Hannibal “Mike” Ware currently serves as the Acting Inspector General for the U.S. Small Business Administration (SBA). In this role, he is responsible for independent oversight of SBA’s programs...
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Eric M. Thorson, Inspector General U.S. Small Business Administration Before the Committee On Homeland Security, Subcommitee On Management, Integration and Oversight, United States House of Representatives July 13, 2006
Chairman Rogers, Ranking Member Meek, distinguished Members of the
Subcommittee, thank you for inviting me here today to discuss the efforts by the Small Business
Administration (SBA) Office of Inspector General (OIG) in connection with the SBA’s response
to the September 11th terrorist attacks. September 11, 2001, was a day in American history that
we can never forget. Beyond the tragic loss of life, the terrorist attacks disrupted the economy of
the United States. The SBA responded to the economic downturn by providing guaranties on
loans made by private lenders through the Section 7(a) Loan Guaranty program, and by making
loans directly to affected small businesses under the Disaster Loan program. My testimony
today addresses the OIG’s efforts to review the efficiency and management of these 9/11
assistance programs and to prosecute wrongdoers who took advantage of this national tragedy by
obtaining loans through fraudulent means.
Overview of the OIG’s Audit of the STAR Loan Program.
In January 2002, Congress
authorized SBA to provide financial assistance to small businesses that were affected by the 9/11
attacks and their aftermath through what is known as the Supplemental Terrorist Activity Relief
or “STAR” loan program. Newspaper articles in the Fall of 2005 raised questions as to whether
borrowers obtained STAR loans even though they had not been affected by the terrorist attacks.
As a result, Senator Snowe, who chairs the Senate Small Business and Entrepreneurship
Committee, and the SBA Administrator asked the OIG to review this program. The audit
objectives were to determine if STAR loan recipients were appropriately qualified to receive
STAR loans and if SBA established and implemented proper administrative procedures to verify
STAR loan recipient eligibility. However, before getting into the results of our review, let me
provide a short background on the STAR loan program, which was administered under the
Section 7(a) Loan Guaranty program.
Overview of 7(a) Program.
Under the Section 7(a) of the Small Business Act, SBA may guaranty up to 85 percent of a loan made by an authorized lender to a small business. This
program is known as the “7(a) program.” In 1983, SBA implemented the Preferred Lenders
Program (PLP) which allows designated lenders to process, service, and liquidate SBAguarantied
loans with reduced SBA oversight and, as SBA’s budget for salaries and expenses has
shrunk over the past decade, the Agency has increasingly delegated this authority to lenders.
Loans made under the 7(a) program that go into default are individually reviewed by
SBA to determine whether the lender complied with the Agency’s lending requirements.
Generally, this review is the primary means that SBA uses to determine lender compliance with
Agency regulations and requirements. If it is determined that the lender did not comply
materially with SBA’s regulations, SBA can negotiate a settlement of the guaranty amount or
deny payment of the guaranty entirely.
The STAR Loan Program.
Under the STAR loan program, SBA was authorized by
Congress to charge lenders reduced fees for guaranties on loans made to small businesses which
were deemed “adversely affected” by the September 11th terrorist attacks and their aftermath.
Although the term “adversely affected” was not defined, Congressional staff and SBA program
managers appear to agree that Congress intended the program to benefit not only those
businesses that were directly impacted by the attacks, i.e., firms located near the World Trade
Center or the Pentagon, but also businesses across the country that were harmed by the economic
consequences of the attacks. Congress appropriated $75 million for the STAR loan program,
which provided authority for SBA to guaranty up to $4.5 billion in loans. Funds were available
from January 11, 2002, through January 10, 2003.
SBA Guidance on the STAR Loan Program.
SBA issued guidance on the STAR loan
program that defined an “adversely affected small business” as any business that “suffered
economic harm or disruption of its business operations as a direct or indirect result of the
terrorist attacks . . . .” Qualifying businesses were not limited to a “particular geographic area
or to any specific type of business.” SBA procedures required lenders to determine that the loan
applicant was adversely affected by the terrorist attacks and to prepare and maintain in its loan
file “a write-up summarizing the analysis and its conclusion that the loan is eligible for the
STAR program.” The guidance made clear that a lender would be deemed not to have met its
responsibility for determining that a borrower was adversely affected if the lender did not
provide a narrative justification demonstrating the basis for its conclusion. Borrowers were
permitted to use STAR loan funds for any purpose authorized for 7(a) loans. Lenders also had
authority to reclassify loans made under the regular 7(a) program as STAR loans if the borrower
Our review found that lenders were initially reluctant to use the STAR loan program due
to concerns that SBA would second guess their justifications and deny payment of the loan
guaranty. Congressional staff expressed concern about the lenders’ lack of interest in the
program and urged SBA to promote the use of the program. SBA reacted by vigorously
promoting the program through articles in trade journals, speeches at lender conferences, and by
directing its district offices throughout the country to contact local lenders to persuade them to
approve STAR loans. SBA advised lenders that a very large percentage of small businesses
could qualify for STAR loans and assured lenders that SBA would not second guess their
OIG Audit of the STAR Loan Program.
