Updated Guidance for Advisers on Disclosure for the Paycheck Protection Program

The Securities and Exchange Commission’s Division of Investment Management released new guidance on April 27, 2020, addressing disclosure surrounding an investment adviser’s participation in the Paycheck Protection Program. That guidance is set forth below:

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).  (emphasis added).

As this guidance correctly references, whether the application for or receipt of a PPP loan is material, and therefore requires disclosure to clients, is a question of fact.  “A matter is material if there is a substantial likelihood that a reasonable person would consider it important…The omission or misstatement of an item…is material if, in the light of the surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the disclosure would have been changed or influenced by the inclusion or correction of the item.”  Put another way, would a typical client or prospective client consider this information important to their investment advisory relationship with their firm.[1]

While the Division of Investment Management staff has stated its belief that disclosure would be necessary if a loan was “require[d] to pay the salaries of your employees who are primarily responsible for performing advisory functions…,” we do not believe that this is a helpful standard in determining materiality, and ultimately, whether disclosure is necessary. 

I would recommend that investment advisers analyze all of the facts and circumstances associated with their current financial position and their decision to participate in the PPP.  After performing this analysis, if they believe that a portion of clients could consider their current financial position or their decision to participate in the PPP material, I would recommend disclosure. In performing the analysis, an investment adviser may want to consider the following non-exhaustive factors:

  • What was the total amount of PPP loan received?
  • What are the investment adviser’s assets and liabilities? Revenues and expenses?
  • How much cash on hand or other lines of credit[2] does the investment adviser have?
  • What will be the distinct use of the loan proceeds? Which employees will receive the loan proceeds? Are the proceeds intended to cover commissions, salaries, or bonuses? Can the investment adviser support all of these items through documentation (e.g., tracking of funds or corporate resolution)?
  • Without the receipt of the loan, what steps will the adviser need to take?
    • Will it simply reduce a profits interest for a principal owner or owners?
    • Will it require all investment professionals to agree to a reduction in salary?
    • Will employees be furloughed?
    • Will all employees be impacted?
  • What level of revenues does the adviser expect in the near future?

Keep in mind that this disclosure need not take the form of a Form ADV Part 2A, Item 18 disclosure.  Investment advisers may determine to notify clients in another manner—such as a client newsletter, market update, or client alert.

In the event that an investment adviser receives a PPP loan and determines that disclosure is unnecessary after performing its analysis, we believe that adviser should document its rationale in reaching their conclusion.  This will be important in the event of a future examination.   If an investment adviser needs any assistance analyzing their specific situation or with documenting their rationale, we remain available to assist.

My previous guidance regarding disclosure obligations under Item 18 of Form ADV Part 2A remain unaffected by the recent guidance.

[1] However, this analysis should not focus on morality or the role of government in our society.  Materiality ought to turn on whether the investment adviser and its personnel remain in an appropriate financial position so that they are able to continue their operations and render investment advice.

[2] Advisers should also be familiar with the recent “Frequently Asked Questions” issued by the Small Business Administration in consultation with the Department of Treasury, available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf. While the guidance appears to apply to large and publicly traded companies, advisers should analyze the “necessity” of the loan in connection with potential other sources of capital.

31. Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification. Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.

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