This article by David Bouchard is one of the most thorough and incisive pieces I have read about the potential scale of SBA Paycheck Protection Program loan fraud prosecutions over the next few years. I reached out to David and he gave us permission to republish it. This is a must-read for professionals and anyone concerned about this subject. – Jeff
David is a partner at Finch McCranie, LLP, where he defends individuals and businesses facing investigation and prosecution. You can contact David at email@example.com.
Republished with the permission of the author. Originally published on Law360.com, Jan. 25, 2021
By last August, just four months after the first Paycheck Protection Program loans were disbursed, federal prosecutors had filed 41 criminal complaints charging nearly 60 people with PPP fraud in cases involving alleged losses totaling approximately $62 million.
Without skipping a beat, Hannibal Ware, inspector general of the Small Business Administration, cautioned that such prosecutions amounted to “the smallest, tiniest piece of the tip of the iceberg.”
A few weeks later, the U.S. Department of Justice‘s Acting Assistant Attorney General Brian Rabbit warned would-be fraudsters: “You will be identified. You will be held accountable. You will face the severest of consequences for trying to exploit your fellow Americans’ suffering for your own personal gain.”
In December, the DOJ announced that since the inception of the program it had secured charges of PPP fraud against more than 90 individuals in cases involving alleged losses totaling more than $250 million. By all indications, the DOJ plans to continue prioritizing PPP fraud prosecutions in 2021 and beyond.
Federal prosecutions of PPP fraud to date have targeted clear-cut, egregious wrongdoing — forgeries, falsified borrower information and demonstrably false certifications on PPP loan applications. Such fact patterns will no doubt remain federal prosecutors’ focus and priority in future PPP fraud cases.
Will DOJ prosecutors only pursue the low-hanging fruit of PPP fraud? If not, what else might draw their attention in the future? The unprecedented, historic nature of the program makes it difficult to predict how the DOJ will allocate prosecutorial resources and which cases it will prioritize in the future.
But over time, federal prosecutors will almost certainly turn their eyes to more complicated fraud schemes, including legitimate small businesses’ use of PPP loans on unauthorized expenses that are difficult to detect, loan recipients’ misrepresentation of their eligibility for the program in nonobvious ways, and employers’ exploitation of the program over the long run by, for example, asking their employees to repay compensation received under a PPP loan or to work for free.
The DOJ is also likely to investigate whether certain loan recipients committed fraud by certifying a PPP loan was necessary, a key component of the PPP loan application that has generated debate and confusion since the advent of the program.
If federal prosecutors begin targeting more complex PPP fraud schemes along the lines discussed above, there will likely be difficult questions about criminal intent. It may be challenging, for example, to distinguish between borrowers that intended to commit fraud and those that were well-intentioned but nonetheless failed to comply with a quickly developed, complex federal relief program subject to an evolving patchwork of rules that many lawyers struggled to keep straight.
There may also be contested questions about the materiality of violations of eligibility rules, e.g., inaccurate representations of employee headcount, or of rules regarding authorized uses of loan funds, e.g., if most funds were used for authorized purposes.
Further, there are likely to be disputes over loss to the government given that, at least arguably, there may not be a loss until a borrower’s loan forgiveness application has been approved and the SBA transmits funds to the lender, eliminating the recipient’s repayment obligation.
While forecasting future PPP fraud prosecutions may feel hypothetical, it is not an idle exercise. The DOJ’s tenacious prosecution of PPP fraud is likely here to stay and is unlikely to be reserved for low-hanging frauds.
A Look Back: PPP Fraud Prosecutions in 2020
The first round of PPP funding, which closed in August 2020, was defined by its scope and speed — SBA-approved lenders disbursed more than 5 million loans totaling over $500 billion in just four months to small businesses nationwide.
In response to widespread fear that the pandemic would cause an economic disaster, U.S. Department of the Treasury officials encouraged lenders to prioritize efficient loan disbursement over extensive preloan due diligence — borrower representations on the PPP loan application were to effectively replace conventional loan underwriting.
As Ware found, federal emphasis on running a high-velocity crisis relief program led to “lower[ing] the guardrails” and “relax[ing] internal controls, which significantly increased the risk of program fraud.”
That risk was exploited by fraudsters enticed by historic stimulus funds to be distributed after minimal lender review. Just weeks after the initial round of PPP loans began flowing, federal prosecutors filed the first charges of PPP fraud, alleging the accused had attempted to fraudulently obtain PPP funds through falsely certifying “to have dozens of employees earning wages at four different business entities when, in fact, there were no employees working for any of the businesses.”
