FINRA Provides Critical Guidance on Net Capital Treatment of Loans Obtained by Broker Dealers through the Paycheck Protection Program of the CARES Act

Business Litigation Update

Date: April 07, 2020

Key Notes:

  • Forgivable PPP loans under the CARES Act are available to most independently-owned broker dealers;
  • New FINRA guidance treats PPP loans as net capital neutral for FINRA member firms.

Smaller securities broker-dealers are likely eligible for forgivable loans under the Paycheck Protection Program (PPP), part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The PPP authorizes Small Business Administration (SBA) approved lenders to provide loans to certain eligible businesses on borrower-friendly terms, including low interest rates and loan forgiveness, without federal tax consequences, if certain payroll levels are met at the conclusion of the second quarter of 2020. Amid investor uncertainty and market turmoil, these loans may be particularly attractive to broker-dealers seeking capital liquidity to maintain sales force and consistent operations during the height of the COVID-19 pandemic. But broker-dealers eyeing the PPP were unclear how these loans—which are legislatively-designed to effectively turn into government grants—would be treated under existing “net capital” rules and calculations. To that end, the Financial Industry Regulatory Authority (FINRA) has published guidance for broker-dealers addressing key issues regarding how broker-dealers can account for PPP loans under existing net capital requirements and obtain favorable treatment.

Paycheck Protection Plan Loans

Loan Term Basics. The PPP loan rules are set forth in Section 1102 of the CARES Act, amending Section 636(a) of the Small Business Act, and permit SBA lenders to offer loans to small businesses in an amount up to 2.5 times a borrower’s “payroll costs” (as defined), with a $10 million maximum. Small businesses—with some exceptions—are defined as companies with 500 or fewer full and part-time employees. Under recent guidance issued by the SBA in coordination with the Department of Treasury, loan terms include:

  • 1% interest;
  • Automatic 6 months deferment;
  • 2-year maturity;
  • No prepayment penalties;
  • 100% guaranteed by the SBA; and
  • No personal guaranty or collateral.

At least 75% of the loan proceeds must be used for payroll costs and the remainder may be used to pay obligations in existence before February 15, 2020, including interest on the borrower’s mortgage obligations, rent, utilities, and interest on other debt obligations.

Loan Forgiveness. PPP loans may be forgiven in an amount equal to a borrower’s actual payments for payroll, interest on covered mortgages, covered rent, and covered utilities as calculated over an 8-week period after the loan is obtained. This amount may be reduced if a borrower reduced workforce or reduced employees’ compensation as compared to a defined lookback period in 2019. The forgiveness amount must be comprised of at least 75% payroll costs.

500 Employee Maximum Across Affiliated Entities. Applicants to the PPP will have to consider the SBA’s existing affiliation rules. Under SBA regulations, the employees of an affiliate are counted as employees of the applicant for purposes of determining compliance with the 500-employee cap on the small business loan program. These affiliate rules deem an applicant’s affiliates to include:

  • individuals or entities that own or control 50% or more of the applicant’s voting power;
  • entities with common management or Board members; and
  • minority shareholders with the ability to block corporate actions.

Careful consideration of a potential borrower’s ownership and management, to determine eligibility under the PPP as a “small business,” is necessary before planning for any PPP loan.

FINRA Net Capital Guidance

Anticipating that many member firms will obtain PPP loans, FINRA has updated its Frequently Asked Questions to provide a detailed explanation of net capital relief for members borrowing under the PPP. Of welcome relief to broker-dealers, FINRA guidance dictates that PPP loans are to be net capital neutral and do not add to aggregate indebtedness. Additionally, certain expenses related to the loans can be added back to net capital.

To obtain this treatment, member firms may:

  • add back to net capital the forgiveness amount under the PPP to the extent the member firm has recorded expenses for the costs making up that amount;
    • the add-back amount must not exceed the liability recorded on the member firm’s balance sheet;
  • exclude the PPP loan from aggregate indebtedness for the 8-week period following issuance of the loan; and
  • after the 8-week period, exclude from aggregate indebtedness the forgiveness amount making up the add-back.

Members must reasonably calculate the forgiveness amount based on the provisions of CARES Act, and the PPP, and retain documentation and records supporting the calculation. The computation must include any estimated reductions in the forgiveness amount tied to a decrease in workforce and/or employee compensation. Members must maintain documentation of the costs and payments that actually comprise the loan forgiveness amount.

Member firms are instructed to report PPP loan liability and the net capital add-back amount on their quarterly FOCUS Reports.

FINRA has also provided guidance and relief concerning member firms’ annual assessment payments. Small firms are advised to follow GAAP and determine whether to accrue a liability for their 2020 annual assessment. If a liability is accrued for an unpaid annual assessment, small firms may add back the amount of that liability to their net worth for purposes of computing net capital and exclude the liability from their aggregate indebtedness in computing their minimum net capital requirement. This relief is only permitted until September 1, 2020.


For more information, please contact:

Riccardo M. DeBari

Brian Lanciault

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