The OIG conducted an audit of a statistical
sample of 59 STAR loans from the universe of 7,058 STAR loans approved between January 11,
2002 and January 10, 2003, to determine whether loan recipients were eligible to receive the
loans. There were 27 lenders included in the sample. Using accepted statistical methodology,
the audit results could be projected with 95 percent certainty. For 50 of the 59 borrowers
(85 percent) in the sample, we were unable to determine from the lenders’ loan files and
discussion with available borrowers whether the borrowers were adversely affected by the 9/11
attacks and their aftermath, as required for STAR loan eligibility. For these 50 loans, the
required justification was either (1) missing – 5 loans; (2) merely a conclusion with no support –
4 loans; (3) based on the adverse affects suffered by the business being purchased with a STAR
loan rather than the “loan applicant” and SBA procedures did not specify whether such loans
could qualify – 11 loans; (4) contrary to documentation in the lender’s loan file or borrower
statements – 21 loans; or (5) vague and neither contrary to nor supported by documentation in
the lender’s loan file or borrower statements – 9 loans. Although these results do not necessarily
show that the 50 borrowers were ineligible for the program, they indicate that lenders failed to
prepare adequate justifications and obtain supporting documentation to determine eligibility.
Further, of 42 borrowers that we were able to contact, only two stated they were aware
that they had received a STAR loan. Thirty-six borrowers said they were not asked, or could not
recall if they were asked, about the impact of the attacks on their businesses. We concluded that,
in many cases, funds appropriated for guaranties on loans to small businesses adversely affected
by the terrorist attacks may not have been used for that purpose.
Inadequacy of SBA Program Controls.
In trying to establish the reasons behind these
findings, we determined that SBA did not implement adequate internal controls and oversight to
ensure that only eligible borrowers obtained STAR loans. Although SBA established guidance
for the program requiring lenders to prepare and file written justifications showing borrower
eligibility, senior SBA officials, in order to encourage the use of the STAR loan program,
broadened the scope of program eligibility. Public statements made by senior SBA officials
conveyed SBA’s expansive interpretation of the term “adversely affected” and that SBA believed
that virtually every small business had suffered some direct or indirect adverse impact and could
likely qualify for a STAR loan. Further, SBA officials reassured lenders that the Agency would
not second guess their eligibility justifications. SBA also did not require lenders to provide their
justifications to the Agency, either at the time a loan was made or at the time that a lender
requested SBA to honor the guaranty on a defaulted loan.
I should note that, although the SBA guaranties may not have been used for appropriated
purposes, we did not find that any businesses legitimately affected by the 9/11 attacks were
precluded from obtaining a STAR loan. Indeed, when the STAR loan program appropriation
expired in January 2003, funds for the program were still available and were transferred to the
regular 7(a) loan program. Therefore, it does not appear that eligible businesses were prevented
from receiving STAR loans due to a lack of funds. Furthermore, the default rate for STAR loans
does not appear excessive in comparison to similar SBA-guarantied loans. As of September 30,
2005, only 8 percent of disbursed STAR loans approved between January 11, 2002, and January
10, 2003, had been transferred to liquidation status, while 10 percent of the 7(a) loans approved
during the same time period had been transferred to liquidation status.
What were the lessons learned from this review? For future special
programs where 7(a) loans are used for nationwide disaster relief, the OIG recommended that
SBA: (1) require loan applicants to justify how the business was harmed by the disaster;
(2) require lenders to obtain supporting documentation to verify applicant claims of injury and
provide detailed justifications showing applicant eligibility; and (3) implement effective internal
controls and program oversight to ensure borrower eligibility and lender compliance.
