and the loan assistant could get into trouble,
the Realtor offered the loan assistant $3,500
for the real estate listing. At a later face-to-
face meeting, the woman gave the loan
assistant $1,000 as good faith money, and
she and the SBA employee signed the real
estate listing agreement. The following day,
she was given a letter from the LADO’s
Legal Division stating that the loan assistant
did not have the delegated authority to
execute the listing agreement. When given
the letter, the woman denied ever personally
meeting with the SBA loan assistant, making
him any promises, or giving him any money.
Other evidence contradicted those denials.

Texas Cellular Phone Distributor
Sentenced for Making False Statements

The owner and president of a Plano, Texas,
cellular phone distributor was sentenced to
15 months incarceration and $254,970
restitution to SBA. He previously pled guilty
to one count of making false statements to
SBA. In return, the Government agreed to
dismissal of the other two counts on which he
was previously indicted. The man obtained
a $230,000 SBA-guaranteed loan by
submitting an SBA Form 912, Statement of
Personal History, that bore a bogus Social
Security number (SSN) and failed to disclose
his criminal history. The bogus SSN was
used on his SBA Form 413, Personal
Financial Statement, as well. He also
admitted that he failed to disclose a number
of debts in the loan application and provided
SBA with altered tax returns and falsified
invoices in support of the loan
disbursements. The OIG opened this
investigation based on a referral from SBA’s
Dallas District Office and continued it jointly
with the IRS.

Semiannual Report March 1998

Texas Automotive School Owners
Indicted for Bank Fraud and Conspiracy

The owners of an automotive repair school in
Houston, Texas, were indicted on eight
counts of bank fraud, making a false
statement to an FDIC-insured bank, and
conspiracy. Their company obtained a
$240,000 SBA-guaranteed loan in 1991. The
OIG’s investigation found that the couple
submitted loan disbursement requests to the
participating lender bank that falsely cited
$69,877 of construction work that was never
completed. The indictment also charged the
husband with fraudulently endorsing loan
disbursement checks totaling $56,540. This
investigation was initiated based on
information developed during the OIG’s
Operation Clean Sweep research at SBA’s
Houston District Office.

Two Kansas Building Material
Manufacturers Indicted for Making False
Statements

Two former owners and officers of a
building-materials manufacturing company
were indicted on three counts of making
false statements to SBA and making false
statements to a Federally-insured lender
regarding its application for a $630,000
SBA-guaranteed loan. The loan was intended
to finance the opening of a plant in
Neodesha, Kansas, to manufacture foam-core
construction panels, but the business failed
and defaulted on repayment of the loan. The
OIG’s joint investigation with the U.S. Secret
Service determined that, to obtain the loan,
the two men misrepresented that the first was
the president and 100% owner of the
company. It was the second man, however,
who actually was the corporation’s president

17



Surety Bond Guarantees

38

Summary of OIG Activity / Surety Bond Guarantees

Audits Underway

5

Investigations Closed / Remaining Inventory

ort

{nvestigations: Declinations Due to Name Check

3

Reviews of Proposed Regulations

1

Semiannual Report March 1998



Small Business Investment Companies

34 Semiannual Report March 1998



‘Summary of OIG Activity / Minority Enterprise Development

Audits Issued

Audits Underway

Indictments Resulting from Investigations

Investigations Closed / Remaining Inventory

Investigations: Deciinations Due to Name Check 2

Reviews of Proposed Regulations

Efforts to Improve SBA
Program Management

Maryland Computer Firm Withdraws
from Section 8(a) Program After
Eligibility Questioned in Audit

A Maryland computer manufacturing firm
withdrew voluntarily from the Section 8(a)
program after an OIG audit concluded the
owners exceeded the net worth limitati
for both initial and continuing eligibility.
According to the audit report the owners
were inappropriately admitted into the
program in 1994 when investment property
owned by one of the company’s principals
was incorrectly represented as part of his
personal residence. At the time of the
application, three parcels of land adjacent to
the owner's home were under a contract for
sale to subdivision developers. Had that land
not been excluded from his net worth under
the exemption for a personal residence, the
owner would have exceeded the net worth
limit for entry into the Section 8(a) program.

In 1996, the owners kept their net worth
below the $750,000 limit to ensure
continuing eligibility by transferring assets

Semiannual Report March 1998

worth a combined $2.3 million to their
wives. The OIG concluded that, under SBA
regulations, assets transferred within 2 years
of submission of the owner's annual personal
financial statement still count as part of the
owner's net worth. Consequently, this firm
would have been ineligible for continuing
participation. Including the transferred
assets, the two owners’ net worth was $1.1
million and $1.2 million, respectively.

The OIG recommended that SBA initiate
action to terminate the firm from the Section
8(a) program. The Acting Associate Deputy
Administrator for Minority Enterprise
Development agreed with the audit's finding
on initial eligibility, but stated the continuing
eligibility rules in effect in 1996 would not
have included the transfer of assets in the
continuing eligibility calculation. The
owners of the firm disagreed with the audit
findings, but satisfied the purpose of the
recommendation by voluntarily withdrawing
from the program. SBA regulations
governing transfer of assets are currently
under review for possible clarification and
revision.



also recommended by SBA’s Committee on
Loan Packager Reforms, is the registration
of loan agents. Without an up-to-date
Tegistry, no effective accountability or
controls are possible. The OIG recommends,
therefore, that SBA establish a loan agent
registration process that includes maintaining
two lists on the Internet: currently registered
loan agents, and agents whose privilege to
conduct business with SBA has been
suspended or revoked. The Internet listing
will allow access to these lists by lenders and
borrowers who are contemplating using loan
agents. SBA should also make clear that loan
agent registration is not an Agency
endorsement of the listed agents and that
SBA is under no obligation to provide
guarantees for loans in which suspended or
revoked agents were involved.

In addition, criminal history checks should
be performed on loan agents as part of the
registration process. These checks would not
only identify candidates who are unsuited for
agent work due to their backgrounds but also
deter individuals who do not want their
records revealed from becoming agents in the
first place. To conduct such checks, the OIG
recommends that SBA propose amending
current legislation to include loan agents
among those subject to National Crime
Information Center background inquiries.

To provide early warning of potential
problems, the OIG also recommends that the
Agency establish a loan agent monitoring
system that holds the lender responsible for
the accuracy of data (including electronic
data) originated by loan agents and
transmitted by the lender to SBA. The
system should also establish purchase rate
benchmarks that would trigger closer

Semiannual Report March 1998

examination of a loan agent's performance,
ensure that all loan data can be linked to the
agents involved, and centralize the evaluation
of agent performance to provide consistency.
The inspection report also discusses the
possible use of lenders’ bond insurance
policies to help protect SBA from losses due
to loan agent fraud. The Agency has not
yet responded to OIG recommendations,
however, its response is expected soon.

Audit of SBA Loan Liquidations Finds
Inadequate Recoveries and Procedural
Problems

An audit of FY 1994 loan liquidations found
that SBA should have recovered $28 million
more in loan liquidations than it did.
Auditors found that liquidation procedures
were applied inconsistently, and SBA did
not effectively monitor lenders nor identify
opportunities to recover losses when lenders
did not follow approved procedures.

SBA “charged off” $345 million in FY 1994
from 3,112 loans liquidated. After
examining a statistical sample of 71
liquidations with $12.5 million charged off,
the auditors concluded there were errors in
12 of the 71 liquidations that resulted in
$652,608 under-recovered. Based on the
sample, the auditors estimated that $28
million was under-recovered in the full year.

The audit was inconclusive on whether it was
more effective for loans to be liquidated by
lenders or by SBA. While lenders had a
higher recovery rate, the audit found that
their recovery rates could have been even
higher. The audit recommended that SBA
ensure that SBA loan officers be made aware
of their responsibility for monitoring lender

1



APPENDIX Il - Part B

Audit Reports with Recommendations that Funds Be Put to Better Use
October 1, 1997, to March 31, 1998

RECOMMENDED
REPORTS | RECs’ FUNDS FOR
BETTER USE
‘A. | For which no management
decision had been made by
September 30, 1997 8 "1 $9,260,477
B. | Which were issued during
the period 0 0 $0
Subtotals (A + B) 8 “1 $9,260,477
C. | For which a management
decision was made during
the reporting period 2 2 $93,000
() Recommendations
agreed to by SBA
management 1 1 $12,000
(2) SBA level $12,000
(b) Program participant
level $0
(ii) Recommendations not
agreed to by SBA
management 1 1 $81,000
D. | For which no management
decision had been made by
March 31, 1998 taal 9 $9,167,477

Recommendations:
“The recommendations resolved did not address all the recommendations within the reports where they appeared;
therefore, the number of reports without management decisions remains unchanged,

Semiannual Report March 1998 71



improve Federal debt collection practice and
promote electronic payments), and
commented on five provisions. First, the bill
requires a contractor to perform a
background check on every individual
performing collection services. The OIG
believes that the bill should further require
that the contractor use only those individuals
who pass their background checks and are of
good character and that the bill set minimum
standards to be followed. Second, the bill
generally requires an agency head, after
terminating collection activity, to sell any
nontax debts owed to the U.S. The OIG
believes that the bill should define an
agency’s responsibility to recompute and
report to IRS any change in imputed income
to the delinquent borrower. Third, the bill
prohibits any person with a delinquent
outstanding Federal debt from receiving any
Federal benefit. The OIG suggested that the
definition of “Federal benefit” be broadened.
The OIG also suggested that the bill provide
a mechanism for Federal agencies to
expeditiously obtain information on
delinquent debtors from other Federal
agencies. Fourth, the bill requires each
agency to sell each loan not later than 6
months after the loan is disbursed and the
further approval of the Attorney General if
the debt is the subject of an allegation of
fraud that has been referred to the
Department of Justice for litigation. The
OIG expressed concerns with these
provisions; many loans could be sold before
any evidence of fraud appears, the term
“fraud” should be broadened to include any
criminal activity, and “referred to the
Department of Justice [for] litigation” should
be clarified. Finally, the bill requires each
IG to review and report on each compromise,
default, or final resolution in bankruptcy of

Semiannual Report March 1998

any high value debt arising out of agency
programs. Given the possible increase in an
OIG’s workload due to this provision and an
OIG’s limited resources, the OIG
recommended that the requirement that IGs
review 100% of such debts be deleted and
language be drafted to give OIGs the
discretion to review such debts where
appropriate. The OIG also recommended
that the legislation establish standards or
criteria for “rating the performance of the
head of the agency in seeking to collect the
debt.”

