SBA Announces: “SBA may begin a review of any PPP loan of any size at any time in SBA’s discretion” & DOJ Announces Multiple Enforcement Actions

Between May 20 and May 22, SBA announced three new Interim Final Rules and the U.S. Department of Justice (DOJ) announced three new fraud prosecutions stemming from PPP loans. Those prosecutions reflect that the DOJ does not need to rely on a borrower’s “certification of necessity” to pursue fraud claims, because DOJ is charging borrowers with “falsely representing that the funds would be used to support payroll expenses…”

On Friday, May 22, SBA stated: “SBA may begin a review of any PPP loan of any size at any time in SBA’s discretion.” (“Loan Review Procedures IFR,” II (2)(c) at p.14). Quite a different situation for PPP loan recipients of less than $2M than some commentators were suggesting just 10 days ago.

Here’s what all this means. 

Use of Proceeds Certification

The use of proceeds certification is the third certification on the PPP Loan Application. It effectively confirms that the Borrower will use the funds solely for four specific purposes:

“The funds will be used to retain workers and maintain payroll or make mortgage interest 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.”

DOJ and SBA have made clear that deviation from those four required categories of spend will not be tolerated. 

FAQ 46’s (Somewhat) False Comfort

Many viewed FAQ 46 (May 13, 2020) as a game changer for borrowers of PPP loans, believing that SBA had announced a robust “safe harbor” for all PPP loans under $2 million. We weren’t convinced and wondered just how limited SBA’s purported “safe harbor” was. We wrote about that in our “FAQ 46 & 47: Crime & Punishment (or the Lack of Either) for PPP Loans Large and Small” (May 14).  When we saw SBA’s (May 15) Loan Forgiveness Application (we published about it here), quickly followed by SBA’s newest Interim Final Rules (IFRs) on May 20[1] (the “Second Extension IFR”) and May 22[2] (“Loan Forgiveness IFR” and “Loan Review Procedures IFR”), we were not surprised to see that the potential risks associated with these loans remain meaningful. As SBA has said in FAQ 39 (published April 29), SBA “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.” (Emphasis added).  Some observers saw FAQ 46 as a retreat, interpreting the statement to mean that SBA would really only review “loans in excess of $2 million.” It didn’t mean that and what’s more, SBA’s statement of how it intended to conduct its own review process didn’t apply beyond SBA’s own review of solely the certification of necessity.

SBA did actually reiterate in FAQ 46 itself that loans under $2M were still fair game for review (though the language could have been more precise), but SBA unambiguously remedied any confusion in Loan Review Procedures IFR (Section 2(c), p.14): 

“SBA may begin a review of any PPP loan of any size at any time in SBA’s discretion.” (Emphasis added).  

How Binding Are SBA FAQs?

Given the exuberance from some corners over FAQ 46, many began pondering the legal force and effect of a governmental agency’s published “FAQs,” as compared to, for instance, an Interim Final Rule or a section of the U.S. Code of Federal Regulations. SBA had partially answered that question in footnote 1 of the FAQ itself: “This document does not carry the force and effect of law independent of the statute and regulations on which it is based.” In the Second Extension IFR (Section II), SBA further explained its own view – that the FAQs are “nonbinding guidance,” referencing the May 13 additions to the FAQ and further noting that the IFR itself may be revised:[3]

“SBA previously announced this intended extension in nonbinding guidance published on May 13, 2020. See FAQ 47 (posted on May 13, 2020).” (Emphasis added).[4]

How Worried Should I Be About My Under-$2M PPP Loan?

Initially, PPP borrowers breathed a sigh of relief in response to the FAQ’s plain language, which specifies that the SBA’s safe harbor applies to “SBA’s review” of  loans under $2M “with respect to” a borrower’s certification of need:  

“SBA, in consultation with the Department of the Treasury, has determined that the following safe harbor will apply to SBA’s review of PPP loans with respect to this issue: Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.” (Emphasis added, footnote removed).

In other words, FAQ 46 is properly understood as a statement of how SBA will approach its own review by presuming good faith solely as to the certification of necessity for loans of a borrower who, together with all of that borrower’s “affiliates,” borrowed in aggregate less than $2 million.  And, until the FAQ is firmly established through the administrative process as a final rule, it appears to be nonbinding on SBA itself because it’s just an FAQ.  We, of course, reserve our right to argue that (1) SBA has defanged the certification of necessity for everyone and (2) the FAQ nonetheless profoundly protects borrowers on the necessity certification nonetheless and in a binding manner.

