November 23, 2020 – Alerts

By Ernest E. Badway

An unprecedented explosion of government investigation and enforcement is at hand as federal regulators focus their efforts on ferreting out any fraud or abuse of the $1 trillion in COVID-19 relief funding programs through loans, grants and tax credits.

For pharma and bioscience companies, it is imperative to take steps now to limit the risks and consequences of such investigations. Regulatory threats to these companies may be forestalled by quick action to preserve evidence and correct systemic problems.

Increased scrutiny and automatic audit triggers were built into the Coronavirus Aid, Relief and Economic Security Act (CARES Act) and its Paycheck Protection Program (PPP). Congress has also created a Special Inspector General for Pandemic Recovery (SIGPR) to oversee CARES Act funding distribution, and the Department of Justice and Securities and Exchange Commission (SEC) have already begun investigations and fraud prosecutions.

Bioscience and pharma companies must be particularly vigilant about protecting against future SEC enforcement risks. These are highly regulated industries facing an enforcement perfect storm – fast cash, limited guidance and retrospective review. Further, they are at the forefront of the COVID-19 relief efforts, making them prime targets for unscrupulous persons as well as government investigations. There can be no deliberate omission, misrepresentation or falsification of information, or these companies will face potentially severe consequences.

Whistleblowers will not be far behind, and we can expect a plethora of civil actions to accompany these governmental inquiries as well.

Preparation, protection and response are the integral components in a company’s risk planning.

Prepare

In preparing to meet the challenges that may arise from participating in a particular program, companies should focus on:

  • eligibility requirements
  • representations made in the application process
  • use of the funds
  • any required follow-up certifications

Documentation is vital to demonstrate prudent business decisions. This preparation should leverage compliance resources as well as documenting the application/funding process along with the ultimate use of the money.

Senior management should be involved in every critical stage, including an interim internal review. The company’s review must include an assessment of its responses to any complaints and an essential check to preserve documents and information.

Protect

Companies that prepare will reduce risk by demonstrating compliance. Protection, therefore, directly correlates with reducing risk.

For example, companies must recognize the interplay between cybersecurity and trade secret protection. Ensuring that corporate best practices are in place for managing and protecting patents and trade secrets will require an inquiry into credible threats to its intellectual property from various sources.

Employees are a first step in the protection process. Critical aspects of the employee lifecycle must be considered to protect the company. Companies should review the on-boarding and exit interview processes to identify issues relating to trade secrets. Remote workforces pose distinct risks and require specific mitigation measures.

Companies should consider using the latest cybersecurity tools to detect both external and internal threats and monitor for misappropriation. Plans to manage risk must also include joint venture partners and vendors, as well as independent contractors.

Respond

When a misappropriation occurs – regardless of preparation or protection efforts – certain responses are mandatory. Governance lapses will potentially lead to criminal prosecution, civil litigation and damages.

Companies must anticipate and prepare to be at the mercy of judicial and government priorities. Even the casual observer can see that the future possibly holds decisions regarding criminal or civil enforcement as well as decisions relating to cooperation with government investigations. Regulators will focus on statutes and available forums, for enforcement, and seek to obtain non-monetary relief – TROs and injunctions – and monetary relief. There are different damages approaches, trends, and litigation best practices, including discovery, trial presentation strategies, and coping with COVID-19 challenges. Further, the DOJ will also focus on hackers targeting COVID-19 vaccine researchers.

Ultimately, companies must be poised to protect their intellectual property in a variety of forums.

SEC Action

All public companies should expect SEC scrutiny. Companies must stay current on SEC guidance, and conduct internal audits regarding COVID-19-related disclosures to forestall SEC scrutiny and disruptions. The SEC will likely investigate and bring enforcement actions, and, accordingly, the SEC’s enforcement role in monitoring relief funding must be evaluated.

The SEC’s role in monitoring disclosures around COVID-19 and insider trading will be critical in any analysis. Finally, company insiders must avoid potential insider trading allegations while in possession of material, non-public information.

Pharma and bioscience companies in particular must monitor spending; avoid overlap; and save interim HHS and industry guidance to protect themselves from future SEC enforcement rules.

Conclusion

Preparation, protection and response are crucial components of coping with the coming wave of federal scrutiny any enforcement. Evaluating team knowledge, and ensuring every regulation and guidance is followed are the first steps in safeguarding any company’s future.

November 16, 2020 – Alerts
By Eric J. Michaels and Adam R. Young

The IRS intends to issue proposed regulations to permit a partnership or an S corporation to deduct specified income tax payments made to a domestic state or local jurisdiction.

In Notice 2020-75, the IRS clarifies that state and local income taxes imposed on and paid by a partnership or S corporation with respect to its income are allowed as a deduction by the partnership or S corporation in computing its non-separately stated taxable income or loss for the taxable year of payment, and are not subject to the state and local tax deduction limitation for partners and shareholders who itemize deductions.

