The past week has seen some important changes in the federal government’s COVID-19 relief programs, especially the Paycheck Protection Program (PPP), and civil plaintiffs have continued to develop and file claims against financial institutions related to the PPP.
Our thinking, and a summary of this week’s key developments, follows.
- Apparently in reaction to public criticism of the PPP, key agencies have changed the way they administer the program. Enforcement agencies have also focused their attention on the program, with the first federal criminal prosecutions for PPP fraud.
- Plaintiffs are filing a steady stream of federal and state-law claims against financial institutions based on alleged improprieties in PPP lending programs. Some major institutions are already facing multiple putative class actions based on different theories of liability. To ensure consistency in approach, institutions may need to involve multiple lines of business and / or geographic units to coordinate their responses to these suits, other suits by commercial counterparties, interactions with regulatory or enforcement agencies (including responses to regulatory requests, applications / filings connected to COVID-19-related relief, and comments filed as part of agency regulatory processes), and inquiries from elected officials and the media.
COVID-19: Weekly update for financial services clients
Must Read Developments through May 8, 2020
Recent developments include:
- The Fed and the Small Business Administration (SBA) have continued to adjust their procedures and guidance related to the PPP.
- The Fed updated the FAQs and term sheet for its PPP Liquidity Facility (PPPLF). The changes: (1) expand access to the facility to all PPP lenders approved by the SBA (including non-depository institutions); and (2) permit eligible borrowers “to pledge whole PPP loans that they have purchased as collateral to the PPPLF.”
- The SBA released guidance on the procedures for completing whole loan sales of PPP loans between participating lenders.
- The SBA also promulgated an Interim Final Rule limiting the amount of PPP loans that any single corporate group may receive and providing guidance on non-bank lender participation in the PPP.
- The SBA drew PPP borrowers’ attention to the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” The SBA observed that (1) in making such certification, borrowers must take into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business and (2) each of (i) a public company with substantial market value and access to capital markets and (ii) a business owned by a private equity or other similar company with adequate sources of liquidity to support its ongoing operations is unlikely to be able to make the required certification. The SBA stated, however, that any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 14, 2020 will be deemed by SBA to have made the required certification in good faith.
- Finally, the SBA published a list of the lenders participating in the PPP as of April 30, 2020.
- In the coming weeks, the Fed plans to start buying shares in eligible corporate debt-focused ETFs through the Secondary Market Corporate Credit Facility. This announcement appears to have caused significant investment interest in corporate bond ETFs.
- The US Department of Justice (DOJ) filed the first prosecutions for CARES Act / PPP fraud against two small business owners.
- The charges in Rhode Island federal court allege that one of the defendants (a restauranteur) sought nearly $500,000 in PPP loans, while the other (the owner of a wireless communications entity) applied for about $100,000 under the program.
- Of particular note for financial institutions, the DOJ press release indicates that the DOJ’s investigation involved “an FBI undercover agent posing as a bank compliance officer.” Several law enforcement agencies with financial-sector expertise took part in the investigation, including the FBI, IRS, Inspectors General for the SBA and FDIC, and the Rhode Island State Department of Revenue.
- Relatedly, as part of DOJ’s preliminary inquiry into COVID-19 stimulus fund distribution and possible fraud, Assistant Attorney General Brian Benczkowski stated that DOJ has already come across several red flags in both approved and rejected PPP loan applications that it has reviewed. Specifically, Benczkowski commented that some applicants seeking large loans had overstated their payroll costs, number of employees, and the nature of their business. DOJ’s review is currently ongoing.
- FINRA explained the role of its new coronavirus-focused Task Force in a blog post, stating that the Task Force “manages a centralized repository of intelligence gathered from across the organization to help ensure efficiency and maximum coordination.” FINRA further stated that the Task Force will focus on areas including “potential fraud by broker-dealers and registered representatives, over-the-counter issuer fraud, insider trading, market manipulation, and investor harm including fraud targeting seniors and vulnerable investors.”
- As noted above, CARES Act / PPP-related suits involving financial institutions have proliferated, but the litigation remains in early phases. Although courts generally seem to be denying requests for TROs or ex parte relief, the matters proceed under a variety of theories.