As noted above, the Loan Review Procedures IFR itself explains:

“SBA may begin a review of any PPP loan of any size at any time in SBA’s discretion.”

There’s not much ambiguity there. SBA provided greater detail in the Loan Forgiveness IFR (quoted at length in our Appendix at the end), noting that SBA will review Borrower Eligibility (which includes “affiliation” analysis), Calculation of Amount, Use of Proceeds, Entitlement to Forgiveness and the certifications on the application and those on the forgiveness form.

How Long Will These Diligence Issues Hang Around?

The Loan Forgiveness IFR clarifies that Borrowers must retain records “for six years after the date the loan is forgiven or repaid in full, and permit authorized representatives of SBA, including representatives of its Office of Inspector General, to access such files upon request…” So, that means Borrowers will have these records into 2027. In addition to the six year record keeping requirement, these matters will have a long shelf life because, as per previously published guidance from our law firm in Law 360 (May 6), “[t]he statutes of limitations for the federal crimes under which charges may be brought range from five to ten years.[5]”

Has the Government Enforced Against Borrowers of Less Than $2M? Yes!

Here’s what we know:

• SBA contacted lending banks and provided loan numbers saying that those loans are being researched and SBA wanted answers on the very next business day. As American Banker Association reported (May 14, the day after FAQ 46):

“The Small Business Administration today notified Paycheck Protection Program lenders that certain loans in their PPP portfolios may require review. Those loans—which have been marked by SBA as being in “research” status—must be reviewed for accuracy and completeness. A lender should verify the borrower’s name, EIN or Social Security number for these loans and make any necessary changes by tomorrow at 5 p.m. EDT.” (Emphasis added).

DOJ continues to issue press releases regarding numerous enforcement actions, several of which are against borrowers of less than $2M (even aggregating separate loans borrowed by “affiliated” entities).  A number of those actions were reported by the lenders themselves or by agencies other than SBA.  We expect SBA’s own loan review to ramp up in connection with SBA’s receipt of applications for forgiveness.

Two important insights emerge from the DOJ press releases on these prosecutions. First, these enforcement actions show multiple agencies (federal, state and local) coordinating – and while observers generally expected SBA, DOJ and FBI to spearhead this activity, there are also agencies we did not initially expect to find in the first wave of enforcement against borrowers (i.e., Office of Inspector General of the FDIC, Treasury Inspector General for Tax Administration (TIGTA). “Atlanta Complex Financial Crimes Task Force supported by the Gwinnett County Sheriff's Office,” IRS-Criminal Investigation (IRS-CI), U.S. Postal Inspection Service, Federal Housing Finance Agency, Office of Inspector General, and the “New York City Police Department, the Office of the New York State Comptroller, and the New York State Department of Labor”). Additionally, the certification of necessity is not needed to enforce against someone who “falsely represented that the funds would be used to support payroll expenses…,” as the use of proceeds certification (among others) will serve. 

That use of proceeds certification alone is driving enforcement actions.  The added certifications in the new loan forgiveness application have also not yet kicked in, but those will add weapons to the enforcement arsenal. 

Despite early and repeated statements by Treasury and SBA that lenders would be held harmless, the Loan Review Procedures IFR clarifies that lenders will be subject to a “clawback”: 

“if within one year after the loan was disbursed SBA determines that a borrower was ineligible for a PPP loan based on the provisions of the CARES Act or applicable rules or guidance available at the time of the borrower’s loan application, or the terms of the loan application, SBA will seek repayment of the lender processing fee from the lender.” 

The threat of clawback will motivate lenders to scrutinize more closely the PPP loans on their books and report irregularities sooner rather than later. Reported irregularities will almost certainly override any presumption of good faith that SBA may otherwise be applying to the certification of necessity. 

Loan Forgiveness Timing

The Loan Review Procedures IFR provided information on timing for decisions on applications for forgiveness.  The lender has 60 days to either approve, deny, or deny “without prejudice…pending SBA review of the loan…” (Section III, 2(b) at p. 12). While SBA then has 90 days to make its own determination (“statutory 90-day period to review the PPP loan and forgiveness documentation”), it is unclear how long SBA may elect to delay additional determinations if it is investigating a loan. See the “subject to any SBA review” language below (same section): 

“If the lender determines that the borrower is entitled to forgiveness of some or all of the amount applied for under the statute and applicable regulations, the lender must request payment from SBA at the time the lender issues its decision to SBA. SBA will, subject to any SBA review of the loan or loan application, remit the appropriate forgiveness amount to the lender, plus any interest accrued through the date of payment, not later than 90 days after the lender issues its decision to SBA.” (Emphasis added)

Borrowers should know soon after the lender submits the forgiveness approval to SBA whether SBA is going to review the loan (resulting in further delay):

“If SBA undertakes such a review, SBA will notify the lender in writing and the lender must notify the borrower in writing within five business days of receipt.” (Emphasis added)

However, because the immediately preceding sentence is the “review at any time” language, we are at the mercy of SBA as it determine whether and when to conduct reviews triggered for other reasons.

