible” for client advisory functions—disclosure is not obligatory. Assume there are material facts relating to the firm’s advisory relationship with clients that led it to apply for the loan. The Staff explains by way of example that the firm should then disclose the nature, amounts and effects of such assistance.
But the Staff inserts another contingency. It explains that “If . . . you require such assistance to pay 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.” (Emphasis added.) This suggests that if PPP funds are not required to pay salaries of that class of employees who are primarily responsible for performing advisory functions for clients (“Advisory Employees”), disclosure is not necessarily called for. Perhaps the firm has other resources and plans in place to support the continued payment of salaries to Advisory Employees while using PPP loan funds to pay salaries of non-Advisory Employees. Thus, with respect to paying salaries of Advisory Employees, the PPP loan may be helpful but not required.
What about the representation in the loan application? The representation in the loan application that current economic uncertainty makes the loan request “necessary to support the ongoing operations” is broad, vague and not particularly helpful on the question of RIA disclosure. The application form is used in a broader context by many small businesses beyond just RIA firms. As a result, the representation language is not tied to, does not distinguish and does not mention, the advisory client relationship. The loan application, unlike the Staff Response, does not focus on whether or not employees are primarily responsible for performing advisory functions for clients.
While there may be many things that are necessary to support ongoing operations yet not material to the advisory relationship, for RIAs, it comes down to why the loan is necessary to support ongoing operations. If it is necessary (i.e., essential) to pay the salaries of employees who are primarily responsible for performing advisory functions for clients, disclosure is appropriate. If the loan is not essential for this purpose, then the text of the Response does not mandate disclosure.