United States

Detecting and preventing fraud for PPP loans

AML AND COMPLIANCE NEWS  | 

The Paycheck Protection Program (PPP) allows small businesses affected by the COVID-19 pandemic to obtain a loan that will provide a direct incentive to keep workers on their payrolls. Since the start of the program, the Small Business Administration (SBA) has approved 8.2 million loans to small businesses totaling $718 billion. The application deadline for the program was originally set for March 31, 2021; however, on March 25, 2021, bipartisan legislation extended the PPP loan application deadlines until May 31, 2021, and the SBA will have until June 30, 2021, to process the applications.

Potential PPP loan fraud and resolutions

Although thousands of businesses have benefited from the PPP, there have been many reports—and convictions—of borrowers and loan agents who have committed fraud in SBA business loan programs. With the extension of the PPP application, lenders should continue to be vigilant about the increased risk of fraud as they lend to businesses.

According to the SBA, the following are the most common types of fraud identified in SBA loan fraud investigations:

Loan agent fraud

Loan agent fraud: A prospective borrower or a lender often pays a loan agent to prepare documentation for an SBA loan application and refer the borrower to a lender. Lenders should note the following fraud indicators:

  • The loan agent has a record of early defaults
  • The loan agent controls all of the communication between the lender and the borrower
  • The loan agent threatens to shop the loan elsewhere
  • The loan agent provides a high number of qualified borrowers in a short period of time
  • The loan agent easily resolves seemingly difficult questions or problems with a loan
  • The loan agent steers the lender to specific appraisers or title companies
  • The borrower replies “no” when asked if a packager was paid to prepare the loan application, when it is known a loan agent is involved in the process
  • Multiple loan applications are submitted simultaneously to different lenders for the same borrower, as indicated in credit reports
  • The loan agent charges excessive fees

To mitigate loan agent fraud, the following practices and internal controls can help deter and detect suspicious lending activity:

  • Develop sufficient management oversight of loan approvals
  • Establish policies (such as a code of conduct) to require business development officers and other lender personnel to disclose the involvement of loan agents in generating or packaging loans
  • Put limits on commissions and other internal inducements that provide incentives for loan officers to concentrate on loan volume at the expense of loan quality
  • Establish internal review and auditing functions to examine the reasons why a particular lending official may have an unusually high number of loans that go into early default or experience other significant problems, or may have a significantly higher loan volume than his/her colleagues
  • Enforce policies to require a higher level of due diligence in reviewing change of ownership transactions, as numerous Office of Inspector General (OIG) investigations have identified fraud on these type of loans
  • Track loan agent participation in their portfolios to find unusually high number of loans that experience early defaults or other significant problems
  • Ask loan agents for references from officials at other lending institutions
  • Search public databases to identify problems and check Better Business Bureau records
  • Communicate directly with borrowers about the loan and loan application, loan agent performance, and fees
  • Use a reputable appraiser and title company known to the lender

Borrower fraud

Borrower fraud: Borrowers may intentionally provide false information to lending institutions during the loan application process. Some of these include:

  • Providing false equity injection documents (such as false gift letters, promissory notes, financial statements, bank statements, etc.)
  • Overstating income
  • Understating or failing to disclose liabilities and debts
  • Overvaluing collateral
  • Failing to disclose criminal records
  • Making false claims of U.S. citizenship
  • Failing to disclose true ownership of the business
  • Using false Social Security numbers to conceal poor credit histories
  • Submitting altered tax returns
  • Providing fraudulent standby agreements
  • Creating false work histories

When lending officials are suspicious that equity injection verification documents may be false, it is suggested that lenders take affirmative steps to detect and deter such fraud such as the following:

  • If a gift letter is involved, have both the donor and the borrower sign an affidavit detailing the alleged gift and stating that the gift does not have to be repaid or returned, and request that the borrower provide a copy of a bank statement showing the injection was made prior to disbursement.
  • If funds are being transferred by wire (especially from a foreign country), request a copy of the wire transfer and include it in the loan file.
  • If an inheritance is cited, verify that the funds exist by obtaining a copy of the inheritance bank statement showing the funds exist prior to disbursement.

As stated by the SBA, “fraud undermines public confidence in the public benefits of SBA lending programs and can lead to higher program costs for borrowers and lenders alike.” When we mitigate these fraud risks, we can continue to support small business growth and job creation during these unprecedented times.

For further details about detecting fraud in small business administration lending programs, read the notice here.

RSM CONTRIBUTORS


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