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Regulatory intelligence

U.S. banks face oversight risks from government COVID-19 stimulus plans

Henry Engler  Thomson Reuters Regulatory Intelligence

Henry Engler  Thomson Reuters Regulatory Intelligence

The vast sums of money being pumped into the U.S. economy due to COVID-19 will soon be subject to Congressional oversight committees looking for evidence of fraud and whether the funds found their way to businesses most in need.

In that review, banks will be on the front lines given the critical role they play in distributing the money, and they need to prepare, say legal experts and former government officials.

The government programs are varied, complex and politically charged. The Paycheck Protection Program (PPP), for example, is targeted at small businesses and has already come under fire for channeling money to larger businesses. An analysis by the Financial Times found that over 80 public companies have tapped into the $350 billion fund designed to keep small businesses afloat through the economic shutdown.

The bulk of the government’s assistance so far falls under the CARES Act, which authorizes funding for a variety of programs to help businesses hurt by the coronavirus pandemic. At a high level, the act includes $46 billion for air carriers and businesses critical to national security; $350 billion for small business loans through the PPP, and $454 billion for the U.S. Treasury to provide support to Federal Reserve programs for businesses, states and municipalities that unlock trillions of dollars in liquidity.

According to Treasury secretary Steven Mnuchin, as much as $4 trillion can be unlocked to support the economy. Congress is moving to pass additional relief, with similar unprecedented price tags.

Critics of how the programs are designed have already made themselves known. Senator Elizabeth Warren (D-Mass.), no stranger to the oversight process, said: “The Federal Reserve is handing out billions of dollars with little oversight and failing to require basic protections that companies retain workers and maintain payroll, failing to include protections against outsourcing, and failing to retain basic protections for union workers.”

While the oversight process will look at all industries receiving assistance, the banking sector will undoubtedly come under scrutiny. Under enormous pressure to get funds out the door, mistakes will inevitably be made, and given mistrust towards banks lingers from the 2008 financial crisis, they will be subject to criticism.

“The banks have been a punching bag for at least a decade, and it has been a long road for the them to regain trust,” said Cliff Stanford, a regulatory expert at the law firm Alston & Bird. “The heat is still on and now they are back in the thick of things in administering these programs.”

Michael Gordon, a partner at the law firm Bradley, and who previously held senior government positions, added: “Emergency relief programs create a perfect storm of oversight risk, with the need to quickly move large amounts of federal money with vague and evolving guidance.”

Several oversight programs — GAO appears out in front

Under the CARES Act, three oversight bodies were established:

  • the Office of the Special Inspector General for Pandemic Recovery within the Treasury Department;
  • the Pandemic Response Accountability Committee, which consists of attorney generals for the Departments of Defense, Education, Health and Human Services, Homeland Security, Justice, Labor and the Treasury, among others; and
  • the Congressional Oversight Commission.

However, these oversight committees have yet to begin work, with the appointed leaders of the committees embroiled in controversy between the White House and Congress. But then there is the General Accounting Office, which sits within the legislative branch and may be difficult for President Donald Trump to meddle with. By the end of April, at least 30 CARES Act reviews and audits are reportedly expected to be underway at the GAO.

Banks may be in a “no win” situation

For the banking sector, despite their best efforts at ensuring the funds are properly distributed and in line with regulatory controls, experts say history suggests the oversight process nearly always uncovers problems.

“Large financial institutions… will be pressured to deliver enormous sums of money quickly to struggling businesses and individuals pursuant to regulations and other guidance that may be ambiguous, incomplete, unevenly administered, or subject to frequent amendment,” said law firm Davis Polk. “As past precedent shows, moreover, what seems clear now may turn out to be less clear later, especially as the political focus shifts from response to oversight and assessment.”

The irony this time around is that banks have scrambled to do what the government wants — lend quickly to lessen the economic blow to businesses — unlike the financial crisis, which was of their own making.

What should banks be doing now?

It’s impossible to identify all potential risks within the government’s programs, and legal experts warn firms to take a cautious and risk-based approach to their participation. Davis Polk, for example, suggests:

  • Developing clear internal processes for identifying, assessing, and categorizing programmatic risks, with internal or external counsel given clearly defined roles in assessing and resolving risks that exceed a certain threshold.
  • Ensuring that all program documentation is aligned with any internal risk assessment processes, and has been subject to business, legal and compliance review; and
  • Obtaining the advice of external counsel for especially significant programmatic considerations, to ensure that all potential compliance vulnerabilities are scrutinized and to provide a basis for raising an advice-of-counsel defense if needed.

“Notwithstanding the immense pressure on CARES Act program participants to distribute or obtain funds as quickly as possible, participants should be careful to ensure that short-term needs are not unintentionally creating longer-term, more significant risks,” the law firm added.

Another area that firms should focus on is their internal whistleblower programs. Employees are bound to discover problems that will be brought to management’s attention. “This is a time when whistleblower programs will be tested,” said Stanford of Alston & Bird. “If there is a time when you are following those procedures it’s now.”

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