By Paul Tzur, William Lawler and Martin Teckler

Law360 (November 10, 2020, 5:00 PM EST) --

Paul Tzur

William Lawler

Martin Teckler

As borrowers prepare, certify and submit hundreds of thousands of Paycheck Protection Program loan forgiveness applications, lenders and third parties need to be aware of and assess various risks they face in this process. The U.S. Department of Justice and U.S. Small Business Administration are reviewing and investigating all violations of the PPP, not just those caused by borrowers.

In this two-part article, we discuss potential pitfalls for PPP borrowers, lenders and third parties and provide recommendations for avoiding potentially serious legal jeopardy as their loan forgiveness applications face investigators' and prosecutors' scrutiny.

The first installment analyzed potential DOJ and SBA investigation angles on forgiveness applications from the perspective of borrowers, while this second installment takes the perspective of lenders and third parties.

As of September, federal prosecutors have brought criminal charges across the country against more than 50 people alleging more than $175 million in PPP fraud schemes.[1]

But that is only part of the story.

With borrowers continuing to submit applications to SBA seeking full or partial forgiveness of their PPP loans, lenders and third parties need to be aware of a variety of risks surrounding misuse of loans and abuse of the process.

Over the past few weeks, lenders have self-reported PPP and disaster relief loan fraud among their own employees. Lenders and third parties need to ensure that they have robust controls in place; that they have adequate management and audit functions in place to review employee behavior; and that they are maintaining a strong tone at the top of compliance and adherence to regulations.

Lenders and Third Parties Must Identify Risks

Lenders and third-party loan service providers are not immune to possible fraud by individuals or groups of employees within their organizations. The top 15 lenders of funds under the PPP issued more than $156 billion in more than 1.6 million loans.

These numbers are staggering and have provided ample cover for enterprising employees to commit fraud.

For example, lender employees had opportunities during the PPP loan application period to create fictitious companies and corporate documents to support loan applications for those fake companies. And, now that we are at the forgiveness stage, little more is required of these fraud-committing employees to convert their loans to federal grants.

As another example, employees of lenders and third-party loan processors have had opportunities to scheme with otherwise legitimate borrowers to obtain larger loans than those the borrowers needed, or qualified for, to cover payroll, with portions of the overages being kicked back to the employees.

Here are several considerations for lenders looking to identify potential or suspected fraud.

Audit your employees.

Lender employees involved with underwriting and processing PPP loans are the ones who were closest to the process and most likely to have an opportunity to commit some type of fraud or other wrongdoing.

Consider sampling a set of loans and thoroughly auditing them. Review the borrowers and their businesses. Try to identify competitors and speak with them. Go to corporate offices or worksites, or at least do so virtually.

Investigate as needed.

If you identify an employee or group of employees who may have engaged in fraudulent behavior in issuing loans, consider conducting an internal investigation, either with in-house personnel or outside advisers.

To be sure, this sometimes can be a time-consuming and costly process, and internal investigations often create suspicions and uncertainty within an organization. But internal investigations are necessary to promote the tone of a business organization and to show how any problems are isolated to specific employees and not the result of a failure in the organization's overall culture.

Self-disclose.

How and under what circumstances to self-disclose wrongdoing by employees are always difficult questions to answer. Factors to consider include:

• The size of the issue, both in terms of dollars and number of employees involved:
• The duration of the issue; and
• The confidence that the conduct in fact was wrong or illegal.

The DOJ certainly encourages self-disclosure,[2] though, explaining that it:

• "[E]ncourages corporations, as part of their compliance programs, to conduct internal investigations and to disclose the relevant facts to the appropriate authorities"; and that
  
  
• "[P]rosecutors may consider a corporation's timely and voluntary disclosure, both as an independent factor and in evaluating the company's overall cooperation and the adequacy of the corporation's compliance program and its management's commitment to the compliance program."

Refresh your compliance program.

Without a doubt, the PPP was unprecedented in scope and speed of execution. The administration encouraged lenders to get funds to the businesses that needed them quickly. Processing the more than 1.6 million loan applications under the PPP was not a scenario many (or any) compliance teams contemplated when developing their compliance programs.

Nevertheless, in light of this experience, compliance functions should consider designing new compliance protocols to use in the event that another macroeconomic event triggers a need to underwrite and process huge volumes of loan applications in a short period of time.

Conclusion

With lenders and third parties facing potential investigations or prosecutions over billions of dollars of PPP loans that were extended during the first few months of the COVID-19 pandemic, they must remain vigilant at identifying potential or suspected fraud.

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Paul H. Tzur, William E. Lawler III and Martin D. Teckler are partners at Blank Rome LLP.

Grant E. Buerstetta, partner and co-chair of the firm's finance, restructuring and bankruptcy practice group, 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.

[1] Remarks by Acting Assistant Attorney General Brian Rabbitt, PPP Criminal Fraud Enforcement Action Press Conference, available at https://www.justice.gov/opa/speech/acting-assistant-attorney-general-brian-rabbitt-delivers-remarks-ppp-criminal-fraud (Sept. 10, 2020).

[2] Principles of Federal Prosecution of Business Organizations, Justice Manual § 9-28.900, available at https://www.justice.gov/jm/jm-9-28000-principles-federal-prosecution-business-organizations#9-28.900.

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