NEW YORK/BOSTON (Reuters) – U.S. federal agencies have begun scrutinizing lenders for potential misconduct when distributing $525 billion in pandemic aid to struggling small businesses, according to half a dozen people with knowledge of the matter, regulatory filings and statements. The sources told Reuters the scrutiny of banks’ roles in the Paycheck Protection Program (PPP) is preliminary and it was not yet clear if it would lead to formal probes. However, it is the strongest sign yet that some lenders could potentially face civil or even criminal charges relating to the program, in addition to borrowers who stole funds. The Department of Justice, the bailout oversight body, known as the Pandemic Response Accountability Committee (PRAC), and the Small Business Administration’s (SBA) internal watchdog are among the agencies exploring whether lenders broke the program’s rules or other lending regulations, according to two people with direct knowledge of the matter and regulatory filings.

The sources declined to be named due to the sensitivity of the matter.

Spokespeople for the Justice Department and PRAC declined to comment.

A spokesman for the SBA’s Office of Inspector General, its internal watchdog, said authorities are not exclusively focused on lenders, and that the attention is part of a broader effort to uncover PPP fraud. He said the agency is focused on “wherever the evidence leads us.”

Under the program, big banks, community lenders and fintech firms dispensed 5.2 million government-backed loans to small businesses hurt by pandemic lockdowns. If borrowers spent the money on payroll and other business expenses, the government repays the lender. One of the people said investigators were looking for signs that lenders did not follow procedures, such as failing to properly vet borrowers’ payroll expense calculations; whether staff knowingly helped ineligible borrowers get loans; if lenders favored or discriminated against a borrower or group of borrowers; or had inconsistent lending processes or policies. The same person said investigators need the cooperation of borrowers and bank staff to gather evidence and that it could take time to build cases. But if the authorities were successful in doing so, they would pursue civil or even criminal charges. Lenders, for their part, have said they were under enormous pressure to lend vast sums of money to millions of businesses quickly, while having to keep up with ever-changing PPP rules. Due to the unusual circumstances, the government promised lenders as the program launched in April that they would not be held responsible if borrowers flouted program rules. That promise initially offered lenders some reassurance that they would not become ensnared in a sweeping federal effort to sniff out what officials say has been rampant borrower fraud. To date, the Justice Department, working with other agencies, has charged over 80 individuals for stealing more than $250 million. Lawyers representing banks said last month that lenders were worried about PPP regulatory risks and were assisting fraud investigators, but believed borrowers rather than the banks were generally the subject of interest.

However, lawyers have also warned that while lenders will not be responsible if borrowers broke the rules, for example, by lying about how many staff they had, banks could be held accountable if they failed to comply with the PPP’s first-come-first-served and equal access standards, or other regulations.

FAIR LENDING?

Congressional investigators last month singled out some large PPP lenders for prioritizing their existing customers, disadvantaging women and minority-owned businesses.[L4N2H73KE]

Depending on the circumstances, policies that hurt such “protected” groups – even if inadvertently – can violate fair lending rules. A study this month by the National Community Reinvestment Coalition, a Washington-based non-profit, also found that Black women and Hispanic men posing as interested PPP borrowers at 47 lenders “were treated less favorably” compared with their White counterparts, despite having stronger finances.

The Federal Deposit Insurance Corporation (FDIC), the New York Department of Financial Services (NYDFS) and the Justice Department’s civil rights division have also all shown interest in whether banks provided equal access to all prospective PPP borrowers, a third source familiar with the matter said.

The Consumer Financial Protection Bureau (CFPB) has also said publicly that it is assessing whether financial companies complied with fair lending rules when dishing out PPP loans. Spokespeople for NYDFS, CFPB and the Justice Department’s civil rights office did not respond to requests for comment.

“We would pursue any evidence of race-(based) lending discrimination wherever it may lead, and whether it involves the PPP or any other consumer lending program,” an FDIC spokesman said. Reuters previously reported that some very active PPP lenders have conducted internal reviews to spot employee violations of the program’s rules. Several lenders have also warned investors in regulatory filings that they faced regulatory risk from their participation in the PPP.

Georgia’s United Community Bank Inc said in June that it had received a request in May from the Justice Department for documents and other information regarding its PPP loans. It added that it would cooperate fully and believed all its loans were compliant. US Bank said this month that it had received inquiries from U.S. legislators, regulators and other government agencies about pandemic programs. A fourth banking industry source said a “vast number” of banks are working with law enforcement to root out fraud in the PPP and that some lenders have improved their procedures to prevent criminal activity. The banks did not respond to requests for comment.

Spokespeople for the SBA and the Department of Treasury, which oversee the PPP, both declined to comment.

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