Proposed Legislation Reviewed;
Paperwork Reduction

The OIG reviewed and commented on H.R.
3310, The Small Business Paperwork
Reduction Act Amendments of 1998.
Section 1(a) of the bill requires the Director
of the Office Management and Budget
(OMB) to publish annually in the Federal
Register a list of paperwork requirements
applicable to small businesses with respect to
the collection of information by Federal
agencies. The OIG is concerned about the
feasibility of publishing such a listing. The
provision requires the publishing in advance
of paperwork requirements for all collections
of information to be undertaken in the
upcoming year; however, some reporting
requirements are unpredictable and not
conducive to this annual reporting
requirement. The OIG therefore suggested
modifying the language imposing this annual
report to require the yearly publication of the
paperwork requirements for recurring
collections of information, and all other
collections for the upcoming year approved
by OMB prior to the publication of the
annual list. The OIG also recommended that

53



programs, with the provision that both be
allowed to issue conditional approval in cases
where the IRS does not meet the programs’
time constraints.

The ODA concurred with the OIG’s first
recommendation and is currently revising its
business loan application to include the
information needed to perform criminal
history checks. The OFA generally concurred
with the recommendations concerning SBA
loan programs. It has revised one of its
applications to obtain the information
necessary for the OIG to perform criminal
history checks and is awaiting approval from
the Office of Management and Budget. OFA
did not concur with the OIG’s
recommendation concerning the Surety
Guarantee program, citing time sensitivity of
the bonding process, and the paperwork
burden involved in obtaining tax verification
information.

Acting Inspector General Testified
Before House Subcommittee on
Benefit Eligibility Verification

On March 2, 1998, the Acting Inspector
General testified before the Subcommittee on
Government Management, Information and
Technology of the House Committee on
Government Reform and Oversight. The
Subcommittee hearing examined legislative
proposals to improve debt collection and to
ensure the accuracy of eligibility information
provided by applicants for Federal benefit
and credit programs. The Acting Inspector
General provided an OIG perspective on the
need for Federal benefit and credit eligibility
verification and access to information to
improve debt collection. She stated that
investigating and prosecuting fraud after it

Semiannual Report March 1998

occurs is very resource intensive and does
not always result in full recovery of the
benefits fraudulently obtained. OIGs have a
keen interest, therefore, in deterring and
preventing fraud -- stopping it at the front
end instead of trying to find it at the back
end.

When applicants submit false information on
benefit or credit applications, they may be
awarded benefits to which they would not
otherwise be eligible. To the extent this
occurs, the Acting Inspector General stated,
the Federal Government unknowingly
rewards and encourages dishonesty,
taxpayers bear the cost of the fraud
committed, and truthful applicants may be
denied assistance once program funding is
exhausted.

The legislative authority for gaining access to
verifying data is a cumbersome, patchwork
quilt. Unfortunately, there is currently no
omnibus authority for efficiently and
effectively addressing the cross-cutting
problem. As a result, taxpayers are
unnecessarily subsidizing individuals who
appear to have no compunction about lying to
their Government.

The Acting Inspector General outlined
significant limitations in existing
Government-wide legislation. The Privacy
Act allows an agency to disclose information
with the individual's consent. It does not,
however, provide an effective and efficient
basis for routine up-front eligibility
verification. The Computer Matching and
Privacy Protection Act, which amended the
Privacy Act, allows Federal agencies to
conduct computer matches pursuant to
written agreement of the agencies involved.

51



Organization, Resources, and Management Initiatives

Organization

The SBA/OIG is organized into four
divisions as follows:

@ Auditing Division

© Investigations Division

@ Inspection and Evaluation Division

© Management and Legal Counsel Division

The Auditing and Investigations Divisions
each administer their field activities through
field offices and resident offices around the
country. The Auditing Division has offices
located in Atlanta, Chicago, Dallas, Los
Angeles, and Washington. The Investigations
Division has offices in those cities as well as
in Denver, Houston, Kansas City, New
York, Philadelphia, San Francisco, Seattle,
and Syracuse. The Investigations Division’s
Office of Security Operations is located in
Washington, D.C. Both the Inspection and

Semiannual Report March 1998

Evaluation Division and the Management and
Legal Counsel Division operate out of
Washington, D.C. A current OIG
organization chart can be found at Figure 7.

Resources

In FY 1998, the OIG is operating with a
funding level of $10.0 million and an
authorized personnel ceiling of 104 full-time
equivalent (FTE) positions. While this level
of funding represents a modest increase from
the number of dollars appropriated in
FY 1997, it provides only a minimal level of
oversight to SBA programs and program
dollars at risk. Congressionally-mandated
Jaw enforcement availability pay, annual cost
of living increases, and various locality pay
adjustments are still not fully funded by the
OIG’s authorized spending levels.

57



Direct Investigation Time by Program Area
October 1, 1997, to March 31, 1998

Program Area Direct Time % | Number of Investigations
Closed In Progress
Business Loans 55% 26 149
Disaster Loans 29% 9 79
SBIC 3%. 1 12
Surety Bond Guarantees 1% i} 4
Government Contracting * 2 3
Minority Enterprise Development 4% 0 17
Economic Development * 41 0
Agency Management and Financial 8% 8 9
Total 100% 47 270
Direct Auditing Time by Program Area
October 1, 1997, to March 31, 1998
Program Area Direct Time % Number of Audits
Issued In Progress
Business Loans 50% 6 10
Disaster Loans 27% 0 3
SBIC * () 0
Surety Bond Guarantees 8% e) 5
Government Contracting * 0 0)
Minority Enterprise Development 8% 2 3
Economic Development 1% 1 )
Agency Management and Financial 6% 2 4
Total 100% 11 22

* Tess than % percent

Semiannual Report March 1998

61



SBA Appropriations

Bac $.814 billion

Bat §.939 billion

Barr 91.893 billion

acme $.852 billion

00 02 04 06 08

1

0
Billions of Dollars

12

Efforts to Improve SBA
Program Management

SBA’s Financial Statements Receive
Second Unqualified Opinion from
Outside Auditors

The SBA's FY 1997 financial statements
received an unqualified opinion from its
independent auditors, Cotton & Company
(Cotton). The unqualified opinion means that
the auditors found SBA's principal financial
statements to be presented fairly in all
material respects in accordance with OMB
guidelines and SBA accounting policies. The
results of the audit were transmitted to the
Chief Financial Officer by the OIG, which

Semiannual Report March 1998

Figure 5

contracted with Cotton to perform the
independent audit. This was the second year
that the Agency received an unqualified
opinion.

Cotton did, however, find three problems
that were considered "reportable conditions"
in the internal control structure: (1) incorrect
calculations were used in the credit reform
subsidy modeling and reestimating process
for the Section 7(a), 504, and disaster
programs, resulting in substantial errors
(these calculations were corrected upon
discovery by the auditors); (2) lack of
planning for financial reporting which
resulted in untimely and erroneous draft
financial statements; and (3) inadequate SBA

49



into fuel pellets. Approval of the loan was
based on the company president’s projection
of the company’s income. The indictment
charged that the woman made false
statements in her loan application when she
(1) provided an altered document to support
her income projections, (2) lied about her
education, (3) failed to inform the bank and
SBA that her contract to obtain the required
waste paper had been canceled prior to the
loan closing, and (4) failed to list on her
Personal Financial Statement that she was a
personal guarantor on a loan from another
lender. The investigation found that, in
response to the bank’s request for
information supporting her income
projections, she had directed her secretary to
alter a letter to reflect that the company
would receive approximately 100 tons of
waste paper a day instead of the 16 tons she
knew to be the true amount. This letter was
then submitted to the bank and SBA to
support her inflated projections. The woman
was charged with perjury for lying to the
U.S. Bankruptcy Court about the alteration
of this letter. The company defaulted on the
loan without making a single payment. This
investigation, conducted jointly with the FBI,
was initiated based on a referral from the
participating lender bank.

Oklahoma Computer Store Owner
Indicted for Making False Statements

The co-owner of a now-defunct Ardmore,
Oklahoma, computer store was indicted on
one count of making false statements on a
loan application to a Federally-insured
financial institution. The store had received
a $50,000 SBA-guaranteed loan from a
participating lender bank. To increase his
chances of obtaining the business loan, the

Semiannual Report March 1998

indictment charges, the man indicated on
SBA Form 912, Statement of Personal
History, that he had never been arrested or
convicted other than for minor motor vehicle
violations. In fact, he had been arrested for
and convicted of extortion in 1976 and, in an
incident involving a minor, arrested for
sexual assault and convicted in 1989 of
indecency and fondling. The OIG’s
investigation found that both charges were
material to approval of the loan application.
The loan was disbursed in August 1993. The
owner closed the store and filed for
bankruptcy in April 1994, and the loan was
charged off in July 1996, with a loss to the
bank and SBA of $54,319. The OIG initiated
the investigation based on the results of its
Operation Clean Sweep inquiries in
Oklahoma.

Mississippi Tractor Dealer Indicted for
Making False Statement

The owner of a now-defunct tractor
dealership in Shubuta, Mississippi, was
indicted on one count of knowingly making
a material false statement to obtain a
$150,000 SBA-guaranteed loan. The
indictment charged him with representing on
a Schedule of Collateral (SBA Form 4,
Schedule A) that he already owned, and
would grant the participating lender bank a
first security interest in inventory worth
$99,373 when, in fact, he had no such
inventory. Supporting information was
developed in the OIG’s investigation, which
was based on a referral from SBA’s Jackson
District Office

24



Surety Bond Guarantees
SBA's Contingent Liability

SBA share for 1997 : $64,876,018

SBA share for 1996 : $724,596,082

ISBA share for 1995 : $964,889,948

ISBA share for 1994 : $864,208, 162

0 100-200 300 400.500 600 700) 800 9001000

Millions of Dollars
Figure 4
Although several audit and investigative determine if SBG fee refunds relating to
activities were in progress during the ‘overpayments, bond cancellations or contract
Teporting period, as indicated in the statistical reductions are properly processed.

summary box on the previous page, no
reportable outcomes were generated.