Specifically related to the STAR loan program, the OIG recommended that the Agency:
(1) implement procedures to require lenders to submit STAR loan justifications when seeking
SBA’s purchase of a STAR loan guaranty; (2) establish criteria to provide more definitive
guidance and examples for purchase reviewers to use in determining what constitutes an
inadequate justification for STAR eligibility; (3) for future purchase requests, determine whether
STAR loans that contain inadequate justifications can be reclassified as 7(a) loans or whether
SBA can deny lender requests for purchase of the guaranties under SBA regulations; and
(4) review guaranties the Agency has already paid under the STAR loan program to determine
whether lenders were paid despite the absence of adequate borrower eligibility justifications. If
there is inadequate justification, we recommended that the Agency determine whether SBA
should reclassify the loan as a 7(a) loan or seek recovery of the guaranties from the lenders.
Disaster Loans for Businesses Hurt by 9/11.
The Small Business Act also permits SBA
to make direct loans to victims of declared disasters. Disaster loans, which are available to
businesses and to homeowners, can be used to fund repairs of physical damage to homes and
businesses, and to provide working capital to disaster-impacted businesses to allow them to pay
their bills or otherwise fund operational needs. These latter loans are known as Economic Injury
Disaster Loans (EIDL). These loans are made at a low interest rate, generally less than
4 percent, with generous repayment terms, which can last up to 30 years. In order to make
Federal assistance available to more businesses that were impacted by the September 11th
terrorist attacks, and not just those located in the declared disaster areas, SBA expanded the
EIDL program to assist small businesses located outside the declared disaster areas. SBA
disbursed over $1.1 billion in 9/11 disaster loans.
9/11 Disaster Loan Fraud.
In 2003, the OIG began a proactive review of defaulted 9/11
EIDLs to assess whether there was fraud involved in obtaining or using loan proceeds.
Inevitably, some of these disaster loans involved fraud due to loan transactions being expedited
in order to provide quick relief to disaster victims. The OIG’s Auditing Division screened a
sample of defaulted 9/11 loans to identify indicators of fraud. Where indicators existed, these
loans were then examined further by investigators. Based on these referrals, as well as those
from other sources such as OIG Hotline, Office of Disaster Assistance, other law enforcement,
etc., the OIG’s Investigations Division opened 51 cases on loans valued at approximately
$20 million. Thus far, 37 cases have been closed, and 14 cases are in an open status at various
stages of investigation. There have been 10 indictments, 10 convictions, and over $1 million in
restitution and settlements.
The types of fraud schemes we identified in these cases included individuals and
businesses claiming losses even though their companies were not located in the disaster area,
false claims related to personal property or equipment damage, misuse of the disaster loan
proceeds, and false statements concerning financial status. For example, in one case, the
president and the managing partner of a business received an SBA disaster loan by falsely
claiming that their company had been located at the World Trade Center. In fact, the business
was not located there on September 11, 2001, and the individuals were salaried employees of
another company at the time. They were sentenced to incarceration and ordered to pay a
combined total of $618,000 in restitution.
OIG Finding Regarding SBA Collection of 9/11 Disaster Loans.
While the auditors were screening defaulted loan files, it became apparent that SBA was not always pursuing collection
timely. Therefore, the OIG conducted a review to determine if delinquent 9/11 disaster loans
were serviced appropriately. As of September 30, 2004, 1,495 of these loans, valued at
$208.8 million, were delinquent. The Office of Management and Budget (OMB) requires that
agencies promptly act on the collection of delinquent debts, using all available collection tools to
maximize collections. Since 1993, SBA has employed the issuance of demand letters as an
important part of the loan liquidation process.
The OIG reviewed a sample of delinquent loans and found that SBA sent pre-demand or
demand letters to only 4 of the 17 borrowers who should have received them. We found that
insufficient staffing of SBA’s liquidation center prevented personnel from following proper
collection methods. Instead of properly issuing pre-demand and demand letters to collect
delinquent loan funds, personnel were used to service bankruptcies, collateral activities, and/or
borrower initiated offers of compromise.
OIG Recommendations on Proper Debt Collection.
The OIG recommended that the
Agency revise its procedures to direct servicing centers to send timely pre-demand and demand
letters to delinquent borrowers and to maintain copies of these letters in loan files. Additionally,
we recommended that the Agency ensure that sufficient staff resources are devoted to liquidation
center activities to fulfill the debt collection responsibilities required by OMB. Attention to the
collection of funds when a loan is delinquent must be part of SBA’s most basic responsibilities.
Conclusion. Thank you for the opportunity to comment. I look forward to answering
any questions that you may have.