Criminal Fraud in the COVID Relief Programs
In 2020, the world confronted a sprawling pandemic caused by a novel Coronavirus, COVID-19. In the United States, the government took various measures to curb the spread of the virus and hopefully, ease the climbing death count. These measures were largely implemented at the local level (after all, what is good for Los Angeles may not be appropriate in North Dakota) and shaped by federal guidance through the Center for Disease Control and Prevention (CDC).
Local ordinances instituted rules for businesses, citizens, and other establishments. These rules included limiting the number customers that could be present at a given time, shutting down certain establishments entirely, requiring customers to wear masks, and advising citizens to stay inside unless absolutely necessary.
All businesses took a hit during COVID to some degree. However, businesses where revenue is dependent on high customer volume took the hardest hits to their bottom line. Restaurants, night clubs, bars, and other service-related businesses were devastated by the government’s ordinances and citizens’ fears of congregating in tight spaces. Aside from delivery orders, most of these establishments saw their business disappear in a matter of weeks.
The federal government recognized their guidance, and the realities of the pandemic, were devastating legitimate businesses across the country. In response, they implemented various government relief programs to counteract the effects and float businesses until the pandemic was over.
The first main program was one most Americans are familiar with – the Paycheck Protection Program (PPP). This program was designed to float businesses by paying employee salaries for a period of months. The program allowed business owners to collect two and a half months of employee salaries through a loan application with the Small Business Administration (SBA). If the guidance was followed, and the loan funds were used for an approved purpose, the SBA would forgive the loan. This program was used by an enormous number of businesses across the country. From sole proprietors to large corporations, companies were entering the PPP to counteract the drops in revenue. The SBA approved loans for nearly $790 billion through the PPP. Of that amount, nearly $757 billion was completely forgiven. https://www.sba.gov/sites/default/files/2021-06/PPP_Report_Public_210531-508.pdf
The second program used by small businesses during the pandemic was the Employee Retention Credit (ERC) program. This program allowed businesses, notably restaurants, to get a tax credit against up to 50% of an employee’s qualified wages for all employees that were retained during the pandemic (this percentage changed to 70% in the 2021 Federal Relief Act). To qualify, the business must show their business was either 1) shut down during the pandemic due to a government order or 2) suffered a substantial decline in revenue. Restaurants across the country met this standard as their businesses were hit the hardest during the government reaction to the pandemic.
The initial goal of the program was to allow employers to lessen their employment tax load (Medicare and social security withholdings) during the downturn. The hope was this relief would allow employers to retain more employees by giving them a tax credit against the employer’s obligations under the employment tax framework.
Though the intention was to assist businesses in real time, the ERC has taken on a new life. The relief package allowed businesses to file amended Form 941s (employment tax returns) to claim the credit after the fact. Put differently, business owners can file amended returns today to claim the credit (maximum $26,000) for each employee that fit the criteria in 2020-2021. These credits are refundable and may result in cash payments to the business when they exceed the current employment tax liability.
The government implemented multiple financial relief programs during COVID. However, the focus of this post is the PPP and ERC programs. These programs were the easiest to enter and became hotbeds for fraudulent activity throughout the United States. The percentage of fraudulent claims is unknown; however, the Department of Justice has active investigations and prosecutions into numerous actors for filing false PPP loan or ERC documents. And the figures tied to such fraud are huge.
In this post, we will go through each of the programs analyzing the false statements that underly these claims, the current data relating to specific fraudulent activity, and the focus DOJ is placing on this ongoing issue.
The Paycheck Protection Program
The PPP is the largest and most utilized of the COVID relief programs. The PPP was administered by the SBA. However, the federal government allowed banks and FinTech companies to facilitate loan documents and money transfers. The PPP program was administered in two waves, commonly referred to as PPP Round One and PPP Round Two.
Applying for the PPP was relatively easy. A business owner was required to fill out an application listing employee wages. The business owner was required to prove up the wages through their 2019/20 tax returns or Form 941s. If the business was continuing to pay those employees during the pandemic, the program would provide the business owner with 2.5 months of financial assistance with those employee’s paychecks. If the business owner was a sole proprietor or paid a salary from the business, the program aided with business owner wages as well.
The program capped assistance at $100,000 per year per employee. This means a person making $100,000 yearly would receive the same assistance as an employee bringing home $500,000. The maximum amount allowed per employee was $20,833 ($100,000 / 12 months * 2.5 months). The total loan amount was capped at $10 million during the first round of PPP. The total loan amount was capped at $2 million during the second round.
When the loan was received, the SBA offered guidance on how the money should be spent to qualify for the second stage of the PPP, loan forgiveness. Put simply, if a business owner could show the loan funds were used for employee wages or other qualified expenses, the SBA would forgive the loan in its entirety.
Once implemented, the PPP took off in the United States. The SBA approved over 11.8 million loans under the program from 2020-2021. The loans totaled a whopping $790 billion during this time period. The fact SBA was giving away free loans to companies throughout the United States led to numerous businesses jumping on board to get their piece of the pie.
The size of the PPP made it impossible for effective oversight within the program. Much like our current tax system, it was impossible for the government to review each filing to scrutinize its veracity. The government attempted to review the larger loans, but they were largely ineffective in ferreting out fraudulent applications prior to the transfer of government backed funds. The PPP became a hotbed for fraudulent activity from 2020-2021 as citizens routinely filed inaccurate documents to support loans that were unnecessary and unwarranted.