The OIG’s Auditing Division is currently
conducting audits of claims by four surety
companies and one survey of SBA’s process
for refunding fees paid to SBA by sureties
and bonded companies. The objectives of the
claims audits are to determine if (1) surety
companies comply with both SBA’s and their
own policies and procedures in applying for
bond guarantees, (2) fees are remitted in a
timely manner, and (3) claims and expenses
paid by SBA are allowable and reasonable.
The objective of the other audit is to

Semiannual Report March 1998 39



APPENDIX II - Part A

Audit Reports with Questioned Costs
October 1, 1997, to March 31, 1998

costs**

REPORTS | RECs‘ | QuesTiONED | UNSUPPORTED

A. | For which no management
decision had been made by

September 30, 1997 Zz 8 $3,492,374 $781,464

B. | Which were issued during
the period 2 2 $589,034 $0
Subtotals (A + B) 9 40 $4,081,408 $781,461

C. | Forwhich a management
decision was made during

the reporting period 5 5 $1,315,389 $0
(V) Disallowed costs 4 4 $1,055,820

(a) Due SBA $1,055,820

(b) Due program

participant $0
(ii) Costs not disallowed 4 1 $259,569

D. | For which no management
decision had been made by

March 31, 1998 4 5 $2,766,019 $781,461

* Recommendations

** Questioned costs are those which are found to be improper, whereas unsupported costs may be
proper but lack documentation.

70 Semiannual Report March 1998



1. Find opportunities for the
reduction of operating costs (salaries
and expenses) associated with and
supporting activities. of SBA's
programs.

2. Identify means for reducing the
subsidy cost of SBA programs.

3. Ensure that SBA programs are
meeting mandated public policy

goals, high performance standards,
and the needs of targeted
participants.

4, Improve the accuracy of SBA
accounting and management
information.

5. Assure Agency implementation
of accepted OIG recommendations
and, to the extent that OIG
resources allow, provide assistance
to program managers in
implementing recommendations.

6. Reduce the opportunity for loan
packager fraud through cooperation
with Agency officials in the
registration of loan packagers and
the pursuit of | packager
investigations.

7. Review proposed legislation,
regulations, standard operating
procedures, and other SBA
issuances to improve Agency
programs and to eliminate the
Potential for mismanagement.

8. Identify program vulnerabilities
or systems weaknesses found during
investigations and alert appropriate
SBA program managers.

The OIG’s second goal is to reduce fraud
and abuse in Agency programs and foster
integrity in SBA’s personnel and the
Agency's resource partners, This goal will

be accomplished by meeting the following
objectives:

1, Assist the SBA in its efforts t0
deter fraud and abuse by auditing a
sample of defaulted loans and
Section 8(a) program participants
suspected of abusing the contracting
assistance program.

2. Assist the SBA in deterring
waste, fraud, and abuse by
responding to complaints concerning
such activities with OIG staff
assistance and consultation,

3. Recommend actions to reduce
any program —_ vulnerabilities
uncovered as a result of OIG
oversight activities.

4. Conduct investigations into
allegations of fraud in SBA
programs according to the perceived
level of risk to the Agency and the
potential for program impact or
increased deterrence.

5. Pursue asset forfeiture
proceedings in all applicable cases.

6. Participate in development of
SBA's fraud and corruption
awareness training programs and
emphasize cooperation of Section
(a) lenders in combating fraud
through fraud awareness briefings
and outreach contacts with lenders.

7. Refer an average of 75 cases
annually to the Department of
Justice for Affirmative Civil
Enforcement (ACE) and increase
the value of civil fines imposed.

8. Preclude persons of poor
character from participating in SBA
programs or employment through
the use of name check requests,
fingerprint requests, —_pre-

Semiannual Report March 1998



APPENDIX II - Part D

Overdue Management Decisions

March 31, 1998

Auditee Report Number Date Issue Status
Business Loan 65F002019 9/20/96 | One of five recommendations
Center under negotiation with Office of
Financial Assistance

LowDoc Loan 65E002022 9/30/96 | Two of five recommendations

Program under negotiation with Office of
Financial Assistance

Maryland SBDC 76HO01006 2/6/97 | Two recommendations continue
under negotiation with District
Office

Grant Proposal, 77H001014 4/25/97 | Under review by Office of

WVHTCF Procurement and Grants
Management

Defaulted Loan, 77F002016 6/30/97 | Under review by District Office

Eastside Bank

LowDoc Loan 77F006017 7/7197 | Recommendations continue

Program - Atlanta under review by the District
Office

LowDoc Loan 77F009020 718/97 | Two recommendations remain

Program - Santa under review by District Office

Ana DO

LowDoc Loan 77F0008022 7131197 | Three of five recommendations

Program - Dallas under negotiation with District
Office

Business Loan 75HO011026 9/30/97 | Under review by Office of the

Guarantee Administrator

Purchases

Semiannual Report March 1998

73



72

APPENDIX II - Part C

Audit Reports with Non-Monetary Recommendations
October 1, 1997, to March 31, 1998

REPORTS

RECOMMENDATIONS

For which no management decision
had been made by
‘September 30, 1997

36

Which were issued during the
period

28

Subtotals (A + B)

For which a management decision
was made (for at least one
recommendation in the report)
during the reporting period

28

For which no management decision
(for at least one recommendation in
the report) had been made by
March 31, 1998

36

Semiannual Report March 1998



California Businesswoman Sentenced for
Filing False Claim

The owner of a jewelry shop in Norwalk,
California, was sentenced to 3 years
probation, 125 hours community service, and
a $50 special assessment. She was also
ordered to continue making timely payments
on her SBA disaster loans. The woman had
previously pled guilty to filing a false claim
with SBA. After her Los Angeles videotape
rental store was looted and burned during the
1992 civil unrest, the woman was approved
for SBA disaster loans totaling $185,000 to
rehabilitate that business. The investigation
revealed that, as part of the loan application,
she submitted a copy of a fictitious 1989
Individual Income Tax return and an altered
copy of her 1990 Individual Income Tax
return. Both of these documents significantly
overstated her income. The investigation
also revealed that, instead of using the
$159,700 of loan proceeds to reopen the
video store, she opened the jewelry shop.
(As a result of the investigation, SBA
canceled the final loan disbursement of
$25,300.)

California Fashion Store Owner Pleads
Guilty to Making False Statement

The former owner of a fashion store in Los
Angeles, California, pled guilty to the one
count of making a false statement to SBA
on which he had been indicted. Following
the 1992 civil unrest, the man had obtained
two SBA disaster loans for the business. The
investigation revealed that, in support of his
applications for an $87,300 physical damage
loan and a $28,100 economic injury loan, he
had submitted copies of tax returns that had
been altered to overstate his income. SBA

32,

would not have made the disaster assistance
loans had his true financial condition been
known; his fraudulent activity resulted in a
$77,000 loss to SBA.

California Nurse Registry Owner Pleads
Guilty to Filing False Claim and Making
False Statement

The owner of a nurse registry in Los
Angeles, California, pled guilty to one count
of filing a false claim with SBA and one
count of making a false statement to a
Federally-insured lender. The investigation
revealed that the owner submitted fraudulent
applications for disaster-related business
loans to a participating lender bank and SBA.
He obtained a $50,000 interim loan from the
bank; he then obtained an $89,600 economic
injury loan and a $72,800 physical damage
loan from SBA. (Of the SBA loan proceeds,
$50,000 was to be used to repay the bank
loan; however, he admitted diverting that
amount.) In each of the loan applications, he
claimed his business was located in a
building damaged by fire during the 1992
civil unrest in Los Angeles. The
investigation disclosed, however, that his
business sustained no damage because he
actually operated the nursing service out of
his residence, which was not affected by the
civil unrest. The SBA disaster loans went
into default after only two payments on each
loan were made, and SBA charged off both
loan balances in 1993. The owner did not
make any payments on the interim loan,
which the bank charged off in 1994.

Semiannual Report March 1998



and 100% owner at the time. This
investigation was initiated based on a referral
from SBA’s Kansas City District Office.

Kansas Couple Indicted for Making False
Statements

The president and the secretary of a fuel-
pellet. manufacturing company in Erie,
Kansas, were indicted on three counts of
making false statements to SBA and
making false statements to a Federally-
insured lender regarding the company’s
application for a $147,650 SBA-guaranteed
loan. The loan was intended to finance the
opening of a fuel-pellet manufacturing plant,
but the business failed and defaulted on
repayment of the loan. The OIG’s joint
investigation with the U.S. Secret Service
determined that the man failed to disclose a
prior defaulted SBA disaster loan and prior
bankruptcy, and the couple failed to disclose
fuel taxes they owed to the State of Arizona.
This investigation was initiated based on a
referral from SBA’s Kansas City District
Office.

California Brokerage Principal Indicted
for Bank Fraud and Making False
Statements

A principal of a San Jose, California, loan
brokerage firm was indicted on December
19, 1997, on 1 count of bank fraud, 11
counts of making false statements on loan
applications to Federally-insured financial
institutions, and 6 counts of making false
statements to obtain SBA-guaranteed loans.
The indictment was the result of a joint
investigation, conducted by the OIG and the
FBI, that was initiated based on information
provided by SBA’s San Francisco District

18

Office. In the indictment, the man was
charged with submitting false documents to
assist his clients in obtaining SBA-guaranteed
loans to purchase convenience stores in
northern California. The allegedly false
documents he submitted generally involved
the applicants’ eligibility and/or source of
down payments and included personal
financial statements that overstated the
applicants’ net worth. The indictment also
charged that the man frequently used “straw”
applicants to conceal the true identity of
principals who would not have been eligible
for SBA-guaranteed loans. Some were
ineligible because they were not permanent
legal U.S. residents, and some would have
exceeded SBA’s per-person loan maximum.
Cited in the indictment are a total of 10 loans
made by a Sacramento bank between 1989
and 1995 and 1 loan made by another
California bank in 1997. Together, they total
nearly $6 million. To date, SBA has paid out
over $1.8 million to repurchase defaulted
loans made to his clients.

Three Georgia Businessmen Indicted for
Conspiracy and Making False Statements

Three Georgia businessmen were indicted in
connection with a $155,000 SBA-guaranteed
loan for purchase of a grocery business in
Kennesaw, Georgia. The buying
corporation's president and owner was
indicted on one count of making a
materially false statement in an SBA-related
matter. On the Personal History Statement,
SBA Form 912, submitted as part of the loan
application package, he certified that he had
never been arrested. The OIG’s investigation
revealed, however, that he had been arrested
twice. The buyer’s corporate secretary and
the chief executive officer of the broker for

Semiannual Report March 1998



substantially overstate their incomes. Both
men were clients of the same tax return
preparer.

Semiannual Report March 1998



restaurant and bar pled guilty to a one-count
information that charged him with making
false statements in applying for, and
accounting for the use of proceeds of, a
$616,000 SBA-guaranteed loan to his
corporation. In the plea agreement the man
admitted that, on the Statement of Personal
History included with his application, he
omitted his arrest and conviction for bribing
a public official. © The owner also
acknowledged submitting to the participating
non-bank lender and SBA altered tax returns
and fraudulently endorsed two-party checks.
The case, worked jointly with the FBI, was
based on information provided by SBA’s
Newark District Office.

