Executive Summary
Last month, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, providing Americans with $2+ trillion of emergency fiscal stimulus funding in response to the economic damage caused by the Coronavirus pandemic. Part of the Act included the Paycheck Protection Program (PPP), which initially authorized up to $349 billion in forgivable loans intended to be used by small business owners to pay their employees during the crisis. However, the overwhelming demand for PPP loans depleted funds in a matter of just a few weeks, leading to an additional round of funding of $310B made available in late April 2020.
Accordingly, small business owners still have the opportunity to apply for funding, leaving many financial advisors faced with the decision over whether to apply for a PPP loan themselves. As while loans are intended for small businesses (with 500 or fewer employees) experiencing economic uncertainty resulting from COVID-19 who need the funding to continue business operations, advisors who receive loans also need to determine whether their loans are disclosable events.
For brokers regulated by FINRA, PPP loans are not considered disclosable events for purposes of Form U4 Question 14K, as FINRA determined that forgiveness of the PPP loan does not constitute a “compromise with creditors” because the potential for loan forgiveness is part of the original terms of the loan.
On the other hand, RIAs must disclose their PPP loans on Item 18 of the ADV Part 2A if the loan constitutes a “material fact” pertinent to the advisory relationship. In most cases, if PPP loans are used for the intended purposes of covering payroll expenses for persons performing primarily advisory functions, the loan would be considered a material fact relating to the advisory relationship. Accordingly, RIAs should be prepared to disclose their PPP loans on their ADVs.
However, while PPP loans should likely be disclosed in most circumstances, RIAs may be able to avoid such disclosure in limited situations. For example, a firm could try to avoid disclosure by claiming that the funds were obtained primarily due to the economic uncertainty posed by COVID-19, but not necessarily because they were “required”. This argument, however, may be difficult to make given the Small Business Administration’s requirement of certifying a PPP loan as necessary due to the current economic uncertainty cause by the COVID-19 crisis.
Another way that an RIA may be able to justify not disclosing receipt of a PPP loan on their ADV Part 2 would be by claiming that funding was used for the payroll of employees who were not directly involved in advisory functions (e.g., staff involved in marketing, events, receptionist duties).
Ultimately, the key point is that because RIA firms and brokers have different criteria for disclosure events, the requirements to disclose PPP loans are different for each. For brokers, the principal question is whether a compromise with a creditor has been made, whereas for RIAs the question is whether the event has a financial impact that materially (or potentially) impacts the ability to fulfill obligations to the client. As such, FINRA brokers are not required to disclose PPP loans on their U4 Forms (assuming they are used according to the original terms of the loan) but RIAs, regulated by the SEC, should lean heavily towards disclosing their PPP loans on Part 2A of their Form ADV.
*** Michael's Note: Be sure to check out our brand new Advisor’s Guide To The Paycheck Protection Program resource page for a run-down of all the important PPP provisions!
Show Notes
- US Treasury - Paycheck Protection Program Borrower Fact Sheet
- FINRA Frequently Asked Questions Related to Regulatory Relief Due to the Coronavirus Pandemic
- SEC Division of Investment Management Coronavirus (COVID-19) Response FAQs
- An Advisor’s Guide to the Paycheck Protection Program
- Quickly Maximizing Paycheck Protection Program’s (PPP) Forgivable Loan Opportunity For Financial Advisors
- Analyzing The CARES Act: From Rebate Checks To Small Business Relief For The Coronavirus Pandemic
#OfficeHours with Nerd's Eye View Video Transcript
Hello, everyone. Welcome to this episode of Office Hours here at the Nerd's Eye View. My name is Jeffrey Levine, your Lead Financial Planning Nerd here at kitces.com.
Thanks for taking some time to join us today to talk about how the most recent SEC guidance on PPP loans impacts RIAs in terms of disclosure on the ADV Part 2A.
