PPP’s complicated rules blurred lines between fraud and honest mistakes

Many U.S. businesses willingly defrauded the government’s Paycheck Protection Program loan program. But PPP’s byzantine procedures, applicants’ mistakes and some banks’ disinterest might have inadvertently caused well-meaning applicants to receive money they shouldn’t have. Now investigators must sift the wheat from the chaff.

Did your favorite restaurant close during the pandemic? If it didn’t, it might be because it received an injection of cash from the U.S. Small Business Administration’s (SBA) temporary Paycheck Protection Program (PPP). Many businesses defrauded the program; we’ve all heard stories of ill-gotten Lamborghinis and gaudy mansions. But many more stayed alive because of the emergency taxpayer money. Now that COVID has eased, government investigators must not only investigate the crooks but also well-meaning applicants who might have received money they shouldn’t have because of their honest mistakes trying to wind through PPP’s convoluted rules.

Emergency money for desperate situations

The financial effects of the COVID-19 pandemic affected all businesses as the world shuttered during the height of the virus’s spread. Faced with public health rules, lockdowns and other restrictions, many businesses struggled. To assist small U.S. businesses suffering losses directly caused by the pandemic, Congress implemented the CARES Act, which became law on March 27, 2020. As part of the funding package, the SBA was tasked with providing much-needed loans to help keep these businesses afloat.

The SBA issued these low-interest PPP loans, via participating banks, with the understanding that they were potentially fully forgivable. To have the loans forgiven, borrowers had to meet specific criteria; for example, they had to use the funds for payroll and other allowable expenses during a specified “covered period.” Companies couldn’t just arbitrarily use the funds; they had to use the loans to pay certain costs.

The PPP’s program rules made it clear that its intent was to incentivize business owners to retain and pay employees — particularly lower-paid employees — during the challenging times of the pandemic, even when sales waned. The funds were meant as a financial bridge to sustain these businesses until the effects of the pandemic passed. The program stipulated penalties of reduced loan forgiveness for companies that cut employees or their wages.

Risky solution to a supposed short-term problem

From its beginning, the PPP program was wrought with difficulties. Because of the sudden and unprecedented financial effects of the pandemic, the government wanted to disburse this money to qualifying businesses quickly. Even Justice Department Inspector General Michael Horowitz said this was a problem. But judging from initial reporting and terms on these loans, it appears the government saw this as a quick solution for a short-term problem. (See “‘Biggest fraud in a generation’: The looting of the Covid relief plan known as PPP,” by Ken Dilanian and Laura Strickler, NBC News, Coronavirus, March 28, 2022.)

Many thought that lockdowns and business closures would last a few weeks until the virus passed. The SBA gave companies eight weeks from the date they received the loans to spend the funds on qualified expenses. But some companies couldn’t use the money on those expenses quickly enough and therefore would’ve had to pay back the unused balances. Shortly after, the SBA allowed borrowers to apply expenses over 24 weeks rather than the shorter eight-week period. This change virtually ensured that these companies could apply for forgiveness of their full loan amount, assuming they used the funds as required. With the benefit of hindsight, we now know that businesses struggled for months and months, and many never recovered. (See “The PPP Dilemma: 24 vs 8 Weeks,” by Peter Harriman, Maine Small Business Development Centers.)

Application for PPP loans and calculation of eligible loan amount

PPP loans were intended for businesses that couldn’t make ends meet as a direct result of the pandemic. Companies that were unaffected or remained profitable weren’t candidates for these loans. Businesses had to certify that they needed these funds to maintain continuing operations. (See “Paycheck Protection Program,” SBA.)

In simplest terms, the SBA calculated each company’s loan amount based on a factor of their average monthly payroll. However, the calculation quickly became more complicated. Limits on compensation and benefits had to be considered. Critically, the SBA quickly approved and funded these loan applications based on companies’ own calculations. But many small businesses didn’t have the sophistication or records to do this calculation accurately. And with the large volume of applications, it’s impossible to believe that lenders had enough time to conduct thorough reviews to guarantee accuracy and eligibility.

The instructions were confusing, so it’s easy to see how small business owners could easily calculate incorrect eligibility amounts. Also, some companies had unique circumstances that weren’t necessarily covered in the instructions. To further complicate matters, the SBA often changed rules, which left the business owners to make their best guesses.

Although banks administered these loans, many small business owners found their regular bankers weren’t familiar with the program. Some banks opened departments specifically dedicated to PPP, but other banks didn’t provide any guidance at all. After the program began distributing loans, some banks sold their portfolios to third parties, which didn’t have relationships with the businesses at all.

This PPP program was unprecedented; participants had to learn as they went. Some banks weren’t committed to applicants and sometimes gave them conflicting guidance. Interestingly, the SBA had indemnified the banks if borrowers failed to follow the program’s rules, thus adding little incentive for banks to vigorously screen applicants. (See the March 28, 2022, NBC News article.)

Because these loans were for businesses in financial need, in theory, only those companies should’ve applied for and received PPP loans. However, this assumption has come under criticism. At the time, businesses argued they were uncertain about the long-term impact of COVID and — lured by the promise of free money from the government —received PPP funds based on their certification of need. But then some of them promptly returned the money, either because of negative publicity or perhaps they had second thoughts about their real needs. (See “Which companies are returning their PPP loans? Here’s the list.,” by Ben Popken, NBC News, April 28, 2020 and “Companies returned $30 billion in small-business loans from Paycheck Protection Program,” by Thomas Franck, CNBC News, July 6, 2020.) Also, experts believe that many companies stretched the truth to receive more funding than they qualified for. (See the March 28, 2022, NBC News article.)

