The first rounds of PPP helped more than five million small businesses in the United States in the amount of $525 billion in funding, but not without a dark side to the program.”
There is no doubt that the COVID-19 global pandemic has challenged communities across the country and has created significant economic downturn, which has hit small businesses especially hard. While individual stimulus checks and the Paycheck Protection Program funding authorized by the CARES Act has helped, it has proven not to be enough to sustain our communities through this crisis.
As part of the new $2 trillion coronavirus stimulus bill, the Economic Aid to Hard-Hit Small Businesses, Non-Profits and Venues Act (Economic Aid Act), Congress authorized another round of PPP funding. The Small Business Association rolled out the third round of relief on Jan. 11 for certain small businesses. These funds are intended for new and smaller borrowers and for borrowers in low- and moderate-income communities.
Fraudsters target PPP loans
Small business owners aren’t the only ones eager to get their hands on additional PPP funds. The first rounds of PPP helped more than five million small businesses in the United States in the amount of $525 billion in funding, but not without a dark side to the program.
Historically, federal relief funds have been highly targeted by fraudsters, and PPP loans are no exception. The nature of these loans makes them particularly susceptible to both misuse and fraud.
During round one of PPP, bad actors surfaced at an unexpected rate, and financial crime divisions of community financial institutions struggled with the realization that loans that had rushed through funding may be fraudulent.
As of December 2020, the Department of Justice had filed at least 41 criminal complaints totaling approximately $62 million in fraudulent loans. According to both the SBA and the Secret Service, this is the “tip of the iceberg.” Assets seized by the DOJ include luxury cars, Rolex watches, expensive watercraft, high-end jewelry and large sums of cash.
In addition, many employees of financial institutions are being investigated for possible involvement in the fraud. Cases resulted from all sizes of institutions and communities; no one was immune.What makes this fraud more heinous than most is that the relief was intended to assist those suffering from the effects of the pandemic and to help rebuild communities.
Round three of PPP funding is targeting assistance for minority, underserved, veteran and women-owned businesses, and it is critical that financial institutions do their part in preventing these funds from going to fraudsters and other bad actors. Red flags for identifying fraudulent PPP applications include:
- Misuse of proceeds
- Unqualified borrowers
- New Employer Identification Numbers (EIN)
- Shell corporations/dormant EINs
- Recent business incorporations
- Inflation of payroll
- Large loan amounts
- False statements on applications
- Fraudulent supporting documents (e.g., payroll, tax forms)
- Employee/employer collusion
- Newly created and/or multiple bank accounts with abnormal transaction activity
- Consumer accounts rather than business accounts
- Rapid movement of money in and out of accounts
- Withdrawals made via cash or apps (i.e., Cash App, Zelle)
- Abnormal transaction activity for client
- Transfers to overseas accounts known for poor anti-money laundering controls
- Crime rings — multiple applications are submitted using phishing information
Financial institutions still have many questions regarding the steps they should take both to prevent fraud and protect themselves from liability, even as they face pressure to issue loans quickly.
Although PPP loans are guaranteed by the SBA, one thing is certain, if a financial institution does not conduct sufficient due diligence on a PPP borrower and a fraudulent loan is funded, the bank may have risk exposure and possible financial loss. Now is the time to include lenders in PPP fraud specific training.
There are other risk factors to consider with PPP loans
In addition to possible hard dollar losses, financial institutions should consider other risk factors when allocating compliance resources to their PPP onboarding and portfolio due diligence:
- Bad debt risks — Loan amounts not forgivable may have a higher level of default.
- Operational risks — Due diligence may have been lax during the rush of applications.
- Compliance risks — Compliance gaps could occur due to rushed processing.
- Reputational risks — What if fraud is found in your portfolio and headlines abound?
The third round of PPP will have more safeguards against fraud prior to SBA approval. While financial institutions are required to follow Bank Secrecy Act requirements and perform proper due diligence, the SBA will conduct additional compliance checks to assist in combatting extensive fraud in round three.
These compliance checks will include verification of business existence prior to the pandemic and a scan to ensure no other PPP loan applications have recently been received to avoid loan stacking.
Financial institutions should follow all Suspicious Activity Report requirements for fraud reporting and be sure to start the 30-day SAR clock as soon as fraud is detected. If a borrower does not comply with the PPP criteria and the loan is not forgiven, a SAR may be warranted for loans that are termed out.
In addition to filing a SAR, the federal government has asked that the following agencies be contacted immediately upon detecting PPP fraud:
Financial crimes units should work closely with lenders and senior management, enhancing training that includes PPP portfolio onboarding and monitoring. After funding, it is equally important to perform CDD and transaction monitoring of these businesses.
Following the use of funds may lead somewhere other than what is expected. The regulators will expect enhanced due diligence for this round since financial institutions now know what to expect.
Terri Luttrell is compliance and engagement director for Abrigo. She is a seasoned AML professional and former director and AML/OFAC officer with more than 20 years in the banking industry, working both in medium and large community and commercial banks ranging from $2 billion to $330 billion in asset size.