Evidence of PPP Fraud Among Investment Advisors Points to Widespread Abuse

Millions of dollars in federal funds were overallocated to investment advisory firms that misrepresented company information on their pandemic relief loan applications. That’s according to a recent study co-authored by William Beggs, assistant professor of finance at the University of San Diego’s Knauss School of Business. 

Introduced in April 2020 as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the Paycheck Protection Program (PPP) allowed the Small Business Administration (SBA) to distribute loans to businesses impacted by the COVID-19 pandemic. However, with the rapid rollout of the PPP came a lack of regulatory oversight, which led some businesses to abuse the program.

In December 2020, the SBA released data identifying PPP loan recipients as well as the loan amounts they received. Referencing 2020 PPP loan data from a group of investment advisors registered with the Securities and Exchange Commission (SEC), Beggs and Dr. Thuong Harvison, assistant professor of finance at Frostburg State University, found that at least $36.7 million in overallocated funds went to advisors who appeared to exaggerate payroll needs on PPP loan applications. 

These overallocations amount to 6% of the total $590 million in PPP funds received by SEC-registered advisory firms. If the study’s results were applied to all 2020 PPP funds, this 6% share would represent more than $39 billion in prospective abuse.

Paycheck Protection Program Rollout

PPP loans were primarily intended to help small businesses with fewer than 500 employees keep workers on the payroll. In addition to covering employee wages and benefits, businesses could use the loan funds to pay their mortgage interest payments, rent and utilities. 

Funds were quick to disappear after the program launched on April 3, 2020. The SBA approved 1.7 million loans in the first 13 days of the program, exhausting the initial $349 billion in funds and prompting a second round of funds totaling $310 billion. This second round was authorized on April 24, and 3.5 million loans were approved before the funds were once again exhausted on August 8. (A third round of PPP funding occurring in 2021 was not evaluated in this study.)

Though intended to support small, financially insecure businesses, PPP loans were more easily available to those with privileged connections to lending banks.

“Our data shows that firm size is a very significant predictor of how soon you got PPP funds,” says Beggs. “Banks tended to streamline applications for their larger clients.”

The PPP rollout wasn’t perfect, Beggs adds. “It was kind of a free-for-all. The more banking connections you had, the quicker you were able to get funds.”

Key Characteristics of Paycheck Protection Fraud

In March 2023, President Joe Biden’s administration released a $1.6 billion proposal to address pandemic-related fraud — including abuse of the PPP — and the U.S. Department of Justice (DOJ) is actively investigating fraud related to pandemic relief programs. According to the U.S. Government Accountability Office (GAO), the DOJ has brought at least 169 cases involving the PPP as of December 2021.

As Beggs and Harvison explain in their study, a number of the PPP fraud cases currently under review by the DOJ involve businesses that falsified their payroll needs to qualify for larger loan amounts. Maximum PPP loan amounts were capped at two and half times a business’s monthly payroll for salaries up to $100,000. By over-reporting the number of employees they had and their rate of compensation, businesses could apply for inflated loan amounts and quickly draw funds from lending banks.

Businesses could also qualify for full loan forgiveness if they used at least 60% of the disbursed funds for payroll costs, retained the same number of employees and maintained their compensation rates. Beggs and Harvison found that employee growth was common for recipients of abnormally large loans, which suggests that these firms obtained more than enough funds to cover payroll.

Beggs believes this data trend may be yet another indicator of fraudulent activity. Rather than returning over-allocated funds, firms pocketed the money and covered their tracks. “I suspect that companies hired more employees after receiving the funds so they could qualify for loan forgiveness,” he explains. “It’s like free capital for these firms.”

An NPR analysis of SBA data released in January 2023 found that 92% of PPP loans were at least partially forgiven, even though billions of dollars in loans went to large businesses whose industries thrived during the pandemic. In contrast, those with the highest rate of unforgiven loans, at 13%, are sole proprietors like barbers, janitors and hairdressers.

Factors Contributing to Paycheck Protection Fraud

Beggs cites two factors related to the PPP rollout that made it easier for fraudulent loans to be approved. “One issue was just the rush to get the money out,” says Beggs. As many states implemented shutdowns in March 2020, small businesses were struggling to keep employees on their payroll and pay their business mortgages. PPP loans were designed to help with that.

“The other issue was that the banks approving the loans were requesting that money from the U.S. Department of Treasury,” says Beggs. “It wasn’t their capital that they were lending.” And because PPP loans were 100% guaranteed by the federal government, there was little financial risk for the lending banks who approved them.

A 2023 report by the SBA’s Office of Inspector General (OIG) acknowledged that by loosening its internal controls to quickly disburse pandemic relief funds, the agency unintentionally created an environment conducive to fraud. As the OIG states in the executive summary of the report, “The allure of ‘easy money’ in this pay and chase environment attracted an overwhelming number of fraudsters to the programs.”

PPP Loan Data Points to Paycheck Protection Fraud

As more news stories began to emerge about suspected PPP fraud among financially stable tech startups and businesses with political ties, Beggs and Harvison decided to take a closer look at the investment management industry. A former securities compliance examiner with the SEC, Beggs saw the warning signs during the PPP rollout. “As an examiner, I reviewed a lot of bad apples,” he says. “And my sense was that there was some kind of misconduct going on with this group of investment advisory firms.” 

