Predicting the Future of DOJ Enforcement Actions Involving COVID-19 Relief Fraud
Predicting the Future of DOJ Enforcement Actions Involving COVID-19 Relief Fraud
In the wake of prior financial crises and natural disasters, the U.S. Department of Justice (DOJ) and its law enforcement partners aggressively pursued instances of federal relief fraud. Early signs indicate that this pattern will continue with the current COVID-19 pandemic. In the span of two weeks in May 2020, less than two months after Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the Fraud Section of DOJ’s Criminal Division in Washington, D.C., working with U.S. Attorneys’ Offices and law enforcement agencies across the country, brought criminal actions against five individuals for allegedly committing fraud and making false statements in connection with the CARES Act’s Paycheck Protection Program (PPP), a government loan program designed to keep workers on the payroll of small businesses. While DOJ’s early enforcement actions involve allegations of brazen and unsophisticated fraudulent conduct, they provide a road map for more sophisticated prosecutions that may follow.
Under the PPP, a small business—generally defined as a company with fewer than 500 employees—can apply for up to $10 million in loans to keep workers on the payroll and to cover other specified business costs. The amount of the PPP loan depends on the number of employees and their average payroll costs for a period of 2.5 months. PPP loans have a maturity of two years and an interest rate of one percent but can be forgiven if the small business spends the loan proceeds on qualifying expenses within eight weeks of receipt and uses at least 75 percent of the proceeds for payroll. Small businesses apply to commercial lenders for PPP loans, which are approved and guaranteed by the Small Business Administration (“SBA”). As part of the application process, an authorized representative of the business must acknowledge program rules, make certain affirmative certifications regarding, for example, the business’s number of employees and average monthly payroll expenses, and provide relevant materials, such as IRS Forms 940, 941, or 944, to support these statements. In total, Congress has made approximately $650 billion available for PPP loans to date.
On May 4, 2020, just over a month after the PPP was launched, DOJ brought its first charges in connection with fraudulent PPP loan applications. Two men from New England, David Staveley of Massachusetts and David Butziger of Rhode Island, were charged in the District of Rhode Island with conspiring to make false statements to the SBA and to commit bank fraud. According to the affidavit in support of the criminal complaint, Staveley submitted three separate loan applications, seeking more than $438,500 in total by claiming that he had about 66 employees working at three different restaurants in Massachusetts and Rhode Island. In fact, Staveley had no connections with two of the restaurants, and the third closed months before the pandemic began. An anonymous witness reported suspicions of Staveley’s fraudulent scheme to local law enforcement, which led to a swift and aggressive investigation by the FBI and IRS. Among other things, agents searched multiple email accounts, conducted an undercover conversation with one of the defendants, and verified the absence of legitimate wage-related tax forms with state and federal tax authorities. The emails recovered by agents included an April 11, 2020, offer to Staveley by Butziger to “create a bull s[--]t 2020q1” for one of the restaurants and emails from Staveley advising Butziger about the need to “dream up” various documents to support their loan applications. In addition to the restaurant schemes, Butziger allegedly made false statements in connection with an application from a wireless company for a loan of $105,381.50 under the PPP program.
On May 12, 2020, DOJ charged Shashank Rai, then an employee at a large multinational energy company, in the Eastern District of Texas for wire fraud, bank fraud, and making false statements to a financial institution and to the SBA in connection with allegedly submitting two fraudulent PPP loan applications. The scale of this alleged fraud was considerably larger than the Rhode Island cases: the defendant sought a total of approximately $13 million from two lenders by claiming that he had 250 salaried employees working for him. Based on the complaint affidavit, it appears that the investigation began when the compliance department at one of the PPP lenders noticed multiple discrepancies in the information provided by the defendant. The second loan, however, was approved by the SBA and was in the process of being funded when law enforcement became involved. Like in the Rhode Island cases, investigators confirmed the absence of legitimate payroll and employment records and obtained a search warrant for email accounts. Indeed, investigators determined that one of the Social Security numbers Rai submitted in support of his application belonged to a “deceased individual who if they were alive today would be 106 years old.” The complaint affidavit also noted that the defendant did not include the ownership of his purported company on his LinkedIn profile, noting dryly, “Based on your affiant’s training and experience, it is highly unusual for an individual owning a legitimate multi-million dollar organization to exclude any references to that organization on publicly available business development websites such as LinkedIn, but to include detailed references to an ordinary salaried engineering job at a multinational energy company.” Investigators also recovered from the defendant’s trash handwritten notes suggesting that the defendant intended to invest the PPP loan proceeds in “futures,” “options,” and “Stocks.”