Massachusetts Coffee Wholesaler
Charged with Making False Statements

The president of a Quincy, Massachusetts,
wholesaler of specialty coffees and related
items was charged with five counts of
making false statements on loan
applications to a Federally-insured
financial institution. According to the
criminal information, he provided false
documents and made false statements in
obtaining two loans and a credit line from a
participating lender bank during 1995. The
larger loan, for $143,000, was guaranteed by
SBA. The business owner is charged with
falsely claiming that he had made an equity
investment in his business, submitting false
documents pertaining to the use of the loan
proceeds, and submitting balance sheets
containing false financial information about
his business. The joint SBA/OIG and FBI
investigation originated from a referral to the
OIG by SBA’s Boston District Office.

20

Towa Manufacturer Pleads Guilty to
Making False Official Certification

An officer of a manufacturing company in
Central City, lowa, which had produced tent
stakes for the Army, pled guilty to one count
of making a false official certification. He
was sentenced to pay a $2,000 fine and
subsequently paid a $25,000 civil settlement.
The SBA/OIG’s joint investigation with the
Defense Criminal Investigative Service found
that, to gain approval of the firm's
application for a $500,000 SBA-guaranteed
loan to buy the assets of a debarred defense
contractor, the businessman submitted a
fraudulent certification of his financial
condition to the participating lender bank.
The information charged that he falsely
certified that he had $175,000 available from
personal savings to invest in the firm and
failed to disclose outstanding debts, including
a significant loan from the owner of the
debarred contractor. This investigation was
opened based on information developed in an
investigation that resulted in the June 1994
conviction of the former owner and an
associate for fraud in connection with an
SBA certificate of competency.

District of Columbia Waste Recycler
Indicted for Making False Statements
and Perjury

The president of a now-defunct waste-paper
recycling company in Washington, D.C.,
was indicted on four counts of making false
statements in a loan application to a
Federally-insured bank, four counts of
making false statements to SBA, and two
counts of perjury. The company had
received a $296,014 SBA-guaranteed loan to
purchase equipment to convert waste paper

Semiannual Report March 1998



Mississippi Automobile Parts Franchisees
Plead Guilty to Conspiracy to Defraud
the Government

A couple who owned an automobile parts
franchise in New Hebron, Mississippi, pled
guilty to one count of conspiracy to defraud
the Government. In return, the Government
agreed to dismissal of the other six counts of
their indictment. Their company obtained a
$120,000 SBA-guaranteed loan in 1991 and
a $42,500 physical damage loan and a
$29,800 economic injury disaster loan in
1992. An investigation found that the couple
carried out a scheme, using fraudulent
receipts and invoices, to conceal their misuse
of proceeds of the SBA loans. The
indictment also challenged their claim that a
tornado damaged structural improvements,
equipment, and inventory of their business.

Semiannual Report March 1998

33



1991 in response to the requirement,
in his Loan Authorization and
Agreement, to provide information
about his financial condition
throughout the time the loan was in
force. The man is currently making
loan payments quarterly through the
U.S. Trustee’s Office pursuant to a
bankruptcy reorganization plan.

© The former owner of a gas station
in San Bernardino, California, was
indicted on four counts of making
false statements to a Federally-
insured lender. Three counts
charged her with submitting altered
Individual Income Tax Returns for
the years 1988-90 and count four
charged her with submitting a false
financial statement with her
application for a $300,000 SBA-
guaranteed loan. The loan was
disbursed in June 1991; by April
1992, she had filed for bankruptcy
protection. In August 1994, SBA
charged off a $292,189 loss on her
Joan.

The individuals identified in items 2 and 3
above pled guilty to the charges against them.
All these actions resulted from an extensive
investigation, conducted jointly with the FBI
and the IRS, based on allegations from an
anonymous complainant. The investigation
focused on loans submitted to a California
bank by the brokerage firm. The firm’s
portfolio at the bank totaled approximately
170 toans, originally valued at more than $60
million. Partially as a result of the default
rate of these allegedly fraudulent loans, the
bank was closed by the Office of the
Comptroller of the Currency in April 1994.

Semiannual Report March 1998

The investigation has focused on a sample of
these loans and is continuing.

Latest Results from Affirmative Civil
Enforcement (ACE) Program

Over this reporting period, the OIG's
participation in DOJ's ACE program
produced eight successful business loan
cases, resulting in $137,216 in recoveries
and $204,624 in civil penalties. All but one
en smallest cases, which produced
penalties, involved fraudulent
representations (primarily bogus tax returns)
in applications for loans, most of which were
stopped before funds were disbursed. (One
of those produced a $40,000 civil penalty
against an unsuccessful applicant for a
$530,000 loan.) The largest result, described
on the following page, involved settlement of
a lawsuit against a Missouri participating
lender and its principal officers.

OIG Briefs Members of Lender
Community

During this reporting period, our
investigations staff continued its practice of
making presentations to groups of
Participating lenders. The Special Agent in
Charge of the OIG's Los Angeles field office
gave a presentation to 42 attendees at a
conference sponsored by SBA's Los Angeles
District Office. Its Financing Division was
training incoming intermediaries in the new
minority pre-qualification program; the OIG
presentation highlighted the benefits to be
gained from cooperation between participants
and the OIG in combating waste, fraud, and
abuse in SBA's loan programs. At a San
Antonio lenders’ conference, the Assistant
Inspector General for Auditing spoke on the

15



APPENDIX II - Part E

Significant Audit Reports Described in Prior Semiannual Reports
Without Final Action as of March 31, 1998

REPORT TITLE DATE DATE OF FINAL
NUMBER SNE? | ‘DecisionoN. | TARGET FOR
RECOMMEN- IMPLE-

DATION MENTATION

3-2-C-002-033 | Administration of 8(a) Program 3/31/93 9/30/94 9/30/95
4-3-H-006-021 | 8(a) Continuing Eligibility 9/30/94 12/30/94 4/30/95
4-3-H-011-016 | SBA’s Award of 8(a) Contracts 5/16/94 12/30/94 6/30/95
5-3-H-004-006 | SBA Loan Servicing and Debt 3/31/95 4/30/95 9/30/98
5-3-E-010-021 | 8(a) Competitive Mix 9/29/95 3/29/96 3/29/97
6-6-H-002-011 | GeoDemographics, Ltd. 3/29/96 9/30/96 4/01/98
6-5-E-002-022 | Low Documentation Loan 9/30/96 3/31/97 6/30/97
6-5-E-001-021 | Basic Ordering Agreements 9/25/96 210/97 9/25/97
6-5-H-006-017 | Section 8(a) Regular Dealers 8/21/96 9/30/96 8/20/97
6-6-H-003-023 | Virginia SBDC 9/30/96 5/12/97 11198
6-5-H-007-014 | FY 1995 Financial Statements 5/1/96 10/28/96 9/30/97
7-7-F-007-021 | LowDoc Loan Program at WDO | 7/18/97 11/06/97 12/31/97
7-5-F-002-019 | CAIVRS 7107/97 9/30/97 12/31/97
7-6-F-003-023 | Approval of Disaster Home 9/04/97 3/17/98 9/30/98
7-6-H-006-015 | FY 1996 Financial Statements 4/29/97 9/30/97 4/30/98
7-7-S-918-018 | User Technology Associates 6/06/97 3/26/98 6/05/98

74

Semiannual Report March 1998



depicted in both Figures 1 and 2 (pages 9 and
26, respectively), the dynamics of the
Agency's portfolio, and the concomitant
demand for oversight, would suggest that the
OIG’s resources be increased to ensure an
adequate level of program oversight. While
the increase in resources from FY 1997 to
FY 1998 ($9 million to $10 million) has been
helpful, it did not allow the OIG to “catch
up” to its expenses after years of chronic
underfunding, and still does not allow the
OIG to fully address SBA’s portfolio and
programs. The OIG continues to experience
difficulty in carrying out its mandate to
provide meaningful oversight of the
Agency's programs and supporting activities
and to safeguard the Government's
investment in SBA’s extensive credit
programs. As is apparent from the
accompanying narrative, some SBA
programs received only modest oversight,
while others virtually went without oversight.
For FY 1999, the President has requested
another small increase in the OIG’s budget
(to $11.3 million) in recognition of SBA’s
burgeoning portfolio, its mandate to transfer
much of its responsibility for portfolio
management to the private sector, and the
projected expenditure of the balance of the
OIG’s special disaster-oversight funding.

The Acting Inspector General continues to
be concerned with the strong demand for
investigations of fraud in Agency programs.
As evidenced by the table on page 59, both
business and disaster loan fraud continue to
be the OIG’s two priorities, in terms of both
active cases carried and time expended on
these cases. During this reporting period the
lion’s share of investigative time (84 percent)
was expended on business and disaster loan
fraud cases. With demand for SBA business

Semiannual Report March 1998

and disaster loans remaining high, it is
expected that the bulk of the OIG’s
investigative efforts will continue to be
devoted to these two programs, stretching
resources severely.

The table on page 59 also illustrates the
Auditing Division's emphasis on the business
loan and disaster assistance programs, as
reflected in the increase in the time spent
reviewing the disaster assistance program.
Available audit hours devoted to disaster
assistance has grown from 3. to 27 percent
over the last 8 reporting periods. The Acting
Inspector General is, of course, also
concerned by the modicum of coverage the
OIG is able to provide to other Agency
programs, supporting operations, and
program participants. There has been only
minimal audit oversight of the Agency
computer systems, and the OIG has been
virtually unable to respond to specific
Agency requests for other program audit
coverage. Key programs such as Section 8(a)
have also received only minimal audit
oversight coverage over the past year, and
other programs such as Small Business
Investment Companies, International Trade,
and Micro-Loans, have also received only a
modicum of OIG oversight.

Management Initiatives
PCIE Committee Issues Two Studies

The Inspection and Evaluation Committee of
the President’s Council on Integrity and
Efficiency (PCIE), which is chaired by
SBA’s Acting Inspector General, issued two
reports. The first, a report on Prescreening
of Federal Grants and Loans by Offices of
Inspector General and Their Agencies’

59



Business Loan Program

SBA's small business loan programs serve one of the most important missions of the Agency:
to ensure that Federal funds and resources are used to help finance qualified small enterprises.
Under the Section 7(a) Guaranteed Loan Program, SBA guarantees loans to small businesses
that are unable to obtain private financing. These loans must be of such merit, or be so
secured, as to reasonably ensure repayment to the lending institution. No loan may be made
unless the financial assistance is not otherwise available on reasonable terms from elsewhere
in the credit market. Under the guarantee program, SBA agrees to purchase the guaranteed
portion of the loan upon default by the small business. SBA's guarantee share of loans by
private lenders averages about 75 percent.

