While reporting receipt of a PPP loan by an RIA is not definitively necessary, affected individuals and entities are cautioned to strongly consider the terms of the loan and the circumstances giving rise to it, and likely should err on the side of disclosure. 

Form ADV reporting and disclosure obligations include those disclosures pertinent to the RIA, as well as any of its affiliates or related persons.  An advisory affiliate is an entity or natural person that is controlled by or controls the registered investment advisor (as the term “control” is defined in the Investment Advisors Act of 1940 and the Investment Company Act of 1940 and the rules promulgated thereunder). A related person also includes other individuals or entities that are under common control (i.e. ownership) with the RIA. 

So, assuming the loan was taken by the RIA or an affiliate, the question becomes whether the loan is material for disclosure purposes.  The SEC has included the following in its COVID-19 FAQs:

Question II.4.

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)

If the firm reasonably determines that the loan was not material (i.e. the loan amount was, for example, $100,000 measured against $2 million in qualifying expenses), then it might not be deemed reportable. (The above figures are illustrative only, and do not represent a calculus or ratio upon which materiality should be determined).  However, it will be difficult – and risky – to argue to the SEC, on the one hand, that the loan was not material, while on the other hand certifying to the SBA under the PPP loan terms that the loan was “necessary due to economic uncertainty.” Doing so can expose a borrower to sanctions from both the SEC and the SBA.

Note, however, that the SBA just announced on May 13, 2020, that entities receiving a PPP loan for less than $2 million will be assumed (without the requisite SBA audit) to have made the necessity certification in good faith, which could allow for an argument to the SEC that although “necessary due to economic uncertainty,” (to satisfy the SBA requirement) the loan is not reportable because it isn’t material insofar as it was not “required … [t]o pay the salaries of your employees who are primarily responsible for performing advisory functions for your clients” and wasn’t due to “[c]onditions that are reasonably likely to impair [the firm’s] ability to meet contractual commitments to its clients.” (Of course, it is presently unknown whether the SBA presumption of good faith could be rebutted and undermined by such an argument to the SEC, which could also expose the borrower to sanctions). Note, also, that for entities borrowing in excess of $2 million, the SBA will still be auditing the borrower to determine the accuracy of the certification, so it is highly unlikely that those entities can satisfy the SBA “necessity” certification while also contending the loan isn’t material for purposes of ADV disclosure.  

Remember, also, that in order to be forgiven, 75% of the loan proceeds have to be used for payroll purposes, which would render it difficult to make the above-mentioned argument to the SEC, while also standing by the SBA certification (regardless of whether the loan is above or below $2 million).  Therefore,  out of an abundance of caution, the internal analysis conducted by the firm to support the good faith necessity certification to the SBA should be well documented and retained in the firm’s business records at least through the time of the application for and receipt of loan forgiveness (and for the necessary period of time thereafter to satisfy regulatory record-retention requirements). 

At the end of the day, prudence suggests disclosure on the Form ADV (and ADV 2Bs for IARs who took the PPP).  It has been suggested that it could be as vanilla as the following (recognizing, of course, that the SEC has not provided specific guidance as to what would or would not be deemed acceptable):

On _________, 2020, the firm received a Paycheck Protection Plan Loan through the SBA in the amount of _______________ in conjunction with the relief afforded under the CARES Act. The firm used the PPP loan proceeds in accordance with the terms of the loan program and the firm did not suffer any interruption of service. 

The financial services lawyers at Reminger are fully operational during the pandemic and stand ready to continue to assist clients to navigate through these unprecedented times.  Do not hesitate to contact us with any questions.

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