This workaround to the state and local tax deduction limitation will provide a benefit to partners and S corporation shareholders in states that impose an entity-level tax on partnerships and S corporations. This is done by treating payments of those items by the pass-thru entity as a deduction by the entity, thereby reducing taxable income of the partnership or S corporation that ultimately flows to the partners or S corporation shareholders.

State and Local Tax Deduction Limitation

The 2017 Tax Cuts and Jobs Act added Section 164(b)(6) which limits an individual’s deduction to $10,000 for the aggregate amount of the following state and local taxes (SALT) paid during the calendar year:

  • real property taxes
  • personal property taxes
  • income, war profits, and excess profits taxes
  • general sales taxes

The SALT Deduction Limitation – which applies for taxable years beginning after December 31, 2017 and before January 1, 2026 – significantly impacts individual taxpayers who itemize deductions in states where income, property and sales tax rates are higher.

Notice 2020-75

In an attempt to relieve taxpayers of the undue burden associated with the SALT Deduction Limitation, the IRS published Notice 2020-75 which permits partnerships and S corporations to deduct state and local income taxes imposed on the partnership or S corporation.

The Notice provides that a partnership or S corporation will be permitted to claim the deduction for state and local income taxes regardless of whether the state gives a full or partial tax credit, deduction or exclusion to a partner or S corporation shareholder and regardless of whether the state entity-level tax is mandatory or elective.

The Notice provides that the proposed regulations will apply to specified income tax payments made on or after November 9, 2020. The notice also provides that the proposed regulations will permit a deduction for specified income tax payments made by a partnership or S corporation for taxable years ending after December 31, 2017 and before November 9, 2020 provided that the income tax payment is made to satisfy a state and local tax liability imposed on the partnership or S corporation pursuant to a state law enacted before November 9, 2020.

State Entity-Level Taxes

Currently, six states have enacted an entity-level tax on partnerships or S corporations: Connecticut, Louisiana, New Jersey, Oklahoma, Rhode Island and Wisconsin. Connecticut is the only state that provides for a mandatory entity-level tax, while the remaining five provide for an elective entity-level tax.

For example, New Jersey recently enacted the Business Alternative Income Tax (BAIT), which is an elective entity-level tax on partnerships and S corporations. If a New Jersey S corporation elects to have the BAIT apply, then the S corporation would pay tax at the entity level and according to Notice 2020-75 the S corporation would be able to claim a deduction for the entity-level tax. The federal income tax deduction for the New Jersey BAIT taken at the S corporation level would reduce the S corporation’s net income that would ultimately flow through to the shareholders, thus permitting the shareholders to work around the $10,000 SALT Deduction Limitation and ultimately receive a tax benefit.

Businesses in states that provide for an election to tax a partnership or S corporation at the entity level should consider whether to make such an election to take advantage of Notice 2020-75 and the forthcoming proposed regulations.

If you have any questions about this alert, please contact Eric Michaels at 973.994.7505 or emichaels@foxrothschild.com, Adam Young at 215.444.7237 or ayoung@foxrothschild.com, or any member of Fox Rothschild’s national Taxation & Wealth Planning Practice.

By Paul B. Edelberg

On October 26, the Small Business Administration (SBA) published a notice in the Federal Register seeking approval from the Office of Management and Budget to release two new forms to be sent to borrowers under the Paycheck Protection Program (PPP) in preparation for audits by the agency. Because these audits have significant legal implications for borrowers such as disqualification and potential civil and criminal liability, entities that obtained PPP loans should consult counsel and exercise great care in answering questions on the forms.

SBA has created separate forms for nonprofits and for-profit loan recipients. For-profit borrowers will receive Form 3509, and nonprofit borrowers Form 3510. While the SBA has not published the forms, the media has distributed Form 3509. Form 3509 states that it is designed to “maximize program integrity and protect taxpayer resources” and that the information to be submitted by the borrower “will be used to inform SBA’s review of your good faith certification that economic uncertainly made your loan request necessary to support your ongoing operations.” This language is in reference to the statutory language under the CARES Act, embodied in the PPP loan application form in the form of a certification made by the borrower applicant when submitting the loan application. As a result of the publicity regarding PPP loans made to purportedly financially solid companies such as Shake Shack and the Los Angeles Lakers, the SBA and Department of the Treasury announced that the SBA would audit all PPP loans in excess of $2 million to determine whether the borrower’s certification that the loan was necessary can be substantiated. The notice in the Federal Register provides for a 30-day comment period prior to the forms’ final issuance.

Business Activity and Liquidity Assessments

The SBA designed each form to be sent to a PPP borrower by its lender. The borrower must complete it within 10 business days after receipt and then return it to the lender, which will then be responsible for sending it to the SBA. If the borrower does not submit the form, the SBA may retract eligibility, seek repayment of the PPP loan or “pursue other available remedies.” Therefore, as currently structured, the filing of this form by a borrower is essentially mandatory.

