Until recently, government enforcement and regulatory scrutiny of fraud and other misconduct related to COVID-19 assistance programs was generally limited to the ultimate recipients of assistance.
These efforts have primarily been directed against fraud under the Paycheck Protection Program, or PPP, a nearly $1 trillion business loan program administered by the U.S. Small Business Administration, which allowed entities to apply for low-interest private loans to pay their payroll. and certain other charges.
According to the US Department of Justice, approximately 178 people have so far been convicted in PPP fraud cases, and numerous other investigations and prosecutions have been initiated. Almost all of these cases involved borrowers who provided false information to obtain the loans, misappropriated loan proceeds, or made false statements in connection with loan cancellation.
The next phase of enforcement can be seen as beginning last month when federal prosecutors in New York charged Rafael Martinez, the managing director of a PPP lender, with multiple federal crimes for what could be called a triple PPP cheat game:
1. Make false statements on a PPP loan application for his own company, MBE Capital Partners LLC;
2. Misrepresent MBE qualifications with the SBA so that MBE becomes a non-bank PPP lender with the SBA; and
3. Make other arrangements to obtain collateral to use for borrowing through a Federal Reserve liquidity facility known as the Payment Protection Program Liquidity Facility.
The crimes charged in this case include wire fraud, bank fraud and misrepresentation to the SBA. The case, which appears to be the first criminal prosecution of a PPP lender, has been strongly touted by the DOJ as a major step in the fight against COVID-19 relief fraud. The lawsuits against MBE are significant because they likely presage increased government control over bank and non-bank PPP lenders.
Data provided by the SBA shows that smaller banks and non-bank lenders account for a large percentage of PPP loans made and total net loan amounts. For example, during the PPP, a total of 4,105 relatively small banks and credit unions, each with assets below $1 billion, issued and approved a total of 1,812,102 PPP loans with a net loan amount of over $101.5 billion. .
As the government continues to investigate and prosecute PPP borrowers – seen as low hanging fruits where much fraud is blatant and easily detectable – it is likely to increasingly prosecute banks and other non-traditional lenders when it can be shown that the lender went bankrupt to comply with its bank secrecy law and anti-money laundering obligations, or turned a blind eye to suspicious PPP loan applications .
Four areas to watch
Government oversight of PPP lenders is likely to focus on the following areas.
Under rules promulgated by the SBA under the PPP, banks must “continue to follow their existing BSA protocols when making PPP loans to new or existing customers who are eligible borrowers under the PPP,” while non-bank lenders need to develop proper AML protocols.
Compliance not only involves taking appropriate steps to prevent potential fraudulent borrowing, but also monitoring borrower activity for ongoing fraud and filing suspicious activity reports when appropriate. Failures to comply could result in penalties under the BSA or, if systemic, potential liability under the False Claims Act.
Existing Borrower Fraud Cases
The government will likely look closely at borrower fraud cases to determine whether lender insiders in these cases aided or facilitated the fraud in any way. If this is the case, the lender itself can be held liable. Instances of borrower fraud may also result in exposure to non-compliance with BSA/AML requirements.
Lenders may receive subpoenas or other requests for information in connection with instances of borrower fraud. The government will expect to receive, in response to these requests, information required to be collected under the SBA’s rules governing the PPP program.
If a lender’s response to government inquiries suggests gaps in compliance with SBA or BSA/AML requirements – for example, failure to obtain necessary SBA certifications or file a business report suspect if any – or if the documents provided suggest that the lender did not act in good faith in making the loan or in canceling the PPP loan, the government may open a wider investigation into the conduct of the lender.
Suspicious loan patterns
The government is also likely to identify, for further scrutiny, lenders whose lending habits are deemed suspicious by the government. These may include:
- Financial institutions behind a large number of fraudulent loans;
- A disproportionate number of high-risk loans, such as loans to foreign companies or non-customers; or
- A disproportionate number of loans close to the maximum loan amount of $10 million or just below certain key thresholds such as $2 million – below which a safe harbor applies as to the need for the loan.
It is likely that the government will use quantitative analysis to target lenders based on these and other factors that the government believes warrant further examination.
Fair Lending Concerns
The Consumer Financial Protection Bureau enforces the Equal Credit Opportunity Act, which prohibits commercial creditors from discriminating against any applicant based on any factor unrelated to creditworthiness, eg race, national origin, gender. The CFPB announced that it has reviewed and analyzed current market developments related to COVID-19 and determined that PPP loans are among the issues most likely to pose a risk to consumers.
Proactive measures to mitigate risks
Lenders are afforded liability protection under SBA rules, which provide that lenders must be “held harmless” in the event of borrowers failing to meet PPP program criteria and will not do so. subject to any enforcement action or sanction related to the granting of the loan. or cancellation of the PPP Loan if the Lender (1) “is acting in good faith with respect to making or canceling the PPP Loan” and (2) “satisfies all other federal, state, local and other applicable legal or regulatory requirements.”
But the question remains: What constitutes good faith? The rules do not provide a clear answer and the extent of this protection has yet to be tested.
Lenders can take several proactive steps to mitigate the risks associated with potential government scrutiny of their PPP loans, including:
- Consult PPP experts to understand PPP risks and potential liability;
- Conduct targeted loan reviews of PPP portfolios to ensure loan files contain proper documentation and information does not flag fraud or misrepresentation;
- Conduct independent BSA/AML testing focused on assessing the adequacy of the policies, procedures and controls that were in place when the PPP loans were created; and
- Prepare to interact with government investigators upon receipt of a subpoena or government request for PPP-related records.
The DOJ’s recent action against a PPP lender and the alphabet soup of government agencies involved in this and other PPP fraud investigations show that a host of federal and state agencies are gearing up to intensively investigate the PPP fraud and misconduct. These include the Pandemic Response Accountability Committee created by the Coronavirus Aid, Relief, and Economic Security Act; the GM; the US Department of Health and Human Services; the SBA; the Federal Deposit Insurance Corp.; and state attorneys general.
Given the increased enforcement that PPP lenders are likely to face in the months and years to come, banks and other lenders would be well advised to take proactive steps to ensure that their PPP loan portfolios can withstand government scrutiny.
Republished with permission. This article, “Prosecution Of NY Lender Marks Shift In PPP Enforcement”, was posted by Law360 April 19, 2022 (login required).