In sum, we expect to see a hive of government enforcement activity from multiple state, federal and local agencies acting in concert, regardless of the comfort many seemed to take in FAQ 46.

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Appendix I: Excerpts from SBA Loan Review Procedures IFR

b. What borrower representations and statements will SBA review?

The Administrator is authorized to review the following:

Borrower Eligibility: The Administrator may review whether a borrower is eligible for the PPP loan based on the provisions of the CARES Act, the rules and guidance available at the time of the borrower’s PPP loan application, and the terms of the borrower’s loan application. See FAQ 17 (posted April 6, 2020).² These include, but are not limited to, SBA’s regulations under 13 CFR 120.110 (as modified and clarified by the PPP Interim Final Rules) and 13 CFR 121.301(f) and the information, certifications, and representations on the Borrower Application Form (SBA Form 2483 or lender’s equivalent form) and Loan Forgiveness Application Form (SBA Form 3508 or lender’s equivalent form).

Loan Amounts and Use of Proceeds: The Administrator may review whether a borrower calculated the loan amount correctly and used loan proceeds for the allowable uses specified in the CARES Act.

Loan Forgiveness Amounts: The Administrator may review whether a borrower is entitled to loan forgiveness in the amount claimed on the borrower’s Loan Forgiveness Application (SBA Form 3508 or lender’s equivalent form).

c. When will SBA undertake a loan review?

For a PPP loan of any size, SBA may undertake a review at any time in SBA’s discretion. For example, SBA may review a loan if the loan documentation submitted to SBA by the lender or any other information indicates that the borrower may be ineligible for a PPP loan, or may be ineligible to receive the loan amount or loan forgiveness amount claimed by the borrower. 13 CFR 120.524(c). As noted on the Loan Forgiveness Application Form, the borrower must retain PPP documentation in its files for six years after the date the loan is forgiven or repaid in full, and permit authorized representatives of SBA, including representatives of its Office of Inspector General, to access such files upon request. Lenders must comply with applicable SBA requirements for records retention, which for Federally regulated lenders means compliance with the requirements of their federal financial institution regulator and for SBA supervised lenders (as defined in 13 CFR 120.10 and including PPP lenders with authority under SBA Form 3507) means compliance with 13 CFR 120.461.

Review:

If SBA has notified the lender that SBA has commenced a loan review, the lender shall not approve any application for loan forgiveness for such loan until SBA notifies the lender in writing that SBA has completed its review.

Lender ClawBack

“b. Are lender processing fees subject to clawback if SBA determines that a borrower is ineligible?

Yes. For any SBA-reviewed PPP loan, if within one year after the loan was disbursed SBA determines that a borrower was ineligible for a PPP loan based on the provisions of the CARES Act or applicable rules or guidance available at the time of the borrower’s loan application, or the terms of the loan application, SBA will seek repayment of the lender processing fee from the lender.”

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Appendix II: DOJ PPP loan enforcement activity in the last three weeks

• On May 22, the DOJ announced announced a prosecution in Washington State: “Software Engineer Fraudulently Sought More than $1.5 Million in CARES Act SBA Paycheck Protection Loans.” In this press release demonstrating additional inter-agency collaboration, it was the bank that made the referral before it even got to SBA. As DOJ noted:

“SBA OIG applauds due diligence by SBA’s lending partners to maintain the integrity of the lending programs,” said Special Agent in Charge Weston King of the SBA Office of Inspector General (SBA OIG) Western Region.  “Providing false statements to gain access to SBA’s programs will be aggressively investigated by our office in partnership with our law enforcement counterparts.  I want to thank the Justice Department and our law enforcement partners for their dedication and pursuit of justice.”

• That same day (May 22), DOJ announced “Hollywood Film Producer Charged with $1.7 Million COVID-Relief Fraud,” noting that:

“Sadleir allegedly obtained over $1.7 million in forgivable loans guaranteed by the SBA by falsely representing 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, including personal credit cards and a car loan.  Sadleir allegedly used three entities he controlled to obtain over $1.7 million in PPP loans…” (Emphasis added).

