Update on COVID-19 in the financial services sector

As various US states (and some foreign countries) make plans to relax quarantine restrictions, there continue to be new developments in financial regulation in response to COVID-19. Our observations on the week’s key developments follow.

US government agencies, especially those involved in the Paycheck Protection Program (PPP), have been focused on accountability and transparency. It has been widely reported in the media that several large corporations received PPP loans (which some of those companies are voluntarily returning). Those reports have led to concern that the initial tranche of PPP funding was not disbursed to support small businesses, as Congress intended. The Small Business Administration (SBA) and the Department of the Treasury have clarified the types of businesses that are eligible for PPP loans and established a safe harbor for any companies that received PPP loans based on a misunderstanding of the eligibility requirements (to qualify for the safe harbor, companies must repay the loan by May 7). Meanwhile, several members of Congress have urged the Inspectors General at the two agencies to investigate whether the program has been properly administered.
Many of the COVID 19-related rules promulgated by federal agencies have provided opportunities for public comment, as is common in agency rulemaking generally. Given the political profile of the COVID-19 crisis and the relief efforts, financial institutions may wish to consider using these opportunities to provide input (or seek clarity) on ambiguous provisions of the rules, to ensure that there are no misunderstandings in the coming months and years.

COVID-19: Weekly update for financial services clients

Must Read Developments through April 30

Recent developments include:

