The uptick CARES Act Paycheck Protection Program Civil Fraud Investigations by the DOJ

The March 2020 Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) afforded companies the opportunity to apply for economic stimulus funding and grants to alleviate the devastating economic impacts from the COVID-19 pandemic.

Until recently, the U.S. Department of Justice’s (“DOJ”) focus was against individuals who allegedly committed fraud and made false statements in connection with CARES Act stimulus funds. Specifically, the DOJJ was filing criminal fraud complaints involving the Small Business Administration Paycheck Protection Program (“PPP”).

Recent DOJ enforcement actions suggests that it may be focusing 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.

If you suspect CARES Act fraud, or have the DOJ’s focused on you, contact experienced and respected white collar litigation attorney Steve Crane. He and his team can help you determine how to move forward.

To schedule a discrete and confidential consultation about your matter, email or call us at (248) 963-6300.

The CARES Act and the PPP

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. However, the general public has taken issue, understandably, with certain large, well-funded companies that have qualified under this apparent loophole.

Given the public outcry, the US Treasury warned companies that they should be prepared to demonstrate that need upon request from the Small Business Administration (“SBA”) to certify in good faith that they need the money.

As a warning shot, the SBA had cautioned 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

In response to PPP relief small businesses received, the DOJ has created a team tasked with rooting out PPP fraud. The composition of the team has seen federal criminal prosecutors actively partnering with the SBA and IRS Criminal Investigation unit.

In 2020, the U.S. Attorney General directed all U.S. Attorneys to prioritize investigation and prosecution of coronavirus-related fraud schemes. In addition, U.S. Attorneys were directed to appoint a coordinator to serve as legal counsel on coronavirus matters, to direct prosecution of coronavirus-related crimes, and to conduct outreach.

In 2020, the SBA made more criminal referrals to, ninety-one, than any year in the past twenty years. Amazingly, the SBA averaged just thirty referrals per year between 2001 and 2019.

From April through December 2020, the SBA made one hundred and two new referrals to the DOJ. Recently, the DOJ Fraud Section released its annual year-in-review report. In the report, 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.

As evidenced in the DOJ report, a number of factors influence will affect PPP fraud enforcement in 2021. These factors include:

• 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.

The SBA will retroactively determine eligibility during its loan forgiveness review because lenders were permitted to rely on borrowers’ representations regarding their eligibility for loans.

Bottom line: In 2021, one may expect far more referrals from the SBA to the DOJ’s dedicated team and the SBA’s Office of the Inspector General.

Common Forms of Allegations of PPP Fraud

The Department of Justice identifies many potential criminal prosecutions by examining PPP loan applications filed through the Small Business Administration (SBA), which administers the PPP loan program.

When it comes to the PPP loan program, the most likely types of alleged fraud fall into three categories: falsifying basic eligibility requirements, increasing the size of the loan through misrepresentation, and misrepresenting the necessity of the loan. Other types of fraud allegations are possible as well.

As of September 10, 2020, the federal government had either recovered or frozen over $30 million of the $70 million in PPP funds that it claims were fraudulently obtained (over $100 million more in PPP loan funds were subject to unsuccessful fraud attempts).

As of September 2020, the DOJ had charged fifty-seven (57) people with trying to steal a total of $175 million in taxpayer-backed coronavirus pandemic loans.

By the end of 2020, it was has been determined that more than half of the money from the Treasury Department’s coronavirus emergency fund for small businesses went to just 5 percent of the recipients. This is according to data based on more than 5 million loans that were released by the government in response to a Freedom of Information Act request and lawsuit.

Eligibility

To be eligible to be considered for a PPP loan, the applicant must (i) have commenced business before February 15, 2020; (ii) fit the legal definition of “small business”; (iii) not be owned by an undocumented alien; and (iv) not be owned (20 percent or more) by anyone who is in prison, on parole, on probation, charged or chargeable with a crime, or convicted of a felony within the last 5 years.

Loan Amount

Since one of the primary purposes of the PPP loan program is to discourage employers from laying off their employees, the amount of the loan that an employer is eligible for is based on average monthly payroll costs.

To be exact, the maximum amount of the loan should be 2.5 times the employer’s average monthly payroll – if payroll is $100,000, for example, eligibility will top out at $250,000. This amount will give the employer enough money to pay its payroll for two and a half months, hopefully long enough to account for both the COVID-19 shutdown and its aftereffects on the business.

Exaggeration of Payroll Expenses

Exaggerating payroll expenses is the most common form of PPP nor its total payroll expenses to qualify for more than it is entitled to, or to create a shell company with no employees and claim payroll expenses.