More than 8,000 lenders have made at least one Section 7(a) loan in the past 5 years
Currently, approximately 42 percent of these loans are being made by participants in the
Agency's Certified Lender Program (CLP) or its Preferred Lender Program (PLP).

Lenders who are heavily involved in the SBA guarantee program and meet the Agency's
criteria can participate through the CLP. Over 1,000 participating lenders, approved for the
CLP program, are permitted to assume greater authorities and responsibilities in processing,
closing, servicing, and liquidating loans. As a result, SBA can process loan guarantee
applications in 3 days, rather than the 2 weeks that it may take for a thorough analysis by
Agency staff, About 8 percent of all business loan guarantees are made through the CLP
process.

As permitted by Section 5(b)(7) of the Small Business Act, SBA delegates even wider authority
to preferred lenders, i.e., lenders who can commit the Agency to guarantee eligible business
loans and decide the level of SBA participation. This program, with over 350 participants,
reduces processing time on strong credit applications and uses the resources of SBA's best
lenders to the maximum. About 34 percent of all business loan guarantees are made through
the PLP process.

The 504 Loan Program provides long-term, fixed-rate financing through certified
development companies (CDCs) to small businesses to acquire real estate, machinery, and
equipment for expansion of business or modernizing facilities. Typically, 504 loan proceeds

Semiannual Report March 1998



making a false statement to SBA. In March
1991, the store owner submitted altered
“copies” of 1987-90 income tax returns to a
participating lender bank to obtain a
$631,500 SBA-guaranteed business loan.
Similarly, he submitted altered copies of tax
returns for 1989-91 to SBA to obtain disaster
assistance for his business following the 1992
Los Angeles civil unrest. He ultimately
obtained a $71,800 physical damage loan and
a $59,200 economic injury loan. All of the
altered tax returns significantly overstated his
adjusted gross income and business income.
This action resulted from a joint OIG/Secret
Service investigation of falsified applications
prepared by two southern California brothers
acting as loan packagers; the case was
opened as a result of a tip from a concerned
citizen and a referral from SBA’s Disaster
Assistance Area 4 Office.

Owner of St. Croix Rental Property
Found Guilty of Making False Statements

The owner of rental property in St. Croix,
U.S. Virgin Islands, was found guilty on two
counts of making false statements to SBA in
applying for a $23,000 disaster loan for
losses to four rental units she owned on St.
Croix. The woman, a Decatur, Georgia,
school teacher, was convicted for submitting
altered “copies” of tax returns for the years
1993-94 following Hurricane Marilyn.
Although the tax returns she submitted to
SBA reported rental income, she had
reported no such income to the IRS. The
loan application was declined when SBA’s
tax verification program detected the
discrepancies. The case was based on a
referral from SBA’s Disaster Assistance Area
1 Office.

30

North Carolina Man Pleads Guilty to
Stealing Disaster Victim’s Check

A resident of Surf City, North Carolina, pled
guilty to a one count information that charged
him with stealing Federal property. The
man admitted converting to his own use an
improperly-delivered $6,300 U.S. Treasury
check intended for a Surf City disaster
victim. The OIG initiated this investigation
based on information received from SBA’s
Disaster Assistance Area 2 Office.

Results of Previously Reported
Investigations

Missouri Consultant Sentenced for
Making False Statements

A Cuba, Missouri, industrial construction
consultant was sentenced to 18 months
imprisonment, 3 years supervised release,
and $100,000 restitution. He had pled guilty
to making material false statements to
obtain SBA disaster assistance. In support of
the loan application, he submitted three
fictitious tax returns for a St. Louis business
that he purchased subsequent to the disaster
and that received two SBA disaster loans
(one for economic injury and one for
physical damage) totaling $407,800.

California Disaster Home Loan Recipient
Sentenced for Making False Statements

A Mission Hills, California, disaster home
loan recipient was sentenced to 18 months
imprisonment, 3 years probation, and a $100
special assessment. The man previously pled
guilty to one count each of making a false
statement to SBA and making a false

Semiannual Report March 1998



FY 1998 Productivity Statistics

First Six Months
Office-Wide Dollar Accomplishments
A Potential Investigative Recoveries and Fines
B. Management Avoidances as Result of Investigations
C. Disallowed Costs Agreed to by Management

D. Recommendations that Funds Be Put to Better
Use Agreed to by Management

E. Settlement Recoveries
Total .

Auditing Division Activities

A. Reports issued

B. Disallowed Costs Agreed to by Management

C. Recommendation that Funds Be Put to Better
Use Agreed to by Management

D. Settlement Recoveries

Inspection and Evaluation Division Activities

A. Reports Issued

Investigations Divi
A Cases Closed

B. Indictments

©. Convictions

D. Potential Investigative Recoveries and Fines
—. Management Avoidances

- Investigation Cases
~ Name Check Program

Totals
$3,858,627
$13,302,630
$1,055,820

$12,000
$0
$18,149,705

"1
$1,055,820

$12,000
$0

47
. 43

26
$3,858,627

$13,302,630
$145,600

- $13,157,030

66 Semiannual Report March 1998



Table of Appendices

Appendix Page
Appendix I - Audit Reports Issued... 02.00.00. o eee cece eee a)
Appendix II
Part A - Inspector General-Issued Audit Reports

with Questioned Costs ......... See e eee eee eee - 70
Part B - Inspector General-Issued Audit Reports

with Recommendations that Funds Be Put to Better Use............. .. 71
Part C - Inspector General-Issued Audit Reports

with Non-Monetary Recommendations ........... .72
Part D - Inspector General-Issued Audit Reports

with Overdue Management Decision....................2.00.. 73
Part E - Significant Audit Reports

Without Final Action... 0... 2.0.00... 00. cee eee eee eee 74

68 Semiannual Report March 1998



APPENDIX |

Audit Reports Issued
October 1, 1997, to March 31, 1998

TITLE NUMBER ISSUE QUESTIONED FUNDS FOR
DATE costs BETTER USE
Business Loans
New Ventures CDC ‘86F007006 12/31/97
First National Bank of
Coffee County 87F006001 10/31/97
Loan Liquidation ‘85F003009 227198. $493,034
Nevada State
Development Company 86F007003 11/26/97
‘Southern Nevada Certified
Development Company 86F007004 12/1197
LowDoc Loan Program’ 87F005002 11/24/97
Program sub-total: 6 audits $493,034

Minority Enterprise Development

Section 8(a) Program

Eligibility -1DP_ 87H004007 1/2/98

Section 8(a) Program

Eligibility - Magnum 87H009008 2/18/98
Program sub-total: 2 audits

Economic Development

it

Hawaii Small Business
Development Company

87F004005

12/24/97

Program sub-total:

Taudit

Agency Mana

jement and Financial

Disbursement Processing | 67HO03011 311/98 $96,000
FY 1997 Financial
Statements Audit 87H080010 3/2198

Program sub-total: 2 audits $96,000
TOTALS (all programs) Reports: 11 $589,034

Semiannual Report March 1998



Efforts to Improve SBA
Program Management

Audits Underway in the OIG’s Disaster
Oversight Effort

The following audits are in progress and will
be issued when completed:

Disaster Loan Approval Rates. To identify
ways to improve the Disaster Assistance home
loan application approval rate without
increasing the program’s delinquency and
default loss rates.

Disaster Home Loan Servicing. To determine
whether disaster home loan servicing centers
are maximizing collections and minimizing
losses at the least possible cost.

Early Defaulted Disaster Loans. To
determine (1) if cash flow was insufficient to
repay the disaster loan at the time of default,
(2) if loan proceeds were used for the intended
purposes, and (3) if assets or income are
available for an SBA recovery. The audit is in
the early stages.

Activities to Enhance Fraud
Detection and Deterrence

California Disaster Loan Applicant
Pleads Guilty to Making False Statements
and Misusing Social Security Number

A Culver City, California, man pled guilty to
two counts of making material false
statements to SBA and one count of misuse
of a Social Security number (SSN). The
man was approved for a $33,000 disaster
home loan following the 1993 Los Angeles

Semiannual Report March 1998

winter storms, but SBA canceled the loan
before any funds were disbursed once its tax
verification program identified discrepancies
between 1990-91 Individual Income Tax
returns submitted to SBA and IRS. The
OIG's investigation confirmed that the tax
return "copies" submitted to SBA had been
altered to overstate his income. The
investigation also found that the applicant had
been the recipient of a $25,000 disaster home
loan following the 1994 Northridge
earthquake, using another name similar to his
own. The application package for that loan
also included altered 1991-92 individual
income tax information and a fictitious SSN.
The OIG opened the investigation based on a
referral from SBA's Disaster Assistance Area
4 Office.

Former U.S. Virgin Islands Resident
Indicted for Making False Statements

A current Maryland resident was indicted by
a Federal grand jury in the U.S. Virgin
Islands on two counts of making false
statements to SBA in connection with her
receipt of a $34,400 disaster home loan. The
indictment charged that the woman submitted
documents falsely claiming that on two
occasions she had used loan proceeds to
purchase furniture and appliances for her
former home in the U.S. Virgin Islands. The
documents were submitted to obtain the
disbursement of the balance of her loan from
SBA. The case was based on a referral from
SBA's Disaster Assistance Area 1 Office and
produced the second indictment for fraud
against SBA in the wake of Hurricane
Marilyn.

27



audit of a nationwide sample of 70 loans was
issued in September 1996, the former SBA
Administrator requested that a larger sample
be drawn to validate the results.
Consequently, the OIG completed a second
audit of 120 loans. The auditors concluded
in both audits that 10% of the sampled loans
should not have been made because of loan
origination deficiencies. The OIG and the
program office are in discussions concerning
findings and recommendations.

