Can BSA/AML Requirements Lead to Deemed Knowledge of Borrower Fraud?
The first two weeks of August brought a milestone of sorts in the ongoing recovery from the economic downturn brought on by the COVID-19 pandemic. The Paycheck Protection Program (“PPP”) ended its enrollment period on August 8, 2020 and the window for borrowers to apply to have their PPP loans forgiven opened on August 10, 2020.
The PPP was a centerpiece of the over $2 trillion Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) that, according to a study by the Massachusetts Institute of Technology published on July 22, 2020 had to that point saved between 1.4 and 3.2 million jobs. Less formally observed but possibly more widely agreed, the PPP caused at least as many headaches with its rocky initial rollout and the ongoing uncertainty over applicable loan forgiveness standards. But, whereas implementing the PPP poses challenges to lenders now, due to the rampant fraud in the program (which, along with all COVID-19-related enforcement actions and policy statements, we track here) and its funding mechanics, it creates substantial downstream enforcement risk through the False Claims Act (“FCA”) for participating financial institutions.
Numerous districts already have charged borrowers with PPP-related fraud. To date, cases generally involve one of these scenarios:
- Borrowers submitted fraudulent loan applications and supporting documents to seek PPP funds for businesses that either already had failed pre-pandemic or that they did not actually own.
- Borrowers lied about amount, or even existence, of employees and payroll. These schemes involve inflated numbers of employees for companies, or even completely fake companies.
- Borrowers certified that they would use loan funds to support payroll expenses or other allowable expenses, but in fact used all or most loan funds to pay personal and non-business expenses.
The prosecutions to date have all centered on relatively obvious fraud by borrowers, not lenders. But, wider-reaching investigations are occurring and though we are very much at the beginning of the enforcement phase, the magnitude of fraud in these programs is coming into focus. On September 1, 2020, the House Select Committee on the Coronavirus Crisis released a preliminary analysis finding, among other things, over $1 billion in fraudulent PPP loans were issued and identifying red flags with respect to an additional $2.98 billion in loans made to 11,000 borrowers.
And, as we discuss, the anti-money laundering (“AML”) requirements of lenders imposed under the Bank Secrecy Act (“BSA”) may expose lenders to greater risk under the FCA, which can impose civil liability for the reduced mental state of reckless disregard. Many lenders have extended PPP loans to previously-existing customers. This is a rational business decision, given typically lower business risks presented by existing customers and lower compliance costs, because existing customers do not need to provide beneficial ownership information under the Customer Due Diligence (“CDD”) rule of the BSA. However, because lenders also are required under the BSA to understand to a degree the historical and current activities of its customers, lenders may be deemed in future FCA actions to have “known” about red flags generated by fraudulent borrowers because of information obtained by the lenders properly executing their AML programs. That is, compliance with the BSA ironically may generate evidence for downstream FCA enforcement actions based on deemed “knowledge” by the lender of borrower malfeasance. This irony may be exacerbated by any disconnect in real time between the AML compliance staff at financial institutions and the front-line business people extending loans, particularly given the incredible speed with which institutions have extended PPP loans, at the government’s urging.
The point here is not that PPP lenders will face direct regulatory liability for alleged BSA/AML failures – although they may. Rather, the point is that PPP lenders may face enhanced FCA liability due to borrower information obtained through an entirely functional BSA/AML program. This phenomenon highlights the need for the “front” and “back” offices at lenders to communicate.
Continue Reading PPP Lenders and Fraudulent Borrowers: False Claims Act Liability and AML Risk