Now, as a quick backstory as to where we are today, the Paycheck Protection Program is that loan program that's authorized under the CARES Act that allows businesses to borrow potentially up to two and a half times their average monthly payroll and it also allows those loans to be forgiven. Now, notably, the first round of $350 billion, roughly, was exhausted in a matter of weeks, and so recently, Congress authorized an additional $310 billion for the same program, which began taking new applications again earlier this week on Monday, April 27th. Now, as I record this video today, there's still money left in the program. We'll see how long that lasts.
However, today really isn't about the Paycheck Protection Program fundamentals. If you're interested in that, we have our advisor's guide to the Paycheck Protection Program, which we have continuously updated, and a link to that will be included with this video, in the show notes.
In addition, we're not going to talk about should or should advisors not get those loans. We did a whole video and an article on that last week. A link to that will also be included.
What we're really looking to focus on today is the SEC's most recent guidance to help us figure out whether RIAs should or should not disclose taking PPP loans on their ADV Part 2A.
Now, it is certainly fair to ask, again, should RIAs be taking these loans, but again, we covered that last week. In general, our opinion is probably not. Most RIAs will likely not qualify for the PPP loan.
But still, if 95% of RIAs don't, that still means thousands of RIAs would qualify. I mean, think of a simple example, an hourly financial planner who is now homebound with their children and literally doesn't have the hours left to do the work that they once did. You know, that would be a clear case where they might have a legitimate need for the PPP loan and a legitimate claim at getting some of those dollars. But again we've covered that in-depth last week. You can go and look at the article in the video if you want more information on that.
Brokers And RIAs Have Different Disclosure Criteria For PPP Loans [00:02:49]
Now, with that said, where are we in terms of disclosure? Well, very quickly, FINRA came out and addressed the issue for brokers. Notably, on the U4 Form, item 14K asked a question of whether or not you had a compromise with a creditor in recent history. And FINRA came out and said, "We will not consider a forgiveness amount under the PPP as a compromise with a creditor because it was part of the initial terms of the loan."
If you want more information on FINRA and FINRA's guidance, again, we'll include a link to that most recent guidance, in the show notes as well. But the SEC was a little bit slower to address this concern for RIAs.
Now, RIAs have a much different concern than "Did you make a compromise with a creditor?" More specifically, for those RIAs that hold either discretionary authority over client's funds or they have custody over client's funds or they billed $1,200 or more at least 6 months in advance, those advisors, on item 18B of their ADV Part 2A, have to make certain disclosures if there is a financial impact to the business that materially impacts or potentially impacts its ability to fulfill its obligations to clients.
And for a long time, or for about a month, or literally exactly a month, we've been wondering whether or not this would require disclosure on Part 2 of the ADV for advisors. And again, the SEC came out and gave us finally some more guidance on this. More specifically, the Division of Investment Management came out with additional FAQs on the coronavirus response.
Part of question 2.4 of that FAQ asks, "If you're a small advisory firm, do you have to make this disclosure?" And unfortunately, in the answer to the question, the SEC did not provide a bright-line test. It gave us no answer that is "Yes for all firms," or "No for others," or "Here are the things that you need to look at precisely in order to determine whether or not you should disclose."
Rather, it gave us a very typical SEC style answer, which is, "It depends on the facts and circumstances as to how material or how not material it is." And so that was a little bit frustrating; however, there is a passage in that answer which reads, and I'm just going to read this for you so I give it to you exactly. It says:
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 would need to be disclosed.
Okay. It is the staff's view that would need to be disclosed.
Again, if you needed this loan to pay the salaries of the people who are performing advisory functions, it is the opinion of the SEC that you should disclose this.
And so while the general answer they gave is "It's a fact and circumstances argument," the fact that they told that if you are taking this loan to pay for the payroll of people that do advisory services that you should disclose that really gives us a hint, and in fact, I would say that my opinion is now advisors, and this is the Registered Investment Adviser entity, should heavily lean towards disclosure, again, on Part 2A, item 18 of the ADV.