Inspection Examines Agency Fraud
Detection Practices

The OIG issued an inspection report that
assessed the use of criminal history and tax
verification information to detect fraud in
SBA programs. To correct the deficiencies
found during the inspection, the OIG
recommended that (1) the Office of Financial
Assistance and the Office of Disaster
Assistance obtain all information necessary
for the OIG to perform criminal history
checks, (2) Preferred Lenders in the business
loan program include completed Personal
History Statements in the loan materials
submitted to the Agency’s Preferred Lender
Program Processing Center, (3) SBA develop
procedures to ensure that all loan applicants’
tax returns and financial statements are
verified with IRS information prior to loan
disbursement, (4) Minority Enterprise
Development officials revise program
procedures to require IRS verification in
processing electronic applications and in
establishing a firm’s continuing eligibility for
the Section 8(a) program, and (5) the Size
Standards program use tax verification on a
permanent basis and the Surety Guarantee
program conduct a one-year pilot test of tax
verification, with the provision that both be

allowed to issue conditional approval in cases
where the IRS does not meet the programs”
time constraints. The ODA concurred with
the OIG’s first recommendation and is
currently revising its business loan application
to include the information needed to perform
criminal history checks. The OFA generally
concurred with the recommendations
concerning SBA loan programs. It has revised
one of its applications to obtain the
information necessary for the OIG to perform
criminal history checks and is awaiting
approval from the Office of Management and
Budget. OFA did not concur with the OIG’s
recommendation concerning the Surety
Guarantee program, citing time sensitivity of
the bonding process, and the paperwork
burden involved in obtaining tax verification
information.

Audits Identify Two Ineligible Firms in
the Section 8(a) Program

An OIG audit found that a Maryland
computer manufacturing firm exceeded the
net worth limitations for both initial and
continuing Section 8(a) program eligibility.
The owners were admitted into the program
in 1994 inappropriately when investment
Property was incorrectly represented as part
of the owners’ personal residence.

Another audit determined that the owner of a
Virginia computer consulting firm
understated his assets substantially for 4
years and became ineligible for the Section
8(a) program in 1996 and 1997. Two
contracts with a total estimated award amount
of $4.1 million were therefore
inappropriately awarded to the firm during
those years.

Semiannual Report March 1998



‘employment screening, and required
background investigations.

The OIG’s last two goals involve
communicating its findings,
recommendations, and results to all SBA
stakeholders and ensuring the economical,
efficient, and effective operation of the OIG.
The extent to which the OIG will be able to
achieve its objectives depends, in part, on the
sufficiency of resources available to fund its
operations.

Highlights of the Past Six
Months

Efforts to Improve SBA
Program Management

Inspection Identifies Ways to Minimize
Loan Agent Fraud

The OIG issued an inspection report that
identifies cost-effective ways to prevent loan
agent fraud in the Section 7(a) program.
While loan agents can provide valuable
assistance to small businesses seeking access
to capital, some have perpetrated fraudulent
schemes resulting in defaulted loans that had
to be purchased by SBA. The OIG
recommended that the Agency (1) establish a
loan agent registration process to provide
accountability, (2) expand current legislation
to include loan agents among those subject to
National Crime Information Center criminal
history checks, and (3) develop a system for
monitoring loan agent performance to
provide early warning of any potential
problems. The criminal history checks
should be performed for each prospective
loan agent as part of the registration process

Semiannual Report March 1998

to identify and/or deter unsuitable candidates.
The OIG also recommends that SBA maintain
two lists on the Internet: currently registered
agents, and agents whose privilege to conduct
business with the Agency has been suspended
or revoked. This would allow borrowers and
lenders to verify the status of agents they are
considering using. The Agency has not yet
responded to OIG recommendations,
however, its response is expected soon.

Audit of FY 1994 Loan Liquidations
Estimates $28 Million Under-Recovered

An audit of 71 loans liquidated in FY 1994
showed that 12 of the loans were under-
recovered. The auditors found that
liquidation procedures were not applied
consistently, and SBA did not effectively
monitor lenders nor identify opportunities to
recover losses when lenders did not follow
approved procedures. Based on the sample,
under-recoveries were estimated at $28
million. The audit was inconclusive as to
whether it was more effective for loans to be
liquidated by lenders or by SBA. The audit
recommended that the Agency ensure that
SBA loan officers be made aware of their
responsibility for monitoring lender
liquidations, and that SBA initiate recovery
actions on specific loans where lender
deficiencies were identified. The Acting
Associate Administrator for Financial
Assistance agreed with the recommendations.

Summary Audit Report on Low
Documentation (LowDoc) Loan Program
Affirms Prior Findings

A follow-up audit of the SBA’s LowDoc
program found results that were similar to an
earlier audit of the program. After the first



role of the OIG, outcomes of Clean Sweep II
criminal history checks, tax verification,
agent registration, results of the LowDoc
audits, purchases of guarantees audit, early
defaults, and the ongoing Section 7(a) loan
processing audit.

Idaho Farm Implement Manufacturing
Executive Sentenced for Bankruptcy
Fraud

A former officer of a Caldwell, Idaho, farm
implement manufacturer pled guilty to one

count of bankruptcy fraud and was

sentenced to 5 years probation, 200 hours

community service, and $52,750 restitution
to the corporation’s bankruptcy trustee. The

joint FBI/IRS/OIG investigation found that

when the company filed for bankruptcy in

1993, the company officer concealed an asset

(a 1987 Ferrari) from the Bankruptcy Court.

The man’s father--the former president of the

company--had previously been indicted on 21

counts of bankruptcy fraud, bank fraud,

money laundering, and criminal forfeiture

in connection with a $750,000 SBA-

guaranteed loan.

Missouri Bank Settles Civil Suit Brought
by SBA and Department of Justice

A Missouri bank paid the Government
$200,000 to settle a civil fraud suit brought
under the Department of Justice’
Affirmative Civil Enforcement program.
The suit was filed in 1997 against the bank,
its president, and its chairman and chief
executive (a father and son) based on the
results of an OIG investigation. The suit
alleged that the defendants submitted a
fraudulent application to obtain SBA’s
guaranty of a $150,000 loan to a New

16

Bloomfield, Missouri, water _ bottling
company. Allegedly, the company’s loan
application misrepresented the status of the
company’s prior loans at the bank, which
were shown as current when they were
actually delinquent. SBA guaranteed the
loan, which soon went into default, and
subsequently paid the bank $137,215 for its
guaranteed portion. (This is the share of the
$200,000 to be paid to SBA.) The suit
sought treble damages, civil penalties,
interest, and costs pursuant to the False
Claims Act. The Government’s settlement
agreement with the bank and the two bank
officers noted that this $200,000 payment
was a compromise and not to be considered
an admission of liability by the defendants.
In 1996 the bottling company’s corporate
secretary pled guilty to mail fraud in
connection with this loan and was sentenced
to 1 year and 1 day in prison. The OIG
initiated this investigation based on a referral
from SBA’s St. Louis District Office.

California Real Estate Agent Sentenced
on Charge of Bribery

A Glendale, California, real estate
salesperson pled guilty to one count of
bribery of an SBA employee, and was
subsequently sentenced to 4 months home
detention, 3 years probation, and a $5,100
fine. The investigation was initiated based
on a referral from SBA’s Los Angeles
District Office (LADO) on the same day the
woman offered compensation to a loan
assistant in its Liquidation Division to
become the listing agent for an SBA-
foreclosed business property. The loan
assistant notified his supervisor immediately
after receiving the offer. During subsequent
telephone calls, and despite warnings that she

Semiannual Report March 1998



actions resulted from an extensive
investigation, conducted jointly with the FBI
and the IRS, based on allegations from an
anonymous complainant. Partially as a result
of the default rate of the allegedly fraudulent
loans, the participating bank was closed by
the Office of the Comptroller of the Currency
in April 1994.

Semiannual Report March 1998



Results of Previously Reported
Investigations

Wisconsin Business Consultant Pleads
Guilty to Making False Statement

A business consultant in Menomonee Falls,
Wisconsin, pled guilty to one count of
making a material false statement to SBA
to obtain a $25,000 SBA-guaranteed loan.
The woman admitted that she knowingly
failed to disclose a recent criminal history
and provided a false Social Security number
on SBA Form 912, Statement of Personal
History, in a LowDoc loan application for
her consulting firm. The OIG’s investigation
found that she had been arrested on a charge
of forging company checks the day before
she applied for the loan, and she was
convicted on that charge after obtaining the
loan.

Would-Be Pennsylvania Tavern Owner
Sentenced for Making False Statements

A Lansdale, Pennsylvania, businessman was
sentenced to 3 years probation and a $50
special assessment. The man previously pled
guilty to making false statements to
influence SBA to approve a $200,000
guaranteed loan to his company. In applying
for the loan, he had submitted a 1991 tax
return altered to substantially overstate his
income and fictitious returns for 1992 and
1993. The loan was canceled when the tax
return discrepancies were confirmed by IRS.

22

Georgia Hotel Owner Sentenced to
Prison for Making Material False
Statements

The former owner of a hotel in Tybee Island,
Georgia, was sentenced to 4 months
imprisonment, 3 years supervised release,
$213,150 restitution, a $5,100 fine, and 200
hours community service. He had pled guilty
to two counts of making material false
statements to influence the actions of SBA.
Approved for a $950,000 SBA-guaranteed
business loan, he submitted falsified invoices
to the participating lender bank, representing
$213,150 in services and equipment, to
obtain payment of loan proceeds.

California Grocer Sentenced for Making
False Statement

The owner of a grocery store in West
Covina, California, was sentenced to 4
months imprisonment followed by 3 years
supervised release. He was not ordered to
pay a fine or to make restitution due to his
financial condition. The man had pled guilty
to one count of making false statements in
a loan application to a Federally-insured
bank. He had obtained a $285,000 SBA-
guaranteed business loan based on an
application containing altered copies of
income tax returns for 1988-90. The grocer
was identified during an extensive
investigation examining the submission of
false documents as part of loan packages
prepared by a loan broker who had
previously pled guilty to bank fraud in
connection with this investigation.

Semiannual Report March 1998



SEMIANNUAL
REPORT OF THE
INSPECTOR GENERAL

OFFICE OF INSPECTOR GENERAL

COVERING THE PERIOD - OCTOBER 1, 1997 - MARCH 31, 1998 » PURSUANT TO PUBLIC LAW 95-452



Transportation Departments and the National
Aeronautics and Space Administration, was
initiated based on both a referral from SBA’s
Washington District Office and the SBA/OIG
audit.

