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The Covid-19 pandemic has resulted in a lot of disruption, in personal lives, the global economy, and investment portfolios. As a result of the economic impact, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act provided for economic relief to numerous parties, including small businesses through the Paycheck Protection Program (PPP).
The PPP allows small businesses, generally defined as businesses with less than 500 employees, to receive loans for up to $10 million to cover payroll and certain other expenses from the Small Business Administration (SBA). These loans are both forgivable and tax-free if certain requirements related to employee retention and other qualifying expenditures are met.
The PPP was intended to help small businesses facing a business disruption as a result of Covid-19. As a business with no employees, we were surprised to learn that Accretive could be eligible to receive a PPP loan.
While our business has been impacted by the Covid-19 pandemic, and there were arguments we could make to accept funds, we came to a consensus as a firm to not elect to receive a PPP loan. There were several reasons for our position:
The Spirit of the PPP
First and foremost, we believe that the PPP is for companies that otherwise would not be able to meet payroll and retain employees as a result of the Covid-19 pandemic. While the definition of employees has been expanded to include owners of multi-member LLCs, like Accretive, we did not believe our participation would be consistent with the spirit of the program. While our revenues were impacted, we have not had any issues meeting our expenses throughout the course of the Covid-19 pandemic.
The Attestation Required
When applying for PPP funds, businesses are required to certify that “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” We did not believe the loan to be necessary to support our ongoing operations. Furthermore, we believe accepting PPP funds requires disclosure on Form ADV (a disclosure document that RIAs are required to file at least annually). In particular, Item 18 of Part 2A of Form ADV requires advisors to disclose any financial information that may impair the firm’s ability to meet its obligation to clients. If the receipt of a PPP loan is necessary to support an RIA’s ongoing operations, it would suggest that the firm would be unable to meet its obligations to clients without such a loan. The staff of the Securities and Exchange Commission (SEC) went so far as to issue a written FAQ reminding advisory firms that are in receipt of PPP loans of this disclosure obligation. The SEC staff also indicated in the FAQ that, in its view, if a firm requires assistance to pay the salaries of its employees who are primarily responsible for performing advisory functions for clients, this fact would need to be disclosed. Some firms may skirt disclosure requirements by saying that they are not paying their investment professionals with their PPP loan proceeds, but dollars are fungible and we do not think the argument withstands scrutiny.
Registered Investment Advisors (RIA's) that have taken PPP funds
A number of RIA’s have taken PPP loans, including some very commercially successful and/or notable ones. We do not understand how such firms can credibly claim that the loan was necessary to support their ongoing operations. Using industry benchmarking studies, we estimate that a large RIA’s revenues would need to decline about 25% for firms before even relatively bloated firms would need to worry about covering overhead.(1)
This could be considered an extreme scenario, as markets have already bounced back significantly since their March lows. As we write this today, the S&P 500 is down about 5% year to date, and the Bloomberg US Aggregate bond index is up about 5%. That implies a 50/50 benchmark is about flat on the year. Perhaps client accounts are down more than these numbers might suggest, since globally diversified stock portfolios have losses that exceed those of the S&P 500, but it would appear to be a stretch for a typical RIA to credibly claim that the receipt of a PPP loan was “necessary”.
Our Thoughts on other Industry Participants Taking PPP
In our view, a large RIA should not need to take a PPP loan to avoid laying off employees or to weather a downturn. This is particularly true for RIA’s disclosing PPP loans now, as markets have had a surprising recovery.
Investors are right to ask the firms that provide them with financial advice whether they have received PPP loans. This is particularly true because some firms that have received PPP loans might be dancing on the head of a pin to justify not disclosing that fact to clients, notwithstanding strong evidence that the SEC staff believes such disclosure to be required. Either the PPP funds were necessary, or they were not. If they were necessary, the firm’s financial condition is precarious and clients should be informed. If they were not necessary, the firm certified to something in the PPP application that is not true. Therefore, in our opinion, advisory firms should not be telling the SBA and the Federal Government that these loans are necessary to continue their operations but represent to their clients that these loans are no big deal or fail to communicate this information to clients at all.
We chose to share about our decision regarding PPP and call out our industry’s participation in a government program. Most of our industry bills quarterly, often in advance, at contractual rates with good profit margins. When market returns are negative, revenues go down, but that goes with the territory and it is what you sign up for as a business owner in financial services.
At Accretive, we are confident in our decision to decline the PPP and believe our business will emerge from this crisis improved and strengthened.
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1: TD Ameritrade Institutional Benchmarking "The Six Dimensions of Standout Performance" 2018