u.s. Small Business Administration
Office of Inspector General
To:
From:
Subject:
Memorandum
Eric R. Zamikow
Associate Administrator, Office of Capital Access
lsi Original Signed
Debra S. Ritt
Assistant Inspector General for Auditing
Date:
March 31 , 2010
Notice of Finding and Recommendation on Material Origination and Closing
Deficiencies Identified in SBA and Lender-Approved Recovery Act Loans
ROM-I0-12
The OIG conducted an audit of7(a) loans disbursed pursuant to the American
Recovery and Reinvestment Act of 2009 (Recovery Act) to determine if loans
made under the Act were originated and closed in compliance with SBA's policies
and procedures and to identify any evidence of suspicious activity. This is the
fourth and last in a series of finding notices related to our initial audit of 30 SBA
approved and 30 lender-approved loans. These reports provide the Agency with
early notification of findings and recommendations related to material deficiencies
in Recovery Act loans and with the loan approval process. The first Notice of
Finding and Recommendation (NFR) identified four SBA-approved loans
involving deficiencies in change of ownership transactions. The second NFR
identified 14 lender-approved loans disbursed without the required borrower
immigration certification. The third NFR identified three lender-approved loans
that were not eligible for SBA guaranties. This NFR identifies miscellaneous
material origination and closing deficiencies in three SBA-approved and one
lender-approved Recovery Act loans.
We made four recommendations to the Associate Administrator for Capital Access
to: (1) revise SOP 50 10 5(b) to require that SBA Form 912, Statement a/Personal
History, be completed by key employees of applicant businesses; (2) provide
counseling and training to the SBA loan officers who approved loan numbers
[FOIA ex. 2]
and [FOIA ex. 2] ; (3) implement the appropriate system controls to
automatically identify the outstanding balances of all SBA loans made to a
borrower to ensure SBA lending limits will not be exceeded upon the approval of
a subsequent loan; and (4) require the lender to bring loan number [FOIA ex. 2]
2
into compliance with SBA requirements, or, if not possible, flag the loan as having
an equity injection deficiency for consideration during the purchase review.
On February 3,2010, we provided a draft of this NFR to SBA management for
comment. On March 23,2010, SBA submitted its formal comments, which are
contained in their entirety in Appendix II. SBA agreed with recommendations
2 and 3, and disagreed with recommendations 1 and 4. A summary of
management's comments and the OIG's response is provided below.
Recommendation 1
SBA disagreed that SBA Form 912 should be completed by key employees. SBA
stated that the SOP in place at the time the referenced loan was made did not
require Form 912s to be completed by managers. SBA also stated that requiring
key employees to submit Form 912 is a significant policy change, and
management is not inclined to make such a change based on one loan identified in
anNFR.
We recognize that the SOP in place at the time the referenced loans was made did
not require that SBA Form 912 be completed by key employees of applicant
businesses. The 7(a) program, however, is governed by regulations outlined in
Part 120 of Title l3 of the Code of Federal Regulations (CFR). This CFR
provides the permanent program rules and supersedes SBA's SOP requirements,
which are simply the Agency's practical guidance to understanding and enforcing
the CFR. The program regulations that were in place when this loan was made,
and remain in place, stipulate that a business with an associate (i.e. key employee)
who is incarcerated, on probation, on parole, or has been indicted for a felony or a
crime of moral turpitude is ineligible for an SBA loan. Therefore, our
recommendation that key employees be required to submit Form 912 is an
important control that needs to be implemented to ensure compliance with
regulatory prohibitions against loans to individuals involved in a felony or crime.
We plan to pursue a management decision on the recommendation through the
audit resolution process.
Recommendation 2
SBA agreed to provide counseling to the appropriate loan officers on SBA' s
requirements governing business valuations, site visits and affiliation analysis.
SBA's proposed action to provide counseling to SBA loan officers about
requirements governing business valuations, site visits and affiliation analysis was
responsive to recommendation 2.
3
Recommendation 3
SBA agreed that one of the loans identified in our NFR exceeded SBA' s combined
program guaranty limit. SBA stated that this loan was processed early in the
Recovery Act implementation period when system changes were being made and
believes that the system has been corrected to identify these situations in the
future. Nevertheless, SBA stated that it will determine if additional changes are
needed and will flag the loans to ensure the guaranty amount paid does not exceed
SBA's lending limits should the loan default.