Acceptable Reasons For RIAs Not To Disclose A PPP Loan On Their ADV [00:06:46]
So it is really, really important that we make this distinction here as to how would you potentially not. If you're going to try and not put that on the ADV, what would be your argument? Because notably, the Paycheck Protection Program is for salaries, is for payroll. That's what it was put in place for. So if we look at this language that the SEC gave us in this FAQ, we've got to try to find some way to chip away at it and argue that the guidance that they gave us in that FAQ doesn't apply to us.
So I can think of only two ways we might be able to do that. The first is to try and parse the way they worded it. They say specifically, "If, for instance, you require such assistance." If, for instance, you require such assistance. So one way we may be able to go about trying not to disclose that, if we were trying to argue that, and again, I think, in general, I would lean heavily towards disclosure, but if you're trying to make the case against it, one argument you might come up with is, "Well, we really didn't require the assistance. It wasn't really required. We chose to get it due to economic uncertainty.”
But I think that's going to be a really challenging argument, because you basically have to make the argument to the SEC, on one hand, that it wasn't required, while at the same time arguing to the Small Business Administration and the Treasury that it was necessary due to economic uncertainty. That is a very fine line to try and walk. You've really got to thread the needle there. And so I think that's not a great way to go, but that would be potential argument number one.
Argument number two, which I think you might have more success with, is to go with the other part of the disclosure or rather the FAQ, which says that, "Are you using this to pay the salaries of employees who are primarily responsible for performing advisory functions?"
So another argument you might claim if you are an RIA looking to take this loan but try to avoid disclosure on your ADV Part 2A would be, "Well, we didn't use it to pay the salaries of people who perform advisory functions. We used it for the marketing staff. We used it for the receptionist. We used it for our events staff," all the people that don't do advisory stuff, all the other ancillary things or positions that an advisory firm may have on staff. That could be your argument.
Now, if you are going to do that, I think you've got a more legitimate argument there than you do threading the needle in the previous way I mentioned. You might try to argue it, however, while it's more easily defended, you still want to do everything in your power to prove that argument.
So, for instance, I would very specifically show how much of those other individual salaries are being paid with the Paycheck Protection Program loan. In addition, if you use the whole firm, including the advisory employees' salaries, to qualify for the loan and you get two and a half months of the entire firm's payroll, well, remember, you can only have the amounts forgiven that are paid as payroll within the first eight weeks.
So what you might find yourself with is a loan where not all of it is forgiven. In fact, a significant portion, if a lot of salary used to determine the amount of the loan was based on payroll for people who do perform advisory functions, well, you can't pay the people who do non-advisory functions enough for the eight weeks following the loan to get it all forgiven. So something else to keep in mind.
And certainly, I would keep those assets in a separate account and line item them. You know, specifically, keep good documentation showing, "These were the salaries we pay to non-advisory personnel or people who do not perform primary advisory functions. And we took it from this account to pay those salaries." Keep really good documentation on that.
Why RIAs Should Disclose PPP Loans On Their ADVs And Consequences To Consider [00:11:13]
But really, I have to go back to my original point, which is that if I was an RIA, I would really lean towards disclosure. I think you've got a lot less risk leaning towards disclosing this on your ADV and eliminating the risk that the SEC doesn't see things the same way you do and creating some sort of enforcement action or other issue for your business than you do by just disclosing it.
It's not a huge deal. Disclosing on ADV Part 2A doesn't mean that something is wrong. It's just that you have to let people know. It's a disclosure document. That's what it is. And by being proactive and taking the initiative to put that on your ADV and disclosing it, you can also frame it in the best wording and best light possible for you, obviously, within the context of the law, but this is where having a good compliance consultant or good attorney on staff or on retainer can be very helpful. They can help you craft the language to disclose that in an appropriate way but one that reads in as bright a light as possible for your firm.
So, of course, the obvious question is, "Jeff, it sounds pretty simple, why wouldn't we just disclose it?" Well, I alluded to this in our video last week, which again, if you want more, you can watch that video or read that article, but the key there is clients and potential clients may see that. That's one possibility.
