A Second Wave Of COVID-19 Fraud Enforcement: An Emerging Risk For Businesses

Vinson & Elkins LLP

On March 26, 2021, the Department of Justice (“DOJ”) issued a press release trumpeting the agency’s “historic level of enforcement action” in response to COVID-19 related fraud.1 Roughly one year after Congress passed the $2.2 trillion Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, DOJ announced that it had criminally charged 474 individuals for their alleged efforts to fraudulently obtain a collective $569 million through schemes related to the COVID-19 pandemic. Most of these cases involve garden-variety frauds perpetrated by individuals who saw the government’s historic economic intervention as an opportunity for illicit profit (or a quick way to buy a Lamborghini). However, if past is prologue, as DOJ churns through the low-hanging fruit of COVID-19 fraud over the coming months, the Department will likely turn its sights toward corporate entities and pursue cases involving more complex white collar conduct.

Fraud liability stems in large part from the certifications companies are required to make to participate in the government’s COVID-19 relief programs. For example, to participate in the Paycheck Protection Program (“PPP”), companies have to endorse multiple certifications on their loan and forgiveness applications. As we have written, some false certifications make for obvious fraud cases, such as where a company certifies that it is not involved in a bankruptcy proceeding when it in fact is. However, other certifications can be substantially more nuanced, such as the certifications related to the economic necessity of the loans or a borrower’s eligibility to participate in the PPP, and these certifications increase the risk of fraud exposure even for sophisticated companies. The check-the-box nature of the certifications tends to exacerbate the risk, as applicants can quickly pass over them without the attention that should be paid to each question.

Several factors increase the risk that companies will find themselves subject to government investigations related to COVID-19 relief, including:

  • An uptick in whistleblower reports and lawsuits under the False Claims Act (“FCA”);
  • Increased cooperation among federal law enforcement agencies across the United States, and internationally; and
  • Audits of all companies that borrowed $2 million or more under the PPP.

Even companies that did not take advantage of COVID-19 relief programs directly could find themselves ensnared in government fraud investigations through the acquisition of PPP borrowers, creating a potential legal and compliance minefield for the combined entity.

Whistleblower Complaints

Whistleblower complaints — which are likely to increase in the coming months — may trigger government inquiries under the PPP and other COVID-19 loan programs. For instance, a whistleblower could make claims based on alleged misrepresentations in the certifications required to secure loans under the PPP. DOJ is actively encouraging whistleblowers to bring claims forward, and certain claims can prove highly lucrative for the whistleblower.2

Qui tam lawsuits under the FCA — lawsuits brought on behalf of the United States by private persons who have knowledge of alleged fraud committed against the government — can pose a substantial risk for businesses. These lawsuits can either be taken over and litigated by DOJ or, if DOJ declines to intervene, pursued by the relator (the private citizen who brought the suit). The FCA provides for civil penalties of up to $23,607 per false claim plus treble damages. This means that the cost of a FCA violation can far exceed the amount of the alleged fraud. For example, as we reported earlier this year, DOJ claimed entitlement to $4.2 million in penalties and damages in the first civil fraud settlement related to the PPP, even though the loan at issue was only worth $350,000. Further, relators and DOJ will often parse the alleged fraud in such a way as to maximize the number of distinct false claims for payment, which further increases a company’s liability by driving up the amount of civil penalties in play. Depending on whether DOJ takes over the case, the whistleblower could recover as little as 15 percent to as much as 30 percent of the total recovery if the suit is successful.

In its March 26, 2021 press release, DOJ noted that there has already been an increase in qui tam whistleblower complaints under the FCA since the government’s COVID-19 relief programs were launched. DOJ described such lawsuits as “an essential source” of leads for government enforcement activity targeting the alleged misuse of public funds.3 Such statements (not to mention the whistleblower’s portion of recovery under the FCA) encourage even more whistleblower complaints to be filed.

Growing concerns about layoffs, whether well-founded or not, could be playing a role in the increase in whistleblower complaints that DOJ has observed. Imagine, for example, an employee working from home who is becoming increasingly fearful of getting laid off and is suffering from pandemic fatigue. The PPP incentivized borrowers not to lay off employees during “covered periods” by conditioning maximum loan forgiveness on employee retention. As those covered periods have ended, some businesses that remained in financial distress have begun conducting layoffs. Fearful, disgruntled employees may drive a further increase in whistleblower claims and referrals to DOJ.

DOJ’s International Focus

Companies with foreign affiliates or operations may face particular risks due to their international footprints.

DOJ has made clear that it is pursuing coordinated enforcement activity across the country, across federal agencies, and internationally. When announcing its enforcement results targeting fraud stemming from the pandemic, DOJ made note of the “coordination” underlying the prosecutions brought in 56 districts across the country and specifically noted that its International Computer Hacking and Intellectual Property (“ICHIP”) program was coordinating with foreign counterparts to combat pandemic fraud.4

While DOJ has promoted ICHIP’s efforts to assist with international frauds involving counterfeit pharmaceuticals and fraudulent coronavirus treatments,5 the international scope of the Department’s enforcement focus raises other concerns for legitimate businesses. For example, companies with foreign affiliates may face scrutiny over how they counted employees to assess their eligibility for a PPP loan. Further, intra-company payments that cross international borders could be an area of increased scrutiny, given that PPP funds cannot be spent by foreign affiliates.