This strategy will require representatives of the company to make false statements under oath, which will trigger criminal liability. The company officials who knowingly make false statements under oath will face personal criminal liability, meaning that they could go to prison. The Department of Justice has already initiated criminal prosecutions for exactly this type of fraud (see below for two examples):

• On June 22, 2020, for example, Elijah Majak Buoi was charged with federal wire fraud in Winchester, Massachusetts over PPP loans worth $13 million. Buai misrepresented both the number of employees his company employed and his company’s total payroll expenses.
• In May 2020, Manhattan resident Muge Ma (also known as Hummer Mars) was charged with fraud for seeking over $20 million in PPP and other government-backed loans that are designed to help small businesses affected by the Covid-19 crisis. More specifically, he claimed payroll expenses for hundreds of employees in two companies, when he was the only employee of either company.

Necessity

To qualify for a PPP loan, a company must assert that the loan is necessary – in other words, that the loan is necessary to ensure that it continues to operate during the period of economic uncertainty caused by the COVID-19 crisis.

The SBA maintains that public companies or other companies with access to funding are not likely to qualify for a PPP loan under the “necessity” test. Company representatives who make false statements under oath to assert necessity are subject to criminal prosecution. Nevertheless, a claim of necessity by itself is a judgment call that will not necessarily result in criminal prosecution — it is false statements about objective facts that trigger criminal liability.

Types of Criminal Charges

Bank fraud is not the only charge that might be asserted against you if you are accused of abusing the PPP loan program. Depending on the circumstances, you might also be charged with:

• Making misrepresentations to the SBA;
• Making false statements to a federal agency;
• Mail fraud;
• Wire fraud; and
• Many other possible charges.

Although it is not always the case, federal charges have a reputation of carrying longer prison sentences than state charges for equivalent conduct.

Possible Defenses

Fraud cases, especially at the federal level, are highly fact-dependent. In other words, they tend to be decided on a case-by-case basis where the court weighs one factor against another. Nevertheless, some of the most common federal fraud defenses are listed below.

• The “false statement” you were charged with making was actually true – at least at the time, it was uttered. In some cases, the dividing line between a true or false statement is clear. In other cases, it’s a judgment call whether a statement is true or false. Did your business have a real “necessity” for a PPP loan? Our job would be to introduce evidence and arguments that created at least a reasonable doubt as to whether the loan was necessary.
• You acted in good faith. Remember, criminal charges require criminal intent, and when it comes to PPP fraud, you will prevail if you can show that any mistake you made (as to whether the loan was “necessary”, for example) was innocent and was not intended to deceive. Perhaps you relied on the statement of an incompetent or corrupt accountant, for example.
• The subject matter of the false statement was not “material.” Keep in mind that ”material” is one of those words that means something very different in a legal context than it means in everyday conversation.
  In this context, “material” means something like “significant” or “important” with respect to the issue of whether you should have been granted the loan. If the misrepresentation wouldn’t have changed the decision, you may have a “materiality” defense.

Bottom line: criminal prosecutions will continue.

The Next Wave of Civil Enforcement of the CARES Act

The DOJ has a broad range of powerful civil fraud enforcement statutes at its disposal. These civil statutes permit the government to seek huge financial sanctions against companies receiving CARES Act stimulus funds, including PPP loans and grants.

The False Claims Act (“FCA”)

The 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”)

The 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 one 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.

Whistleblowers are Incentivized to Report Violations

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.

First-Ever Civil FCA and FIRREA Settlement Involving Alleged PPP Loan Violations

The DOJ used its enforcement tools to establish under SBA rules, companies under bankruptcy protection are not eligible to access the PPP.

In January 2021, the DOJ announced its first-ever civil settlement of alleged FCA and FIRREA violations with a bankrupt internet retailer who received a PPP loan. SlideBelts Inc., an e-commerce company selling apparel and wearable technology, is a bankrupt internet retailer and is ignominiously the first borrower under the PPP to settle civil Justice Department fraud allegations after the company falsely claimed it wasn’t bankrupt on a $350,000 loan application.

SlideBelts did return the $350,000 loan proceeds in July after multiple requests by the Small Business Administration, which administers the PPP. However, SlideBelts Inc., and its chief executive Brigham Taylor agreed to pay $100,000 in damages and penalties to resolve civil fraud allegations. In addition, Taylor and SlideBelts 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.

Companies Should Be Prepared for the Next Wave of Civil Enforcement of the Cares Act

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.”

Companies Should Be Prepared for the Next Wave of Civil Enforcement of the Cares Act

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.”