SBA's proposed actions to determine if additional system changes are needed and
to flag the loans to ensure guaranty limits are not exceeded were responsive to
recommendation 3. It was not clear; however, why the Recovery Act would have
impacted the system controls related to the maximum guaranty limit as this limit
was already in effect and did not change under the Recovery Act.
Recommendation 4
SBA disagreed that the equity injection for loan number [FOIA ex. 2] did not
comply with SBA's requirements. SBA stated that review of the lender's file
identified three separate cash injections totaling $49,591 and that the approximate
$3,000 shortfall was not considered material.
We continue to support our position that loan number [FOIA ex. 2] did not comply
with SBA's equity injection requirements. While SBA claimed that the lender's
file demonstrated a cash injection of$49,591, documentation in the lender's file
did not evidence an equity injection of this amount. It appears that SBA accepted
buyer credits annotated on the escrow settlement statement for two deposits
totaling $45,615, a county tax payment of$3,451 and a $525 refund. Bank
statements in the loan file showed, however, that $20,000 of the $49,591 was
provided from the operating company's existing cash. As discussed in our NFR,
this existing cash does not qualify as equity injection.
Further, although SOP 50 10 5(a) required the settlement statement to be
accompanied by bank account statements showing the injection of funds into the
business prior to disbursement, the required statements were not provided for the
remaining $29,591. Nevertheless, based on the descriptions provided on the
escrow settlement statement, it appears the remaining $29,591 was also derived
from the operating company's existing cash. As noted in our NFR, the lender
specifically documented that the business needed its existing cash, an additional
cash injection of $52,589, plus $40,000 of working capital from loan proceeds in
order to cover its operating needs. As a result, we continue to support our position
4
that the $52,589 injection of cash was never made and intend to pursue a
management decision on this issue through the audit resolution process.
We appreciate the courtesies and cooperation of the Office of Capital Access. If
you have any questions concerning this NFR, please call me at 202-205-[FOIAex2lor
Debra Mayer, Director, Recovery Oversight Group, at 202-205-[FOIAex2l
ACTIONS REQUIRED:
Please provide your management response for recommendations 1, 2 and 3 on the
attached SBA Forms 1824, Recommendation Action Sheet, within 30 days from
the date of this report. Please provide your management response for
recommendation 4 on the attached SBA Form 1824, Recommendation Action
Sheet, within 80 days from the date of this report. Your responses should identify
the specific actions taken or planned to fully address each recommendation and the
target dates for completion.
Attachment
5
U.S. Small Business Administration
Office of Inspector General
Notice of Finding and Recommendation
Audit Location/Division
Office of Capital Access
Date
March 31, 2010
Description of Issue
SBA and lender-approved Recovery Act loans were not
originated and closed in compliance with SBA
requirements
BACKGROUND:
The purpose of this Notice of Finding and Recommendation (NFR) is to inform you of
issues that were identified during our initial audit of7(a) loans disbursed under the
American Recovery and Reinvestment Act of2009 (Recovery Act). As part of this audit,
we reviewed 30 SBA-approved loans and 30 lender-approved loans for compliance with
SBA's loan origination and closing requirements.
CONDITION:
We identified three SBA-approved 7(a) Recovery Act loans that were not originated in
compliance with SBA requirements. One of these loans may not have been eligible for
an SBA guaranty because the key manager of the business had been convicted of a
felony, and there was evidence that he was on probation at the time of loan application.
Furthermore, SBA did not comply with its change of ownership requirements in
approving this loan because it did not ensure the lender (1) obtained an independent
business valuation for a change of ownership transaction in which a close relationship
existed between the buyer and seller, and (2) conducted a site visit of the assets being
purchased. Eligibility was also questionable for a second loan approved by SBA because
it did not determine the effect that multiple affiliates of the borrower had on the business'
size, repayment ability, and creditworthiness. Finally, a third loan approved by SBA was
partially ineligible for an SBA guaranty because it resulted in the business exceeding by
$86,176 the $1.5 million combined program guaranty limit.
We also identified a lender-approved loan that was disbursed without satisfying SBA's
closing requirements. Specifically, the lender did not ensure $52,589 of cash was
injected into the business as equity capital prior to loan disbursement as required by the
6
loan authorization. Documentation in the lender's loan file demonstrated the business
needed its current cash balance, an additional cash injection of $52,589, and $40,000 of
working capital from loan proceeds in order to cover its operating needs. In its credit
memorandum, the lender specifically documented that the borrower's required equity
injection would be derived from the principals' personal cash assets, thereby preserving
the operating company's cash resources needed for the business. However, the $52,589
injection of cash was never made. Instead, the lender provided the operating company's
bank statements for the 4 months prior to loan disbursement showing the business'
existing cash as evidence of equity injection. The business' existing cash does not
qualify as equity injection and no deposits were made into the business account from the
principal's personal resources before loan disbursement. See Appendix I for a listing of
the loans discussed in this NFR.