But the other thing is that, once you make that a public disclosure, other professionals will try to use it and exploit it. There are a lot of people who believe that RIAs, no matter what their business model is, should never be allowed to take these funds, and that's certainly their opinion. Everybody is entitled to their own. But there has been a significant push by some people to really shame those advisors who may take loans.
And so you risk putting yourself at the mercy of what other advisors and other professionals might say, and they might be particularly vicious in certain comments, etc., and you just may want to avoid that. But again I think that risk is much lower than the risk of not disclosing it and having the SEC view things differently.
So, with that said, I do want to take a few moments to address just a few quick questions I've already been getting from people based on this guidance. First is, "Jeff, why are they favoring brokers with no disclosure over RIAs and making them disclose it?" And first off, I would ask, who's they? Who is they in this scenario? But once we get that answer, I would say, it's not a fair comparison. The U4 questions is asking, "Is there a compromise with creditors?" It's a completely different question than, "Is there some sort of material issue with your business that makes the finances a little bit questionable as to whether or not you could fulfill your obligation to clients?" So they're very different items. And of course, the U4 is a personal form, whereas when we're looking at the ADV brochure, it's for the business, which actually leads into the second question.
Sole Proprietors Who Work Under An RIA May Not Be Required To Disclose PPP Loans On The Firm’s ADV [00:14:25]
"Jeff, I work for a large RIA, but I get paid as 1099. So I'm really my own business. I'm my own sole proprietor. If I take a Paycheck Protection Program loan, do I have to make a disclosure somewhere?" And best as I can see, the answer to that is no. Because ultimately, you're not filling out, you don't have your own Part 2A brochure. It's the firm's brochure. And if you are struggling financially and you ultimately decide to call it quits, so you hang up, you close shop, the RIA, the entity itself is still responsible for servicing your clients and fulfilling its fiduciary obligation. And so, with that in mind, I would say, I don't see the individual IAR having to make any disclosures. I think it's more of a firm type of question.
And so, again, to kind of sum things up, we don't have a bright-line test, I wish we did, a definitive answer as to whether or not, the SEC says, a PPP loan should be disclosed. But in light of its wording in that FAQ, again, a link to that will be below, item 2.4, I do believe that if I was in a registered investment advisory firm, I would lean heavily towards disclosing that I took a PPP loan if I did. Of course, given that this is a good legal matter, it is worth consulting with your compliance consultant and/or attorney and making sure you get their advice and their opinion as to your specific circumstances. Because as the SEC alluded to, facts and circumstances here matter.
So, with that said, thanks for joining me for this episode of Office Hours. My name is Jeffrey Levine, your lead financial planning nerd at kitces.com, and I look forward to speaking with you all real soon. If you've got questions or comments, we'd love to hear from you. Put it in the comments section below this article or reach out to me on Twitter, @CPAPlanner. Thanks so much. Have a great day, everyone. Bye-bye.
Does this apply just the same to the EIDL program or are the disclosure rules different, particularly if all that is received is the under $10,000 payment from EIDL that will be coverted to a grant and not carried as a loan?
Hi GB – Did you ever receive an interpretation on this? I have the same question.
I really hope that RIAs that didn’t have a material need for the PPP funds either did not apply or intend to return the funds. There has been so much abuse of this program by firms that didn’t have a material impact to their revenues, while other firms with less sophistication either didn’t get their applications in soon enough or were ignored by banks like Wells Fargo. Those businesses – restaurants, salons, and small retail shops desperately need the PPP to stay in business.
For example, I just talked to a restaurant owner today. He submitted his PPP application with Wells Fargo at the very beginning of the process, Wells apparently did not process it when they ran into complications of their own, and left him in limbo with no communication. Now, as funds are drained again, he’s left out in the cold, and his two restaurants are likely to fail due to the shutdown.
I agree with you, but as one has already done with their down arrow, expect the “holier than thou” comments to you.
