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The Next Wave of CARES Act Enforcement: Paycheck Protection Program Civil Fraud Investigations

The March 2020 Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) created enormous incentives for companies to apply for economic stimulus funding and grants to alleviate the devastating economic impacts from the worldwide pandemic. Until recently, the U.S. Department of Justice (“DOJ”) focused mainly on filing criminal actions against individuals who allegedly committed fraud and made false statements in connection with CARES Act stimulus funds, in particular criminal fraud cases involving the Small Business Administration Paycheck Protection Program (“PPP”). But a recent PPP enforcement action in California suggests that DOJ may be ramping-up fraud investigations under the civil False Claims Act and the Financial Institutions Reform, Recovery, and Enforcement Act. Civil fraud enforcement under these statues brings with it the potential for whistleblower awards, treble damages, and statutory penalties against companies receiving PPP funds.

The CARES Act and the Paycheck Protection Program

The CARES Act has four main programs to aid businesses that have been most impacted by COVID-19: the Paycheck Protection Program, the Economic Injury Disaster Loan Emergency Advance, SBA Express Bridge Loans, and SBA Debt Relief. In March 2020, Congress authorized $349 billion in PPP loans, followed by an additional $310 billion in April 2020. The PPP loan is designed to encourage employers to keep workers on their payroll and to help small businesses cover their expenses (e.g., payroll, mortgage, rent, utilities, etc.) in the near-term. PPP loans are designed for small business owners, which generally means a business that has less than 500 employees. Companies with more than 500 employees may also be eligible if they satisfy the SBA employee-based size standards for the entity’s primary industry, but the public has taken issue, perhaps rightly so, with certain large, well-funded companies that have qualified under this apparent loophole.

Given this, the Treasury has emphasized that companies have an obligation to certify in good faith that they need the money, and warned they should be prepared to demonstrate that need upon request from the Small Business Administration (“SBA”). The SBA cautions that “[i]t is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.”

Allowable uses for loan proceeds include payroll costs, which includes paid leave, severance, retirement, and payroll taxes. Other permitted used for SBA business loans include insurance premiums, interest on mortgage obligations, rent, utilities, and inventory and supplies.

By the time the PPP closed to new applications on August 8, 2020, over 5.2 million loans had been approved, for a total in excess of $525 billion. These loans were made to businesses in virtually all sectors of the economy, from manufacturing and construction to health care, education, and the arts.

PPP reopened in January 2021 with $284 billion in new funding to provide forgivable loans to first- and second-time borrowers. The deadline for applications is March 31. On March 3, the SBA released new guidance on the changes to PPP, including changes to the formula for calculating loans to sole proprietors and some other businesses, with the goal of making the program more attractive to smaller companies.

CARES Act Enforcement to Date

As millions of small businesses applied for and received PPP relief, DOJ created a team tasked with rooting out PPP fraud. Federal criminal prosecutors are actively partnering with the SBA and IRS Criminal Investigation unit as part of this effort. Last year, the Attorney General directed all U.S. attorneys to prioritize investigation and prosecution of coronavirus related fraud schemes, and each U.S. Attorney was directed to appoint a coordinator to serve as legal counsel on coronavirus matters, to direct prosecution of coronavirus-related crimes, and to conduct outreach.

SBA made more criminal referrals to DOJ in fiscal year 2020 (91) than any year in the past two decades. The SBA averaged 30 referrals between 2001 and 2019. From April through December 2020, 102 new referrals were made. In late February, the DOJ Fraud Section released its annual year-in-review report, in which the government forecasts that combatting PPP fraud will be a significant initiative in 2021. DOJ reports there was an increase in the number of individuals charged in PPP-related cases in the first two months of 2021. As of the date of the report, DOJ has charged 97 defendants. The charges involve more than $260 million of attempted loss from PPP fraud, and $130 million of actual loss. More than $64 million in illegal proceeds has been seized or frozen.

A number of factors will influence what is expected to be robust PPP fraud enforcement in 2021: second-draw loans are now available; the recently enacted Economic Aid Act has altered lending terms for first-draw and second-draw loans; and many small businesses have yet to apply to the SBA for loan forgiveness. Because lenders were permitted to rely on borrowers’ representations regarding their eligibility for loans, the SBA will retroactively determine eligibility during its loan forgiveness review. Expect far more referrals from the SBA to the DOJ’s dedicated team and the SBA’s Office of the Inspector General.

The Next Wave of CARES Act Enforcement

Although federal prosecutors have focused mainly on criminal prosecutions of egregious loan fraud, DOJ has powerful civil fraud enforcement statutes at its disposal permitting the government to seek huge financial sanctions against companies receiving CARES Act stimulus funds, including PPP loans and grants. The federal civil False Claims Act (“FCA”)  imposes liability on persons and companies who defraud government programs. Under the FCA, the government can bring an enforcement action against any party who, among other things, “knowingly presents or causes to present a false claim for payment or approval” or “knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim.” In addition to allowing the federal government to pursue perpetrators of fraud on its own, the FCA also allows private citizens to file “qui tam” suits on behalf of the government against those who have allegedly defrauded the government.

With respect to PPP loans, the government can investigate alleged FCA violations under a number of  different scenarios, including misrepresentations in order to obtain a loan, misappropriation of funds after loan proceeds have been disbursed, and splitting of loan proceeds between affiliated entities.

