The Small Business Administration (SBA) launched its first round of the $660 billion Paycheck Protection Program (PPP) in early April, and criminal charges by the Justice Department (DOJ) against borrowers for alleged fraud are just beginning to emerge.
The speed with which the SBA and Treasury Department set up the program, and the volume of loans funneled through it, means more fraud cases are likely to follow, Sara Lord, a partner at Arnall Golden Gregory LLP, told Banking Dive.
"The kinds of cases that we've just seen are really low-hanging fruit — the fraudster trying to get a loan under false and fraudulent pretenses," Lord said.
So far, that includes two New England businessmen who sought more than $543,000 in PPP loans for businesses that were not operating prior to the start of the pandemic, and a man in Texas who sought more than $5 million to pay his purported business’s 400 employees. The workers' names were created through a random name generator on the internet, the DOJ said.
The PPP, which is part of the CARES Act, is meant to aid businesses negatively affected by the coronavirus pandemic.
"With a program that offers as much as this program does with fewer restrictions than most programs, you're going to get a fair amount of fraudulent behavior," Lord said.
PPP loans are forgivable for small businesses that use the government-backed loans mostly to cover employee payroll, making a business's employee count a new data point that banks have not previously had to verify.
"In general, these loans are underwritten in a traditional way," said Patricia Hines, head of corporate banking at research and advisory firm Celent. "But it's very difficult to validate employees. ... The credit bureaus validate lots of things about the information on loans, but we've never had a way of measuring, for instance, payroll amounts or the number of people on the payroll."
Prosecutors have contacted 15 to 20 of the largest loan processors and seen evidence of applicants overstating their payroll costs or employee count or misrepresenting the nature of their business, Assistant U.S. Attorney General Brian Benczkowski told Bloomberg this month.
More complex PPP schemes could take years to uncover, Lord said.
"I call the Rhode Island and Texas cases low-hanging fruit because they were pretty conspicuous frauds," she said. "For the more subtle fraud schemes, it takes a while for that to bubble to the surface. And the more complex a scheme is, the more time it takes to investigate it."
Lord cited the U.S. Treasury’s Troubled Asset Relief Program (TARP), which was instituted in the wake of the 2008 financial crisis, as an example of how long it can take the government to uncover stimulus fraud.
Some of the fraud linked to the program, which was meant to stabilize the financial system by having the government purchase troubled companies' assets and stock, "didn't get finally disposed of for several years," Lord said.
The CARES Act was largely designed to protect banks from borrower fraud, Lord said.
"The CARES Act kind of goes out of its way to lift some of the traditional restrictions on SBA loans in order to allow the banks to get the money to the borrowers as fast as possible," Lord said. "If the banks were duped and did everything that the CARES Act requires, then they wouldn't or shouldn't face any consequences from the government."
While regulators have said a bank would be "held harmless" in the case of borrower fraud, banks could still suffer from the collateral damage of a federal investigation, Julie Copeland, a partner at StoneTurn, a global advisory firm, told Banking Dive.
"If there is a fraud investigation, it's going to cost institutions a great deal of money because they're going to have to produce documents, witnesses and go back and look at what happened," Copeland said. "You don't have to be the target or subject of an investigation for it to mess up your life."
Although the CARES Act indicates that banks can rely on information submitted by borrowers, lenders still need to practice good judgment, Copeland said.
"If it's a cleaning business and you know they only have five employees and they submitted payroll for millions of dollars, you know something's wrong and you shouldn’t extend that loan," she said. "You need to make sure the documents they’re giving you make sense."
The DOJ sent grand jury subpoenas to big banks, seeking records as part of a broad investigation into PPP abuse, Reuters reported last week.
"Right now, we don’t think banks are 100% the target," a source told Reuters, adding, "There are concerns that there will be a boomerang effect six months down the road on banks that they didn’t do enough."