Some brokers with PPP loans for undisclosed side hustles might have to pay them back

Some financial advisors might have to repay their forgivable pandemic loans.

That’s the unpleasant prospect for brokers now under scrutiny by Wall Street’s self-regulator over whether they violated industry rules or securities laws when they received Paycheck Protection Program loans.

Bloomberg News

“If you’ve got a regulatory inquiry or violation, it could jeopardize your ability to seek forgiveness of that loan,” said Matthew Schwartz, a securities litigation lawyer at Kass Shuler in Tampa, Florida.

Added Robert Willens, an independent tax and accounting expert in New York: “I would imagine they would run the risk of losing ‘forgivability’ of the loan.”

FINRA began probing last month whether registered representatives — independent financial advisors who trade securities through a broker-dealer or brokerage but don’t work for those firms — violated FINRA rules about fessing up to outside business activities, or flouted federal securities laws, when they took out the loans. PPP money can be enticing for brokers with small-business side gigs, like a cafe or consulting firm, that the pandemic may have imperiled. The issue is whether brokers have disclosed to FINRA as required those so-called outside business activities.

The flood of forgivable, government-backed loans — $523 billion from last April through August, and another $284 billion in new funding on tap as of last December — has been the government’s signature effort to keep small businesses afloat in the COVID economy. More than 1,400 financial advisory firms took out PPP loans of more than $150,000 each in the first round, according to Small Business Administration data.

Since last October, borrowers who have used the bulk of their PPP cash to pay employees have been able to apply for forgiveness from the federal government. Loans that aren’t erased have to be repaid at one percent interest over two or five years, depending on whether they were issued before or after June 5, 2020.

The loans, from banks and other private lenders, are forgiven by the SBA if a borrower can document that at least 60% of the money was used to pay employees, and the rest went to eligible business expenses. Borrowers have to fork over business receipts, cancelled checks, bank records, documents showing the number of full-time employees, evidence of business rent or lease and utilities payments, Internal Revenue Service payroll tax forms and state quarterly wage forms as proof.

Brokers who got PPP money for undisclosed side hustles shouldn’t automatically panic, said Ronak Patel, Co-Chair of the Securities Litigation & Enforcement at Winstead, in Austin, Texas. “It’s not a matter of course that not disclosing, say, your donut shop, would automatically cancel out loan forgiveness.” Those with fully disclosed outside activities have little to fear, given that brokers typically don’t report to FINRA their investment scams. For others, “it’s an easy regulatory inquiry for the regulators and for the firms to do a double check against the (SBA) list to see that their outside representatives are disclosing,” said Emily Gordy, a securities lawyer at McGuireWoods and a former Deputy of Enforcement at FINRA. She compared the process to “shooting fish in a barrel.”

Side businesses are common among independent financial advisors, particularly in remote or rural areas, according to the Financial Services Institute. But they’re not always permitted. Undisclosed or illegal gigs have ranged from freelance accounting services and immigrant visa mills to industrial warehouses for growing medical marijuana and running Ponzi schemes, according to FINRA disciplinary proceedings.

Even before the pandemic, FINRA was concerned with sussing out brokers’ unreported outside business activities. The investment firm that a broker is affiliated with typically files the required disclosure, known as Form U4, with FINRA.

Now, Schwartz said, brokers who took out — or plan to take out — PPP loans are “by definition indicating” that they have a business that needs cash — and are thus “inviting FINRA” to see whether that business is a side hustle that has been disclosed.

Edward Wegener, a former Senior Vice President and Midwest Regional Director focused on regulatory risk management and compliance at FINRA, said that a broker’s unreported activities could in fact be legitimate, like owning rental properties. Or they could be an investment scam. He called PPP loans “a shiny lure” for unscrupulous brokers. There are 624,674 registered representatives, according to FINRA data.

But Dean Zerbe, a tax lawyer in Houston who is National Managing Director of Alliantgroup and a former tax counsel to the Senate Finance Committee, argued that a broker who doesn’t report his outside business doings could be seen as engaged in “gross negligence or fraud on the US government.” The reason, he said: “You’re improperly engaged in activities that you didn’t disclose.”

The SBA’s most recent guidance on loan forgiveness doesn’t mention what happens if a loan recipient runs afoul of industry regulations or securities laws. The SBA did not respond to repeated requests for comment.

Because both the government and lenders effectively allowed borrowers to pinky-swear in good faith on their applications that they needed the money, the PPP loan program has been rife with fraud, according to industry watchdogs.

The SBA initially released granular data for borrowers who took up to $150,000. Last December, a federal judge ordered it to disclose the identities of borrowers of all sums. Gordy said that “I am sure there are folks out there that did seek PPP loans for their OBA (outside business activities), and they may be surprised” once FINRA cross-checks SBA data on loan recipients with broker disclosures.

A FINRA spokesperson declined to elaborate, saying only that “FINRA is proactively looking at registered representatives that obtained loans through undisclosed outside business activities.”

With mounting scrutiny by the Treasury Department and Justice Department of PPP loan fraud, brokers who took out the loans to prop up undisclosed side hustles “should sprint to talk to your lawyers and give the money back” to the government, Zerbe said. “I wouldn’t wait for a FINRA call. I’d go ahead and just unwind it all and get yourself clean.”