By November, DOJ prosecutors had secured charges against 73 people concerning similarly egregious frauds, many of which involved using PPP funds for unauthorized purposes: Lamborghinis, a Rolls-Royce, a diamond-studded $52,000 Rolex watch, a gambling spree in Las Vegas.
And in December, the DOJ announced that to date more than 90 people had been charged with PPP fraud. In one of those cases, United States v. Ameet Goyal, the accused is scheduled to stand trial in March 2021 in the U.S. District Court for the Southern District of New York on various charges, including lying on PPP loan applications to circumvent the rules that each borrower is limited to one loan and that applicants with pending criminal charges are ineligible to participate in the program.
While the fact patterns in the early cases varied, most can be fairly described as the low-hanging fruit of PPP fraud. They involve what is alleged to be obvious abuse of the stimulus program, often for the borrowers’ self-enrichment.
Looking Ahead: Future PPP Fraud Prosecutions
With many businesses hamstrung by the ongoing pandemic, the second round of PPP loans is expected to generate another frenzy of applications from cash-starved businesses. Bad actors are certain to try to exploit the fast-moving relief program by filing fraudulent loan applications, just like they did last year. And there is no reason to believe that the DOJ will call off its hunt for egregious cases of PPP fraud — whether it occurred in round one or two of the program.
After federal prosecutors have targeted the most obvious, straightforward frauds, they will almost certainly turn their attention to investigating and prosecuting more complex cases. While there are no certain answers as to what types of cases the DOJ will pursue going forward, the DOJ is likely to prioritize the following issues, among others.
First, the DOJ will likely continue targeting loan recipients that misused PPP funds. PPP loan recipients are authorized to use loan funds for specified purposes, such as payroll expenses, rent, mortgages and utilities. When applying for loan forgiveness, recipients must document and certify their use of PPP funds for valid purposes.
The DOJ may prosecute a loan recipient for misrepresenting its use of PPP funds and for improper use of such funds. Among other potential charges, such conduct may give rise to prosecution under Title 18 of the U.S. Code, Section 1341 for mail fraud; Section 1343 for wire fraud; and Section 1344 for bank fraud.
Second, the DOJ is likely to continue pursuing loan recipients that were ineligible for PPP relief under applicable rules. Both rounds of PPP funding were limited to businesses with a certain number of employees — in the first round, 500 employees; in the second round, 300 employees — including employees of affiliate businesses.
Accurately calculating employees under the applicable guidance is a challenge for most lawyers, let alone small businesses trying to navigate a pandemic. The eligibility requirements are even more complex when considering that businesses also may have been eligible for PPP funding if they otherwise qualified as a small business concern under SBA standards or met the alternative size standard.
DOJ prosecutors may decide that PPP loan recipients that were ineligible for PPP funds should be prosecuted for, among other things, misrepresentations on loan applications. Considering the many landmines that even well-meaning loan recipients might inadvertently step on in certifying eligibility for a PPP loan, such cases would likely generate contested questions regarding intent.
Third, future DOJ criminal investigations will likely focus on an issue picked up in anonymous complaints appearing in news reporting — employers that received PPP loans asking employees who received compensation because of a PPP loan to provide free work for the employer in the future or to pay the employer back for payments provided as a result of a PPP loan.
For example, The New York Times reported that owners of a Pilates studio that received a PPP loan told instructors running virtual classes during the pandemic that the instructors would receive short-term extra payments out of the studio’s PPP loan but that the instructors’ future wages would be garnished when the pandemic subsided.
Similarly, the Times reported that an owner of a dermatology clinic began garnishing a worker’s wages after the worker was paid more than usual thanks to a PPP loan the owner received.
Ware said the SBA is aware of these more complicated schemes, and it stands to reason that the DOJ is too.
Fourth, the DOJ is likely to investigate whether certain loan recipients falsely attested their PPP loans were necessary and, in doing so, committed a crime. To be eligible for a loan, borrowers must certify on the PPP loan application under threat of potential civil and criminal penalties: “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
If anything, that proposition is ambiguous. The Department of Treasury’s relevant guidance is hardly clarifying that:
Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.
In short, the Treasury’s oblique advice has done little to resolve confusion and uncertainty arising from the thorny necessity certification.
If PPP loan recipients took comfort in the necessity certification’s focus on then-existing economic conditions, i.e., “current economic uncertainty,” the SBA’s recently released loan necessity questionnaire may be cause for concern. The questionnaire features a series of questions about a loan recipient’s financial performance after receiving a PPP loan. It asks, in part, that recipients provide information on:
Gross revenues compared to the prior year;
Capital improvement projects;
Dividends or capital distributions to owners;
Prepayment of outstanding debts;
Employees or owners receiving annualized compensation of more than $250,000 during the covered loan period.
