Is a Registered Investment Advisor (“RIA”) eligible to participate in the Payment Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”)? The short answer is “yes.”

The PPP was promulgated as part of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) which in part set aside hundreds of billions of dollars to help small businesses retain their employees during the COVID-19 crisis and the resultant work from home orders set forth by governors across the country.

Background

We understand that many RIAs applied for and were granted a loan under the CARES act, and that some of these RIAs may be unsure of whether they were granted the loan in error, how they may spend the loan funds or if they can spend the loan funds. The guidance below will hopefully answer some of these questions because applying for and receiving a PPP loan in a knowingly false fashion is a criminal offense, and we strongly encourage any RIA unsure of its PPP eligibility to seek particular legal advice.

The guidance below hinges on whether an RIA engages in speculative operations, holds any securities or other speculative assets, or is simply engaged in financial advisory services.

SBA Guidance

The SBA published an Interim Final Rule on April 2, 2020 (the “Interim Final Rule”). Specifically, the Interim Final Rule provides that “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2….” (the “SOP”).

Some of the ineligible financial markets and funds businesses listed in the SOP include, without limitation:

• Banks;
• Life insurance companies (but not independent agents);
• Finance companies;
• Investment companies;
• Certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
• Speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

On April 24, 2020, the SBA issued its Fourth Interim Final Rule on the PPP (the “Fourth Interim Final Rule”). The Fourth Interim Final Rule explicitly states that hedge funds and private equity firms are not eligible for a PPP loan.

Discussion

Ineligible Companies.

If the RIA is also a hedge fund or a private equity firm, then it may not be eligible to receive a PPP loan. If, however, the RIA is legally distanced from those entities through appropriate corporate structures, and the loan is only used for the RIA business, then the RIA should be eligible to receive the PPP funds.

Because most RIAs are not also banks or life insurance companies, the exclusions should not apply. However, as some RIAs also sell life insurance products, such individual situations may require more research.

Finance companies are also ineligible under the SBA guidelines to receive PPP funds. The SBA guidelines define a finance company as one “primarily engaged in the business of lending, such as banks, finance companies, and factors.” (Sec. 120.110(b) of the SBA’s Business Loans regulations). Thus, this exclusion should not apply. Similarly, an RIA may not be deemed an investment company, which is a company organized under the Investment Company Act of 1940, unless the RIA was in fact incorporated under that Act.

An RIA also may not meet the definition of a “speculative business” as defined above in the Interim Final Rule. If an RIA does not purchase or hold assets until the market price increases or engage in a risky business for the chance of an unusually large profit, then it will not meet this definition. Speculative businesses may also include: (i) wildcatting in oil, (ii) dealing in stocks, bonds, commodity futures, and other financial instruments, (iii) mining gold or silver in other than established fields, and (iv) building homes for future sale, (v) a shopping center developer, and (vi) research and development. (Sec 120.110(s) of the SBA’s Business Loans regulations, SBA Eligibility Questionnaire for Standard 7(a) Guaranty and SOP Subpart B D (Ineligible Businesses).  It is our understanding that an RIA that merely provides portfolio management services would not be deemed to be involved in a “speculative” business based on the examples of such businesses provided by the SBA. If the SBA had taken the position that financial advisory services are speculative, it could easily have so indicated by including such services in its lists of speculative services.

Financial Advisory Services.

Consistent with this view, the SBA has provided clear guidance that financial advisory services are eligible for SBA loans, including loans under the PPP. In the SBA’s SOP, the SBA provides the following: “A business engaged in providing the services of a financial advisor on a fee basis is eligible provided they do not use loan proceeds to invest in their own portfolio of investments.” (SOP Sec III(A)(2)(b)(v) pp.104-105) (emphasis added).

This guidance is clear that the focus of ineligibility is at the portfolio company level, not the advisory level, and this is consistent with the guidance noted above making hedge funds and private equity firms ineligible. Hedge funds and private equity firms make money based upon speculative investments and/or appreciation of the markets. An investment advisor operates at the consulting or services level. In other words, the SBA has distinguished between true speculative operations such as wildcatting, speculative real estate development and investing in securities, and service-based operations such as the investment advisory business. Assuming that an eligible RIA did not use any proceeds of the PPP loan at any investment level, such RIA should not be deemed a speculative business and is eligible for a PPP loan.

SEC Guidance

SEC guidance affirms that RIAs are eligible for PPP loans. While the SEC imparts certain burdens on RIAs that accept PPP loans, the fact that the SEC even acknowledges such burdens should give most RIAs confidence that a PPP loan is available to them.

For RIAs who are eligible to receive PPP funds under the SBA guidance set forth above, the SEC instructs that they must comply with their fiduciary duty under federal law and make a full and fair disclosure to their clients of all material facts relating to the advisory relationship. The SEC further posits that “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.” An example of a situation the SEC would require such disclosures would be an RIA requiring PPP funds to pay the salaries of RIA employees who are primarily responsible for performing advisory functions for clients of the RIA. In this case the SEC would require disclosure as this may materially affect the financial well-being of an RIA’s clients.

The SEC additionally provides that “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). (SEC Division of Investment Management Coronavirus (COVID-19) Response FAQs).

Summary

While the Cares Act and PPP are recently enacted, and there is some confusion surrounding the eligibility requirements for the PPP, the SBA had a clear opportunity to deem financial advisors ineligible in the Interim Final Rule and Fourth Interim Final Rule, but specifically chose not to do so. Instead, the SBA followed the direction of its historical eligibility requirements, holding to ineligibility at the fund and portfolio company level, but continuing to permit loans to firms operating at the advisory level.

While it is possible that the SBA could interpret its own rules and regulations inconsistently with the specific guidance provided in the Interim Final Rule and Fourth Interim Final Rule, the weight of the evidence strongly suggests that an investment advisor is eligible for a PPP loan as long as it does not use the proceeds for fund or portfolio company purposes.