The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) provides the DOJ another tool  in civil CARES Act fraud enforcement. FIRREA imposes civil penalties if the government can prove violations of 14 specified criminal statutes, including bank fraud and mail/wire fraud “affecting a federally insured financial institution.” The government can seek statutory penalties for violations up to $1,963,870 per violation or up to $5 million for a continuing violation. Like the FCA, FIRREA has a lower burden of proof than criminal statutes. DOJ must prove only that a defendant committed on of FIRREA’s predicate offenses by a preponderance of the evidence. FIRREA makes it easier for the DOJ to bring an enforcement action based upon conduct that is already actionable under the criminal code.

Both the FCA and FIRREA permit whistleblowers to report potential violations to the Attorney General in a confidential declaration. DOJ is required to investigate to determine whether to pursue civil  charges. Unlike the FCA, FIRREA whistleblower awards are statutorily capped at $1.6 million. Additionally, FCA damages are usually tied to the amount of federal dollars received by an entity and can be mitigated by the return (or payback) of those federal dollars. In contrast, FIRREA penalties can be statutorily imposed without the government having to prove losses—and the penalties can be imposed by a court merely if the government sufficiently proves liability for the underlying predicate criminal offense.

Going forward, companies can expect increased use of civil enforcement statutes by DOJ to launch investigations of suspected PPP fraud. On January 12, 2021, DOJ announced its first-ever civil settlement of alleged FCA  and FIRREA  violations with a borrower of a PPP loan. SlideBelts Inc., an internet retail company and debtor in bankruptcy, and Brigham Taylor, the company’s president and CEO, resolved government allegations that they committed PPP loan fraud. According to DOJ, Taylor and SlideBelts made false statements to federally insured banks that SlideBelts was not in bankruptcy in order to influence those banks to approve, and the SBA to guarantee, a PPP loan to SlideBelts. DOJ alleged that SlideBelts received a PPP loan for $350,000 as a result of the alleged false statements. In response to demands by the government, SlideBelts returned the PPP funds to the lender, and Taylor and SlideBelts later admitted in the settlement that their statements caused false claims to be made to the SBA in connection with the PPP loan. This settlement resolved claims that Taylor’s and SlideBelts’ misconduct violated the FCA and FIRREA. DOJ alleged damages and penalties totaling $4.1 million based on SlideBelt’s violations of the FCA and FIRREA.

“The defendants made false statements to multiple banks in order to obtain a Paycheck Protection Program loan that should have been disbursed to an honest small business suffering financially from the economic effects of the COVID-19 pandemic,” said U.S. Attorney McGregor W. Scott in a DOJ press release. In announcing the settlement, the government made it clear that “The Department of Justice and our partners at the SBA will use all tools at our disposal, including civil fraud statute, to aggressively pursue those who exploit federal programs intended to help those in need during this national emergency.”

Be Prepared for the Next Wave of Enforcement

Many companies receiving CARES Act aid have never before done business with the government. Unlike companies with prior government contracting experience, these businesses may not know that FCA and FIRREA violations can lead to treble damages and statutory penalties. Although so far the cases brought by the DOJ have involved brazen conduct, like using loan proceeds to buy things like cars, homes, or jewelry, as time goes on we can expect that DOJ will begin investigations for less apparent violations. These investigations have the potential to target PPP loan applicants who tried in good faith to comply with program requirements, but unintentionally or unknowingly made  false or misleading statements without any intent to defraud, such as where an eligibility requirement may be vague or ambiguous and/or the subject of evolving guidance.

PPP loans are “compliance minefields” for businesses. PPP loan certifications create potential criminal and civil liability for false statements where companies submit inaccurate information about eligibility, size of the business, and economic necessity. Companies seeking PPP loan forgiveness must be very careful in calculating and reporting their use of loan proceeds. Businesses retaining non-compliant forgiven funds can be liable under the FCA’s so-called “reverse false claims” provisions, and employees can become potential whistleblowers under both the FCA and FIRREA.

Federal CARES Act legislation and PPP compliance requirements continue to evolve. Entities applying for and receiving PPP loans should be aware of the risks related to noncompliance with all applicable laws and regulations and stay up to date on published guidance by all government agencies. Companies receiving CARES Act money should carefully document their eligibility for PPP loans (including economic need certification), document and track how the money was spent (including tracking and separating expenditures), and provide a detailed accounting if they are seeking loan forgiveness. Although it has been said that money is fungible, we know from experience that government investigators “follow the money” in a straight line into the business. So, following good compliance practices now will help in any audits or enforcement actions in the future. After all, as the old adage goes: “an ounce of prevention is worth a pound of cure.”

Authors

Vince Farhat, Chair, White Collar Defense & Investigations Group
Justin Anderson, Associate, White Collar Defense & Investigations Group
Julia Consoli-Tiensvold, Associate, White Collar Defense & Investigations Group

 

JMBM’s White Collar Defense & Investigations Group is keenly focused on our clients’ business objectives and is committed to minimizing the disruption, anxiety, and public scrutiny that can arise from criminal and civil investigations and litigation. We are leaders in the representation of companies, boards of directors, management, and individuals in connection with a broad range of government investigations, enforcement actions, remediation and compliance, administrative proceedings, internal investigations and white collar criminal investigations and prosecutions.