Next year will mark the tenth anniversary of a decision noteworthy for sheer political drama, as well as for its unique place in the history of Small Business Administration-backed lending. On February 23, 1998, the U.S. Court of Appeals for the Eighth Circuit refused to overturn Susan McDougal’s conviction on any of four counts associated with a fraudulent $300,000 SBA loan she had received from Capital Management Services (U.S. v. McDougal, 137 F.3d 547 (8th Cir. 1998)). In the original trial—the first of the Whitewater controversy—the lender’s president, David Hale, had accused then-President Bill Clinton of pressuring him to make the loan when Clinton had been governor of Arkansas. Clinton’s testimony to the contrary became a key topic of Special Prosecutor Kenneth Starr’s wide-ranging investigation.
Before a grand jury in 1996, McDougal refused to answer questions such as whether Clinton had lied in his testimony. Consequently, she was held in contempt of court and sentenced to 18 months in jail. McDougal served that sentence in full and maintained her silence until brought on trial for criminal contempt and obstruction of justice charges in 1998. At that point, she testified that she and Clinton had never discussed the $300,000 loan and that, as far as she knew, Clinton had testified truthfully. McDougal was found not guilty of obstruction of justice, and a hung jury on the contempt charges resulted in a mistrial. Starr opted not to try McDougal again, the end result being that her first Whitewater conviction, for fraud, remained her only one.
A more practical facet of McDougal, at least for parties involved in SBA loans, is that it happens to be the only published federal court case dealing with SBA Form 1031. For regulatory oversight purposes, a separate Form 1031 must be completed and submitted to SBA in connection with any SBA-backed loan. Susan McDougal was convicted, in part, for committing mail fraud by causing a false Form 1031 to be mailed in connection with her $300,000 loan. Writing for the Eighth Circuit Court, Judge John R. Gibson notes, “The Form 1031 stated that the purpose of the loan was to provide ‘working capital’ to Master Marketing.” In fact, the Master Marketing entity did not exist. Rather, the loan was deposited in McDougal’s personal checking account, after which it was all spent to pay off previous loans, purchase land, fund her brother’s political campaign, etc.
In appealing her mail fraud conviction, McDougal argued that Hale had mailed Form 1031 six days after she received the $300,000 check and, therefore, the mailing was not in execution of the scheme to defraud (as required by Kann v. U.S., 323 U.S. 88, 93-94 (1944), Parr v. U.S., 363 U.S. 370, 392-93 (1960), and U.S. v. Maze, 414 U.S. 395, 403 (1974)). Judge Gibson countered that, according to the Supreme Court in Schmuck v. U.S., 489 U.S. 705, 715 (1989), “The relevant question is whether the mailing is part of the execution of the scheme as conceived by the perpetrator at the time of the fraudulent transaction.”
Additionally, quoting the Eighth Circuit’s own precedent in U.S. v. Pemberton, 121 F.3d 1157 (8th Cir. 1997), mail fraud may occur after the fraudulent transaction by a mailing necessary for the defendant “to retain the fruits of the fraud” (1171). By both standards, Judge Gibson concluded, “The facts amply satisfy the requirement that the mailing be done in execution of the fraud.”
Besides McDougal, the only guidance on SBA Form 1031 to arise from a published federal decision came not from the courts, but from the Office of Hearings and Appeals of the SBA itself. Deciding In the Matter of First New York Small Business Investment Company (SBA No. 618, June 16, 1988), Administrative Law Judge Lewis F. Parker ordered the respondent’s small business investment company license revoked. Like McDougal, First NY concerned the submission of 1031 forms known to include false statements. In this case, writes Judge Parker,
“In each of … four transactions …, respondent filed a Form 1031 which stated, falsely, that it had loaned money to one company for use as working capital whereas, in fact, at least half of the loan proceeds, with respondent’s knowledge and consent, were used to repay an indebtedness owed by another company.”
In doing so, the company violated SBA regulations 13 C.F.R. §107.906(b), which prohibit knowingly false statements and misleading omissions in any form submitted to SBA. Separately, the company was also found to violate 13 C.F.R. §107.903(b)(4), which prohibits a Licensee from financing to discharge or free other funds for discharging an obligation to an Associate (defined in 13 C.F.R. §107.3). One of the respondent’s loans had been used to repay a debt owed to an entity in which a general partner of the respondent had an equity interest greater than 10 percent. Another loan had been used to repay an obligation to the father of a general partner of the respondent.
The scarcity of federal decisions regarding Form 1031—as well as the obvious manner in which laws or regulations have been violated in the two cases where the form has appeared—suggest that the form should not present legal problems if carefully and truthfully completed. Ultimately, basic integrity and familiarity with SBA regulations should be sufficient to avoid most pitfalls.