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Mitigating DOJ Enforcement Risk for Participants in COVID-19 Relief Programs

Mitigating DOJ Enforcement Risk for Participants in COVID-19 Relief Programs Background Decorative Image

The U.S. Department of Justice (DOJ) has a track record of aggressively pursuing those suspected of fraudulently exploiting federal relief programs meant to combat crises,1 and early signs indicate that DOJ will continue this practice with the current COVID-19 pandemic. In March 2020, Attorney General William Barr directed every U.S. Attorney’s Office “to prioritize the detection, investigation, and prosecution of all criminal conduct related to the current pandemic.”2 Brian Benczkowski, Assistant Attorney General for the Criminal Division, similarly commented that “whenever the government makes a large amount of money available to help individuals and businesses, the fraudsters will come out of the woodwork and seek to get access to that money. So we are preparing vigorously for what we absolutely know is coming.”3

Nearly two months since Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), and even before all of the money has been paid out, DOJ has already charged seven cases against eight different individuals with fraud in connection with the CARES Act’s Paycheck Protection Program (PPP). DOJ’s initial prosecutions have arguably been “easy” cases involving straightforward misrepresentations of objective facts. As such, they do not tell us much about the types of less brazen frauds that the Government might eventually prosecute. And there are significant questions. For example, the Government has indicated that it does not expect a lender under the PPP to perform any independent due diligence on a borrower’s expected use of the funds or to exercise any judgment about the credit worthiness of an individual applicant.4 What implications will a lender’s reliance on that guidance have when a prosecutor is considering allegations or evidence that a lender “knew or should have known” that the borrower did not intend to expend the funds as required under the program?

The risk landscape for borrowers is potentially even more clouded. The extreme urgency with which the program was passed has left them with incomplete and even changing guidance concerning applicant eligibility. Despite best efforts, there are also questions about the permissible uses and efforts to modify the time period in which the funds must be expended. Yet, given the choices of proceeding under this cloud of potential second-guessing or watching the near certain financial collapse of their life’s work due to the Government’s own shutdown orders, most small business owners are taking the funds and hoping for the best. But what steps can be taken to reduce the risk of future prosecution? We offer some suggestions to mitigate that risk.

The Paycheck Protection Program

Under the PPP, a small business can apply for up to $10 million in loans to keep workers on payroll and to cover other specified business costs.5 The actual size of the PPP loan a company can receive depends on the number of employees a company has and its average payroll costs over a period of 2.5 months. PPP loans have a maturity of two years and an interest rate of one percent. However, it is the Congressional intent and expectation of the program that the loans can be forgiven by the Government if the small business spends the loan proceeds on specific qualifying expenses within eight weeks of receipt and uses at least 75 percent of the proceeds for payroll. Procedurally, small businesses apply for PPP loans through applications submitted to lenders that have been approved by the Small Business Administration (SBA). PPP loans are approved and guaranteed by the SBA. As mentioned above, SBA and Treasury have already agreed to hold banks harmless if they relied in good faith on certifications and supporting documentation to determine a borrower’s eligibility for a PPP loan.6

This latitude to lenders was no doubt critical because there is substantial confusion surrounding borrower eligibility.  Perhaps one of the most vague requirements of the PPP, or any other federal entitlement program, is the expectation that companies would only participate in the program if it is necessary for them to do so. Specifically, all borrowers must certify as part of their application that the “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”7 This vague standard is not found in other SBA loan programs. In an FAQ subsequently published (and then updated multiple times), the SBA tried to clarify that “borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.”8 Does this require that the borrower demonstrate that they could not get credit elsewhere? In other SBA programs, there is a specific “Credit Elsewhere” requirement.9  Here, the SBA has made clear that no such standard applies and businesses with access to other credit may still apply for and receive PPP funds. Therefore, according to the SBA guidance, eligibility determinations (and certifications) seem to be a highly subjective balancing test combining the applicant’s good-faith judgment of the current and expected damage to the business and the amounts, types, and attractiveness of other sources of capital.10 One might expect that this lack of an objective standard would be a barrier to prosecution, but political pressures may compel DOJ prosecutors to bring cases nonetheless. While the likelihood is low that any single borrower will suffer an expensive investigation into his or her eligibility and use of the PPP funds, given the inability of the statute to anticipate all scenarios and the societal instinct to seek out and to publicly demonize unintended and “unworthy” recipients of the funds, it seems inevitable that these prosecutions will be brought.

