Managing Director, Forensics and Litigation Services Weaver
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What to Know About Fraud and the Paycheck Protection Program

Now that the SBA has opened its PPP forgiveness portal and lenders begin to accept forgiveness applications, the review process will undoubtedly uncover more fraud. This article covers how some borrowers are perpetrating fraud so you can be more aware and potentially help prevent the issue.

Aug 27th 2020
Managing Director, Forensics and Litigation Services Weaver
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As we know, the Paycheck Protection Program (PPP) has provided a lifeline to more than 5.2 million small businesses, sole proprietors, independent contractors and self-employed individuals; disbursing over $525 billion in forgivable loans. But as of August 25, 2020, the U.S. Department of Justice has filed charges in 37 matters, and counting, against more than 50 defendants for fraudulently applying for or obtaining hundreds of millions of dollars in PPP funds.

A common theme among fraud perpetrators was the falsification of documents submitted to lenders and the misrepresentation of certifications in loan applications. Falsified documents included everything from bank records and tax files to insurance reports, payroll records, and audited financial statements.

One defendant submitted a list of employees that investigators found was obtained from a publicly available random name generator on the Internet. In another instance, the partnership applying for the loan was not created until April 2020, days before the loan application was submitted. Several defendants falsely denied that they had been convicted of a felony in the past five years.

In a particularly ambitious scheme, a group of nine defendants conspired to obtain millions of dollars in fraudulent PPP loans. The first of the defendants allegedly obtained a fraudulent PPP loan for his company using falsified documents. 

After submitting that application, they allegedly began to work with other co-conspirators on a scheme to submit numerous fraudulent PPP loan applications in exchange for kickbacks. The scheme involved the preparation of at least 90 fraudulent applications totaling more than $24 million.  Many of those loan applications were approved and funded by financial institutions, distributing at least $17.4 million.

Were Known Fraud Risks Adequately Addressed?

In an April 3, 2020 report about the SBA’s 7(a) loan program, the Office of Inspector General (OIG) warned about certain general areas of risk in all 7(a) loan programs. For example, the OIG pointed out that increased guarantees from the SBA reduced the risk to lenders. As a result, lenders may not have the incentive to exercise due diligence in originating loans, thereby increasing the risk of potential financial losses to the SBA.

In addition, increased loan volume, loan amounts, and expedited loan processing timeframes may make it more difficult for the SBA to identify red flags in loan applications. A later review of the PPP program affirmed some of these risks.

In its initial report on its ongoing oversight efforts, the U.S. Government Accountability Office (GAO) stated that, “because of the number of loans approved, the speed with which they were processed, the limited safeguards and lack of timely and complete guidance associated with the PPP, there is a significant risk that some fraudulent or inflated applications were approved. In addition, the lack of clear guidance has increased the likelihood that borrowers may misuse or improperly receive loan proceeds.”

In hindsight, there were key OIG recommendations that were not met for the PPP program. This may have opened the door to fraud. For example:

1. Issue clear requirements and ensure timely communication to lending partners.

The GAO stated that publishing answers to FAQs and frequently updating guidance on a rolling basis, left lenders and borrowers confused. The SBA did not release the loan forgiveness application until May 15, 2020, and delayed posting key regulations on loan forgiveness until May 22, 2020, one week later. More than four million loans were approved before borrowers received this critical clarifying information on loan forgiveness.

2. Establish proper controls in the loan approval phase to ensure eligibility of participants and to mitigate the risk of loan default.

The SBA’s initial interim final rule allowed lenders to rely on borrower certifications to determine the borrower’s eligibility and use of loan proceeds. The process required limited lender review of documents provided by the borrower to determine the qualifying loan amount and eligibility for loan forgiveness.

The GAO stated, “Reliance on applicant self-certifications can leave a program vulnerable to exploitation by those who wish to circumvent eligibility requirements or pursue criminal activities” and “because of the limited loan underwriting, lenders and SBA have less information from applicants to detect errors or fraud.”

3. Establish a quality assurance plan to prevent and detect improper payments.

The SBA has announced efforts to implement safeguards after loan approval. Treasury Secretary Steven Mnuchin announced on April 28, 2020 that the government will perform a full audit on all companies receiving more than $2 million in PPP loans before forgiving the debt. The SBA expects to facilitate these reviews through electronic screening of borrower and loan characteristics that may confirm the validity of the certification.

How Do Previous Economic Stimulus Loan Programs Compare?

Fraud is not unique to the PPP program. The OIG has reported deficiencies in previous SBA loan programs, including:

1. Origination and Closing Deficiencies: In OIG’s report on 7(a) Recovery Act Loan Approvals, 40% of 7(a) stimulus loans showed deficiencies. Nearly 2,000 (1,996) of the loans were not originated and closed in compliance with SBA’s policies and procedures, translating to at least $869.5 million in inappropriate or unsupported loan approvals. 

2. Eligibility problems: OIG’s report on Audit of the SBA’s Administration of the Supplemental Terrorist Activity Relief (STAR) Loan Program found that the SBA did not ensure that only eligible borrowers obtained stimulus loans.  This report also showed that lender files did not contain sufficient information to demonstrate that borrowers were adversely affected as required by SBA loan program policies and procedures.  As a result, eligibility could not be determined for 85% of the loans reviewed. 

What Does This Mean for Most Borrowers?

While stories about fraud in the PPP may make the news headlines, the vast majority of borrowers legitimately received PPP loans and will seek to have them forgiven. Most borrowers will be able to demonstrate that they were eligible to receive the loan, they applied for and received the correct loan amount, and loan proceeds were spent on authorized expenses. 

Here are five recommendations borrowers can take to prepare for the forgiveness process and a potential SBA audit:

1. Accurately summarize the ways economic uncertainty – those that existed or were anticipated at the time you submitted your PPP application – made the loan necessary to support ongoing operations.

2. Document your assessment of access to other sources of liquidity.

3. Use PPP funds only for the authorized purposes. If you are unsure – ask your CPA, attorney or other trusted advisor.

4. Document, Document, Document.  Maintain and retain accurate and complete records.

5. Make sure you understand and stay current on evolving loan forgiveness requirements.

Conclusion

When the SBA and other government agencies are tasked with distributing large amounts of money in a short period of time, fraud is an unfortunate byproduct. Since PPP funds have been distributed, the spotlight is now on loan forgiveness and the measures the SBA and lending community will take to uncover fraud in the program. With programs of this size, it takes vigilance and perseverance to outwit and track down those who have misused PPP and other government funds.

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