PPP Fraud Actions Highlight Importance Of Lender Vigilance

By Richard Alexander, James W. Cooper and Kevin Toomey
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Law360 (June 23, 2020, 3:44 PM EDT) --
Richard Alexander
James W. Cooper
Kevin Toomey
As anticipated, beginning in early May, the U.S. Department of Justice began bringing actions against individuals for fraudulently seeking forgivable loans guaranteed by the Small Business Administration through the Paycheck Protection Program, or PPP, as established by the Coronavirus Aid, Relief, and Economic Security, or CARES, Act.

During the first month of enforcement, the DOJ announced seven separate actions against applicants for filing fraudulent applications for PPP funds. In total, the eight defendants charged in the actions sought more than $40 million in PPP loans, with individual requested loan amounts ranging from approximately $105,000 to more than $6 million.

This first wave of criminal actions demonstrates the DOJ's prioritization of investigations of bad actors seeking to defraud the government and profit off of emergency lending programs.

The speed with which the DOJ brought these actions — the initial round of the PPP launched in early April — is also a credit to many lenders that participated in the various investigations, including by identifying red flags, reporting information to the FBI and the DOJ, and cooperating with agents and prosecutors.

As more than 5,000 bank and nonbank lenders throughout the country rush to disburse $660 billion in funds allocated to the PPP and inject much-needed stimulus into small businesses and the economy, many lenders remain wary of the scrutiny that may be applied to them by the DOJ,  regulators and other government agencies.

Such scrutiny, if and when it occurs, will likely focus on perceived lapses in anti-money laundering compliance and failures to conduct adequate customer due diligence on borrowers or failures to monitor and report suspicious activity in connection with the loan applications or the applications for forgiveness.

A closer look at the charging documents in the first DOJ actions reveals extensive lender involvement in the investigations, provides examples of monitoring and reporting that has proven valuable to prosecutors, and may be informative for lenders and their compliance departments as they tailor their anti-money laundering programs to assure that they are reasonably designed to address the risks presented by lenders' involvement in the PPP. For example:

In U.S. v. Fayne, a reality television personality allegedly submitted a fraudulent loan application to a bank seeking more than $2 million in PPP funds to pay a payroll of 107 employees for his company, Flame Trucking, when, in fact, the proceeds went toward unauthorized uses.

After the loan proceeds were disbursed, the defendant transferred $350,000 of the proceeds to an individual at another bank. According to the affidavit in support of the complaint, an investigator at the receiving bank questioned the recipient about the wire transfer, and the recipient explained that she was not an employee of Flame Trucking and that the originating party was her brother.

She also explained to the investigator that she disbursed $84,000 of the funds to a jewelry store and another $40,000 to an individual for child support services, both at the direction of the defendant.

In U.S. v. Rai, a Texas-based engineer was charged with allegedly filing multiple loan applications fraudulently seeking more than $10 million in PPP funds to pay a payroll of 250 employees, when, in fact, he had no employees working for his business.

According to the affidavit in support of the complaint, during a review of the application for PPP funds, a senior vice president in the lender's regulatory compliance department noticed multiple discrepancies in the applicant limited liability company's employment information, concluded the application may be fraudulent, and, based on the discrepancies, the lender denied the application.

Following the denial, law enforcement sought financial records from two other lenders. At the request of law enforcement, a representative from one of those lenders recorded a telephone conversation with the defendant for the purpose of confirming information listed on the PPP loan application for the applicant LLC.

In U.S. v. Staveley, two individuals were charged with conspiring to seek forgivable loans guaranteed by the Small Business Administration, claiming to have dozens of employees earning wages at four different restaurant business entities when, in fact, there were no employees working for any of the businesses.

According to the affidavit in support of the complaint, one of the lenders that received a loan application from the defendants had prepared an enhanced due diligence review analysis memorializing the lender's due diligence on the loan opportunity, ultimately concluding that the business was not legitimate.

Specifically, the analysis detailed that the restaurant business had closed in November 2018, that the local government tax assessment database indicated the property of the business had been purchased by another company in January 2020, and that a drive by of the property by the lender's Bank Secrecy Act officer indicated that the property was "currently in disrepair. There were dumpsters on-site and large red/orange notices indicating 'stop work' posted on door and windows of property. The restaurant has not been functional since it closed in 11/2018."

These actions demonstrate how several financial institutions, including lenders, but also counterparty institutions that receive proceeds of PPP loans, have been successful in identifying red flags and alerting law enforcement of their findings.

Importantly, lenders should continually evaluate trends observed from public resources (i.e., enforcement actions, agency releases, Small Business Administration FAQs) and during their monitoring of PPP applications, and document and communicate these red flags to the business lines and compliance function.

PPP lenders should also establish policies and procedures for monitoring and reporting suspicious activity relating to the both loan and forgiveness applications in order to set clear standards for compliance staff and establish records for supervisory examination.

PPP lenders that design and implement anti-money laundering programs in a manner to identify irregularities and discrepancies in loan applications and transaction activity, and diligently memorialize their program procedures and customer due diligence findings, will be well-positioned to withstand governmental scrutiny if, and when, the agencies turn their focus from the applicants to the intermediary financial institutions that are disbursing the stimulus funds.

Finally, adding an extra degree of scrutiny to the distribution of stimulus funds is the recent appointment of the special inspector general for pandemic recovery. On June 2, the U.S. Senate confirmed Brian Miller for this post. Pursuant to the CARES Act, Miller will have the authority to conduct, supervise and coordinate audits and investigations of "the making, purchase, management, and sale of loans, loan guarantees and other investments" made by the secretary of the U.S. Department of the Treasury, including PPP loans — as well as a $25 million fund backing his efforts.

The special inspector general for pandemic recovery is directed to maintain current lists of businesses receiving assistance and total amounts outstanding, and will also be required to submit quarterly reports to Congress on such information.

If history is an indication, the special inspector general will have an outsize enforcement role. In the wake of the 2008 financial crisis, the special inspector general for the troubled asset relief program, tasked as the watchdog for $425 billion in financial commitments, emerged as an active investigator and law enforcement agency, the investigations of which resulted in convictions of, or penalties against, 380 defendants.

Richard Alexander is a partner and chairman at Arnold & Porter.

James W. Cooper is a partner at the firm 

Kevin Toomey is a senior associate at the firm.

Partners Christopher Allen, David F. Freeman Jr., Jonathan Green and Michael Mancusi contributed to this article.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

For a reprint of this article, please contact reprints@law360.com.

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