DOJ’s PPP Enforcement Actions So Far

As stated above, the very first cases brought by the DOJ focus on what are allegedly very straightforward allegations of fraud. Most of these cases are being prosecuted jointly by the DOJ Criminal Division’s Fraud Section.11

The first case was brought in Rhode Island where the DOJ charged David Staveley and David Butziger with conspiring to make false statements to the SBA and to commit bank fraud.12 Staveley and Butziger allegedly discussed via email the creation of fraudulent loan applications and supporting documents to seek PPP funds for businesses that had either already failed pre-pandemic or that they did not actually own.13 In the Eastern District of Texas, Shashank Rai was charged with wire fraud, bank fraud, and making false statements to a financial institution and to the SBA by allegedly submitting two fraudulent PPP loan applications totaling more than $10 million.14 Rai allegedly claimed to have 250 employees when, it appears, his business had no employees.15 In another case, Samuel Yates was also charged with wire fraud, bank fraud, and making false statements.16 In his applications for $5.5 million in PPP loans from two different lenders, Yates allegedly falsely claimed that he had over 400 employees on his payroll, when, in fact, no one worked for him, and he used a random name generator to invent names for the purported payroll.17

In Atlanta, the DOJ brought bank fraud charges against reality television personality Maurice Fayne, also known as “Arkansas Mo,” who received PPP loans of more than $2 million.18 Despite certifying during the application process that he would use the loan proceeds to “retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments,” Fayne allegedly used most of the proceeds to repay loans, buy jewelry, pay child support, and lease a Rolls-Royce.19 In Los Angeles, the DOJ charged William Sadleir, a Hollywood distribution executive, with allegedly filing bank loan applications fraudulently seeking more than $1.7 million in PPP loans.20 Sadlier allegedly falsely represented that the funds would be used to support payroll expenses for three film production and distribution companies, when, in fact, Sadleir intended to use and did use a significant portion of the funds for personal and non-business-related expenses.21 In New York, the U.S. Attorney for the Southern District charged Muge Ma with fraudulently attempting to obtain more than $20 million in PPP loans.22 Ma allegedly claimed that his companies had hundreds of employees and a multimillion-dollar payroll, when, in reality, Ma appears to be the only employee of his companies.23

Finally, in Washington State, DOJ charged Baoke Zhang with filing fraudulent bank loan applications seeking more than $1 million.24 Zhang allegedly sought over a million dollars in PPP loans from multiple banks by claiming fictitious payroll expenses associated with fictitious information technology companies that he created.25

Potential Prosecutions of Other PPP Fraud

But what are the prosecution risks for less brazen fraud? What are the risks for good-faith applicants to the PPP program being subjected to “after-the-fact” scrutiny and prosecution for allegedly failing to comply with the PPP?  First, some applicants might have interpreted some agency statements as providing a “safe harbor” for loans under $2 million.26 The Treasury Department has already indicated that borrowers of less than $2 million of PPP funds will not be subject to routine audits by SBA or Treasury.27 Borrowers receiving in excess of that amount should expect a Government audit of the circumstances supporting their application, their eligibility, and the use of the funds. However, while applicants seeking less than $2 million may not be subject to a routine audit, they should recognize that scrutiny can arise from many other sources, such as a whistleblowing former business partner, laid-off former employee, a dissatisfied vendor, or even a vengeful former spouse or other personal relation. Many criminal cases have started in these ways. A smaller loan amount simply does not assure that an applicant will avoid scrutiny.  Borrowers should expect scrutiny.

It can be reasonably expected that most prosecutions will look like one of the following: (1) an immediate and ongoing brazen fraud such as those already prosecuted; (2) a circumstance where the loan was forgiven by the Government based on an allegedly fraudulent representation that the borrower expended the funds within the required time period and for qualifying expenses; or (3) a circumstance where the borrower did not seek forgiveness but did not or cannot repay the loan amount within two years28 and either the application contained alleged misrepresentations and/or the money was applied to ineligible expenses. It is possible that a prosecution could be brought where the loan was repaid, but generally speaking, financial fraud cases have very little jury appeal when there is no loss to the Government. With those scenarios in mind, PPP borrowers should consider some action items now to avoid problems later.

