Justice Department Will Crack Down On PPP Fraud
May 27, 2020
Terry Grugan is a white-collar defense lawyer with the Philadelphia-based law firm Ballard Spahr. Grugan has represented countless businesses that have been the target of government investigations for fraud. He spoke with Banking Mid Atlantic about the potential fraud and liability associated with the Small Business Administration’s Paycheck Protection Program.
Treasury Secretary Mnuchin announced plans to scrutinize the largest recipients of emergency small business loans and indicated potential criminal penalties for big companies that misrepresent their financial situation to secure the money. How prevalent of an issue is fraud with the PPP program? Do you think it will be a major issue?
Based on historical experience with government spending programs, we can expect fraud to be a significant problem with the PPP, as it likely will be with other components of the COVID-19 stimulus bills. Though it is impossible by the very nature of fraud to know with certainty its general scope, experts estimate that anywhere from 3-10% of all government spending is subject to fraud. The PPP will be no different.
What will set it apart are two characteristics of it that make it (and the other stimulus spending programs) unique: (1) the speed with which it was enacted and money disbursed under it; and (2) the incredible scrutiny it is and will continue to be under. As to the first characteristic, because the CARES Act was crafted and passed and money disbursed under it so quickly, there are likely features of it that will be exploited that might not otherwise have existed had the legislation been subject to typical legislative scrutiny. In fact, we are seeing this occur already with public companies and other large borrowers who probably were not intended recipients applying for and receiving PPP loans.
The legitimacy of those loans will be evaluated according to how “necessary” they were for the recipients to receive. While from a lay standpoint we all may have an idea what “necessary” means, from a legal standpoint and, certainly from a criminal standpoint, which Constitutionally requires real precision, that standard is notably vague. The second feature in many ways relates to the first: there has been a great deal of scrutiny over these bills already as we are in the throes of this crisis.
Once the crisis has passed and the check comes due for these programs, there will be an additional level of scrutiny both by regulators and the public to ensure these funds went where they were supposed to go.
Are only big companies going to be targeted? What do you think the threshold is going to be? How big does a company have to be to grab the government’s attention?
The size of a recipient may drive government oversight to some extent, but it won’t be the only determinative factor. Regulators, whether the SBA while auditing loans or the IRS when analyzing corporate tax returns, or other agencies, will be looking for red flags that might indicate fraud.
If it appears that a company retained loans while its payroll decreased, the government will likely target that company. If it appears that a company had sufficient liquidity, yet still applied for and received a loan, the government will likely target that company. If there is evidence a company overstated its number of employees in its loan application, the government will likely target that company. These are only examples and we can be sure investigators will look for any indicator that a company took money from the PPP under false pretenses.
What type of penalties do you envision against companies that misrepresent their financial situation?
If the government believes that a company made misrepresentations to receive a PPP loan, it will not hesitate to pursue criminal charges. While a company itself is a legal entity that can face criminal, civil, and administrative penalties, the individuals running the company who made the misrepresentations will be charged personally.
These are incredibly high-profile programs so prosecutions of fraud under them will be very high profile. The government will be significantly incentivized to bring charges against potential fraudsters. And if the government wins convictions, people will go to jail and people and companies will owe restitution and additional penalties.
The SBA and Treasury were notoriously slow with guidance on PPP. Is that a defense? Can people say they were following guidance known when they applied? Or do the rules apply to when the loan comes due and not when it was executed?
Fraud occurs when a person commits a deception to get something from someone else. The deception is the fraud, not the receipt of money or property. And fraud prosecutions ultimately come down to intent; when an individual makes a statement, was that statement knowingly false and was it made for the purpose of deceiving the listener.
With that said, the lack of guidance on the PPP initially will certainly be a defense to fraud charges down the line. If Treasury and SBA refine the lending criteria over time, a borrower cannot be said to have lied concerning that criteria if it didn’t exist at the time they made their representations.
On the other hand, Treasury and SBA’s guidance is not necessarily changing criteria as much as it is explaining what Treasury and SBA intended when the criteria was initially created, so there will be an element of “should have known” applied to borrowers. At the end of the day, as noted above, potential charges will come down to intent.
If someone knowingly lied to receive a loan, that person would not have needed guidance to know that was wrong. It is the instances between outright deception and fully above-board borrowing where what exactly the lending criteria is and what borrowers believed it to be at the time they applied for loans will come into play.
Is there anything to stop a big company from accepting PPP funds as a hedge, so to speak? What if they take it, in effect, as a line of credit and then just repay the loan? Are there penalties associated with that?
As mentioned, to the extent fraud occurs, it occurs at the application point. If someone accepts a loan “as a hedge” that almost necessarily means they could not have in good faith certified the loans were “necessary.”
As of now, this is almost a $700 billion program. Do you think the federal government is going to invest resources in trying to recapture a $1 million loan?
The government has spent more to recover less. In criminal terms, when we talk about PPP fraud, we are talking about companies stealing money from the stimulus program. We would never say the government should not bother pursuing a $1 million fraud under normal circumstances. Or even far less than that.
In civil terms, the government will certainly be incentivized to pursue repayment of loans in the event companies don’t meet the requirements for loan forgiveness. The costs of doing so will not always be greater than the potential recovery.
However, this depends on a borrower’s ability to repay, which is a very open question. You can easily imagine a borrower not meeting the requirements for forgiveness because, despite the stimulus funding, it was not able to keep its doors open. That hypothetical company will likely default on its repayment obligations and the government will not have much incentive to pursue repayment.
Do you think enforcement will vary depending on the U.S. Attorney? Will sum prosecute these cases simply to grab attention?
Fraud in the PPP and other stimulus programs will be a Justice Department priority going forward because of the size of these programs and their high profiles. And every U.S. Attorney’s Office will bring cases against PPP fraudsters. The high profile of these cases and the potential or likely political pressure that will come to pursue fraud and recoup as much money from fraudsters as possible might incentivize some United States Attorneys to bring cases. But, mostly, I believe United States Attorneys will bring cases against PPP fraudsters because it is their job to do so. Defrauding the government is a crime.
Terence M. Grugan is a member of the Ballard Spahr’s white collar defense/internal investigations, securities enforcement and corporate governance litigation, and anti-money laundering practice groups. He is based in Philadelphia, Pennsylvania.
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