Best Practices: Due Diligence Can be the Best Deterrent for Fraud

Fraud has been popping up more and more frequently in SBA lending – from fraud in the underwriting of a loan, to fraud during the loan closing, to fraud occurring after the loan has closed.  Fraud can be committed on loans of all sizes and can involve anyone who has an interest in the transaction, including borrowers, sellers, referral agents or anyone else that stands to benefit from the transaction closing.  The larger the deal, the more incentive there is for parties to engage in wrongdoing.

With respect to fraud that occurs in the underwriting stage, this can involve fraudulent activities of the borrower, in misrepresenting its financial picture, or, in a change of ownership transaction, it could involve similar misrepresentations by the seller of the business.  Sometimes this type of fraud may only be discovered after a loan has closed and the buyer discovers that the assets are not as represented, or that the business is grossly under-performing the seller’s representations.  Lenders should ensure that they are always adhering to SBA requirements for business valuations and tax return verifications, as these items can protect a lender from attempted fraud in the underwriting process.

During the closing phase of a loan, lenders and other closing agents are increasingly being subjected to fraud schemes involving wire instructions whereby the fraudster employs social engineering to trick the disbursement agent into wiring funds to the wrong account.  There are numerous tactics these parties are employing, including using similar looking email addresses or “spoofing” a legitimate email address, to change wire instructions just prior to closing.  Every lender and disbursement agent should review their policies on wire transfers and verifying wire instructions to ensure that they are not victimized by this increasingly common scam.

Other times you may have a borrower that engages in fraudulent actions after a loan closes, such as misappropriating, or misdirecting the lender’s collateral.  SBA lenders that scrupulously follow the SBA’s servicing and liquidation guidelines, and that diligently service their loan portfolios by reviewing financial statements and conducting timely site visits, should be able to minimize this risk.

When fraud is committed on an SBA loan, the SBA is the victim.  However, the bank may be a victim of the fraud as well.  As long as the lender engages in a commercially reasonable level of diligence, and complies with all SBA requirements and guidelines, the SBA will generally honor the guarantee.  However, the SBA will not underwrite a lender’s sub-standard compliance practices, and will evaluate the loan file very carefully to evaluate the lender’s adherence to SBA loan requirements.  Lenders should also remember that any suspected fraud relating to an SBA loan must be reported to the Office of the Inspector General (OIG) as soon as the lender becomes aware of the suspected fraud.  Keeping the SBA in the loop on suspected fraud is not just important, it is required.

By performing proper due diligence, there are simple ways to protect your organization from fraud at any stage of the loan process.  For more information on best practices to avoid fraud in SBA lending, contact Lyndsay at lrowland@starfieldsmith.com or 267.470.1154.