One week later, on May 19, 2020, DOJ charged Samuel Yates in the Eastern District of Texas with wire fraud, bank fraud, and making false statements to a financial institution and to the SBA. According to the DOJ press release, Yates falsely claimed in his applications seeking a total of approximately $5.5 million in PPP loans from two different lenders that he had over 400 employees on his payroll. In fact, no one appeared to work for him, and the names on the payroll list Yates submitted in support of his application were allegedly invented using a random name generator on the internet. At the time of the writing of this client alert, the complaint affidavit was not available, but one can surmise from allegations such as this one that Yates’ alleged fraud may have been relatively obvious.
The Staveley, Butziger, Rai, and Yates prosecutions all stem from false statements made regarding the applicant’s eligibility for PPP loans. In another case, DOJ brought charges based on the defendant’s use of PPP loan proceeds. On May 12, 2020, DOJ brought bank fraud charges in Northern District of Georgia against reality television personality Maurice Fayne, also known as “Arkansas Mo,” who received PPP loans for more than $2 million for his trucking company. Despite certifying during the application process that he would use the loan proceeds to “retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments, as specified under the Paycheck Protection Program Rule,” Fayne allegedly used a majority of the proceeds to make loan payments, purchase jewelry, pay child support, and, possibly, lease a Rolls-Royce. (According to the complaint affidavit, Fayne told agents that he “Kinda, sorta, not really” used loan proceeds to purchase the vehicle.)
Past history teaches that DOJ and its law enforcement partners respond aggressively in times of financial distress. Between 2005 and 2011, DOJ criminally charged over 1,400 people with various fraud offenses related to Hurricanes Katrina and Rita, including cases in which individuals filed false applications seeking benefits to which they were not entitled. As of March 31, 2020, the Special Inspector General for the Troubled Asset Relief Program, which was created by Congress following the 2008 financial crisis, reported that 443 individuals had been criminally charged, enforcement actions had been brought against 24 institutions, and $11 billion had been recovered from investigations.
There is every reason to believe that DOJ and its law enforcement partners will respond similarly in the wake of COVID-19. In a March 16, 2020 memo to all United States Attorneys, Attorney General Bill Barr, wrote, “The pandemic is dangerous enough without wrongdoers seeking to profit from public panic and this sort of conduct cannot be tolerated. Every U.S. Attorney’s Office is thus hereby directed to prioritize the detection, investigation, and prosecution of all criminal conduct related to the current pandemic.” Similarly, the head of DOJ’s Criminal Division observed, “we know from past history, whenever the government makes a large amount of money available to help individuals and businesses, the fraudsters will come out of the woodwork and seek to get access to that money. So we are preparing vigorously for what we absolutely know is coming.” While the five cases discussed above represent brazen, unsophisticated fraud schemes, they nevertheless show that DOJ and its law enforcement partners are reacting vigorously to PPP fraud, as promised. Indeed, it is striking that law enforcement agents conducted in-person interviews, executed search warrants, and performed physical surveillance in compressed time windows, all during a time of widespread stay-at-home orders, in pursuit of these cases.
More importantly, the five cases discussed above set out a blue print for enforcement actions against more sophisticated actors. Even sophisticated companies that apply for and receive PPP loans, as well as loans under other provisions of the CARES Act, could face allegations that they were not eligible for the loans or that they failed to use funds for qualified purposes. As demonstrated by the recent public outcry against publicly traded restaurant chains receiving PPP loans, determining one’s eligibility for the program is not a straightforward exercise. According to the CEO of one such company, “[t]he ‘PPP’ came with no user manual and it was extremely confusing.” And eligibility requirements seem to be a moving target, as the Treasury Department and the SBA have revised their guidance in reaction to such controversies. Recent Treasury Department Guidance suggests that that companies who receive PPP loans over $2 million may be subject to audits by SBA or Treasury and face potential penalties if the “good faith” certification requirement is not met. As the Firm has advised elsewhere, for most borrowers criminal prosecution is unlikely, but it is still a risk to be considered. To minimize the likelihood of a negative outcome, companies applying for PPP and similar loans should closely examine the basis for their eligibility and monitor their use of the loan proceeds—and should thoroughly document both.
