Fraud, bad actors are inevitable with $350 billion federal loan program

The federal government recently handed $350 billion to small businesses struggling to survive the coronavirus crisis. It took just two weeks, a remarkable achievement even if the rollout of the Paycheck Protection Program hit a few potholes.

Businesses can have the loans forgiven if they use most of the money to pay employees, which should keep millions of people working for at least a couple more months.

Most businesses will abide by the spirit of the program. But one thing is certain to follow the allocation of so much “free money”: abuse. It’s as inevitable as humid Florida summers.

Some business owners will make innocent mistakes. Others will flirt with breaking the rules, stopping short of committing a crime, but opening themselves up to lawsuits and public shaming. And, of course, too many will commit outright fraud. They will use the money to buy a boat or create a shell company to funnel funds to family members, who aren’t really employees.

The temptation is simply too great. It happened after the Great Recession, when bad actors took advantage of federal efforts to stabilize the economy, including the Troubled Asset Relief Program, commonly known as TARP.

The Paycheck Protection Program has some checks in place that should help curtail abuse. The requirement to spend 75 percent of the loan on payroll gives businesses less wiggle room than some previous programs. Background checks on the business owners also will help.

“But there’s no way to close all the loopholes when you’re dealing with such a big program, and you’re trying to get money out quickly,” said former federal prosecutor Derek Cohen.

Cohen and colleagues Dave Callaway and Grant Fondo prosecuted cases related to the Troubled Asset Relief Program and natural disasters including Hurricane Katrina. The trio, which now works at the global law firm Goodwin Procter, recently put out a tip sheet for how businesses can avoid trouble.

They warned businesses that don’t really need the money to think hard about accepting a loan, even if technically they meet the requirements. That scenario might not lead to criminal prosecution, but “very active and financially incentivized plaintiffs” attorneys will be scrutinizing larger businesses that take the money. Employees from within companies also will blow the whistle if they think taxpayer dollars are being misused. Lawsuits will follow.

“Some of this is optics,” Fondo said. “They have to ask if it’s worth the risk.”

In the past, businesses that took government money have gotten into trouble when they discover a mistake and try to cover it up. They mislead auditors and investigators or falsify paperwork. Taking the money isn’t a crime, but misusing and lying about it gets them in hot water.

“They turn a mistake into a criminal case,” Fondo said.

Federal prosecutors often prioritize going after businesses that steal hundreds of thousands or millions of dollars. But anyone who lies about their eligibility to obtain a Paycheck Protection loan or misspends smaller amounts shouldn’t rest easy, the three attorneys advised. During Hurricane Katrina, for instance, prosecutors won cases against people who misused $15,000 in government money, sometimes even less.

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Prosecutors "end up taking cases (they) never would have given a second look,” Fondo said. “People shouldn’t be comfortable saying, 'This is only $10,000. I’m going to be fine.’”

Many white-collar criminals don’t see themselves as criminals, Cohen said, which helps explain why programs like Paycheck Protection are so susceptible to fraud. There’s a dose of cognitive dissonance — people tell themselves everyone is doing it or that it’s just the way business gets done.

“When someone puts on a mask and robs a bank, it’s very hard to convince themselves that they’re not a criminal,” Cohen said. “But most white-collar criminals I’ve encountered don’t think of themselves that way.”

Matthew Hall, an attorney at Hill Ward Henderson in Tampa, said the program’s rollout was confusing, with poor early instructions about who was eligible. Even the guidelines on how businesses could spend the money weren’t clear, he said. Hall worries about businesses trying to do the right thing but getting sideways to the law and potentially having to pay back the loans.

“You’ll get under-informed people who don’t know they are doing anything wrong,” he said. “There are a lot of speed traps. We will find out later how much of this we got right.”

We’ll also find out which businesses break the rules.

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