Action Items for Avoiding Criminal Enforcement Over PPP

    1. Avoid Bad Faith: One might expect that the shifting guidance and other issues with the PPP would pose an unusually high hurdle to a subsequent prosecution of a borrower. However, that is generally not a problem for federal prosecutors who routinely prosecute fraud cases with far less statutory specificity than the PPP. They do so by relying on evidence of the defendant’s own bad faith. Evidence of specific bad faith generally overcomes statutory vagueness challenges. What that means is that a defendant cannot credibly assert that the “necessary” standard under the PPP was “too vague” when there is evidence that the borrower lied, instructed others to lie, or bragged to others that they were ineligible or they did not need the money. Any perceived evidence of such bad faith substantially increases the likelihood of prosecution. Therefore, there should be no cynical comments or joking in emails, for instance, that the company does not actually need the funding, it is too late for the funding to save the business, the company does not intend to spend the funds properly, or the company is seeking somehow to take unfair advantage of the funds. If a borrower or business owner either makes or becomes aware that any employees or partners have made such statements, either in writing or orally, those reckless or cynical communications must be preserved. Never destroy or instruct anyone to conceal such statements. However, the prospective borrower should immediately correct the record by making clear that such statements do not reflect the true intention or attitudes of the borrower. This retraction will also be credible if the eligibility and true need for the loan is contemporaneously documented as well.
    2. Plan Your Work, Work Your Plan: Compliance by you and your business with a newly enacted and fast changing program with non-intuitive requirements in a time of turmoil and distraction will not just magically happen. This is especially true for businesses that are not experienced in dealing with the Government. The best chance a small business has to meet the program’s requirements is to study them, understand them, and implement an operational plan for how it will achieve those compliance requirements. Waiting until the end of the loan period to determine whether you have complied is too late and a recipe for trouble. If your business has the resources to do so, you should appoint a single person to monitor, enforce, and document compliance with the PPP terms.29 The funds should be placed in a separate account and not commingled with other company funds from which, it could be argued, they were used for non-compliant purposes.
    3. Avoid Self-Dealing: Prosecutors love related party transactions and other forms of self-dealing because they can easily be characterized as evidence of bad faith and an intent to defraud. The terms of any salary or rent you will pay to yourself or any family member will be inherently suspect and not reflective of true market value. If any related party transaction is part of a borrower’s intended PPP use, the borrower should expect close scrutiny, and there should be a long history of having made such rent or salary payments and compelling, objective evidence that the payments are reasonable and in compliance with PPP guidance.
    4. Preemptively “Change the Facts”: In most cases, and certainly in fraud cases, a favorable outcome can be achieved if the target can convince the prosecutor that, while the company or individuals may have gotten some requirement wrong, they acted in good faith. Unfortunately, too many of those investigation targets have nothing more to offer the prosecutor than the empty and too familiar claim that “this is a good company [or person], and they tried hard to get it right.” Because everybody makes that same claim, assume the prosecutor will adopt the view that “what isn’t documented, didn’t happen.” With that in mind, you should consider today what arguments you would like to make and what supporting evidence you would like to present at that future meeting. Then, instead of later regretting it and wishing you had some specific evidence to present, take time now to create the processes, follow them, and memorialize your efforts. That will be compelling evidence that you did actually try to get it right.

Please visit our Coronavirus: Preparation & Response series for additional resources we hope will be helpful.

1 For instance, between 2005 and 2011, DOJ brought criminal charges against over 1,400 individuals for fraudulently seeking federal relief related to Hurricanes Katrina and Rita.  See U.S. Dep’t of Justice, Disaster Fraud Task Force, Report to the Attorney General for Fiscal Year 2011, available at https://www.justice.gov/sites/default/files/criminal-disasters/legacy/2013/04/04/ReportDFTF2011.pdf. Similarly, DOJ has brought criminal charges against 443 individuals and enforcement actions against 24 institutions for fraudulently seeking to take advantage of the Troubled Asset Relief Program following the 2008 financial crisis. See Christy Goldsmith Romero, Special Inspector General, SIGTARP Semiannual Report to Congress, October 1, 2019 – March 31, 2020, available at https://www.sigtarp.gov/Quarterly%20Reports/April_30_2020_Report_to_Congress.pdf.

2 Memorandum from William Barr, Att’y Gen., U.S. Dep’t of Justice, for All United States Attorneys, COVID-19 – Department of Justice Priorities (Mar. 16, 2020), available at https://www.justice.gov/ag/page/file/1258676/download.

3 Matt Zapotosky, Justice Dept. anticipates coronavirus stimulus will be a major target for fraud, Wash. Post (Apr. 22, 2020), available at https://www.washingtonpost.com/national/coronavirus-stimulus-fraud/2020/04/22/f17d952a-833e-11ea-878a-86477a724bdb_story.html.

4 See Paycheck Protection Program Loans FAQs (May 27, 2020), available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf.

5 15 U.S.C. § 9001 et seq.; see also Caution: Incomplete Government Guidance and Forms Pose Risks for Businesses Applying for Stimulus Aid, Vinson & Elkins Insight (Apr. 2, 2020), available at https://www.velaw.com/insights/caution-incomplete-government-guidance-and-forms-pose-risks-for-businesses-applying-for-stimulus-aid/.

6 See Paycheck Protection Program Loans FAQs (May 19, 2020), available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf.