Form 3059 is divided into two categories of information requests: a “Business Activity Assessment” and a “Liquidity Assessment.” In some instances, detailed disclosure is required. Under the “Business Activity Assessment” section, the form requires information regarding the following items in the form of a series of questions for each such item:

  • A financial revenue comparison from the second quarter of 2020 to the second quarter of 2019 (with special rules for seasonal employees), or if the company was not in business in the second quarter of 2019, to the first quarter of 2020.
  • Information on changes in the business operations after March 13, 2020 (the date of the issuance of the National Emergency Declaration issued by President Trump) due to the pandemic, including the impact of state and local emergency orders and any cash outlays caused by the changes in business operations.
  • Information on voluntary measures taken after March 13, 2020 due to the pandemic, including cash outlays caused by changes in the business operations.
  • Capital expenditure projects after March 13, 2020 due to the pandemic, and the approximate cash outlay for these projects.

The Liquidity Assessment section of the form requires information regarding the following items in the form of a series of questions for each such item:

  • The borrower’s cash position and any payment of dividends during the period commencing March 13, 2020 through the end of the loan forgiveness covered period for the PPP loan (the “Liquidity Assessment Period”).
  • The payment of any dividends during the Liquidity Assessment Period, excluding dividends for any pass-through estimated tax payments.
  • Any prepayments of any outstanding debt during the Liquidity Assessment Period.
  • Compensation payments in excess of $250,000 to any employee or to any owner employed by the borrower.
  • The market capitalization on the date of the PPP loan application for a borrower that is a public company and for any 20% publicly owned parent of a borrower.
  • If the borrower is a private company, the book value of the borrower in the last calendar quarter prior to the loan application.
  • For borrowers that have 50% foreign ownership by a parent company, the market cap of the parent company if it is a public company listed on a U.S. or non-U.S. securities exchange.
  • For borrowers that are 20% owned by a private equity fund, a venture capital fund or a hedge fund, either directly or indirectly, disclosure of that relationship.
  • Disclosure of any foreign state enterprise that owns 50% or more of, or is affiliated with, the borrower.
  • Information on other funding under the CARES Act.

The borrower has the option to write additional comments to any question under both the Business Activity Assessment and the Liquidity Assessment. The purpose of that option is unclear.

The borrower is also required to provide supporting documentation in the form of financial data with respect to the quarterly comparison disclosed under the Business Activity Assessment section and the cash position, payment of dividends, prepayment of outstanding debt and excessive compensation payments disclosed under the Liquidity Assessment section.

Finally, the borrower must certify that it has made “reasonable inquiry of people, systems, and other information available to Borrower.” No clarification is given as to the meaning of “reasonable inquiry,” but the borrower should be diligent in completing the questionnaire to avoid any liability to the SBA due to any misrepresentation or inaccuracy.

Questions and Concerns

It is anticipated this form will not be well received by borrowers or lenders. First, it contemplates a “rearview mirror” analysis. For example, requesting a revenue comparison at the end of the second quarter of 2020, which for many borrowers occurs after the date of making the loan, is not contemplated under the CARES Act. The certification for the PPP loan was made as of the date of the loan application, and there were no accountability standards for the future financial condition of the company after the date of the loan. In fact, the genesis of the PPP Loan Program was to keep companies in business and assist them financially in the hope of minimizing a company’s loss of revenue. Likewise, some of the information addresses business activities occurring after the date of the loan application.

The form also introduces criteria to the PPP Loan Program that did not exist at the time of application. It inquires about compensation to employees and to owner-employees who earned in excess of $250,000. One has to question why that should be a factor in the audit. There are no compensation limitations under the PPP Loan Program except with respect to the determination of the proposed amount of the loan. One also has to question the purpose of estimating the market capitalization or value of a company. Is this a new separate consideration under the PPP Loan Program? In addition to the difficulty many borrowers will have in determining their value as of the specified date, it is unclear why this is relevant. Does this indicate that the SBA is reviewing a borrower’s compliance with eligibility requirements?  If so, the value of a company generally was not one of the criteria for determining eligibility.

Similarly, why are there questions on foreign ownership and investment fund ownership? Perhaps that is designed to provide information to the auditor in conducting an eligibility review or in determining the borrower’s access to capital at the time of the PPP loan application.

Complete With Caution

Most importantly, this form will most likely be used by auditors to prepare for audits of PPP loan borrowers. The audit has legal implications, such as disqualification of a borrower and potential civil and criminal liability. A borrower must be careful in answering these questions and should seek legal advice before submitting the application. A borrower may be inclined to respond to the open-end solicitation for additional information, but we recommend against completing any of these sections without the advice of counsel. If not stated correctly, the response to such an open-ended question could inadvertently be turned against a borrower by an auditor. A borrower will be certifying to the truthfulness of this form, and there is potential legal liability if it incorrectly presents the information. Moreover, any statement made in this application would constitute an admission in any civil or criminal action brought by the SBA based upon the audit.