Companies should therefore be mindful about such risks, maintain accurate records, and ensure that they fully document the source of funds transferred to overseas affiliates.

The Coming Wave of PPP Audits

Companies are also likely to face heightened scrutiny due to audits by the Small Business Administration (“SBA”) when applying for forgiveness of their PPP loans.

The government has said it will automatically audit all PPP loan recipients who received $2 million or more when evaluating whether to forgive the loans. The scope of this commitment is significant — tens of thousands of loans issued under the program meet or exceed this threshold.6 There are $83.8 billion in loans currently under review by the SBA and a further $227.8 billion in outstanding loans for which forgiveness applications have not been received.7

A PPP borrower subject to a SBA audit must complete a loan necessity questionnaire, which, as we have explained, collects “supplemental information” to be used for a post hoc assessment of the certification of economic necessity which the borrower signed as part of the loan application process. Many of the items in this questionnaire are targeted at gathering information in the period following a company’s certifications to evaluate how well or poorly the company predicted its need for the PPP funds. As some companies performed better than initially anticipated at the pandemic’s outbreak, there are growing fears that the SBA audits will result in adverse determinations with respect to loan forgiveness, or even allegations of fraud.

As we have noted, the standard of whether the funds were necessary for PPP loans hinges on documentation of the company’s good faith determination. Such documentation should take the form of a memorandum including supporting evidence demonstrating the company’s view of the economic uncertainty it faced, how that uncertainty impacted its operations, impacts on the company’s business attributed to the uncertainty created by the pandemic, the (un)availability of other potential sources of liquidity and the adequacy of such liquidity, and the reasons why a PPP loan was necessary to retain employees. It is this standard, which certainly includes a fair amount of subjectivity and the potential for Monday morning quarterbacking, that creates heightened risk for those loan recipients.

Other Emerging Risk Areas

Many distressed companies took PPP loans over the past year and are now being acquired by other companies. The SBA has outlined procedures that must be followed when an event qualifying as a “change in ownership” occurs.8 Such events include the sale of at least 20 percent of the ownership interest of the PPP borrower, the PPP borrower selling or otherwise transferring at least 50 percent of its assets, or the PPP borrower merging with or into another entity.9

Because the PPP borrower remains responsible for complying with all obligations under the loan,10 companies looking to acquire a PPP borrower should pay attention to the continued compliance obligations that will come with the acquired entity. There is a risk that the acquiring company could face successor liability for any fraud committed by an acquired company. It is therefore advisable to conduct due diligence targeted specifically at potential fraud related to pandemic relief programs when deciding whether to acquire such a company and to retain counsel who are well versed in the government’s COVID-19 relief programs and applicable guidance.

The Bottom Line

Although DOJ’s enforcement of COVID-19 related fraud has so far focused on what could be viewed as low-level street fraud, there is a growing risk for more established companies as DOJ ramps up its enforcement in this area. Such companies should take steps now to ensure they are maintaining robust files that provide support for all representations made to secure pandemic relief through government programs.

1 Press Release, Dep’t of Justice, Justice Department Takes Action Against COVID-19 Fraud (Mar. 26, 2021), https://www.justice.gov/opa/pr/justice-department-takes-action-against-covid-19-fraud.

2 See id.

3 Id.

4 Id.

5 Id.

6 See Small Bus. Admin., Paycheck Protection Program (PPP) Report 6 (Aug. 8, 2020), https://www.sba.gov/sites/default/files/2020-08/PPP_Report%20-%202020-08-10-508.pdf (reporting that as of August 2020, there were nearly 29,000 PPP loans made which were over $2 million). As of April 4, 2021, there were an additional 490 loans made in 2021 which were for over $2 million. See Small Bus. Admin., Paycheck Protection Program (PPP) Report 6 (Apr. 4, 2021), https://www.sba.gov/sites/default/files/2021-04/PPP_Report_Public_210404-508.pdf. The deadline to apply for a PPP loan is currently May 31, 2021.

7 See Small Bus. Admin., PPP Data (last visited Apr. 6, 2021), https://www.sba.gov/funding-programs/loans/covid-19-relief-options/paycheck-protection-program/ppp-data#section-header-2.

8 SBA Procedural Notice, Control No. 5000-20057 (Oct. 2, 2020), https://www.sba.gov/sites/default/files/2020-10/5000-20057-508.pdf; see also Adrianne Goins & Brittany A. Sakowitz, SBA Approval Not Required for Some “Change of Ownership” Transactions Involving Paycheck Protection Program Borrowers, Vinson & Elkins, Oct. 9, 2020, https://www.velaw.com/insights/sba-approval-not-required-for-some-change-of-ownership-transactions-involving-paycheck-protection-program-borrowers/.

9 Id.

10 Id.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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