The U.S. Small Business Administration (SBA) provides loan programs available at most banks and commercial lending that are U.S. government-backed and guaranteed. Each year, the administration guarantees billions in loans and assists thousands of U.S. small businesses with obtaining financing that may otherwise not be available to them from traditional outlets.

Although the SBA does not directly lend money, it assists small businesses’ development through guaranteeing loans made to them through the private lending markets. As of 2015, the SBA held more than $118 billion in its investment portfolio and appeared to be increasing that amount for 2016. This amount of exposure rightly demands diligent oversight to ensure fraud is reduced and money ends up in the right hands, but some lenders have begun talking about underhanded tactics from the government.

While the SBA continues to struggle with fraud, it has stepped up enforcement efforts, in conjunction with the Department of Justice and Housing and Urban Development, to target and prosecute program violators. The SBA has always utilized site visits to determine if a borrower is legitimate, but it was not until recently that it began using the False Claim Act (FCA) to find, investigate and prosecute what SBA feels is fraudulent activity on the part of the lender.

Navigating the False Claims Act (FCA) Liability

The FCA was originally enacted after the Civil War to thwart profiteers making false claims of loss against the United States government. It currently applies to anyone making a false claim to the government or presenting false information affecting a government claim. More recently, the law has been applied to government programs and contracts through regulatory enforcement actions. The FCA is used by both the Department of Justice (DOJ) and HUD to pursue and recover damages from organizations that rely on government guarantees or loan purchases as part of their business. The agencies often use the law to prosecute violators either through DOJ lawsuits, or qui tam relator suits.

Under the SBA, the FCA can be utilized against lenders in the same fashion it was used to go after government-sponsored lenders after the 2008 economic crisis. Small business lenders must contend with ramifications that fall under the purview of the FCA, and make adjustments to ensure they do not fall into traps that risk possible litigation. While the FCA was intended to identify and prosecute fraud against the U.S. government, it can also be used to enforce violations of procedures with regard to loans the SBA guarantees or purchases. The Act allows the government to go after lenders, Realtors or other entities or organizations tied to SBA lending activity.

How FCA is Applied to Violations

The FCA can place both preferred and regular lenders on notice for violations, including lenders offering loans under the FHA and HUD. For SBA Preferred Lenders providing Section 7(a) and CDC/504 loans, the requirement for vetting the viability of the small business borrower falls squarely at the feet of the organization and principals. Lenders must ensure they follow SBA guidelines, as well as perform their internal set of due diligence checks to make sure they are dealing with a legitimately qualified SBA business. Even a failure to provide borrower information to the SBA can become a cause for an action.

Both government and private persons can bring suit against a lender based on FCA violations. The DOJ often prosecutes lenders under the FCA, but it is not unheard of for former employees or customers to file suit using arguments from the Act. However, the primary area of concern for SBA lenders should remain with adhering to agency guidelines.

The SBA regulations change from time to time, and as such a lender must consistently adjust internal procedures to ensure meeting those changes. It is also the responsibility of the lender to report any changes in income, qualifying requirements, or company financial issues to the SBA during the application process. Any failure to report these changes can be construed by the SBA as an FCA violation.

How Lenders Can Avoid FCA Investigations

An alleged violation of the FCA made by a government entity is a dangerous situation that requires immediate legal guidance. However, there are steps that lenders can take to mitigate exposure to FCA violations and prevent attracting unwarranted FCA scrutiny.

Compliance – The best way to avoid undue scrutiny stemming from alleged violations is not to expose yourself in the first place. Ensure that your company has the proper internal procedures in place to properly research and qualify small business customers. Create and provide a comprehensive employee training program that details warning signs of potential violations. Perform periodic internal audits to enforce compliance and adherence to Agency requirements for SBA loans.

Education – Ensure company executives are well schooled on FCA violations and how to avoid them. Enlist the help of counsel to provide oversight and guidance about how corporate activity, or inactivity, can lead to an investigation. Hold regular board meetings to discuss possible areas of concern and evaluate the performance of the internal audit process, compliance program and reporting systems.

Consultation – As mentioned previously, an FCA violation is a serious problem that could result in fines, removal from government-sponsored loan programs or even loss of your lenders license. It is important to obtain competent legal counsel in response to any DOJ or private FCA action taken against the firm. Legal advice will be paramount in implementing an internal investigation and plan of action to prevent irreversible damage resulting from an FCA claim or inquiry.

The best way to avoid an FCA investigation is not to put your company into a position that presents a reason for the SBA or DOJ to come calling. Implementing a robust compliance program, internal or third-party auditing system, and accurate record keeping and reporting is paramount to ensuring you continue to operate according to SBA guidelines and regulations.

Dennis Baranowski’s article originally appeared in Private Lender by AAPL: March/April 2017.