As mentioned at the outset of this article, this form has not yet been published by the SBA. The above discussion is subject to any changes in the form or its procedures in its final promulgation by the SBA. It is subject to a 30-day comment period. Hopefully, the form will be pared back in its final iteration or safeguards for borrowers will be added.

By Marissa Koblitz Kingman

Since the pandemic began, the federal courts have been inundated with Compassionate Release applications from attorneys seeking the immediate or early release of clients in custody. Compassionate Release is indeed a feasible option for some people who are incarcerated or about to surrender to a federal prison. Because Compassionate Release is a worthwhile opportunity, it is extremely important that you have a knowledgeable attorney to assist you during the process.

What is Compassionate Release?

A person requests Compassionate Release through 18 U.S.C. § 3582, which was amended by the First Step Act. The law allows a reduction of an inmate’s term of imprisonment if the court finds that:

  1. extraordinary and compelling reasons warrant a reduction in the person’s prison sentence;
  2. the reduction would be consistent with applicable policy statements of the Sentencing Commission; and
  3. the applicable sentencing factors are met.

Extraordinary and Compelling Reasons Standard
Since COVID-19, “extraordinary and compelling reasons” can usually be demonstrated by having a medical ailment or co-morbidity that increases the risk of severe illness from the virus that causes COVID-19 (i.e., cancer, type II diabetes, obesity, heart conditions, sickle cell disease) and a showing that COVID-19 cases in the prison are rising or likely to rise. Other factors, such as advanced age or compelling family circumstances, can also sometimes satisfy the “extraordinary and compelling” standard.

Applicable Policy Statement
The Sentencing Commission’s policy statement addressing the reduction of a sentence under 18 U.S.C. § 3582 provides that a defendant’s physical and medical condition, age, and family circumstances may all serve as independent grounds for the existence of a compelling reason to reduce one’s sentence.

Applicable Sentencing Factors
The applicable sentencing factors, as set forth in 18 U.S.C. § 3553(a), include, but are not limited to:

  • the nature and circumstances of the underlying offense
  • the history and characteristics of the defendant
  • the need for the sentence imposed to reflect the seriousness of the underlying offense
  • the need for the sentence to provide adequate deterrence
  • the need to protect the public from further crimes of the defendant
  • the need to avoid unwarranted sentence disparities

In weighing these factors, courts look to weather the underlying offense was violent, if the defendant had a violent history or posed any threat to the community, and if the prison sentence was long enough and/or is necessary to deter the defendant’s conduct.

When Can You File for Compassionate Release?

Pre-Surrender
While less courts have granted pre-surrender Compassionate Release, meaning that the defendant has not yet surrendered to the prison, it is possible to win such an application. A defendant can request that the court, Warden and/or counsel for the Bureau of Prisons (BOP) modify the defendant’s sentence to time served and convert the unserved prison term to supervised release with the additional condition of home confinement even before the defendant has ever stepped foot inside a prison. While a person must satisfy all of the requirements outlined above for a pre-surrender Compassionate Release application, it is also important to show some kind of changed circumstance from the date of sentencing to the date of the Compassionate Release application.

Incarcerated
You can file a Compassionate Release application at any time while incarcerated and after exhausting one’s administrative remedies. The shorter the prison sentence, and the more time the defendant has served of that prison sentence, the higher the probability that the applicable sentencing factors will be weighed in the defendant’s favor.

Who Should You Address Your Compassionate Release Request to?

The short answer is – everyone.

BOP Senior Counsel
There is a BOP senior counsel who is assigned to the different prisons and regions. It is important that a Compassionate Release application be sent to that person. It is also important that your attorney contact the BOP counsel and discuss the defendant’s specific circumstances. The BOP counsel can be a helpful ally throughout the Compassionate Release process.

Warden
In some jurisdictions, contacting the Warden prior to filing a Compassionate Release application is required. The Compassionate Release statute previously permitted sentence reductions only upon motion of the Director of the BOP. Currently, however, the statute permits courts to consider motions filed by the defendant as long as the defendant has exhausted all administrative rights. In order to exhaust one’s administrative rights in the Compassionate Release context, one must make a Compassionate Release request to the Warden. Once the request is made to the Warden, and the Warden either denies the request or 30 days has passed, (whichever is earlier), the person may then file a Compassionate Release motion before the Court. The request to the Warden must contain specific language in order to begin the 30-day clock.

The Judge
The Compassionate Release Motion should be filed before the district court judge who sentenced the defendant.

The Government
While most Assistant United State Attorneys (AUSA) do not “consent” to a compassionate release application, an AUSA will occasionally “take no position” on the application – which is as good as it gets from the government. So, it is important that your attorney communicates with the AUSA assigned to your case and understands the government’s position on a potential Compassionate Release application.

Now What?

