Covid Loan Fraud Probes Turn to the Bankers Who Approved Them

The Justice Department has spent the pandemic years handily securing guilty pleas from small-time scammers who’d purchased luxury items using emergency relief loans.

Now comes the hard part: Finding lenders liable for rubber stamping fake loans made available under the more than $1 trillion in federal spending intended for struggling businesses.

DOJ’s Covid-19 fraud enforcement task force is shifting its focus to financial institutions in cases that will involve years of document-intensive review and interviews with industry insiders to uncover evidence that banks ignored obvious red flags, bypassed fraud-detection measures, or colluded with customers, attorneys say.

The government will have to overcome forgiving Trump-era guidance that banks stand ready to cite in defense, and it might not be enough to prove a bank negligently failed to spot false applications.

“In many cases, ‘should’ve known’ is enough to prove fraud, but I’m not sure that ‘should’ve known’ is enough in a case under the CARES Act, unless the lender itself is the one that caused the problem,” said Gregg Shapiro, a former DOJ civil enforcement chief who investigated Covid-19 fraud at the pandemic’s outset.

Larger banks with more sophisticated prevention practices are less vulnerable, but regional and local institutions and fintechs—or web-based financial services providers—face greater scrutiny.

One Settlement

Thus far, the department has little to show for its efforts. DOJ has yet to replicate its first-ever False Claims Act settlement with a Paycheck Protection Program lender—a regional bank in Texas and Oklahoma that agreed to pay $18,673.50 for allegedly processing an ineligible customer’s loan.

By comparison, DOJ announced last fall that prosecutors had seized $1.2 billion, charged about 1,500 defendants with crimes, and investigated over 1,800 individuals and entities for alleged civil misconduct—all tied to Covid relief funds.

But a congressionally-extended 10-year statute of limitations provides ample time for investigators to build cases in the finance sector.

DOJ’s acting Covid enforcement chief divulged a few details of his new focus during recent speaking engagements.

Thanks to data analysis and individual cooperators, “we can identify particular lenders, particular financial institutions that really enabled this to happen,” said Michael Galdo, the acting chief, at a False Claims Act conference in February. He said those cases will take longer to build, “but I think we’re going to see more activity in that space.”

While his speech may have signaled to whistleblower lawyers that DOJ needs assistance, defense lawyers say they’ve noticed an enforcement uptick that bears out Galdo’s words.

Cases unfolding behind the scenes appear to be in their infancy, and will predominantly attempt to hold institutions civilly liable, although criminal charges remain possible for blatantly willful and systemic offenders, the attorneys predict.

Most likely targets include fintechs, many of which launched in response to CARES Act programs like PPP and Economic Injury Disaster Loans for small businesses, but lacked experience in establishing anti-fraud controls.

Yet even for the nontraditional lenders, the compressed time frame and quickly-changing regulatory guidance during the PPP rollout offer strong defenses, said Denise Barnes, a former trial attorney at DOJ’s civil fraud section, where her investigation of Wells Fargo led to a $2.1 billion settlement.

“That’s the argument I would make—that ‘this was so fast paced, we’re doing the best we can, we’re rolling out the information, we’re rolling out additional controls as we’re learning,’” said Barnes, now a white-collar defense partner at Honigman. “‘Maybe we didn’t do the best job, but who was doing the best job because the world was on fire?’”

Further, financial institutions are prepared to hold the government’s own 2020 words against it—including the Small Business Administration’s mandate to prioritize speed over diligence and assurance that lenders will be held “harmless” if they relied on information applicants submitted.

Bank Secrecy Act

Defense lawyers, whistleblowers’ counsel, and former department prosecutors are skeptical that the task force can accomplish an enforcement sweep comparable to the post-housing crisis period when DOJ obtained a combined $4.8 billion in FCA penalties from 20 lenders.

Those challenges aren’t stopping the department from trying, particularly since the reach of one lender can far surpass that of a single borrower.

The False Claims Act, a 19th century civil statute that’s commonly leveraged against companies for defrauding government agencies, remains a reliable mechanism for DOJ to try recouping taxpayer dollars from CARES Act lenders, practitioners said.

Another potential lever is the Bank Secrecy Act, which requires financial institutions to thwart money laundering.

“Government officials have publicly stated that they’re looking at Bank Secrecy Act claims against financial institutions,” said Caleb Hayes-Deats, a MoloLamken partner and former assistant US attorney in the Southern District of New York. “I would expect them to focus on potential deficiencies in customer due diligence for loan applicants, and failure to report fraud or other suspicious activity.”

The time-sensitivity in approving Covid relief funds led the government to waive most of the standard verification protocols required of lenders before approving applications. But the pandemic aid package still required them to establish BSA anti-money laundering systems to conduct internal audits and flag suspicious customers.

In contrast to established banks, new entrants trying to cash in on government processing fees for handling high volumes of PPP loans didn’t have pre-existing BSA compliance programs.

“That’s an area where I think you’re going to find some cases brought,” said Derek Adams, a Potomac Law Group partner who investigated banks as a DOJ civil fraud trial attorney. “Given the craziness of the world in the spring of 2020, to try to stand up a BSA/AML program if you didn’t already have one would be near impossible.”

In the aftermath of a Bloomberg Businessweek analysis in October 2020 finding financial technology companies handled 75% of the approved PPP loans connected to fraud by DOJ, a fintech crackdown has been expected, but is still awaiting resolutions.

One such online lender, Kabbage Inc., disclosed last year that it was under DOJ investigation for PPP fraud, and the SBA announced in December that it’s investigating eight other lenders implicated in a House subcommittee report. Practitioners say those probes are likely in coordination with DOJ.

Finding Evidence

Brick-and-mortar banks could also be the subject of investigations.

“There’s going to be many cases where there was a tight relationship,” giving banks knowledge that customers were fabricating information on applications, said Justin Berger, a partner at Cotchett, Pitre & McCarthy who’s bringing whistleblower PPP fraud claims against lenders.

Regional and local banks may be particularly prone to such investigations for failing to cross-check information on file when scheming borrowers “were a known entity to that bank,” said Eva Gunasekera, a former DOJ civil fraud attorney who is now a partner at whistleblower firm Tycko & Zavareei.

To that end, defense lawyers like Michelle Rogers, a Cooley partner, are preparing their arguments ahead of expected DOJ advances against financial institution clients.

“There was so much white noise around the program,” Rogers said. “I think it just created, for me as a defense lawyer at least, real things to dig into to say ‘is this really traditional False Claims Act-type fraud or were the issues really caused by the program execution based on the way the government rolled it out?’”