On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). The CARES Act provides emergency financial relief to individuals, businesses and specific industries in connection with the COVID-19 pandemic. The CARES Act has a broad reach covering an array of stimulus measures including:

• direct cash payments for households
• enhanced unemployment benefits
• loans to small businesses
• changes to employee benefit plans, and 
• assistance for distressed industries. 

While financial services providers continue to study the CARES Act to understand fully its ramifications, the availability of small business loans has been of particular and immediate interest to broker-dealers, investment advisers and their independent contractor representatives. One of the hallmarks of the CARES Act is the establishment of a new lending program, called the “Paycheck Protection Program” (the PPP), which was added to the Small Business Act (the SBA) for the benefit of small businesses. Financial assistance may also be available to such borrowers through an Economic Injury Disaster Loan (the EIDL). In this alert, we provide guidance with respect to factors broker-dealers, investment advisers and their independent contractor representatives may want to consider before applying for a loan under the PPP or the EIDL. We also review some broker-dealer and investment adviser-related compliance considerations that may arise after a loan is obtained.

The PPP in General 

The PPP is being administered by the Small Business Administration and the Department of the Treasury. The applicable provisions in the CARES Act are sections 1102 (Paycheck Protection Program) and 1106 (Loan Forgiveness). Section 1102 amends the SBA to establish the PPP and defines critical terms, including “payroll costs.” Additionally, it establishes the maximum loan amount and the permissible uses for a loan. Section 1102 also provides that independent contractors and sole proprietors are eligible to apply for PPP loans.

Section 1106 and interim final rules adopted under the CARES Act establish the mechanism by which borrowers can receive loan forgiveness. For example, section 1106 defines the types of lease and mortgage obligations that an applicant for a loan may use to establish the applicant’s eligibility for a loan and forgiveness of the loan. Notably, such obligations must be a current liability of the borrower, with the rent or mortgage obligation incurred before February 15, 2020.

In general, the PPP is available to businesses with 500 or fewer employees and businesses that are deemed “small” based on their size relative to others in the same industry. A borrower applying for a loan under the PPP pays no application fee, is not required to post any collateral, and is not required to personally guarantee the loan. The PPP requires that the loan applicant certifies in good faith that the uncertainty of economic conditions at the time of application makes the loan request necessary. The interest rate on the loan is set at one percent. Importantly, if certain conditions are met, borrowers may qualify for loan forgiveness.

Broker-dealers, investment advisers and their independent contractor representatives, among others, may find such loans attractive and a lifeline in these challenging times. As with all loans, however, attention must be paid to the details of the terms and conditions of the loan, and to the ways in which such loans may impact the operations of the borrower or require new compliance or supervision oversight in order to comply with SEC and FINRA rules. 

Pre-Borrowing Considerations – PPP Terms and Conditions. Prior to applying for a PPP loan, broker-dealers, investment advisers and their independent contractor representatives will want to understand, first, that loans made under the PPP have a very specific purpose, which is keeping workers paid and employed. Interim final rules adopted under section 1102 stipulate that for purposes of loan forgiveness, not more than 25 percent of loan proceeds may be used for non-payroll costs. In addition, non-payroll costs are limited in type; they consist only of eligible mortgage, rent and utility payments, along with certain payments for employee benefits and interest payments on certain other debt obligations. 

Second, borrowers need to understand that loan forgiveness is tied directly to the purposes for which PPP loans will be made. To be afforded loan forgiveness, borrowers must present documentation to the lender showing that loan proceeds were used to pay eligible expenses (e.g., payroll, rent, utilities, group employee benefits) incurred eight weeks after receipt of the loan. In addition, the borrower must maintain its employee headcount in accordance with specific criteria, and pay wages that also conform to certain metrics. 

Third, borrowers need to understand that lenders are not required to forgive 100 percent of any loan. Instead, they are required to collect and review documentation that shows the eligibility of the use of loan proceeds. Thus, it is possible for a borrower to incur a debt that will not be forgiven under the PPP. 