The process for applying for Compassionate Release can be complicated. It requires the ability to communicate with the Warden, BOP Counsel, Court and the assigned AUSA. Be sure to contact an attorney that has experience in this area of law. For questions about compassionate release, or assistance in filing a Compassionate Release application, please contact Marissa Koblitz Kingman

By Matthew D. Lee and Marissa Koblitz Kingman

While the $525 billion Paycheck Protection Program (PPP), enacted as part of the CARES Act, has undoubtedly helped millions of deserving businesses survive the COVID-19 pandemic, it has also provided a unique opportunity for fraudsters to take advantage of the government’s unprecedented largesse. The Justice Department has already filed charges against dozens of borrowers alleging PPP loan fraud, but federal authorities are preparing to cast a wider net that will dramatically expand the number of loans that face scrutiny.

As we have written previously, the Justice Department and other federal law enforcement agencies have acted swiftly to identify and prosecute PPP loan fraud — in many cases while loans were still being made by the Small Business Administration (SBA). Since the CARES Act passed barely seven months ago, the Justice Department has filed criminal charges against 65 borrowers who it alleges collectively tried to fraudulently obtain $227 million in PPP loan funding, in loan amounts ranging from $30,000 to $24 million. These early criminal cases represent the most brazen examples of PPP fraud, such as borrowers claiming phantom employees and using PPP funds for personal items. But these early cases are just the beginning, as government investigators move beyond the most egregious examples of fraud to focus on more nuanced issues of potential fraud, such as eligibility for PPP loans, expenditure of PPP loan proceeds and loan forgiveness. At the same time, the Small Business Administration has vowed to audit all PPP loans in excess of $2 million and Congress has intensified its oversight (and criticism) of the PPP program. In this highly charged environment, we can expect to see more significant scrutiny of borrowers across the PPP loan spectrum, and not just for the most glaring instances of fraud.

Criminal Prosecutions Continue Apace

In an October 7, 2020 speech, Deputy Attorney General Jeffrey A. Rosen announced that the Justice Department has criminally charged 65 individuals with PPP loan fraud in connection with $227 million in relief funds. Eight of those defendants have already pleaded guilty and more convictions are expected.

The PPP loan fraud cases filed by the Justice Department largely fall into two categories. The first category is made up of individuals or small groups who lied on loan applications about having legitimate businesses, or who claimed they needed PPP funding to pay their employees, but instead used the money to purchase luxury cars and jewelry for themselves, finance home renovations and even gamble in Las Vegas. The second category of cases involves organized criminal rings. For example, the Justice Department recently filed charges in Ohio and Florida against 11 individuals, including a professional athlete and his manager, who applied for $24 million in PPP funding.

More criminal cases involving PPP fraud are undoubtedly on the horizon. In a recent speech, Acting Assistant Attorney General Brian Rabbitt emphasized that the Justice Department is not slowing its efforts in this area. To would-be fraudsters, he delivered a stern warning: “You will be identified. You will be held accountable. You will face the severest of consequences for trying to exploit your fellow Americans’ suffering for your own personal gain.”

Intensifying Congressional Oversight

Over the summer, the Senate Select Subcommittee on the Coronavirus Crisis opened an investigation of the PPP following allegations that it favored larger companies over small businesses. The subcommittee reviewed data on all 5.2 million PPP loans approved by the Small Business Administration, and issued its preliminary analysis on September 1, 2020, concluding that “tens of thousands of loans issued by the administration could be subject to fraud, waste, or abuse.” The Select Subcommittee also concluded that the administration “appears to lack the appropriate oversight mechanisms to identify and root out these problems,” noting that the SBA has stated it will only audit PPP loans in excess of $2 million, leaving the remaining 99.4 percent of funded PPP loans with no scrutiny whatsoever.

The Select Subcommittee identified a series of issues with the PPP that suggest a high risk for fraud, waste and abuse, described below:

  • The SBA’s PPP rules provided that businesses were not permitted to apply for more than one loan. The Select Subcommittee determined that over $1 billion in loan proceeds went to companies that received more than one PPP loan. The Select Subcommittee identified 10,856 loans in this category, and noted that only 65 of these loans were in excess of $2 million and therefore subject to SBA audit.
  • Many PPP loans went to companies that have been debarred or suspended from contracting with the federal government. Pursuant to the SBA’s PPP eligibility criteria however, such companies were ineligible for PPP loans. The Select Subcommittee identified 613 loans totaling $96.3 million in this category.
  • Government contractors with known performance and integrity issues received PPP loans. The federal government’s Federal Awardee Performance and Integrity Information System (FAPIIS) database tracks contractor misconduct. The Senate Subcommittee found that the SBA approved 353 loans worth $195 million to companies identified in FAPIIS.
  • By comparing data contained in the federal government’s System for Award Management (SAM) with PPP loan applications, the Senate Subcommittee identified numerous red flags involving more than 11,000 borrowers and nearly $3 billion in PPP funding. The discrepancies identified by the Senate Subcommittee include:
    • Key information in PPP loan applications that does not match data in SAM
    • Inconsistent business addresses
    • Companies that were created after February 15, 2020, and were therefore not eligible for PPP loans.
  • Many PPP loan applications omitted key information about the borrower and were nonetheless approved. For example, hundreds of loan applications failed to identify the name of the borrower in the “borrower name” field, and several hundred additional applications did not have complete business addresses for the borrower.