Forgiveness applications even more complex

To avoid repayment, a borrowing company had to submit an application to have its loan forgiven by a certain date following the end of its covered period. The calculation to determine the amount of loan forgiveness was even more convoluted than the initial determination of the loan amount. If a company used the funds for allowable expenses within prescribed time limits and kept employees on the payroll, it could have its entire loan forgiven. But each company needed to go through a series of steps to determine how much of their loan would be eligible for forgiveness and how much it would have to pay back.

Furthermore, borrowers had difficulty acquiring accurate data to substantiate these expenses. While many large payroll service providers quickly developed additional PPP-specific reports for their clients, many borrowers (who didn’t use a third-party payroll service or whose provider didn’t offer such reports) were left with the difficult task of accurately calculating costs for their forgiveness applications when payroll dates didn’t necessarily correspond with key loan dates.

The forgiveness application instructions were complicated. The SBA offered vague answers to Frequently Asked Questions, and sometimes terribly cumbersome calculations and exceptions. The agency gave numerous rules, exceptions to the rules and different rules for different businesses, such as seasonal employers. On top of that, the SBA required several “tests” that measured whether it would penalize a company if it cut employees’ pay rates, hours or staffing.

Remember that the stated purpose of the PPP program was to offer help for companies to keep employees on payroll during the pandemic, regardless of whether the business was open or closed. However, some businesses were forced to reduce staffing. Or to try to keep employees, they reduced their pay rates so employees would at least continue to receive some salary. Companies applying for loan forgiveness had to calculate whether any of these penalties kicked in, whether they met certain exceptions (“safe harbors”) to these penalties and what, if any, effect they had on the amount of the loan that the company could’ve had forgiven.

To determine which tests applied to which employees, companies had to analyze in detail individual payroll data for each employee. Different rules and tests applied, depending on where an employee fell on the pay scale, which left employers to determine the amount of eligible expenses they could claim. Complex hour and wage-reduction tests could ascertain whether companies would receive 100% forgiveness on loans. Fortunately, most payroll providers captured this data as part of their PPP reports, but those companies that didn’t employ these services had to compute these values manually.

Payroll cost headaches

The primary basis for the loan forgiveness application was the calculation of the company’s payroll and other allowed expenses that it had incurred during the covered period (24 weeks for most companies). The company was required to have spent at least 60% of the loan amount on payroll costs and no more than 40% on those other allowed expenses, such as rent and utilities. If the company failed to meet these thresholds, it would affect the forgiveness amount.

However, determining allowed payroll costs wasn’t easy. The company needed to compute each employee’s wages and associated payroll expenses, such as health insurance and retirement payments the company paid during the covered period. Finally, the company needed to figure the amount, if any, of penalty in the wage-reduction test plus the full-time equivalent ratio, which determined whether the company maintained staffing at required levels during the period. The SBA factored these amounts to reduce the incurred expenses and arrive at the potential forgiveness amount. In any circumstance, the maximum amount of forgiveness a company could receive was the full amount of the loan.

When applying for forgiveness of the loan to the SBA, the company could only claim a maximum payroll expense for each employee, even if the company’s actual expense during its covered period was more.

Concerns of good faith vs. fraud

All these complicated rules beg the question: What’s the delineation between outright fraud and good faith errors made by recipients of PPP funds? Applicants clearly could misunderstand or misapply a restriction so they’d technically run afoul of the program rules, which would possibly result in the government awarding them funds to which they weren’t entitled. However, contrast that with the criminals who knowingly, and with intent, defrauded the banks and government by applying for and receiving PPP funds for fictitious companies under fraudulent identities and similar dishonest methods. Many of these actors had been caught because of their obvious misuse of the funds to buy expensive cars and houses. (See the March 28, 2022, NBC News article.)

Many PPP loan recipients are facing the SBA’s review to determine whether they were (1) originally eligible (2) received the proper amount of funds and (3) used the funds properly if the loans were ultimately forgiven. According to the SBA, the tab for the fraud in these loans is $84 billion. (See “$84 Billion in PPP Loans Are Potentially Fraudulent, But Only 1% of Funds Have Been Seized,” by Katherine Fung, Newsweek, March 25, 2021.) It’s not clear whether the $84 billion includes loans that were issued in error (as opposed to those from blatant fraud), but the amount is staggering.

It will be extremely difficult for the government to prosecute and recover funds simply given the sheer volume of loans despite the government routinely flagging certain loans they deemed suspicious during the awarding. (See “The Great Pandemic Swindle: Feds Botched Review of Billions in Suspect PPP Loans,” by Nick Schwellenbach, Neil Gordon, Sean Moulton and Leslie Garvey, Project on Government Oversight, Oct. 6, 2022.)

Wisdom of Solomon

Those businesses that had legitimate needs but may have to repay PPP loans because of unintentional errors — whether they miscalculated their eligibility because of the rush to apply or because of banks’ incentive to quickly approve applications without careful oversight — may now be hobbled by the sudden lack of income. And some of those businesses now must endure a confusing loan-forgiveness process. Rejection of their applications could spell doom.

The need for government help may seem less pronounced now that the uncertainty and panic at the initial stages of the pandemic have subsided. Does this mean that some small businesses facing the challenge three years ago unwittingly received taxpayer funds they shouldn’t have? It might take the wisdom of Solomon for government authorities to conduct their examinations fairly.

Charles Rabeno, Ed.D., CFE, is a forensic accounting specialist with Murphy, Miller & Baglieri, LLP, in Glen Rock, New Jersey. He spent over 22 years as a special agent with a federal law enforcement agency. Contact him at crabeno@mmbllp.biz.