There are two distinct areas of PPP fraud that we have seen in our practice: 1) filing false numbers or documents with an application to support an improper loan amount or 2) filing false documents or information to support proper use under the forgiveness provisions. We will take each of these in turn.
Filing False Documents to Support the Loan
Each PPP loan application requires the applicant to swear to the accuracy of the filing before submission. This is akin to the declarations a person would find on their tax returns or a bank loan document. This sworn declaration, signified by the applicant’s signature, is the source of the criminal fraud allegations under this theory.
Each PPP application required the applicant to provide supporting documents to prove up the wages that supported the loan amount. If the request was for business owner wages in a sole proprietorship, the applicant could file their 2019 schedule C to show how much was made the prior year. If the request related to W-2 wages for employees, the business owner applicant could file prior Form 941s to show the wages being paid within the business. These two documents supported the vast majority of loan requests.
Though the federal government was administering the loans, the actual application process was left to banking institutions and FinTech companies like Square. These local entities provided the applications to customers, transferred the applications to the SBA, and ultimately, transferred the funds into the customers bank accounts. Additionally, these same entities handled the loan forgiveness applications for their customers. In short, banks and FinTech companies served as the middleman between the applicant and the SBA.
Under that framework, it is not difficult to see how fraudulent activity ran rampant through the PPP. Most commonly, the applicant would draft an unfiled, false tax return or Form 941 to support whatever figures were presented in the application. These false documents were not reviewed by the SBA or compared to recent tax filings. The bank would briefly review the document and transfer the package over to the SBA. If the loan was less than $2-3 million, the SBA would rubber stamp the loan package and bless the release of funds.
A fraudulent actor could submit the package on a Monday and have hundreds of thousands of dollars transferred into their bank account by the following week. The lack of oversight ensured nearly all packages would be approved. The federal government would then have to claw back their money, and bring criminal charges, once the falsities were discovered.
This route for PPP fraud makes up the vast majority of waste in the system. Having said that, not all applications under this theory are created equal. Some applicants falsely inflated wages in an existing business or added employee wages outside of the approved window. Others took it a step further and created a business out of thin air to support their loan request. The most egregious we have seen is a PPP package for $1.5 million relating to a company that never existed. The applicant created an entire company in his imagination, drafted false tax documents, and submitted them to the government. The entire $1.5 million was transferred to the applicant before anyone recognized the false statements.
Filing False Documents to Support Loan Forgiveness
Once the PPP funds were transferred, the applicant had to wait for a few months before applying for loan forgiveness. The PPP funds were initially a valid loan with a 1% interest rate. The default rule required the applicant to repay the loan amount unless the SBA approved forgiveness.
The SBA would approve loan forgiveness as long as the business owner could show the funds were used for their stated purposes – retaining employees through wage payment. This required the business owner to show the funds transmitted by the SBA were used for the proper purpose. Often, this rule required the applicant to submit bank statements and other documents to track the funds into a business account and out to payroll.
There was a huge incentive for all applicants to get approved under the forgiveness guidance. Most applicants under the PPP would have never applied for the loan unless the SBA agreed to not require repayment down the road.
Under these incentives, again, the motive for fraudulent activity was obvious. Fraud in this area took on two distinct tracks: 1) filing false documents for forgiveness on a fraudulent base loan and 2) filing false documents for forgiveness on a valid loan. Though the end result is the same, these two paths to fraudulent filings deal with two very different sectors of society.
The former applicant has already engaged in criminal fraud under the first theory – filing false documents to support the loan. The loan itself was an ill-gotten gain. The obvious next step in that scheme requires fabrication of documents to avoid repayment. It would be difficult to find a person that fraudulently obtained a PPP loan and later decided to not ask for forgiveness.
The latter group of applicants consisted largely of legitimate business owners with legitimate loans. However, once the loans were received the funds were not used within the confines of the forgiveness rules. For instance, let’s assume a business owner received $500,000 from the PPP. The $500,000 was obtained with a truthful application filed through Wells Fargo and supported by accurate 2019 tax filings. The rules require the business owner to spend 75% of the loan amount, or $375,000, on employee compensation to obtain forgiveness.
Instead of earmarking the money accordingly, the business owner spent $100,000 on employee compensation and the other $400,000 on rent and other overhead costs. While there is nothing improper about spending the money in this fashion, the loan would not be forgiven in its entirety. Many business owners found themselves in a tough position. They could either repay certain amounts of the loan or produce misleading documents to obtain forgiveness. This story encompasses a wide cross section of the fraud currently being investigated by DOJ.
The PPP was built on a foundation of good intentions. However, like most government programs of this size, the actual implementation was wrought with waste and fraudulent activity. The vast majority of applicants seized on the PPP for the right reasons. They filed accurate documents and obtained assistance during a very strange time. Having said that, the fraudulent activity linked to the program was not minor. The government has no idea how much money was loaned, and later forgiven, under false documents or fabricated businesses.
DOJ continues to go after PPP fraud in federal courts across the country. Their focus remains on the big fish who illegally obtained millions from the program during the pandemic. The little fish will likely get a free ride.
In the next post, we will look at a fresher topic related to fraud within the COVID relief programs – ERC Fraud. The employee retention credit program is currently overflowing with applications. The application numbers are so high, and the known fraud so prevalent, the government has recently put a stop on the payments under the ERC. Fraudulent behavior linked to the ERC will soon be the source of numerous federal prosecutions across the country.