Economic Injury Disaster Loans

Separate from the PPP, the CARES Act expands the eligibility requirements for the SBA’s EIDL program and provides $10 billion for Emergency EIDL loan advances for small business owners impacted by COVID-19. EIDLs are low-interest loans with longer terms that are administered directly through the SBA, and they usually require that a loan recipient is located in a disaster area and has been adversely impacted by a disaster or emergency. These loans also typically require that a small business has exhausted all other credit options as a condition of approval. 

For purposes of COVID-19 EIDLs, the CARES Act requires the Small Business Administration to declare that the COVID-19 pandemic is a national emergency that has affected all states, the District of Columbia, and the territories, thereby permitting small businesses throughout the nation to qualify for EIDLs and loan advances. The CARES Act also requires the Small Business Administration to waive the requirement that an applicant must be unable to obtain credit elsewhere as a condition of receiving an EIDL. The CARES Act makes available emergency loan advances for small businesses who complete an application under the program. These loan advances are effectively grants because the recipient is not required to repay an advance, which can be for no more than $10,000. 

Considerations for Borrowers

Broker-Dealer Borrowers. For legal entities registered with the SEC as broker-dealers, the emphasis on continuing to pay payroll costs under the terms and conditions of the PPP means that broker-dealers considering applying for a loan will need to carefully engage in “headcount math” and then apply that math, or adjust it, to ensure that any loan amount requested is consistent with the broker-dealer’s staffing expectations for the eight-week period following delivery of the loan proceeds to the borrower. In this regard, close attention must be paid to the definition of payroll costs and employees so that the broker-dealer does not inadvertently request a loan amount that cannot be supported by the necessary underlying documentation. Note that independent contractors do not count as a broker-dealer’s employees because such persons have their own ability to apply for a PPP loan. 

Helpfully, recent guidance published by FINRA in the form of FAQs will relieve broker-dealer borrowers of one aspect of compliance that threatened to hamper the ability of broker-dealers to apply for a PPP loan. On April 2, 2020, FINRA advised that it would permit broker-dealers to treat PPP loan proceeds favorably for purposes of calculating their required amount of net capital under the SEC’s net capital rule. With this impediment now gone, small broker-dealers should have a clearer shot at obtaining this particular type of loan. 

Independent Contractor Representative Borrowers. Broker-dealers and investment advisers considering the implications of CARES Act participation by their independent contractor representatives should be focused on a number of issues as they consider the possibility that their representatives, either directly as sole proprietors or through a personal services corporation under which they conduct certain aspects of their business, may apply for and receive benefits from the PPP and potentially other programs available under the CARES Act. Among other things, broker-dealers should consider the following implications:

• Form U4 Disclosures – Does the PPP or EIDL create any current, or future, obligation to amend Form U4 disclosures?  What, if any, supplemental education should a broker-dealer consider providing to its registered persons in the event they participate in a CARES Act program?
• Supervision – What oversight or supervision should a broker-dealer consider providing related to its registered persons’ receipt of funding under the CARES Act?  Should a broker-dealer collect information on receipt of such funding?  Should a broker-dealer collect information on the programs during the firm’s annual compliance meeting and provide any level of supervision related to the programs? 

Client Disclosures. Under both the EIDL and PPP loan programs, recipients are required to certify that the economic conditions brought about by COVID-19 make the loan application necessary. Broker-dealers that are dually-registered as investment advisers, and independent contractors that maintain a separate registered adviser, will want to consider whether disclosure regarding the receipt of the loan is called for in the adviser’s Form ADV Part 2. 

Conclusion. The availability of small business loans has generated interest among broker-dealers, investment advisers and their independent contractor representatives. In considering whether to avail themselves of the available loan programs, there are numerous factors broker-dealers, investment advisers and their independent contractor representatives may want to consider before applying for a loan and various compliance considerations that may arise after a loan is obtained.

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