The Senate Subcommittee’s report concluded with a series of recommendations to improve oversight of PPP.

  • First, the subcommittee recommended that SBA and Treasury should improve internal controls for loan forgiveness, including making use of existing federal and commercial databases to verify information provided by borrowers.
  • Second, the subcommittee recommended that the administration should improve its audit plan for PPP borrowers. As noted, the SBA’s stated plan is to audit only those PPP loans in excess of $2 million and “other PPP loans as appropriate.” Finding this plan to be “plainly insufficient,” the Senate Subcommittee recommended that the SBA implement a risk-based audit program and utilize random sampling techniques. The subcommittee further recommended that SBA audits should be accompanied by public outreach to warn borrowers about criminal penalties and to encourage whistleblowers to come forward to the SBA’s Office of Inspector General.
  • Third, the Senate Subcommittee stated that Treasury and the SBA must improve their cooperation with oversight bodies such as Congress and the Pandemic Response Accountability Committee.

Enforcement 2.0: What’s Next

The Justice Department’s unrelenting torrent of criminal charges against PPP borrowers shows no sign of easing, so we expect to see more announcements of new criminal cases and additional guilty pleas in the months to come. But as we noted, identifying and prosecuting the most brazen examples of PPP loan fraud — the “low-hanging fruit” — was the easy part.

Now comes the hard part: auditing some reasonable sample of the more than 5.2 million PPP loans that were funded. To this end, we anticipate that a variety of government agencies will engage in a new wave of enforcement activity. To start, we expect the SBA to follow through on its promise to scrutinize larger PPP loans. While the SBA previously announced that it would focus its limited audit resources on loans in excess of $2 million — which comprise only .6 percent of all PPP borrowers — it was careful to qualify that statement by stating that it would also audit “other PPP loans as appropriate.”  This means borrowers with loans under $2 million are not immune from scrutiny and should be prepared for inquiries from government investigators.

Congressional oversight of the entire PPP framework can be expected to drive additional regulatory scrutiny of borrowers. The Senate Subcommittee report from September 2020 was highly critical of the administration’s approach to PPP implementation, and identified five categories of loans in which fraud and abuse were most likely to be prevalent, and recommended that SBA adopt a risk-based approach to audit selection.

Finally, we anticipate that other regulatory agencies may assist the SBA in its herculean task of auditing PPP borrowers. The Department of Labor has already begun auditing PPP loan recipients under the guise of routine wage and hour inquiries. Other federal agencies may support the SBA in this effort in the coming months.

Any business owner concerned about PPP loan compliance should immediately consult counsel and not wait to be contacted by law enforcement. Any business owner who has already received a subpoena or inquiry from any law enforcement agency regarding a PPP application or loan should immediately consult with counsel who can assess the full potential for civil and criminal exposure before responding to any such subpoena or inquiry.

For additional information on the topic of this alert, contact Matthew D. Lee at mlee@foxrothschild.com or 215.299.2765; Marissa Koblitz Kingman at mkingman@foxrothschild.com or 973.548.3316; or any member of the firm’s national White-Collar Defense & Regulatory Compliance Practice.

PPP Fraud Prosecution Tracker

Fox Rothschild’s White-Collar Criminal Defense & Regulatory Compliance Practice Group is tracking in real time all federal criminal cases alleging PPP loan violations.

To access our PPP Fraud Prosecution Tracker, contact White-Collar Criminal Defense & Regulatory Compliance Practice Group Co-Chairs Matthew S. Adams at madams@foxrothschild.com or 973.994.7573 and Matthew D. Lee at mlee@foxrothschild.com or 215.299.2765.

By Matthew S. Adams, Matthew D. Lee and Christopher J. Pippett

The Small Business Administration (SBA) has opened the portal for applications for forgiveness of Paycheck Protection Program (PPP) loans established under the Coronavirus Aid, Relief and Economic Security Act (CARES Act). The commencement of the loan forgiveness application process raises two important questions for many borrowers:

  1. To what extent will the loan be forgiven?
  2. Will the loan and application be audited by the SBA?

The answer to the first question is fairly straightforward. A borrower’s loan forgiveness will be determined predominantly by its compliance with the requirements of the CARES Act in terms of its use of proceeds and the documentation it provides as part of its forgiveness application. If a borrower has used the proceeds of a PPP loan for the permitted uses as set forth in the CARES Act and applicable guidance, and provides adequate documentation of that use, the loan should be forgiven.

