After the 2008 subprime mortgage crisis, the Department of Justice settled False Claims Act claims against the country’s largest mortgage lenders for billions of dollars. When Congress approved the Paycheck Protection Program in response to the Covid-19 pandemic, many predicted another wave of big-dollar FCA settlements.
But guidance from the Small Business Administration subsequently cast doubt on the likelihood of such suits, explicitly permitting PPP lenders to rely on borrowers’ certifications.
Against that backdrop, the DOJ’s recent announcement of its “first-ever” FCA settlement with a PPP lender for $18,673 might not seem like important news. But don’t let the dollar amount fool you. The Prosperity Bank settlement shows DOJ’s view that, notwithstanding SBA’s guidance, PPP lenders can face FCA liability for borrower fraud, at least in some circumstances.
The borrower in Prosperity Bank falsely certified eligibility for a PPP loan. But DOJ still pursued Prosperity Bank, alleging it knew of the falsity. That approach should place other PPP lenders on alert.
DOJ could take—and historically has taken—an expansive view of when lenders “know” of borrower fraud, relying on the FCA’s definition of “knowing” to include deliberate ignorance and even recklessness.
Initiative and Aftermath
After the mortgage crisis, DOJ brought dozens of FCA suits on behalf of the US Department of Housing and Urban Development. Rather than sue based on individual mortgages, the DOJ targeted banks and lenders that certified thousands of mortgages to HUD insurance programs.
The effort, known as the Big Lender Initiative, accused lenders of “recklessly” pressuring underwriters to approve loans, ignoring the risk that many did not meet HUD’s eligibility criteria. The DOJ ultimately recovered more than $4.75 billion from over 20 lenders, including many household names.
When Congress passed the CARES Act in 2020, many foresaw a second Big Lender Initiative. The PPP provided $349 billion for loans, processed by private lenders, to borrowers who met certain eligibility requirements relating to their business’s ownership, operations, number of employees, and use of funds.
Observers predicted that, if lenders rushed to certify PPP loans, ignoring the risk that borrowers did not meet eligibility requirements, they could face the same FCA allegations lenders encountered a decade earlier.
The SBA, however, appeared to remove much of the threat. In an interim final rule issued in April 2020, SBA allowed “lenders to rely on specified documents provided by the borrower to determine the qualifying loan amount and eligibility for loan forgiveness.” So long as lenders gathered required information from borrowers, they would be “held harmless for borrowers’ failure to comply with program criteria.”
Later events may have led the government to regret the SBA’s rule.
An investigation by the House’s Select Subcommittee on the Coronavirus Crisis found widespread fraud in PPP loans—up to $4.6 billion. As much as $3.6 billion went to borrowers on the Treasury Department’s “Do Not Pay” list. Another $402 million went to borrowers whose taxpayer identification numbers was created after the PPP cutoff date, and thus presumably were not in business before the pandemic.
The alleged fraud apparently affected some lenders more than others. According to the subcommittee, fintech lenders processed 15% of PPP loans, but were associated with 75% of loans suspected of fraud. Some fintech lenders allegedly approved loans in “as little as an hour,” often with little or no human review.
For many such lenders, more than 25% of their loans had indicia of potential fraud, according to a University of Texas study. One fintech lender, Kabbage Inc., recently acknowledged in a court filing that DOJ is investigating it under the FCA, “on the theory that Kabbage improperly approved PPP loans that were either obviously fraudulent or not within [SBA] parameters.”
The settlement with Prosperity Bank spotlights potential FCA actions DOJ may pursue against other PPP lenders. Prosperity Bank approved a $213,400 PPP loan to Woodlands Pain Institute. That business’s sole owner falsely certified that he was not facing criminal charges, hiding his business’s ineligibility to receive the loan.
Although Prosperity Bank could rely on that certification under SBA’s interim final rule, DOJ still pursued an FCA claim, alleging that “Prosperity Bank employees knew [the owner] was facing charges.” The parties then settled for $18,673, nearly double the 5% processing fee that Prosperity Bank received for the loan.
The settlement indicates that DOJ will not credit reliance on borrower certifications that a PPP lender knows to be false. How DOJ will apply that principle in practice, however, is unclear and could ultimately create tension with SBA’s guidance that lenders would be “held harmless for borrowers’ failure to comply with program criteria.”
The FCA’s definition of “knowing” further complicates the issue. That definition explicitly includes “deliberate ignorance” and “reckless disregard” of information’s truth or falsity. If a potential borrower has submitted obviously deficient documentation, will DOJ impute “knowledge,” “deliberate ignorance,” or “reckless disregard” of that deficiency to the lender, particularly if the lender is a fintech that performed no human review?
Such theories of liability could result in suits resembling the Big Lender Initiative. They would attempt to hold PPP lenders accountable for widespread failures to meet eligibility requirements. Whether DOJ will pursue those theories is unclear, but the description of the Prosperity Bank settlement as the “first-ever” promises that it will not be the last.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Caleb Hayes-Deats is a partner at MoloLamken, where he represents companies and individuals in False Claims Act and other types of whistleblower litigation. Previously, he served as an Assistant U.S. Attorney in the Southern District of New York.