Together Beggs and Harvison created a data set that cross-references SBA-released PPP loan data with information that 2,999 investment advisory firms submitted through the Form ADV, which SEC-registered advisors are required to file annually. The Form ADV contains information such as the number of employees the firm has, the assets under its management and any past legal or regulatory violations it has faced. Analyzing the firms’ annual Form ADV disclosures from the months before and after the PPP rollout made it easy to identify discrepancies between those forms and the loan applications.  

Being able to access such comprehensive data is due in large part to the industry. “The nice thing about this particular data set is that I can look at how many employees the firm actually has because they have to disclose it to the SEC,” says Beggs. “Not many other types of businesses have to submit regulatory filings like the Form ADV.”

Beggs and Harvison also consulted academic research on investment industry fraud, including a model developed by Dr. Stephen Dimmock and Dr. William Gerken that uses Form ADV data to predict fraud among investment managers. The Dimmock and Gerken model effectively determines a propensity for future fraud among investment advisors with past regulatory or legal offenses. Investors who consult the model to avoid the 5% of firms with the highest risk for fraud can avoid 29% of investment frauds and over 40% of total dollar losses.

“We were able to use the Dimmock and Gerken model to validate our research,” Beggs explains. “The firms who received loans that we suspected were abnormal aligned with the model’s predictions of misbehavior.”

Method and Findings

Beggs and Harvison created a two-step regression method to identify abnormally large loans and determine if these loans were likely instances of fraud or abuse. Using Form ADV data, they found a maximum PPP loan draw for each of the 2,999 firms. They then applied outliers from the two-step regression to the Dimmock and Gerken (DG) model to corroborate whether abnormally large loans may be instances of fraud or abuse.

Using this two-step regression analysis along with the DG model, Beggs and Harvison revealed several key insights, including:

• Out of 12,643 SEC-registered investment advisors, 2,999 received loans totaling over $590 million.
• About 25% of those 2,999 firms, or 753 advisors, reported more employees on their PPP application than they disclosed on their Form ADV.
• Of those 753 firms that overreported employees, 299 were predictive of abnormally large loans.
• Additionally, 206 of these 299 firms received PPP loan amounts that were in excess of their estimated maximum loan draw.
• The total dollar amount of PPP loans received by these 206 firms in excess of the estimated maximum was $36.7 million, which represents 6% of the total $590 million in PPP funds allocated to firms in the investment management industry.
• Recipients of abnormally large PPP loans were:
• Three times more likely to disclose past civil or criminal misconduct. 
• Nearly twice as likely to disclose past regulatory infractions.
• Eight times more likely to have committed fraud in the past.

Expand Your Knowledge of Business Rules and Regulations

Beggs and Harvison published their research in February 2023, and the SEC reached out soon after to learn more about their findings. “The SEC contacted me, and I went over the data with them,” says Beggs. “They’re looking over some of the instances we identified to see if there’s any action that they can take.”

By analyzing investment advisory firm data through a regulatory lens and pointing out potential misconduct, the research conducted by Professor William Beggs and Professor Thuong Harvison is helping government organizations like the SEC find specific entry points to begin investigations and establish regulations to prevent future instances of fraud.

Although the abnormal loan amounts Beggs and Harvison revealed in their data set represent a relatively small portion of the total $659 billion in 2020 PPP funds, their research provides a valuable glimpse into the behaviors driving pandemic-related fraud on a larger scale.

Beggs is among the faculty members at the University of San Diego’s Knauss School of Business who are actively engaging with top industry issues through groundbreaking research. Discover how educators at the University of San Diego are bringing current insights into the classroom to prepare the next generation of business leaders.

Recommended Readings:

Auditor-Client Communications: Industry Implications for Engagements

How Underlying Consumer Values Can Support New Strategies for Nonprofit Organizations

Finding Opportunity in Crisis: Developing Strategies for Managing Climate Risk    

Sources:

Congressional Research Service, “SBA Paycheck Protection Program (PPP) Loan Forgiveness: In Brief”

Journal of Banking and Finance, “Fraud and Abuse in the Paycheck Protection Program? Evidence From Investment Advisory Firms”

NPR, “How the Paycheck Protection Program Went From Good Intentions to a Huge Free-for-All”

Reuters, “The New Frontier of Fraud, Waste and Abuse: COVID-Related Misconduct Enforcement Trends”

University of San Diego, William Beggs

U.S. Government Accountability Office, “COVID Relief: Fraud Schemes and Indicators in SBA Pandemic Programs”

U.S. Small Business Administration, COVID-19 Pandemic EIDL and PPP Loan Fraud Landscape

U.S. Small Business Administration, First Draw PPP Loan

U.S. Small Business Administration, Paycheck Protection Program (PPP Report): Approvals through 12 PM EST 4/16/2020

U.S. Small Business Administration, Paycheck Protection Program (PPP Report): Approvals through 8/10/2020

William Beggs joined the Knauss School of Business as an assistant professor of finance after earning his PhD in finance from the University of Arizona in 2019. A Chartered Financial Analyst, his research focuses on issues in investment management including fund performance, conflicts of interest, trading impact and portfolio choice.