The question of whether or not a PPP loan will be audited is more complicated. The issue of loan audits arose following news reports on some high-profile companies that obtained PPP loans in the initial round of funding. The SBA responded by issuing somewhat murky guidance regarding the need certification borrowers were required to provide in conjunction with their loan applications. The guidance stated that it would be “unlikely that publicly traded companies that have substantial market value and access to capital markets will be able to make the required certification [regarding need] in good faith.” The combination of bad press and unclear guidance led many large companies to return their loan proceeds and take advantage of a safe harbor provision included in a subsequent guidance stating that if funds were returned by May 14, 2020 the need certification would be deemed to have been made in good faith.

Any PPP Loan Can Be Audited

In conjunction with establishing the safe harbor, SBA stated in the guidance that it would review all loans in excess of $2 million. This has led many borrowers and their advisors to conclude incorrectly that loans of less than $2 million will not be reviewed. However, the language in the guidance clearly states that the SBA “will review all loans in excess of $2 million, in addition to other loans as appropriate, following lender’s submission of the borrower’s forgiveness application.” Consistent with this language, the SBA’s interim final rule clearly states that the SBA may review “any PPP loan, as the Administrator deems appropriate” for the purposes of verifying borrower eligibility, loan amounts and use of proceeds and loan forgiveness amounts. The interim final rule further states that such review may be undertaken “at any time.” Thus, while PPP loans in excess of $2 million are clearly subject to review, no borrower should expect that its loan cannot be audited.

The SBA has not released guidelines or protocols for PPP loan audits. Borrowers should be careful, not only in making certifications and providing documentation in conjunction with forgiveness applications, but in responding to follow-up requests for additional information or documentation. While some of these contacts may seem innocuous, they could be a prelude to further scrutiny of the loan. An adverse PPP loan audit outcome could result in denial of forgiveness or, in a worst-case scenario, civil or criminal penalties or prosecution of responsible individuals. For this reason, borrowers should involve counsel upon the first contact from the SBA following submission of a PPP loan forgiveness application.

If contacted by the SBA, borrowers should gather the following basic documentation before contacting an attorney:

  1. PPP loan application and supporting documentation.
  2. 2019 tax returns and financial statements.
  3. Corporate organization and ownership structure
  4. Number of affiliated employees
  5. PPP loan documentation executed
  6. PPP Loan Forgiveness Application and supporting documentation
  7. Copies of all emails or other correspondence with lender or SBA

Fox Rothschild has assembled a multidisciplinary team of corporate and white-collar criminal defense attorneys who are well versed in the PPP loan requirements, have developed a procedure for handling PPP loan audits and are available to assist borrowers in navigating the process and limiting the risk of an adverse outcome should a PPP loan be audited for any reason.

Federal and state governments have numerous criminal, civil and regulatory tools at their disposal to pursue COVID-19-related investigations targeting small and midsize businesses. While the issues these inquiries raise are novel, the strategies that must be deployed to blunt their impact do not differ markedly from other white-collar criminal defense and regulatory compliance engagements.

For additional information on PPP Loan audits, contact Matthew S. Adams at madams@foxrothschild.com, Matthew D. Lee at mlee@foxrothschild.com, Christopher J. Pippett at cpippett@foxrothschild.com, or Paul B. Edelberg at pedelberg@foxrothschild.com.

Additional Information

By Matthew D. Lee and Marissa Koblitz Kingman

Shortly after the Small Business Administration began accepting applications for Paycheck Protection Program (PPP) loans, two Rhode Island businessmen quickly applied for a combined $543,881 from the program. A few days later, the Justice Department announced that both were criminally charged with conspiracy to make false statements to influence the SBA and conspiracy to commit bank fraud, becoming the first individuals to face criminal charges related to the program, which was created by the federal Coronavirus Aid, Relief and Economic Security (CARES) Act. In the press release announcing the charges, the Justice Department said the arrests should serve as a stern warning to other PPP loan applicants, and promised that the FBI and other federal law enforcement agencies would aggressively pursue anyone taking advantage of the pandemic to commit fraud. The Justice Department has kept that promise, and to date has criminally charged 15 individuals alleged to have defrauded the PPP loan program of millions of dollars. On June 24 alone, three criminal cases were announced in Virginia, Texas, and Ohio.

The CARES Act Paycheck Protection Program

The CARES Act is designed to provide emergency financial assistance to Americans who have suffered economic losses related to the COVID-19 pandemic. It provides forgivable loans to small businesses to cover payroll and other specified expenses through the PPP loan program. Most PPP loans were funded in April and May. Since then, 15 individuals have been criminally charged across the country in connection with allegedly fraudulent PPP loan applications. These criminal cases are notable for several reasons.

Are These White Collar Investigations Happening Unusually Quickly?