CRITERIA:
13 CFR 120.110 (n) states that a business with an associate who is incarcerated, on
probation, on parole, or has been indicted for a felony or a crime of moral turpitude is
ineligible for an SBA loan.
13 CFR 120.10 (2)(i) defines an associate of the small business as an officer, director,
owner of more than 20 percent of the equity, or key employee of the small business.
13 CFR 121.103 states a "key employee" is an employee who, because of his/her position
in the concern, has a critical influence in or substantive control over the operations or
management of the concern.
SOP 50 10 5(a) lists the requirements for a change of ownership transaction. It specifies
that if there is a close relationship between the buyer and seller, the lender must obtain an
independent business valuation from a qualified source. Additionally, the SOP states that the
lender must conduct a site visit of the assets being acquired and document in its loan file the
date of the site visit as well as comments.
13 CFR §120.150 states that the applicant must be creditworthy. Loans must be so sound
as to reasonably assure repayment, and SBA will consider the effect any affiliates may
have on the ultimate repayment ability of the applicant.
SOP 50 10 5(a) states that the applicant business combined with its affiliates must not
exceed the size standard designated for either the primary industry of the applicant alone
or the primary industry of the applicant and its affiliates, whichever is higher.
SOP 50 10 5(a) states that the maximum SBA guaranty amount outstanding of all loans
to anyone business (including affiliates) cannot exceed $1 .5 million.
SOP 50 10 5(a) states that lenders must verify injections prior to disbursing loan proceeds
and maintain evidence of such verification in their loan files . Additionally, it states that
lenders are expected to use reasonable and prudent efforts to verify that equity is injected
and used as intended, and failure to do so may warrant a repair or partial/full denial.
7
SOP 50 10 5(a) states that verifying a cash injection requires documentation, such as a
copy of a check along with evidence that the check was processed (e.g., at least one bank
account statement dated before, but close to, disbursement showing that the funds were
available and deposited into the borrower's account), or a copy of an escrow settlement
accompanied by a bank account statement showing the injection into the business prior to
disbursement. A financial statement, alone, is generally not sufficient evidence of cash
injection.
CAUSES:
In all 4 loans, SBA and lenders did not comply with SBA requirements for loan
origination and closing, indicating a lack of due diligence and a lack of appropriate
control procedures to really ensure compliance.
Concerning the first loan, SBA does not have procedures in place to enforce 13 CFR
120.110(n) by preventing an SBA loan from being made to a business with a key
employee who is incarcerated, on probation, on parole, or has been indicted for a felony
or a crime of moral turpitude. In order to enforce this regulation, SBA previously
required key employees to complete SBA Form 912, Statement ofPersonal History,
which requires disclosure of all indictments, arrests, and convictions. SBA, however,
revised this procedure and no longer requires completion of this form by key employees.
As a result, businesses with key employees that have committed crimes of moral
turpitude may currently obtain SBA loans.
Concerning the third loan, the appropriate system controls do not appear to be in place to
automatically identify the outstanding balances of all SBA loans made to a borrower to
ensure SBA lending limits will not be exceeded upon the approval of a subsequent loan.
EFFECT:
Four Recovery Act loans valued at $2.4 million were not originated or closed in
accordance with SBA requirements. The inappropriate SBA-approved loans will (1)
increase the risk of loss to SBA should these loans default, and (2) reduce the availability
of SBA loans to other lenders and eligible borrowers. If the lender-approved loan is not
brought into compliance with SBA requirements, the lender risks losing its SBA guaranty
in the event of loan default.
RECOMMENDATIONS:
We recommend that the Associate Administrator for Capital Access:
1. Revise SOP 5010 5(b) to require that SBA Form 912, Statement ofPersonal
History, be completed by key employees of applicant businesses.
8
2. Provide counseling to the SBA loan officers who approved loan numbers
[FOIA ex. 2] and [FOIA ex. 2] about their mistakes and train them adequately to:
(1) ensure lenders perform the appropriate business valuations and site visits for
change of ownership transactions, and (2) evaluate the effect of affiliation of a
borrower's size, repayment ability, and creditworthiness.