• On May 21, DOJ announced charges against a “$20 Million Scheme To Fraudulently Obtain” PPP Loans in New York (MUGE MA, a/k/a “Hummer Mars,”) allegedly defrauding the government with respect to multiple loans aggregating $20M.  Interestingly, this prosecution involved numerous state, local and federal authorities, as the DOJ:

“praised the investigative work of the FBI’s Financial Cybercrimes Task Force, SBA-OIG, and IRS-CI, and noted that the investigation remains ongoing.  Mr. Berman also thanked the New York City Police Department, the Office of the New York State Comptroller, and the New York State Department of Labor for their assistance with the investigation.” 

• On May 13, DOJ announced that “Maurice Fayne, who stars in Love & Hip Hop: Atlanta, has been arrested on federal bank fraud charges arising from a Paycheck Protection Program (“PPP”) loan that he obtained in the name of Flame Trucking.”
• Also, that same day (May 13), DOJ announced that “Texas Engineer Fraudulently Sought More than $10 Million in CARES Act SBA Paycheck Protection Loans.”
• On May 5, DOJ announced “First in the nation to be charged with fraudulently seeking CARES Act SBA Paycheck Protection Loans,” for loans aggregating just over $500K in Rhode Island and Massachusetts.

As American Banker reported (May 7):

“individuals who are working with banks to combat misconduct in the $660 billion program — including former California banking commissioner Walter Mix — estimate that fraud rates could be as high as 10% to 12%.

Those estimates, which are based on initial reviews of loan files at dozens of banks, are roughly consistent with what has happened after other disasters. In the aftermath of Hurricane Rita and Hurricane Katrina, a government audit found that around 16% of applicants for federal disaster assistance used invalid information. If 10% of the PPP’s funding went to fraudsters, taxpayers would be defrauded by tens of billions of dollars.”

To see our prior alerts and other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

[1] Interim Final Rule on Second Extension of Limited Safe Harbor with Respect to Certification Concerning Need for PPP Loan and Lender Reporting (5/20/2020).

[2] Interim Final Rule on Loan Forgiveness (5/22/2020) and Interim Final Rule on SBA Loan Review Procedures and Related Borrower and Lender Responsibilities (5/22/2020). 

[3] The Second Extension IFR (Section II) explains the emergent need to provide guidance and skip the customary comment period, which may result in issuing revisions after this rule takes effect:

“Although this interim final rule is effective immediately, comments are solicited from interested members of the public on all aspects of this interim final rule, including section III below. These comments must be submitted on or before [INSERT DATE 30 DAYS AFTER DATE OF PUBLICATION IN THE FEDERAL REGISTER]. SBA will consider these comments and the need for making any revisions as a result of these comments.” (Bracketed language in the original). 

[4] This guidance is part of a confusing background paragraph (Section II, p.3-4) in the Second Extension IFR, which seems to conflate the FAQ 46 “safe harbor” applicable to SBA’s review of loans as to certification of necessity (“FAQ 46 Loan Review Safe Harbor”) with the “limited safe harbor” available to those who repay in full their loans on or before May 7^th (later extended to May 14 and then to May 18) (the “Repayment Limited Safe Harbor”):

Specifically, SBA, in consultation with the Department of the Treasury, issued additional guidance with regard to the safe harbor posted on SBA’s website on May 13, 2020. See FAQ 46 (posted May 13, 2020). SBA, in consultation with the Department of the Treasury, determined that extending the safe harbor deadline from May 14, 2020 to May 18, 2020 would afford Paycheck Protection Program borrowers time to review SBA’s May 13, 2020 guidance and decide whether to avail themselves of the safe harbor. SBA previously announced this intended extension in nonbinding guidance published on May 13, 2020. See FAQ 47 (posted on May 13, 2020). [Footnotes omitted, emphasis added] 

[5] The following is footnote 4 from the Law 360 Article: “See 18 U.S.C. § 3282 (five-year statute of limitations generally applies); 18 U.S.C. § 3293 (10-year statute of limitations for financial institution offenses, including mail fraud affecting a financial institution (18 U.S.C. § 1341), wire fraud affecting a financial institution (18 U.S.C. § 1343), false statements to banks with respect to loans (18 U.S.C. § 1014), and bank fraud (18 U.S.C. § 1344)).”