The rapidity with which these initial PPP cases were investigated and charged is highly unusual. In typical white-collar cases, federal agents first try to determine if a crime was committed. Investigations can take months or even years to determine what potential crimes occurred and who was responsible. As the investigators review materials, talk to witnesses and subpoena records, investigations evolve, generating new leads and revealing more materials to review. White collar investigations often involve voluminous financial records which can take years to obtain and analyze. In stark contrast, the first 15 PPP cases were investigated and charged within a few short weeks after passage of the CARES Act.

Why Are These Crimes Being Charged?

One of the explanations for the atypical pace of these investigations is no doubt to deter others from engaging in similar misconduct. Each of the initial cases was announced by a strongly-worded press release from the Justice Department. With billions of dollars in public money at stake in the PPP, the federal government wants to ensure that borrowers who are tempted to misuse the money are fully aware of the very real criminal penalties they will face if they are caught. By aggressively prosecuting these cases, the DOJ is sending a clear message to the public that this behavior will not be tolerated.

How is the Government Able to Investigate and Charge These Cases so Quickly?

Federal prosecutors rarely reveal their sources, so at this point we do not know how these 15 cases came to light so soon. There are a variety of ways such information could make its way to investigators. Banks could be a source of information via their customary filing of Suspicious Activity Reports with the Financial Crimes Enforcement Network, a division of the U.S. Treasury. As the DOJ acknowledged in one recent press release, it was thankful for the “due diligence” of the “SBA’s lending partners to maintain the integrity of the lending programs.” Whistleblowers are another possibility. Many federal agencies encourage whistleblowers and offer rewards for information. For example, the FBI makes whistleblowing fairly easy by maintaining a 24/7 Cyber Complaint Center.

Which Agencies Are Investigating and Prosecuting These Crimes?

The sheer number of federal agencies involved in investigating PPP loan fraud is notable. Not surprisingly, the inspectors general of several federal agencies are leading the charge, including the Small Business Administration, the Federal Deposit Insurance Corporation, Federal Housing Finance Administration and the Federal Reserve. Other traditional federal law enforcement agencies, including the FBI, the Internal Revenue Service–Criminal Investigation Division, and the U.S. Postal Inspection Service are well represented in these cases. Finally, state and local law enforcement agencies are supporting this effort, too.

What Kind of White Collar Crimes Are Being Charged?

Most of the charges in these cases involve bank fraud, wire fraud, false statements to a financial institution and/or false statements to the Small Business Administration. For example, on May 22, 2020, William Sadleir, a film producer, was charged in the Central District of California with wire fraud, bank fraud, false statements to a financial institution and false statements to the SBA. Sadleir was the owner and founder of Aviron Group, LLC, which was the parent of several film distribution companies. Sadleir allegedly made misrepresentations to a bank to secure a PPP loan in excess of $1.7 million. He then allegedly used the funds to retire personal credit card debt and pay other personal expenses, rather than legitimate business needs.

The initial cases that have been charged appear to represent the most egregious cases, with allegations spanning phantom companies and non-existent employees to the use of PPP loan proceeds to pay personal expenses and fund lavish lifestyles. This does not mean that others will not be criminally charged, however. Other PPP borrowers will certainly be investigated in the months and years to come. Indeed, some of the potential charges that can be brought in a PPP loan fraud case carry a ten-year statute of limitations, providing federal law enforcement agencies plenty of time to build cases.

The Future of PPP Loan Fraud Enforcement

Scrutiny of PPP loans from all quarters is expected to intensify in the coming months. The Trump administration has vowed to audit all loans in excess of $2 million. The Justice Department shows no signs of slowing down its initial efforts to combat PPP loan fraud. Congressional oversight will be intense as well, with the CARES-Act created Pandemic Response Accountability Committee charged with detecting mismanagement of COVID-19 relief funds. The Special Inspector General for Pandemic Recovery, also created by the CARES Act, is charged with conducting audits and investigations related to CARES Act relief programs, including the PPP.

Any business owner concerned about PPP loan compliance should immediately consult counsel and not wait to be contacted by law enforcement. Any business owner who has already received a subpoena or inquiry from any law enforcement agency regarding a PPP application or loan should immediately consult with counsel who can assess the full potential for civil and criminal exposure before responding to any such subpoena or inquiry.

PPP Fraud Prosecution Tracker

Fox Rothschild’s White-Collar Criminal Defense & Regulatory Compliance Practice Group is tracking in real time all federal criminal cases alleging violations of the CARES Act Paycheck Protection Program.

To access our PPP Fraud Prosecution Tracker, contact White-Collar Criminal Defense & Regulatory Compliance Practice Group Co-Chairs Matthew S. Adams at madams@foxrothschild.com or 973.994.7573 and Matthew D. Lee at mlee@foxrothschild.com or 215.299.2765.

For additional information on the topic of this alert, contact Matthew D. Lee at mlee@foxrothschild.com or 215.299.2765; Marissa Koblitz Kingman at mkingman@foxrothschild.com or 973.548.3316; or any member of the firm’s national White-Collar Defense & Regulatory Compliance Practice.