These and other data points solicited by the questionnaire were not in the round one PPP application, which simply asked whether “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
Nonetheless, the SBA says it will use the questionnaire to evaluate whether loan recipients properly certified that economic uncertainty made their loan requests necessary.
Thus, the SBA plans to evaluate whether loan recipients completed the necessity certification in good faith based at least in part on their financial performance after receipt of a PPP loan — i.e., based on metrics that were neither known nor knowable when recipients completed the necessity certification and submitted their applications.
The SBA has been cryptic about how the questionnaire data will be weighed against other relevant factors, saying that its “assessment of a borrower’s certification will be based on the totality of the borrower’s circumstances through a multi-factor analysis.”
Even so, the questionnaire increases the risk that when federal investigators make decisions about the propriety of a loan recipient’s necessity certification, they will rely on 20-20 hindsight and minimize the “current economic uncertainty” that motivated a PPP loan application.
The SBA has promised that it will not refer any perceived violations of the necessity certification to other agencies, e.g., the DOJ, if the borrower simply repays the PPP loan at issue. But that assurance is unlikely to give much confidence to concerned borrowers. Some may not be able to repay at all or may not be able to meet whatever repayment deadline the SBA dictates. In either case, the SBA would presumably feel free to proceed as it chooses.
And even if the SBA’s conditional promise were enforceable, it has not been adopted by other federal agencies. There appears to be nothing stopping the DOJ, for example, from learning through other means that a borrower allegedly improperly executed the necessity certification and then proceeding as it deems fit. Based on the stern warnings from DOJ officials about PPP fraud, that seems reasonably likely to occur.
Further, the SBA’s prefatory language to the loan necessity questionnaire could be read to conflict with its previous promise to extend grace to noncompliant borrowers that simply repay their loans:
Failure to complete the form and provide the required supporting documents may result in SBA’s determination that you were ineligible for either the PPP loan, the PPP loan amount, or any forgiveness amount claimed, and SBA may seek repayment of the loan or pursue other available remedies.
Even if the SBA does not intend such language to modify its earlier promise, there are good reasons discussed above why that promise may provide cold comfort.
Federal prosecutors will almost certainly continue pursuing PPP fraud cases with zeal, and the highest priority cases will likely remain those that involve egregious wrongdoing. Such cases are easiest to identify and prosecute. They are also politically popular; they provide easier, faster wins for the DOJ and eye-catching headlines that may help to deter other would-be fraudsters from trying to exploit a crisis relief program.
Only time will tell what types of PPP fraud cases the DOJ will prioritize in the future, but it is likely that federal prosecutors will eventually set their sights on more complicated schemes, such as those discussed above. In the meantime, warnings from regulatory and prosecutorial authorities make clear that PPP fraud prosecutions have only just begun. To date we have seen “the smallest, tiniest piece of the tip of the iceberg.”
David Bouchard is a partner in the law firm of Finch McCranie, LLP. He defends individuals and businesses facing investigation and prosecution. David can be reached at firstname.lastname@example.org. To read more about David: https://www.finchmccranie.com/david-bouchard.html.
For decades, the esteemed lawyers of Finch McCranie, LLP have successfully defended individuals and businesses in criminal investigations and prosecutions nationwide. The firm boasts a deep bench of white-collar criminal defense lawyers, including former federal prosecutors, a former Federal Defender, and alumni of white-collar groups at top international law firms.
 Only for-profit and non-profit businesses that received, together with affiliates, PPP loans with an original principal amount of $2 million or greater are required to complete the Questionnaire. https://www.sba.gov/sites/default/files/2020-12/SBA%20Form%203509%20–%20PPP%20Loan%20Necessity%20Questionnaire%20%28For-Profit%20Borrowers%29-508_0.pdf.
Previously, “SBA, in consultation with the Department of the Treasury,  determined that the following safe harbor will apply to SBA’s review of PPP loans with respect to [the necessity certification]: Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.” https://www.sba.gov/sites/default/files/2020-12/Final%20PPP%20FAQs%20%28December%209%202020%29-508.pdf (FAQ 46).
SBA cited to conservation of “finite audit resources” and the desire to “focus its reviews on larger loans, where the compliance effort may yield higher returns,” as some reasons for the safe harbor. Id. Yet SBA has also stated that PPP loans smaller than $2 million will be subject to review by SBA “as appropriate” to evaluate “compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form.” Id. For these reasons, and those stated in the above article, the safe harbor for loans under $2 million may do little to quell concerns about criminal and civil inquiries.