One of the federal government’s early responses to the COVID- 19 global pandemic was to provide funding to help small businessesmaintain their operations by retaining their workforce. Thus, the SmallBusiness Administration authorized aforgivable loan through the PaycheckProtection Program (PPP) under theCoronavirus Aid, Relief, and EconomicSecurity (CARES) Act, but without providing meaningful guidance.
The 2020 market crash drastically impacted the profits and revenuesof many small businesses, includinginvestment advisors. As the worldbegan to shelter-in-place, many smallbusinesses had to consider the possibility of laying off workers or closingtheir doors.
Generally, an advisor’s revenue andprofit are tied to the value of assetsunder management. But as assets andprofits began to decline, many advisors were uncertain as to whether theywould be able to maintain their currentoperations — especially if the marketcontinued its downward trend.
Advisors saw the PPP loan as anopportunity to support their operations, including retaining employees,during what appeared to be a potentially unprecedented historical event.However, there was a catch — smallbusinesses needed to act quickly if theywanted to benefit from the PPP, andthey had to do it based on the guidanceavailable at that time.
Finally, on April 27, 2020, a month
after the PPP went live, the Securities
and Exchange Commission’s Division
of Investment Management released
guidance addressing whether an
advisor must disclose its participation
in the PPP.
Specifically, the SEC’s guidanceregarding an advisor’s regulatoryreporting obligations provided that,“[a]s a fiduciary under federal law, youmust make full and fair disclosure toyour clients of all material facts relating to the advisory relationship. If thecircumstances leading you to seek aPPP loan or other type of financialassistance constitute material factsrelating to your advisory relationshipwith clients, it is the staff’s view thatyour firm should provide disclosureof, for example, the nature, amountsand effects of such assistance. If, forinstance, you require such assistance topay the salaries of your employees whoare primarily responsible for performingadvisory functions for your clients, it isthe staff’s view that you would need todisclose this fact. In addition, if yourfirm is experiencing conditions that arereasonably likely to impair its ability tomeet contractual commitments to itsclients, you may be required to disclosethis financial condition in response toItem 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).” (empha-
Whether the application for orreceipt of a PPP loan is material, andtherefore requires disclosure to clients,is a question of fact. Materiality turnson whether this information rises tothe level of “need to know” informationfor a typical client or prospective client. (The standard of materiality underfederal securities laws is whether thereis a substantial likelihood that a reasonable investor would have considered theinformation important.)
If after performing this analysis, theadvisor believes that their decision toparticipate in the PPP is a material factimpacting their advisory relationships,then the advisor should disclose the PPPloan. However, this analysis should notfocus on morality or the role of government in our society. Materiality oughtto turn on whether the advisor andits personnel remain in an appropriatefinancial position so that they are ableto continue their operations and renderinvestment advice.
In the event an advisor receives a PPPloan and determines that disclosure isunnecessary after performing its analysis, then the advisor should document itsrationale in reaching its conclusion.
Thomas D. Giachetti is chairman of theInvestment Management and Securities PracticeGroup of Stark & Stark, a law firm with officesin Princeton, New York and Philadelphia thatrepresents investment advisors, financialplanners, BDs, CPA firms, registered repsand investment companies, and is a regularcontributor to Investment Advisor. He can bereached at firstname.lastname@example.org.
THE COMPLIANCE COACH
By Thomas D. Giachetti
Is the PPP Just a Loan?
SEC guidance on disclosure of these loans to clients turns on materiality,
that is, if it affects them.