Semiannual Report March 1998

45



Outstanding Guaranteed SBA
Business Loans

3/31/98 $29,872,770,016

9/30/97 $29,340,744,471

9/30/96 $26,547,087,185

9/30/95 $24,811,582,381

9/30/94 $21,188,886,942

10.0 15.0 20.0 25.0 30.0
Billions of Dollars

Figure 1

Efforts to Improve SBA validate the results. Consequently, a second
Program Management audit of 120 loans in Atlanta, Santa Ana,
Washington, and Dallas was performed. The

New LowDoc Audit Verifies Findings of results were very similar:

Previous Audit First Audit Second Audit

A second audit of the SBA’s Low Loans with proces-

Documentation loan program (LowDoc) sing deficiencies 19 % 10 %
produced results similar to an initial audit ;
conducted in September 1996. After the first Loans with deficien-

cies that should have

audit of a nationwide sample of 70 loans was precludedopmeal 10 % ue

published, the former SBA Administrator
requested that a larger sample be drawn to Average number of

Semiannual Report March 1998 9



are provided as follows: 50 percent by an unguaranteed first mortgage bank loan, 40 percent
by an SBA-guaranteed debenture, and 10 percent by the small business customer. The
maximum SBA debenture is $1 million.

With the creation of the Agency’s Low Documentation (LewDoc) application process, lenders
are now able to use their own internal loan application documents, plus a single page, two-
sided SBA form to apply for an SBA guarantee on a loan of $100,000 or less. The demand
for this program contimues to exceed 25 percent of all Section 7(a) loan approvals.

Summary of OIG Activity / Business Loan Program
‘Aucits Underway 10
Ault Reports Issued 6
Indictments Resulting from Investigations 29
Convictions Resulting from Investigations 12
Investigations Closed / Remaining Inventory 26/149
Investigations: Restitutions /Fines / Other Recoveries | $1,051,786 /$222,049 / $37,225
Investigations: Loan Declinations Due to Name Checks $12,928,704
Investigations: Cases Referred to Other Agencies 7
Inspections Underway 1
Inspection Reports Issued 1
Reviews of Proposed Regulations 2
Reviews of Standard Operating Procedures 1

Semiannual Report March 1998



SMALL BUSINE

OFFICE OF INSPECTOR GENERAL

INSPECTOR GENERAL

DEPUTY
INSPECTOR GENERAL

SS ADMINISTRATION

MANAGEMENT & LEGAL
COUNSEL DIVISION

AUDITING
DIVISION

INSPECTION AND
[EVALUATION DIVISION |

INVESTIGATIONS |
‘DIVISION

OPERATIONS | | ortactions, CPSEAIGNAT | | inADOTNS.| | wewvorK ATLANTA | | cHicaGo | Los aNanLes
Se Creare] Leoveron | {feaans en]

In FY 1994, the OIG received $3 million in
supplemental “no year” disaster funds to be
used for activities related to the Agency's
expanding disaster assistance program; these
funds will remain available until expended
(see discussion below). At this time the OIG
projects that these no year funds will be
completely expended by the end of FY 1998.
To ensure continued OIG oversight of the
disaster assistance program during FY 1997
and 1998, the Congress authorized transfers
of $500,000 in Agency funds for the OIG in
each of those 2 years. At the end of the
current reporting period, 7 auditors, 6
investigators, 3 attorneys, and 2 secretaries
were serving with the OIG on temporary
appointments supported by disaster funding.

58

Figure 7

Considerable difficulty has been experienced
in recruiting, training, and retaining
employees serving on _ temporary
appointments. The nature of the special
funding for disaster assistance oversight
forces the OIG to pursue recruitment of
auditors, investigators, and attorneys on a
“non-permanent” basis. These temporary
employees are understandably eager to obtain
more permanent positions elsewhere, and
when they are successful, the OIG is
deprived of the expertise they have
developed, their productivity, and its
investment in their training.

The relatively static level of resources over
the past 5 years remains troubling. As

Semiannual Report March 1998



Summary of OIG Activity / Government Contracting

Investigations Closed / Remaining Inventory

213

Reviews of Proposed Regulations

4

Efforts to Improve SBA
Program Management

Proposed HUBZone Regulations
Reviewed

The OIG reviewed an early draft of proposed
regulations governing the new HUBZone
program established by Title VI of the Small
Business Reauthorization Act of 1997, Pub. L.
105-135, enacted December 2, 1997. The
HUBZone program provides Federal
contracting assistance to small businesses
located in “historically underutilized business
zones” (HUBZones).

The OIG recommended several changes to
reduce potential program abuse or
inefficiencies. Such changes included
strengthening the “non-manufacturing” rule to
preclude HUBZone companies from making
minor modifications to non-HUBZone
manufactured products and then selling the
product as a HUBZone product; eliminating
double preferences for small disadvantaged
businesses located in HUBZones; not limiting
HUBZone contracts to only those considered
“Jabor-intensive;” not restricting a company to
one-half the size standard for its Standard
Industrial Classification (SIC) code at the time
of application; requiring small businesses to
obtain employees’ self-certification as to
residency in a HUBZone; and adding SBA
Form 912, Statement of Personal History, to

Semiannual Report March 1998

the list of required forms so that the Agency
can perform a name and background check
during the certification process. The OIG also
focused on such issues as verification of
eligibility, maintaining HUBZone status,
notification of material changes, additional
requirements for contract bidding, and
penalties.

The Agency changed the proposed regulations
to incorporate a significant number of the
OIG’s recommendations prior to their
publication.

Draft of Small and Disadvantaged
Business (SDB) Regulations Reviewed

The OIG reviewed a draft of proposed final
amendments to 13 CFR Part 124, governing
the SDB program, and provided numerous
comments to the Agency for its consideration
in developing new regulations. The OIG’s
comments focused on such issues as
determinations of disadvantaged status,
character determination and tax verification as
part of SDB certification, limits on the
number of joint ventures, qualification
standards and tenure rights of Private
Certifiers, Certifier fees, self-certification, the
presumption of eligibility of former Section
8(a) firms for SDB certification, and protests
of SDB status.

41



repayment ability. The investigation, which
the OIG initiated based on information
provided by SBA’s Disaster Assistance Area
4 Office, found that the man’s business had
closed before SBA disbursed any funds. It
also showed that he used a false Social
Security number (SSN) and provided altered
income tax returns in support of both
applications. The owner filed for bankruptcy
to forestall eviction from the property that
was in foreclosure and used a second false
SSN in the bankruptcy petition.

California Market Owner Indicted for
Making False Statements

The owner of a mini-market in Los Angeles,
California, was indicted on one count of
making false statements to SBA. After the
mini-mart was burned down during the 1992
civil unrest, the man had obtained disaster
loans totaling $116,000. With SBA
approval, he relocated to Oregon City,
Oregon, and opened an Asian food
restaurant. The SBA/OIG’s investigation
found that, to receive further disbursements
of disaster loan funds, he falsely certified that
he had spent the previously-disbursed loan
funds in accordance with the Loan
Authorization and Agreement. He submitted
to SBA a Borrower's Progress Certification
with an invoice showing purchases exceeding
$94,000 from a restaurant equipment
supplier. The investigation found that he
only purchased approximately $2,000 of
items from the supplier and instead used at
least $56,000 of the loan funds as a down
payment on a home. The owner
subsequently filed bankruptcy, and SBA
incurred a loss of approximately $91,000.
The case was referred to the OIG by SBA’s
Portland District Office.

Semiannual Report March 1998

SBA Recovers Misused Loan Proceeds
from Florida Businessman and His Two
Companies

SBA recovered $136,567 from a Homestead,
Florida, businessman and two corporations of
which he was president. The two businesses,
a warehouse business and a “certified process
server,” had been approved for disaster loans
totaling $212,700, primarily to repair/replace
real property, machinery, and equipment
damaged by Hurricane Andrew. Based on
information from SBA’s Disaster Assistance
Area 2 Office and the OIG’s referral to the
U.S. Attorney’s Office for Southern Florida,
a civil complaint had been filed against the
businessman and the two corporations in
1996. The lawsuit alleged that proceeds of
both loans had been diverted to unauthorized
uses and that Borrower’s Progress
Certifications, SBA Form 1366, covering
earlier disbursements totaling $132,362 had
been falsified so that SBA would continue
disbursing loan funds. The man paid the
Government $26,653; subsequently, the
Government was awarded a $109,914
judgment on the breach of contract and
default of contract charges. This matter
was handled as part of the Justice
Department's Affirmative Civil Enforcement
program.

California Liquor Store Owner
Sentenced for Making False Statements

The owner of a Lomita, California, liquor
store was sentenced to 5 years probation,
1,000 hours community service, and $87,000
restitution to SBA. The man previously pled
guilty to one count of making false
statements in a loan application to a
Federally-insured bank and one count of

29



Entrepreneurial Development
(Business Information Education and Training)

46 Semiannual Report March 1998



Pennsylvania Businessman Sentenced for
Making False Statement

A Lycoming County, Pennsylvania,
wholesale computer salesman and
telemarketer was sentenced to 3 years
probation and a $3,000 fine. He had pled
guilty to one count of making a false
statement to SBA by omitting from his
application for disaster assistance a mail
fraud charge to which he had agreed to plead
guilty. The false statement was made in
connection with his application for disaster
loans, totaling $78,300, relating to floods in
the Susquehanna River valley in January
1996. SBA declined the loans after
discovering the undisclosed criminal charze
The investigation, which the OIG worked
jointly with the FBI, was based on
information provided by SBA’s Disaster
Assistance Area 3 Office.

Pennsylvania Attorney Indicted for
Making False Statements

A Harrisburg, Pennsylvania, attorney was
indicted on one count of making false
statements to SBA by overstating his income
and omitting a theft conviction on his
application for three SBA disaster loans. The
man made the allegedly false statements in
connection with applications for $40,000 in
disaster assistance relating to floods in
Pennsylvania’s Susquehanna River valley in
1996. The loans were declined when SBA
discovered that his income certification did
not match the income reported on his Federal
tax returns. The case, worked jointly with
the FBI, was based on information provided
by SBA’s Disaster Assistance Area 3 Office.

28

Missouri Nautical Consultant Pleads
Guilty to Making False Statement

‘A marina operator/developer in West Alton,
Missouri, pled guilty to a one count
information that charged him with making a
material false statement to SBA to obtain
disaster assistance for his company. The
business was damaged by the Great Midwest
Flood of 1993. The man presented bogus
invoices to falsely document that he had
spent $12,862 of disaster loan proceeds for
repair of a lift well (nautical machinery)
when he had actually paid only $4,500. The
investigation also determined that, in
applying for the $93,700 disaster loan, he
falsely indicated that certain equipment
would be used as collateral for the loan; he
actually sold the equipment, however, before
he received any disaster assistance.