7 Paycheck Protection Program Borrower Application Form, available at https://www.sba.gov/sites/default/files/2020-04/PPP%20Borrower%20Application%20Form.pdf.

8 Paycheck Protection Program Loans FAQs, at Question 31 (May 19, 2020), available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf.

9 See 13 CFR § 120.101.

10 See New Guidance on SBA Review of Certification of Necessity under Paycheck Protection Program, Vinson & Elkins Insight (May 14, 2020), available at https://www.velaw.com/insights/new-guidance-on-sba-review-of-certification-of-necessity-under-paycheck-protection-program/; What Does the PPP Loan Standard of Necessity Mean for My Business?, Vinson & Elkins Insight (May 13, 2020), available at https://www.velaw.com/insights/what-does-the-ppp-loan-standard-of-necessity-mean-for-my-business/.

11 All of the cases discussed herein are being prosecuted jointly by the Criminal Division’s Fraud Section and an Assistant U.S. Attorney in the district in which the cases have been brought.  The sole exception is United States v. Ma, Case No. 20-mj-05202 (S.D.N.Y. May 20, 2020), which is being handled by the U.S. Attorney’s Office for the Southern District of New York’s Complex Frauds and Cybercrime Unit.

12 United States v. Butziger, Case No. 20-mj-00033 (D.R.I. May 4, 2020).

13 Two Charged in Rhode Island with Stimulus Fraud, DOJ Press Release (May 5, 2020), available at https://www.justice.gov/opa/pr/two-charged-rhode-island-stimulus-fraud.

14 United States v. Rai, Case No. 20-mj-95 (E.D. Tex. May 12, 2020).

15 Engineer Charged in Texas with COVID-Relief Fraud, DOJ Press Release (May 13, 2020), available at https://www.justice.gov/opa/pr/engineer-charged-texas-covid-relief-fraud.

16 United States v. Yates, Case No. 20-mj-15 (E.D. Tex. May 18, 2020).

17 Texas Man Charged with $5 Million COVID-Relief Fraud, DOJ Press Release (May 19, 2020), available at https://www.justice.gov/opa/pr/texas-man-charged-5-million-covid-relief-fraud.

18 United States v. Fayne, Case No. 20-mj-370 (N.D. Ga. May 12, 2020).

19 Reality TV Personality Charged with Bank Fraud, DOJ Press Release (May 13, 2020), available at https://www.justice.gov/opa/pr/reality-tv-personality-charged-bank-fraud.

20 United States v. Sadleir, Case No. 20-mj-02326 (C.D. Cal. May 18, 2020).

21 Hollywood Film Producer Charged with $1.7 Million COVID-Relief Fraud, DOJ Press Release (May 22, 2020), available at https://www.justice.gov/opa/pr/hollywood-film-producer-charged-17-million-covid-relief-fraud.

22 United States v. Ma, Case No. 20-mj-05202 (S.D.N.Y. May 20, 2020).

23 Chinese National Arrested for $20 Million Scheme to Fraudulently Obtain Loans Intended to Help Small Businesses During COVID-19 Pandemic, DOJ Press Release (May 21, 2020), available at https://www.justice.gov/usao-sdny/pr/chinese-national-arrested-20-million-scheme-fraudulently-obtain-loans-intended-help.  Unlike the other cases discussed herein, the prosecution of this case is being handled by the U.S. Attorney’s Office for the Southern District of New York’s Complex Frauds and Cybercrime Unit.

24 United States v. Zhang, Case No. 20-mj-269 (W.D. Wash. May 21, 2020).

25 Software Engineer Charged in Washington with COVID-Relief Fraud, DOJ Press Release (May 22, 2020), available at https://www.justice.gov/opa/pr/software-engineer-charged-washington-covid-relief-fraud.

26 See New Guidance on SBA Review of Certification of Necessity under Paycheck Protection Program, Vinson & Elkins Insight (May 14, 2020), available at https://www.velaw.com/insights/new-guidance-on-sba-review-of-certification-of-necessity-under-paycheck-protection-program/.

27 See id.; see also Paycheck Protection Program Loans FAQs (May 27, 2020), available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf.

28 A recent proposal in the U.S. House of Representatives would extend the payback period from two years to five years.  See Jim Saksa, Democrats widen eligibility for payroll loans, but add no funds, Roll Call (May 12, 2020), available at https://www.rollcall.com/2020/05/12/democrats-widen-eligibility-for-payroll-loans-but-add-no-funds/.

29 See PPP Loan Standard of Necessity Hinges on Documentation, Vinson & Elkins Insight (May 1, 2020), available at https://www.velaw.com/insights/ppp-loan-standard-of-necessity-hinges-on-documentation/.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.