PPP loans and fraud scrutiny: What financial advisors and small businesses need to know

Nearly 1 in 4 SEC-registered investment advisory firms tapped the multibillion dollar federal aid program as a financial lifeline during the pandemic.
Nearly 1 in 4 SEC-registered investment advisory firms tapped the multibillion dollar federal aid program as a financial lifeline during the pandemic.

With most tax returns now across the filing deadline, some investors and their wealth advisors are confronting potential scrutiny of the free money they received during the pandemic.

More than $800 billion in easy-to-get, mostly forgivable loans went to roughly 11 million businesses in 2020 and 2021, a financial lifeline intended to shore up the backbone of the American economy when COVID-19 ground things to a near halt. Roughly 92% of the federal loans were forgiven by the government. 

Unsurprisingly for quick cash requiring little documentation and honor-system assertions, fraud was rampant. The Internal Revenue Service and Justice Department, along with the watchdog of the brokerage industry and the Securities and Exchange Commission, are taking notice.

As of March 23, the IRS had brought 975 fraud cases totaling $3.2 billion against firms and individuals that improperly received Paycheck Protection Program loans in 2020 and 2021. It's likely the tip of the iceberg: One study by three scholars at The University of Texas at Austin's McCombs School of Business estimated that as much as $117.3 billion was doled out to fraudsters.

Wealth advisors don't always know what certain small business clients are up to. If a customer falls under audit for a PPP loan, "you walk them through how to correct it," said Clark Kendall, the president and CEO of Kendall Capital in Rockville, Maryland. "And you make sure you document it."

Meanwhile, nearly 3,000 investment management firms, or nearly 1 in 4 of all advisors registered with the SEC, tapped the PPP spigot for $590 million, according to an academic study by scholars at the University of San Diego and Frostburg State University, in Frostburg, Maryland, that was published last February in the Journal of Banking & Finance.

The government made PPP loans of up to $10 million available at 1% interest to firms with fewer than 500 employees, a restriction later relaxed for the hotel and restaurant industries. Businesses had to use the loans for up to 10 weeks of payroll costs, capped at $100,000 per worker per year, and keep wages close to pre-crisis levels during the two to six months after receiving the loan. 

Loan recipients could also use the money to pay business mortgage interest payments, rent, utilities, paid medical leave, insurance costs, and state and local taxes. Companies could have their loans forgiven if they used at least 60% toward payroll expenses.

FINRA, which oversees brokers and tracks independent advisors, said in January 2021 that it was looking at advisors who took the loans to shore up outside business activities, such as selling private securities or dealing in confidential client information, that were not disclosed to their employers. Brokers and advisors are supposed to disclose such activities in a document known as Form U4, and the watchdog said some brokers would need to update their disclosures

Asked to comment on its scrutiny, FINRA spokesman William Bagley said Monday, "We can't provide any information about ongoing reviews."

'Abusing'
The Journal of Banking & Finance study estimated that more than 6% of the then-$590 million in loans received by 2,999 investment advisory firms registered with the SEC were improper and "abnormally large." Those loans went "to firms abusing" the government program, authors William Beggs of the University of San Diego and Thuong Harvison of Frostburg State University, wrote.

Most of the dollars went to small or tiny financial planning and wealth management firms, such as Sprague Wealth Solutions in San Ramon, California ($2,585) and Executive Wealth Advisors of Marlton, New Jersey ($3,864). Some 92% of the loans were forgiven. The Small Business Administration doesn't distinguish between firms that got free money and those that repaid it.

But some big industry players with boldfaced names in wealth management also got money.

Dynasty Financial Partners of St. Petersburg, Florida, a network of advisors overseeing roughly $68 billion, took out more than $1.3 million in 2020 to retain 69 jobs. It repaid the loan in 2021.

Ritholtz Wealth Management, which oversaw $1.3 billion in 2020, borrowed nearly $602,000 in 2020 and quickly repaid, Institutional Investor reported, following a firestorm of public criticism. 

Focus Financial Network of Minneapolis received $927,200 and did not repay the money.

Carson Group of Omaha got a $4 million loan in 2020 to cover its events and coaching businesses. Megan Belt, a company spokeswoman, said the company repaid the money.

Some wealth advisors still view the loans as a sign of financial weakness, either actual or perceived. 

"We just decided that it wasn't worth it for us," said Perry Green, the chief financial officer and senior wealth strategist at Waddell & Associates in Memphis. "There was too much opportunity for reputational risk."

But it may have been worth it. 

"I haven't heard anyone that got that PPP money regretting it or losing clients because of it," said Zachary Milam, a vice president at Mercer Capital, a valuation and consulting firm for financial advisors based in Memphis.

Processed by banks, with JPMorgan in the lead, but mostly by financial technology companies, the loans were for payroll costs and regular business expenses, such as mortgage interest on a business's property. They weren't expressly aimed at helping independent advisors deal with the sharp market downturn that materialized as the pandemic unfolded. 

Still, said Max Schatzow, a co-founder and partner at RIA Lawyers in Ewing, New Jersey, "No one knew where the heck the economy was going, where markets were going, where revenues were going." 

He argued that advisors who earn fees on assets under management that plummeted when the S&P 500 fell 34% over February-August 2020 were justified in taking PPP loans because they would have had to "downsize or discontinue their growth plans."

The Journal of Banking & Finance study said that some investment firms said they would retain a number of jobs greater than the payroll figures disclosed on their Form ADV. Investment firms took "liberties" to "exaggerate payroll needs" that "may have facilitated misconduct in the PPP loan procurement process," the study said.

The SEC, which oversees registered investment advisors, warned independent advisors in April 2020 that as fiduciaries, they're obligated to tell clients of any PPP loan or other financial assistance if they "constitute material facts relating to your advisory relationship with clients." 

It cited payment of salaries to employees performing advisory functions and any questions over a firm's ability to meet its contractual commitments to clients as items the firm would need to disclose to regulators on their registration form with the Wall Street regulator.

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Tax Industry News Independent advisors Paycheck Protection Program Audit FINRA COVID-19 RIAs Small business SBA Dynasty Financial Partners Fintech
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