Until recently government enforcement and regulatory scrutiny of fraud and other misconduct relating to COVID-19 relief programs were generally limited to end recipients of the relief.

These efforts have mostly been directed to fraud in connection with 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 for their payroll and certain other costs.

According to the U.S. Department of Justice, approximately 178 individuals so far have been convicted in PPP fraud cases, and many more investigations and prosecutions have commenced. Nearly all these involved borrowers who provided false information to obtain the loans, misused loan proceeds or made misrepresentations in connection with loan forgiveness.

The next phase of enforcement can be viewed as beginning last month when federal prosecutors in New York charged Rafael Martinez, the chief executive officer of a PPP lender, with multiple federal crimes for what might be termed a PPP fraud triple-play:

1. Making misrepresentations on an application for a PPP loan for his own business, MBE Capital Partners LLC;

2. Misrepresenting MBE's qualifications to the SBA for MBE to become a non-bank PPP lender with the SBA; and

3. Making further representations to obtain collateral for use in borrowing through a Federal Reserve liquidity facility known as the Payment Protection Program Liquidity Facility.

The crimes charged in that case include wire fraud, bank fraud and making false statements to the SBA. The case, which appears to be the first criminal prosecution of a PPP lender, was highly touted by the DOJ as a major step in combating COVID-19 relief fraud. The MBE prosecution is significant because it likely presages increased government scrutiny of bank and nonbank PPP lenders.

Data provided by the SBA shows that smaller banks and nonbank lenders account for a large percentage of PPP loans extended and total net loan amounts. For example, over the course of the PPP, a total of 4,105 relatively small banks and savings and loan associations, each with assets less than $1 billion, extended and approved a total of 1,812,102 PPP loans with a net loan amount of more than $101.5 billion.

As the government continues investigating and prosecuting PPP borrowers — viewed as low-hanging fruit where much of the fraud is egregious and easily detectable — it is likely to increasingly pursue both banks and other nontraditional lenders where a case can be made that the lender either failed to comply with its Bank Secrecy Act and anti-money laundering obligations, or turned a blind eye to suspicious PPP loan applications.

Four Areas to Watch

Government scrutiny of PPP lenders is likely to focus on the following areas.

BSA/AML Compliance

Under rules promulgated by the SBA in connection with the PPP, banks must "continue to follow their existing BSA protocols when making PPP loans to either new or existing customers who are eligible borrowers under the PPP," while nonbank lenders must develop appropriate AML protocols.

Compliance involves not only taking appropriate steps to prevent potential fraudulent borrowing, but also monitoring borrower activity to detect ongoing fraud and filing suspicious activity reports where appropriate. Compliance failures could lead to sanctions under the BSA or, if systemic, potential liability under the False Claims Act.

Existing Borrower Fraud Cases

The government is likely to closely examine borrower fraud cases to determine whether lender insiders in those cases aided or facilitated the fraud in any way. If so, the lender itself can face liability. Borrower fraud cases can also lead to exposure for noncompliance with BSA/AML requirements.

Lenders are likely to receive subpoenas or other requests for information in connection with borrower fraud cases. The government will expect to receive, in response to these requests, the information required to be collected under the SBA rules governing the PPP program.

If a lender's response to government requests suggests deficiencies in compliance with SBA or BSA/AML requirements — for example, failure to obtain the necessary SBA certifications or to file a suspicious activity report when appropriate — or if the documents provided suggest that the lender did not act in good faith in originating the loan or in connection with forgiveness of the PPP loan, the government may open a broader investigation into the lender's conduct.

Suspicious Lending Patterns

The government is also likely to identify, for additional scrutiny, lenders with lending patterns that the government deems suspicious. These may include:

• Financial institutions that originated a large number of fraudulent loans;
• A disproportionate number of high-risk loans, such as loans to foreign businesses or noncustomers; or
• A disproportionate number of loans near 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 necessity of the loan.

It is likely that the government will use quantitative analysis to target lenders based upon these and other factors the government believes warrants additional scrutiny.

Fair Lending Concerns

The Consumer Financial Protection Bureau oversees compliance with the Equal Credit Opportunity Act, which prohibits business creditors from discriminating against any applicant on the basis of a factor that is not related to creditworthiness, e.g., race, national origin, sex. The CFPB announced that it has reviewed and analyzed current market developments related to COVID-19 and determined that PPP lending was among the issues that were most likely to pose a risk to consumers.

Proactive Steps to Mitigate Risk

Lenders are afforded a measure of protection from liability under the SBA's rules, which provide that lenders are to be "held harmless" for borrowers' failure to comply with PPP program criteria and will not be subject to any enforcement action or penalty relating to loan origination or forgiveness of the PPP loan if the lender (1) "acts in good faith relating to the origination or forgiveness of the PPP loan," and (2) "satisfies all other applicable Federal, State, local, and other statutory or regulatory requirements."

But the question remains: What constitutes good faith? The rules provide no clear answer, and the scope of this protection has yet to be tested.

Lenders can take several proactive steps to mitigate risk associated with potential government scrutiny of their PPP loans, including:

• Consulting with PPP experts to understand PPP-related risks and potential liability;
• Conducting targeted loan reviews of PPP portfolios to ensure that loan files contain the appropriate documentation and that the information does not raise red flags for fraud or misrepresentations;
• Conducting independent BSA/AML testing focused on assessing the adequacy of the policies, procedures and controls that were in place when PPP loans were originated; and
• Preparing to interface 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 that and other PPP fraud investigations show that a host of federal and state agencies are ramping up to intensively investigate PPP fraud and misconduct. These include the Pandemic Response Accountability Committee created by the Coronavirus Aid, Relief and Economic Security Act; the DOJ; the U.S. Department of Health and Human Services; the SBA; the Federal Deposit Insurance Corp.; and state attorneys general.

Given the increased enforcement PPP lenders are likely to face in the months and years ahead, banks and other lenders would be well advised to take proactive steps to ensure their PPP loan portfolios can withstand government scrutiny.

Republished with permission. This article, "Prosecution Of NY Lender Marks Shift In PPP Enforcement," was published by Law360 on April 19, 2022 (login required).