3. Implement the appropriate system controls to automatically identify the
outstanding balances of all SBA loans made to a borrower to ensure SBA lending
limits will not be exceeded upon the approval of a subsequent loan.
4. Require Wachovia SBA Lending, Inc. to bring loan number [FOIA ex. 2] into
compliance with SBA requirements, or, if not possible, flag the loan as having an
equity injection deficiency for consideration during the purchase review should
the loan default and purchase be requested.
9
APPENDIX I. LOANS WITH ORIGINATION AND CLOSING DEFICIENCIES
Loan
Number
Borrower
[FOIA ex. 2]
[FOIA ex. 4]
[FOIA ex. 2]
[FOIA ex. 4]
[FOIA ex. 2]
[FOIA ex. 4]
[FOIA ex. 2]
[FOIA ex. 4]
SBA or Lender
Approved
SBA
SBA
SBA
Lender
Lender
Loan
Amount
Deficiency
Coppermark
Bank
$200,000
A,B
Affinity FCU
$150,000
C
$1,600,000
D
$445,000
E
Mountain West
Bank
Wachovia SBA
Lending, Inc.
$2,395,000
Total
Deficiency Type Legend:
A.
B.
C.
D.
E.
Associate convicted of a felony and on probation
Noncompliance with change of ownership requirements
No evaluation of affiliates
Exceeded lending limits
Unsupported equity injection
APPENDIX II. AGENCY COMMENTS
10
U.S. SMALL BUSINESS ADMINISTRATION
WASHINGTON,
TO:
FROM:
SUBJECT:
D.C. 20416
March 24,2010
Debra S. Ritt
Assistant Inspector General for Auditing
Eric R. Zamikow
Associate Administrator
Office of Capital Access
Management Response to Draft Notice of Finding and
Recommendation on Material Origination and Closing Deficiencies
Identified in SBA and Lender-Approved Recovery Act Loans,
Project No. 9512E
Thank you for the opportunity to respond to the Draft Notice of Finding and
Recommendation (NFR) on Material Origination and Closing Deficiencies
Identified in SBA and Lender-Approved Recovery Act Loans, Project No. 9512E,
dated February 3, 2010.
Please find our response to the proposed
recommendations below.
1. Revise SOP 50 10(b) to require that SBA Form 912, Statement of Personal
History, be completed by key employees ofan applicant business.
SBA disagrees with this finding. The SOP in place at the time the loan was
made did not require an SBA Form 912, for managers. The guidance at the
time required that SBA Form 912 be completed by (a) the proprietor, if a sole
proprietorship; (b) by each partner, if a partnership; and (c) by each officer,
director, and additionally by each holder of 20% or more of the ownership
stock, if a corporation, limited liability corporation, or a development
company. Requiring key persons to submit SBA Form 912s is a significant
policy decision. SBA is not inclined to make such a policy change based on
one loan identified through an NFR.
2. Provide counseling to the SBA loan officers who approved loan numbers
[FOIA ex. 2]
and [FOIA ex. 2] about their mistakes and train them adequately
to: (1) ensure lenders perform the appropriate business valuations and site
11
visits for change of ownership transactions, and (2) evaluate the effect of an
affiliation ofa borrower's size, repayment ability, and creditworthiness.
SBA will provide counseling to the SBA loan officers that made the referenced
loans about requirement governing business valuations, site visits and
affiliation analysis.
3. Implement the appropriate system controls to automatically identifY the
outstanding balances of all SBA loans made to a borrower to ensure SBA
lending limits will not be exceeded upon the approval ofa subsequent loan.
This loan was processed early in the Recovery Act implementation period
when system changes were being made to implement the Recovery Act. SBA
believes that the system has been corrected to identify these situations in the
future and will further evaluate to determine if additional changes are needed.
The loans will be flagged to ensure the guaranty amount paid does not exceed
SBA's lending limits should the loan default.
4. Require Wachovia SBA Lending, Inc. to bring loan number [FOIA ex. 2] into
compliance with SBA requirements, or, if not possible, flag the loan as having
an equity injection deficiency for consideration during the purchase review
should the loan default and purchase be requested.
SBA disagrees with this finding. Review of the lender's file identified three
separate cash injections totaling $49,59l. The approximately $3,000 shortfall
is not considered material in relationship to the $447,500 loan. The loan
complies with SBA requirements.
We appreciate the opportunity to comment on the Draft Notice of Finding and
Recommendation prepared by your office. Please let us know if you have any
questions or need additional information.