Commercial lenders should also be sure to follow established compliance procedures in issuing PPP loans. Because federal agencies agreed to hold banks harmless if they relied in good faith on borrower certifications and supporting documents to determine an applicant’s eligibility for a PPP loan, and because of the heightened scienter requirement for criminal prosecutions, DOJ is unlikely to investigate banks simply because an applicant committed fraud. But a bank could be subject to investigation and prosecution if one of its employees conspires with an applicant to fraudulently secure such loans. Similar allegations of bank employee complicity in obtaining fraudulent mortgages were abundant following the 2008 financial crisis. Recent reports that DOJ sent PPP-related subpoenas to major banks likely reflect DOJ’s efforts to build cases against applicants by, for example, showing that a bank account was recently created solely to receive PPP funds or showing how money was spent, such as in the Rai and Fayne cases, respectively. But banks regulatory compliance functions could come under scrutiny if DOJ uncovers a significant amount of fraud associated with a single institution. In any event, the subpoenas show DOJ’s determination in pursuing COVID-19 related fraud, even as the pandemic continues.
 Brief Overview of CARES Act Loan Programs, Morrison & Foerster Client Alert (Mar. 27, 2020), available at https://www.mofo.com/resources/insights/200327-overview-cares-act-loan-programs.html.
 Two Charged in Rhode Island with Stimulus Fraud, DOJ Press Release (May 5, 2020), available at https://www.justice.gov/opa/pr/two-charged-rhode-island-stimulus-fraud.
 United States v. Butziger, Case No. 20-mj-00033, ECF No. 3 (D.R.I. May 4, 2020).
 Engineer Charged in Texas with COVID-Relief Fraud, DOJ Press Release (May 13, 2020), available at https://www.justice.gov/opa/pr/engineer-charged-texas-covid-relief-fraud.
 United States v. Rai, Case No. 20-mj-95, ECF No. 2 (E.D. Tex., May 12, 2020).
 Texas Man Charged with $5 Million COVID-Relief Fraud, DOJ Press Release (May 19, 2020), available at https://www.justice.gov/opa/pr/texas-man-charged-5-million-covid-relief-fraud.
 United States v. Fayne, Case No. 20-mj-370 (N.D. GA, May 12, 2020).
 See Disaster Fraud Task Force Report to the Attorney General for Fiscal Year 2011, available at https://www.justice.gov/sites/default/files/criminal-disasters/legacy/2013/04/04/ReportDFTF2011.pdf.
 See SIGTARP Semiannual Report to Congress, October 1, 2019 – March 31, 2020, available at https://www.sigtarp.gov/Quarterly%20Reports/April_30_2020_Report_to_Congress.pdf.
 COVID-19 – Department of Justice Priorities, Memorandum for All United States Attorneys (Mar. 16, 2020), available at https://www.justice.gov/ag/page/file/1258676/download.
 Justice Dept. anticipates coronavirus stimulus will be a major target for fraud, Matt Zapotosky, Washington Post (Apr. 22, 2020).
 Shake Shack returning $10M loan from ‘confusing’ federal small-business relief program, Zack Budryk, available at https://thehill.com/policy/finance/493629-shake-shack-returning-confusing-government-small-business-loan.
 See, e.g., House Passes a $484 Billion Relief Package; Treasury and the SBA Release New Guidelines for PPP Loans, Morrison & Foerster Client Alert (Apr. 23, 2020), available at https://www.mofo.com/resources/insights/200423-house-passes-relief-ppp-loans-covid-19.html; The SBA Imposes a $20M Limit on PPP Loans for Corporate Groups, Morrison & Foerster Client Alert (May 4, 2020), available at https://www.mofo.com/resources/insights/200504-sba-imposes-limit-ppp.html; Is My Company’s PPP Loan “Necessary to Support Ongoing Operations?” What If I’m Wrong? Morrison & Foerster Client Alert (May 6, 2020), available at https://govcon.mofo.com/small-business/is-my-companys-ppp-loan-necessary-to-support-ongoing-operations-what-if-im-wrong/; Are Foreign Employees Included in Calculating Size for PPP’s 500-Employee Size Standard? New Guidance Makes the Answer Unclear, Morrison & Foerster Client Alert (May 18, 2020), available at https://govcon.mofo.com/small-business/are-foreign-employees-included-in-calculating-size-for-ppps-500-employee-size-standard-new-guidance-makes-the-answer-unclear/.
 See Paycheck Protection Program Loans FAQs (May 19, 2020), available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf.
 U.S. Justice Dept. subpoenas Wall Street banks for small business loans info, Koh Gui Qing & Pete Schroeder (May 15, 2020), available at https://www.reuters.com/article/us-usa-doj-banks/exclusive-u-s-justice-dept-subpoenas-wall-street-banks-for-small-business-loans-info-sources-idUSKBN22R3EZ.