Jeff & Michael, nice piece. Wish the regulators were a bit clearer, but here are a few questions that I did not see addressed. Perhaps you can lend some further insights.
1) How is this any different for state registered advisers only (non SEC registered)?
2) How long does it need to be disclosed?
a. So if you already filed your 2020 ADV (some may not of given the extension), do you have to put out an Amendment? If so, when?
b. If you haven’t yet filed your 2020 ADV, do you include it now (2020 ADV), if you receive funds and do not decide to return them?
c. If you use the funds and it is forgiven all within 2020, would you still need to disclose this in your 2021 ADV Filing? If so, why? For how long? Could you not file a 2020 Amendment and then file another once the loan is forgiven, basically only having your current ADV show the disclosure for 3 months?
3) How does the disclosure of PPP loan differ from another private loan or standard SBA 7(a) loan that could be used to pay employees specifically tied to providing advisory services to clients?
Again, keep up the good work and thanks as always for being a trusted resource and curator of experts.
I have these questions as well. I’m a small, solo-advisor RIA formed in late 2018. Do I need a PPP to continue operations and meet my contractural obligation to clients? No. My wife has a high paying job and we can get by on her salary. Does current “uncertainty” require me to take a loan to pay myself? Possibly, but my firm will not go under if I get the loan. I just may not be able to pay myself or pay myself as much.
I’m not sure that this will require disclosure on my ADV because my family situation means I won’t have to close up shop, but my business situation does qualify me for the loan. I know my situation may be unique, but I have these questions along with the ones J.P. posted
For those shaming advisors who took out the PPP loan, did any of those advisors (Doing the shaming) and who have children return their Child’s portion of CARES Act rescue funds? Did you donate the funds? Surely your child didn’t need it, right? I mean, we are financial advisors, and because of that there is no variability in our business and financial lives, at least that is the belief of some. Surely, no financial advisor doing the shaming has had a spouse lose their job during this time or had a relative pass from Covid. Nobody is at risk of losing a client, right? No variability whatsoever, because advisors should be perfect. Do you think our local health clinics, CPAs, attorneys, consulting companies, and whatever else I’m missing are sitting around writing multi-thousand word communications about disclosure and PPP worthiness? I highly doubt it. Are architects shaming each other and saying “if you took out the PPP that makes you a bad architect”? Of course not. Does taking out a small loan to shore up the balance sheet for our business during times of incredible uncertainty really make someone a bad fiduciary? Not any more than talking about financial responsibility with a client from your luxury car, or bragging up your golf membership (you are charging too much).
Enough of the holier than thou BS. Your self righteousness is the true eyesore on the industry, not some advisor wanting to make sure they will be there for their clients and having exercised the same rights afforded to every freaking other small business in the US during this time of crisis. The fact that a Merrill broker can jump to Morgan Stanley and not have to disclose their six figure forgiveable loan (handcuffs?) and that an IAR at a bigger RIA “may not” have to to disclose their loan makes me frustrated for all the boutique firms that had the guts to go out on their own and that will now be demonized by someone who maybe took out a loan themselves but didn’t have to disclose it.
Gotcha. Since one person does it, it makes it okay for another? Maybe I’m misunderstanding your post. I do agree that if you took the money, disclose it. Why are you hiding? Why is hiding this even being discussed?
Hello Jeff
Thanks again for your terrific work, as usual! Two questions that will help me and perhaps others, if you have the time:
1. For hybrids who run business through their BD RIA but run planning only through their own RIA, would ADV disclosure on the planning RIA be recommended?
2. How long does the disclosure last? One filing period? Forever?
Thank you.
Has anyone taken a PPP and/or EIDL loan and actually updated their ADV yet? I’d be interested in seeing the language in Item 18. Thanks!
My firm did before I was able to leave (thank goodness). I refused as the CCO to have the language that it was for salaries, etc. I was really surprised though that not one single client questioned the advisor receiving 5 figures when his income increased in 2020;