The Small Business Administration (SBA) published an interim final rule clarifying the types of businesses that are eligible for the PPP and providing other guidance. The interim final rule specifies that hedge funds, private equity firms, and bankrupt businesses are not eligible for PPP loans.
- The interim final rule also authorizes a safe harbor for businesses that obtained loan funds “based on a misunderstanding or misapplication” of the program’s requirement that PPP applicants certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the [a]pplicant.”
- This safe-harbor provision appears intended to respond to public scrutiny of the program following reports that large businesses received PPP funds. Businesses that received funds based on a “misunderstanding or misapplication” are required to repay their loans in full by May 7.
- Separate guidance from the Department of the Treasury reiterates the May 7 deadline for returning loan funds and emphasizes the need to certify in good faith that the PPP loan request is necessary for the applicant’s business. The guidance notes that “it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith,” and that such companies may be requested to demonstrate the basis for its certification.
- In a media interview, Treasury Secretary Steven Mnuchin stated that the federal government will audit all PPP loans over $2M.
- The OCC has issued a Dear CEO letter encouraging banks participating in the PPP “to prudently document their implementation and lending decisions” and “identify and track loans made to small business borrowers with annual revenues of $1 million or less, located in low-to moderate-income areas.”
Several Democratic members of Congress sent letters to the Inspectors General at the SBA and the Department of the Treasury urging investigations into whether the PPP has been appropriately administered – in particular, whether small businesses have been unfairly excluded from the program.
The Fed has committed to publish monthly reports on funds distributed under the “liquidity and lending facilities” governed by the CARES Act. These reports will include: (1) “[n]ames and details of participants in each facility;” (2) “[a]mounts borrowed and interest rate charged”; and (3) “[o]verall costs, revenues, and fees for each facility.”
- Separately, the Fed also published an interim final rule “amending [its] Regulation D … to delete the numeric limits on certain kinds of transfers and withdrawals that may be made each month from ‘savings deposits.’” The announcement states that “financial disruptions arising in connection with the novel coronavirus situation have caused many depositors to have a more urgent need for access to their funds by remote means, particularly in light of the closure of many depository institution branches and other in-person facilities."
The SEC has formed a coronavirus task force, called the COVID-19 Market Monitoring Group, with representatives from several SEC divisions. The group will: (1) help the agency prepare various forms of regulatory relief, market analyses, and other actions in response to the crisis; and (2) coordinate the SEC’s coronavirus-related cooperation with other government agencies, including the SEC’s participation in multiagency processes (e.g., the President’s Working Group on Financial Markets).
- The SEC also issued two new FAQs, which provide that the SEC will not recommend enforcement action against certain broker-dealers if the COVID-19 pandemic interferes with their ability to comply with regulatory obligations requiring them to: (1) to send customer checks during April, May, or June 2020; and (2) conduct quarterly counts of physical securities certificates. To qualify for the no-action relief, however, broker-dealers must comply with certain conditions set out in the FAQs.
- The SEC brought its first enforcement action against a company based on misstatements related to COVID-19 (the SEC had previously ordered a trading halt for the issuer’s shares). The company, Praxsyn Corp., allegedly issued press releases in which it falsely claimed to be negotiating the sale of millions of N95 masks and that it already had a large quantity of masks available, for which it had received orders. Praxsyn later issued a statement admitting that these statements were false and that it never had any masks available.
The CFTC has granted targeted no-action letters to: (1) provide relief for futures commissions merchants and introducing brokers participating in the PPP under certain conditions; and (2) grant temporary relief relating to fingerprinting requirements.
The CFPB issued an interpretive rule stating its position that, under the Electronic Funds Transfer Act and applicable regulations, government agencies distributing COVID-19 relief funds may require consumers to establish an account “with a particular financial institution as a condition of receiving pandemic relief payments,” subject to certain conditions laid out in the rule.
FINRA provided new guidance regarding: (1) disclosure of mark-ups on trades in fixed-income products; and (2) FINRA’s decision to give funding portal members additional time to pay the Funding Portal Gross Income Assessment.
On April 30, the Fed announced that “it is expanding the scope and eligibility for the Main Street Lending Program” (MSLP) by:
- creating a new loan option (in addition to the preexisting MSLP “priority” and “expanded” options) under which “lenders would retain a 15 percent share on loans that when added to existing debt do not exceed six times a borrower's income”;
- lowering minimum MSLP loan size to $500,000 from $1M; and
- expanding the pool of MSLP-eligible borrowers to include businesses with up to 15,000 employees or $5B in annual revenue (up from 10,000 employees or $2.5B in annual revenue).
In connection with that expansion, the Fed confirmed that:
- For MSNLF and MSPLF, the methodology used by the Eligible Lender to calculate adjusted 2019 EBITDA for an Eligible Borrower must be a methodology it previously used for adjusting EBITDA when extending credit to the Eligible Borrower or to similarly situated borrowers on or before April 24, 2020.
- For MSELF Eligible Loans, the methodology used by the Eligible Lender to calculate adjusted 2019 EBITDA for the Eligible Borrower must be the methodology it previously used for adjusting EBITDA when originating or amending the underlying loan on or before April 24, 2020.
- Based on feedback from potential participants that quickly implementing new systems to issue loans based on SOFR would require diverting resources from challenges related to the pandemic. Although financial institutions are transitioning to more robust reference rates, LIBOR remains the most common base rate used in business lending, even though firms cannot rely on LIBOR being published after the end of 2021. Consistent with the recommendations of the Alternative Reference Rates Committee, Eligible Lenders and Eligible Borrowers should include fallback contract language to be used should LIBOR become unavailable during the term of the loan.
- MSNLF Loans, MSPLF Loans, and MSELF Upsized Tranches may be secured or unsecured.
- An MSELF Upsized Tranche must be secured if the underlying loan is secured. In such case, any collateral securing the underlying loan (at the time of upsizing or on any subsequent date) must secure the MSELF Upsized Tranche on a pro rata basis. Under such an arrangement, if the borrower defaults, the SPV and lender(s) would share equally in any collateral available to support the loan relative to their proportional interests in the loan (including the MSELF Upsized Tranche). Eligible Lenders can require Eligible Borrowers to pledge additional collateral to secure an MSELF Upsized Tranche as a condition of approval.
- Eligible Borrowers should make commercially reasonable efforts to retain employees during the term of the MSNLF Loan, MSPLF Loan, or MSELF Upsized Tranche. Specifically, an Eligible Borrower should undertake good-faith efforts to maintain payroll and retain employees, in light of its capacities, the economic environment, its available resources, and the business need for labor. Borrowers that have already laid-off or furloughed workers as a result of the disruptions from COVID-19 are eligible to apply for Main Street loans.