Pressure exposes vulnerabilities. That concept became a fact when the federal government launched the Paycheck Protection Program (PPP), and fraud followed risk management lapses. Lenders had been pressured to quickly process a high volume of government loan applications through a program with limited oversight and eligibility criteria. The program, established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, provided a total of $934 billion in funding to companies affected by the COVID-19 pandemic. To date, government investigations have identified more than $1 billion in fraudulent PPP loans issued to about 1,000 borrowers.
The Small Business Administration (SBA) had stated that lenders could rely on the representations made by borrowers on PPP application forms and needed only to perform a “good faith review” of certain items. But good faith review wasn’t defined, creating potential risk to lenders, who still needed to comply with all regulations.
In one example of fraud, two defendants in Florida were charged with conspiracy and making false statements to a financial institution. According to the complaint, the defendants used their home IP address to submit at least 70 false and fraudulent loan applications, including for shell companies and a defunct tax-preparation company. The conspirators sought more than $5.8 million in PPP and Economic Injury Disaster Loan funds, and they misused funds by paying off a luxury vehicle, spending more than $62,000 at casinos and for other personal purposes.
That wasn’t an isolated case, said Chris Ludwig, managing director and leader of Anti-Money Laundering and Office of Foreign Assets Control at Grant Thornton. “There are many examples of people forging documents, leveraging companies that have been defunct for a couple of years, forging IRS documents and articles of association, and presenting falsified documents to the bank to claim hundreds of thousands or millions of dollars.”
Retrospective analysis of the loans has found that a lack of lender due diligence contributed to illegitimate loans. Although the PPP situation is unusual, it offers an opportunity for lenders to look thoughtfully at how lapses occurred, assess their controls and processes, and reduce risk going forward.
Where due diligence broke down
“Some of the lenders’ processes have a blatant shortcoming,” Ludwig explained. “For example, an applicant would come to the bank and say something like, ‘My company has six employees. Each is making $20,000 per month, so my payroll cost is $120,000 a month. I’ve had 12 months of losses; therefore, I’m claiming $1.5 million.’ The lender didn’t always check what kind of company would have six employees with each making $20,000 a month.” Through the anti-money laundering process, the lender should have verified the person applying for the loan and checked data points, Ludwig added. “That would have uncovered some red flags.”
Even basic information sometimes wasn’t clearly documented — or accessible. In working to uncover possible problems, one lender struggled to list which loans it distributed through the PPP, Ludwig said.
Frederick Kohm, partner in Forensic Advisory Services at Grant Thornton, said: “Fraud has been a constant theme since the inception of the program.” Fraudulent applications have put lenders in a difficult situation. Lenders have raised the problem of some applicants being disconnected with economic necessity, he explained. “Companies have taken out loans without knowing whether they were going to need the money. One corporation with a complex structure received several million dollars in PPP and other loans across several companies. Three of the five companies need help reconciling how they used the money. If the recipient is having trouble figuring out how to support that the loans were used in the right manner, that makes it more difficult for a lender to determine whether that support was viable.”