This Notice provides information, tips and recommendations to detect and deter fraud in the Small Business Administration (SBA) business loan programs.
Every year, the OIG obtains multiple convictions of borrowers and loan agents that have committed fraud in the SBA business loan programs. The OIG’s concerns about potential fraud have increased in light of the recent passage of the American Recovery and Reinvestment Act, which implements new lending programs and is intended to expand significantly SBA loan volume.
Detecting and reporting fraud is in the best interest of all program participants. Fraud undermines public confidence in the public benefits of SBA lending programs, which support economic opportunity, small business growth and job creation. In addition, fraud can lead to higher program costs for borrowers and lenders, alike.
The SBA OIG would like to make you aware of fraud patterns that we continue to see in our loan fraud investigations so you can be on the lookout for such fraud. Lenders and other program participants are urged to exercise a high level of diligence if there is suspicious activity and to report suspected fraud to the OIG through the contact information at the end of this Notice.
A. Loan Agent Fraud
g., loan brokers/packagers) to prepare documentation for an SBA loan application and/or refer the borrower to a lender. Loan agents can provide a useful function in bringing borrowers and lenders together and facilitating loan transactions. However, OIG investigations during the past ten years have identified fraud schemes perpetrated by loan agents in the hundreds of millions of dollars.
The borrower replies “no” when asked if a “packager” was paid to prepare the loan application, when it is known a loan agent is involved in the process,
Track loan agent participation in their portfolios to determine whether agents are bringing an unusually high number of loans that experience early defaults or other significant problems,
Use a reputable appraiser and title company known to the lender (loan agent fraud has often been found to involve collusion with title and other companies).
B. Borrower Fraud
Borrowers, whether acting alone or in collusion with others, may intentionally provide false information to SBA and lending institutions during the loan application process as detailed below:
1. False Equity Injection
Gift letters and gift affidavits (investigation often proves such “gifts” to be false – either the money does not exist, or it is never paid into the business, or it is subsequently repaid to the donor),
There are many ways a borrower or loan agent may attempt to falsify the equity injection or conceal the actual source of funds. OIG investigations have often determined that the cash injected was actually borrowed, and that the related debt was not disclosed to the lender or SBA. As a reminder, lenders are expected to comply with the equity injection verification requirements contained in SBA Standard Operating Procedures (SOP) 50-10-5(A) Chapter 4, and SOP 50-51(C) Chapter 13. When lending officials are suspicious that equity injection verification documents may be false, it is suggested that lenders take affirmative steps to detect and deter such fraud such as the following:
If a gift letter is involved, have both the donor and the borrower sign an affidavit detailing the alleged gift and stating that the gift does not have to be repaid or returned, and request that the borrower provide a copy of a bank statement showing the injection was made prior to disbursement,
If funds are being transferred by wire (especially from a foreign country), request a copy of the wire transfer and include it in the loan file, and
If an inheritance is cited, verify that the funds exist by obtaining a copy of the inheritance bank statement showing the funds exist prior to disbursement.
The OIG encourages lenders to take proactive steps in order to reduce fraud, including such measures as having borrowers sign a certification at closing detailing the equity injection requirements for the SBA loan, and specifically how they have been met, and verifying with bank records that the equity injection is actually put into the business prior to disbursement, and used by the business.
2. Other Types of Borrower Fraud
The vast majority of lending officials are honest, and the SBA OIG has identified very few instances of fraud by loan officers and other lender employees. However, even one corrupt lending official can damage the institution’s reputation and profitability as reflected in the recent conviction of a loan officer for fraud involving approximately $85 million in SBA-guaranteed loans. Therefore, vigilance is needed to prevent fraudulent practices within the lending community. Although many lenders have undoubtedly implemented processes to identify potential fraud and improper activities, the SBA OIG recommends consideration of the following practices and internal controls to deter and detect suspicious lending activity:
Development of sufficient management oversight of loan approvals, including the use of multiple “eyes” reviewing the underlying documents that are used in generating credit approval memoranda, at least on larger dollar loans,
Policies (such as a Code of Conduct) to require business development officers and other lender personnel to disclose the involvement of loan agents in generating or packaging loans,
Limits on commissions and other internal inducements that provide incentives for loan officers to concentrate on loan volume at the expense of loan quality,
Internal review and auditing functions to examine the reasons why a particular lending official may have an unusually high number of loans that go into early default or experience other significant problems,
Internal review and auditing functions to examine the reasons why a particular lending official may have a significantly higher loan volume than his/her colleagues, particularly if that lending official is known to work with a particular loan agent or agents, and
Policies to require a higher level of due diligence in reviewing change of ownership transactions as numerous OIG investigations have identified fraud on these type of loans.