- The Fourth Circuit Court of Appeals summarily denied a request for injunctive relief pending appeal of a Maryland federal court decision ruling that the CARES Act does not confer a private right of action (discussed in previous updates).
- In the Central District of California, a court denied a TRO application made by a pair of small businesses (on behalf of a putative class) against four financial institutions. The claim alleges that the financial institutions “caused confusion which prevented [plaintiff] from applying for a PPP loan before initial funds were exhausted.” A judge in the Southern District of Texas also denied a TRO request in a putative class action alleging CARES Act violations.
- Not all PPP-related suits allege violations of the CARES Act, however. For example, a putative class action pending in federal district court in Colorado is based on only Colorado state law, including common-law claims and alleged violations of the Colorado Consumer Protection Act. Note that this may be a reaction to precedents, such as the Maryland case, establishing that there is no private right of action under the CARES Act.
- Nor are financial institutions the only targets of CARES Act litigation. A California technology firm and two of its subsidiaries sued the SBA and the Department of the Treasury in California federal court over the agencies’ recent guidance stating that companies likely would not qualify for PPP loans if they could obtain financing from other sources. The plaintiffs claim that the text of the CARES Act does not impose this requirement and – because they have already spent PPP funds to pay employees – they would need to go into debt to repay those loans.
- The Federal Reserve finalized a rule to extend the initial compliance dates for certain parts of its single-counterparty credit limit rule by 18 months. Large foreign banks will need to comply with the rule by July 1, 2021, and small foreign banks will need to comply by January 1, 2022. The extension will allow foreign banks additional time to certify compliance with similar credit roles in their home countries, given that some foreign jurisdictions are still in the process of finalizing their rules or standards.
- The Fed and the OCC responded to a public question about how COVID-19-related market conditions impact the market risk capital rule.
- This rule “requires that a banking organization identify, once each quarter, the number of business days for which the actual daily net trading loss, if any, exceeds the corresponding daily VaR-based measure (‘exceptions’) that have occurred over the preceding 250 business days” and then “apply a multiplication factor … to determine its VaR-based and stressed VaR-based capital requirements” (unless the organization’s primary regulator instructs otherwise).
- The agencies recognized that “[a]dditional time may be required in order to evaluate the root cause of recent backtesting assumptions” given increased market volatility, “which otherwise could result in a capital requirement for market risk that is not commensurate with the firm’s covered positions.”
- The agencies further noted that: (1) federal banking regulators “generally consider” events like the pandemic “[w]hen determining whether a different adjustment to … [these] capital requirements for market risk is appropriate”; and (2) certain banks were already given the option to apply the multiplication factor that applied as of December 31, 2019, rather than applying a higher multiplier based on the most recent exceptions.
- The SEC announced that it is providing temporary and conditional relief to allow small companies affected by COVID-19 to meet urgent funding needs through a Regulation Crowdfunding securities offering.
- The Temporary Final Rule reduces the time period in which sales can be made in order to allow businesses to access funds sooner and provides an exemption from certain financial statement review requirements for issuers offering $250,000 or less.
- In a notice filed with the SEC, Nasdaq “propose[d] to provide listed companies with a temporary exception … from certain shareholder approval requirements” in light of COVID-19.
- The proposal would provide relief from existing requirements that shareholders approve: (1) an issuance of 20% or more of common stock or voting power outstanding before the issuance; and (2) certain issuances that permit officers, directors, employees, or consultants to acquire stock. Companies seeking to rely on this temporary exception must comply with certain requirements, including filing an 8-K or issuing a press release describing the issuance and seeking a necessary approval from Nasdaq.
- The IFRS’s International Accounting Standards Board proposed giving companies another year to implement changes for classifying and reporting debt as current or non-current for accounting purposes.
- The Fed also released a record of the April meeting of its Community Depository Institutions Advisory Council. At the meeting, the Council discussed the actions that have already been taken to address the pandemic and the expected tools and challenges for future mitigation efforts by community depository institutions.
- A CFPB report found that consumer credit applications declined substantially in March, apparently for reasons related to the pandemic. The decrease is especially notable among consumers with higher scores. The trend reflects significant geographic variation, too: the South and Mountain regions saw relatively smaller drops, while the Northeast and California experienced the largest.