Pandemic loan fraud prosecutions shine spotlight on rushed rollout

COVID-19 may be mostly behind us, but government agencies are working overtime to recover an estimated $200 billion in potentially fraudulent loans taken by businesses and individuals during the height of the pandemic. Given the emergency nature of those loan programs and the error-ridden manner in which they were launched, prosecutors charged with investigating fraud now face the challenge of differentiating between a loan recipient's genuine confusion and their willful intent to violate the law.

The Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDL) program were originally intended to address the economic toll of the virus by providing businesses with funds to maintain payroll and normal operating expenses, such as rent and utilities. They were seen as critical measures to prevent a wave of business closures and an accompanying rise in unemployment and were therefore rushed onto the national stage with few constraints. According to the Brookings Institute, the "SBA removed the majority of [its loan guarantee] program's rules - requiring no fees, no credit scores, and no collateral from applicants. This enabled the financial system to move a historic amount of capital in a very short period."

It should be no surprise, then, that thousands of parties with no legitimate claim helped themselves to these funds. The Pandemic Response Accountability Committee has identified 69,000 questionable SSNs used to obtain $5.4 billion in possibly undeserved pandemic small business loans and grants. The Department of Justice's Pandemic Response Accountability Committee, comprised of 20 agency inspectors general, has deployed data scientists to find $38 million in potentially improper or fraudulent loans obtained with the SSNs of deceased individuals. The False Claims Act allows the Department of Justice to recover as much as treble damages from those who made claims and certifications on applications that are proven to be fraudulent.

But the task of prosecuting loan recipients may be made more complicated due to the confusing and fluctuating backdrop in which many of these loan applications were prepared, processed, and fulfilled. In addition to the challenge of proving fraudulent intent, prosecutors will have to prove the materiality of any rule violation, which is not as straightforward as it may first appear, given the ever-changing nature of the program rules and the forgiveness process. NPR reports that "As the program evolved, its rules became increasingly complicated, and even experts struggled to make sense of them. At one point, the SBA published a list of frequently asked questions on loan forgiveness that was 11 pages long."

The government's mistakes in rolling out these COVID loan programs in 2020 may provide ample grounds for defendants to avoid liability today.

Confused rollout

In the early days of the virus, the Small Business Administration was under pressure to act fast, and businesses scrambled to apply for limited funds that were offered on a first-come first-served basis.

COVID loan applications started flooding banks in April 2020 with surprisingly few details and almost no guidance to banks or businesses. In fact, "program rules were rushed through the approval process and provided to participating banks and lenders less than a day before the program was set to officially start on April 3rd."

Logistical challenges

With little lead time, banks also faced significant logistical challenges as they tried to process a tidal wave of applications. On April 3, 2020, many banks were not ready to begin accepting applications, and when they did, their loan application pages frequently experienced technological issues and outages.

Facing the prospect of hundreds of thousands, if not millions, of applications, the SBA sent an email to lenders apologizing for "ongoing technical issues" that were delaying the process. Following the first round of PPP applications, the White House announced that the SBA had processed more than 28,000 loans in 24 hours. The agency normally handled just 60,000 loans annually.

Changing rules

Ever-changing PPP rules highlighted the evolving nature of the government's approach to the program. These changes were reflected not only in the updated guidance and FAQs that were released, but also in the PPP application itself. The original PPP loan application, from March 2020, required the applicant to certify as follows: "The funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments; I understand that if the funds are used for unauthorized purposes, the federal government may pursue criminal fraud charges."

However, the PPP loan application dated June 2020 required this certification: "The funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments as specified under the Paycheck Protection Program Rule; I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable, such as for charges of fraud." (emphasis added).

It remains to be seen whether the lack of specificity in the original PPP application could effectively support arguments that, even if funds were used to retain workers in ways not explicitly specified under the PPP Rule, there was no rule violation.

Further, when banks first started to accept loan applications in early April 2020, applicants had to initial a one-line "Certification of Need" confirming that "[c]urrent economic uncertainty makes this loan request necessary to support ongoing operations of the Applicant." But, after large numbers of borrowers had already applied for PPP loans and publicly traded loan recipients came under scrutiny, the SBA made changes to the certification requirements.

On April 23, 2020, FAQ 31 warned borrowers for the first time that the SBA would scrutinize their individual situations to determine whether they really needed PPP loans and could make the Certification of Need in good faith. On April 29, 2020 - 26 days after large numbers of borrowers had applied for loans - the SBA issued yet another FAQ.

FAQ 39 stated that "[t]o further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender's submission of the borrower's loan forgiveness application."

As of May 29, 2021, the SBA had still not identified what amount of liquidity, cash-on-hand, available credit, outside capital, or other potential sources of income would make an applicant ineligible for a PPP loan.

Loan forgiveness rules similarly underwent changes. In June 2020, Congress passed the Paycheck Protection Flexibility Act of 2020, which significantly changed what PPP funds could be used for and for how long businesses could spend those funds while still being eligible for forgiveness.

Ongoing confusion

For businesses lucky enough to receive PPP funds in early 2020, there was widespread confusion about how to properly spend, record, and secure maximum forgiveness for those funds, as well as about the consequences of spending PPP funds improperly.

It was unclear whether businesses had to segregate PPP funds or take other measures to track and document their use, and there was conflicting information about whether small businesses could legally use PPP funds as short-term, low-interest loans.

According to one website, "Even though PPP loan forgiveness rules state at least 60% of your PPP loan must go toward maintaining payroll, and 40% on business-related rent and utilities, etc., that limitation only applies to the funds for which you plan on requesting forgiveness. The PPP still makes sense if you decide not to apply for forgiveness and pay it back at 1% interest. In this case, you can view the PPP as a low-interest, short-term business loan."

Another website, however, stated that the idea that one can "use the PPP funds like a low-interest loan" is a "common misconception" because the loan application requires a certification that ended with this statement: "I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable, such as for charges of fraud."

What it all means

From the start, the PPP loan program was destined for problems. Speed was prioritized over security, and conscious choices were made to dispense with almost all safeguards. The SBA even chose to bypass the Treasury Department's Do Not Pay list, which would have caught potential fraudsters. These missteps may have allowed more fraudulent applications to be pushed through, and they may have also caught well-intentioned business owners in a quagmire of the government's making.

In its June 27, 2023, White Paper Report, the SBA acknowledged these errors. "In the rush to swiftly disburse COVID-19 EIDL and PPP funds, SBA calibrated its internal controls. The agency weakened or removed the controls necessary to prevent fraudsters from easily gaining access to these programs and provide assurance that only eligible entities received funds."

Justice Department Inspector General Michael Horowitz, chair of the Pandemic Response Accountability Committee, put it plainly: "What didn't happen was even minimal checks to make sure that the money was getting to the right people at the right time."

For individuals and businesses who now find themselves in the DOJ's crosshairs because of PPP loans, the government's mistakes could provide a strong defense. The burden will ultimately be on the DOJ to prove intent to defraud and materiality.

Annika Russell, a paralegal at Adams, Duerk & Kamenstein LLP, also contributed to this article.