California Lighting Company Owner
Pleads Guilty to Making False Statements

The owner of a lighting company in Los
Angeles, California, pled guilty to one count
of making false statements to SBA and one
count of making a ‘false statement on a
bankruptcy petition. In return, the
Government agreed to dismissal of the other
six counts on which he was previously
indicted. The company owner was approved
for a $25,900 disaster business loan
following the 1994 Northridge earthquake:
however, no proceeds beyond the first
$10,000 were disbursed because SBA became
aware of a foreclosure on a property which
he owned (and where he resided) but had not
disclosed on his application. The man also
applied for a disaster home loan following
the 1995 floods in southern California, but
this loan was declined due to lack of

Semiannual Report March 1998



Office of Inspector General
Actual Personnel on Board as of March 31, 1998
A. Immediate Office 2
B. Auditing Division 34
Professional 27
Support 4
C. Investigations Division 45
Professional 36
Support 9
D. Inspection and Evaluation Division 9
Professional 8
Support . 1
E, Management and Legal Counsel Division 9
Professional . 7
Support 1.2
OIG Total 96
Additional Temporary Disaster Staffing
Funded from Supplemental Appropriations
A. Auditing Division 8
B. Investigations Division 7
C. Management and Legal Counsel Division 3
OIG Disaster Total 18
Semiannual Report March 1998 65



Audit of SBA Rebate and Refund
Disbursements Finds Processing Errors

An OIG audit found that a lack of
coordination between different elements of
the Office of Financial Operations (OFO)
caused errors in the manual processing of
SBA rebate and refund disbursements in FY
1996. The audit identified manual
processing errors, primarily payments which
were not recorded in SBA’s loan accounting
system within the required 30 days. The
auditors determined that SBA’s accounting
records reflected incorrect information and
SBA was due approximately $96,000 from
overpaid payees. The OFO concurred with
the findings and recommendations and has
already begun their implementation.

Activities to Enhance Fraud
Detection and Deterrence

Results of False Tax Return Cases
Increase

Over the last 7 years, the OIG has received
389 allegations that false tax returns were
submitted in support of SBA business or
disaster loan applications. These fraud
referrals now involve loan applications
submitted to 51 SBA district offices, totaling
$124 million and involving 1,251 individual
subjects. To date, 112 individuals have been
indicted on criminal charges: 103 have been
adjudicated guilty, 3 indictments were
dismissed, and 6 others have not yet gone to
trial.

Affirmative Civil Enforcement Program

The OIG continues to produce results from

Semiannual Report March 1998

its participation in the Department of
Justice's Affirmative Civil Enforcement
(ACE) program. This program, which is
implemented by U.S. Attorney offices around
the country, targets cases which might not be
prosecuted criminally because of the minimal
dollar amounts involved, absence of financial
loss to the Government, or because other
facts of the case might not support a criminal
prosecution. During the time that the OIG
has been involved with the ACE program,
we have had a total of 104 successful cases,
resulting in $3,057,884 in civil penalties and
$4,359,683 in recoveries by SBA.
Individual ACE outcomes are reported in the
program area chapters, as appropriate.

Investigation of California Loan
Brokerage Firm Yields Host of Charges

Criminal charges of making false statements
to a Federally-insured lender were filed
against six Californians for alleged fraud in
connection with loan packages submitted to a
now-defunct participating lender bank by an
Inglewood, California, brokerage firm. The
firm’s portfolio at the bank totaled
approximately 170 loans, originally valued at
more than $60 million. In the charges filed to
date, a former principal of the brokerage firm
was charged with three counts for allegedly
causing the submission of individual income
tax returns which he knew had been altered
to overstate the applicants’ adjusted gross
income. The loan applications covered in
these three counts totaled $1,850,000. Five
borrowers were charged with one count each
for allegedly submitting altered “copies” of
individual income tax returns in connection
with SBA-guaranteed loans _ totaling
$2,035,000. Two of the borrowers have pled
guilty to the charges against them. All these



the sale of the grocery were indicted on
seven counts of conspiracy, making false
statements to a Federally-insured bank,
and making false statements to SBA. The
investigation, initiated based on a referral
from SBA’s Atlanta District Office, found
that these two men conspired to conceal the
true purchase price from the participating
lender bank and SBA. The original loan
application indicated a purchase price of
$300,000, with the seller financing
$100,000; however, SBA declined the
application based on that price, stating that
repayment of the debt was unrealistic
According to the indictment, the broker
subsequently told the bank’s senior vice
president that the buyer and seller had agreed
to reduce the purchase price to $200,000; the
broker also faxed an Offer to Purchase to the
bank indicating a purchase price of
$200,000. The loan application was re-
submitted and approved by SBA. This
investigation revealed that the purchase price
‘was never reduced to $200,000, but remained
at $300,000, restructured into $200,000 for
the sale of tangible assets and $100,000 for
the sale of goodwill. SBA and the bank were
never informed about the goodwill aspect of
the sale, however. Furthermore, at the loan
closing the secretary submitted a $25,000
check as part of the required capital
injection; he allegedly did not have sufficient
funds to back the check and made
arrangements with the seller to exchange the
check for a $25,000 promissory note after the
closing. The indictment charges that the
secretary concealed this agreement from SBA
and the bank.

Semiannual Report March 1998

‘Texas Couple Charged with Making
False Statements

The former owners of a convenience store in
San Antonio, Texas, were each charged in an
information with two counts of making false
statements in their application to SBA for a
$131,100 handicapped-assistance business
loan, The information charges the couple
with not disclosing to SBA that they had
previously filed for bankruptcy and had
already sold the business for which the loan
was obtained. The joint investigation with
the Social Security Administration’s OIG was
based on a referral from SBA’s San Antonio
District Office.

Washington State Meat Processor
Sentenced for Making False Statements

The former owner of a meat processing and
packaging business in Endicott, Washington,
was sentenced to 5 years probation and
$43,614 restitution for making false
statements to an SBA/OIG special agent.
The investigation found that, to sell his
business for an increased price, he provided
altered tax returns to both SBA and a
participating non-bank lender to show higher
income than he had reported to the IRS.
When interviewed about the tax returns
submitted to SBA and the lender, the man
made false statements to the SBA/OIG
special agent regarding their accuracy. This
investigation, conducted jointly with the IRS,
was based on a referral from SBA’s Spokane
District Office.

New Jersey Restaurant Owner Pleads
Guilty to Making False Statements

The owner of a Seaside Heights, New Jersey,

19





Status of Investigations as of March 31, 1998 Totals
A Total Cases 317
B. Closed Cases 47
C. Pending Cases 25
D. Open Cases : 245
E. Subjects Under Investigation 1,028
Summary of Indictments and Convictions
A. Indictments from OIG Cases 43
B. Convictions from OIG Cases 26
Summary of Recoveries and Reductions of Risk
A. Potential Recoveries and Fines as a Result of OIG Investigations $3,858,627
B. Reductions of Financial Risk as a Result of OIG Investigations $145,600
C. Reductions of Financial Risk as a Result

of the Name Check Program $13,157,030
Total: $17,161,257
‘SBA Personnel Actions Taken as a Result of Investigations
A. Dismissals .. . 1
B. Resignations/Retirements 2
C. Suspensions 0
D. Reprimands* 1
Program Actions Taken as a Result of investigations
‘A. Suspensions 0
B. Debarments 0
C. Removals from Program 0
D. Other Program Actions 0
Summary of OIG Fraud Line Operation
A. Total Fraud Line Calls/Letters . 778
B. Total Calls/Letters Referred to Offices Outside the OIG 751
C. Total Calis/Letters Referred to Investigations Division for Evaluation 27
* A SCORE volunteer
Semiannual Report March 1998 63



Activities to Enhance Fraud
Detection and Deterrence

Officers of Michigan Specialized Small
Business Investment Company (SSBIC)
Plead Guilty to Misapplying Funds of
Financial Institution and Failing to File
Required Currency Transaction Report

Two officers and directors of a specialized
small business investment company (SSBIC)
in Farmington Hills, Michigan, were charged
in a misdemeanor criminal information.
Each businessman was charged with one
count of misapplying funds of a financial
institution and one count of failing to file a
required Currency Transaction Report.
Both have pleaded guilty to the charges; one
was ordered to pay $325,000 to the
Government. Under the civil forfeiture
order, the $325,000 will go to the IRS and
the U.S. Secret Service. SBA will receive
none of these proceeds even though more
than $100,000 of the misapplied funds came
from the SSBIC. The SBA/OIG continues to
seek legislation allowing it to participate in
the Government’s Asset Forfeiture program.
With regard to the count of “misapplying
funds,” the two caused the SSBIC to loan
money to a business in Michigan when they
knew the funds would be forwarded to a
business in California previously denied a
loan by the SSBIC. With regard to the count
of “failure to file,” the pair, as officers of the
SSBIC and a related company, caused the
related company to accept, in the regular
course of business, $20,000 in cash but failed
to file a Currency Transaction Report with
the Department of the Treasury. The
investigation was conducted jointly by the

36

U.S. Secret Service, the IRS, and the
SBA/OIG; it developed from information
uncovered in an investigation of another
SSBIC.

California SSBIC Chairman Pleads
Guilty to Conspiracy and Misapplication
of Funds

The chairman of the board of a now-defunct
Westminster, California, specialized small
business investment company (SSBIC) pled
guilty to one count of conspiracy and three
counts of willful misapplication of funds
belonging to the SSBIC. This plea is the
culmination of an extensive OIG investigation
initiated in 1992, based on information
provided by SBA’s Investment Division
shortly after $1 million in SBA funds were
advanced to the SSBIC. The investigation
found that the chairman made false
statements with respect to his initial cash
injection, the true ownership of the small
business concerns to which the $1 million
were loaned, and the disposition of the loan
proceeds. He recently repaid $927,000 of
the $1 million he fraudulently obtained from
SBA in April 1992. In addition, based on
information developed in the investigation,
the SSBIC’s receiver negotiated out-of-court
settlements with a bank and its operations
officer for $150,000 and $50,000,
respectively, for their assistance to the
SSBIC’s chairman in manipulating the
SSBIC’s funds.

The SBA, in response to the criminal plea,
has entered a stand still agreement with the
two individuals who pled guilty. Pursuant to
this agreement, the two are suspended from
their positions with the SSBIC and have

Semiannual Report March 1998



agreed to take no part in the operation of the
SSBIC. Additionally, SBA has refused to
roll over $2 million of SBA-owned
debentures, issued to the SSBIC, which are
due and payable.

Semiannual Report March 1998

37



The procedures for negotiating agreements
for initial and recurring matches, however,
require the expenditure of enormous
personnel resources. In addition, most
computer matching operations are "back-end
file to file" matches occurring after an
applicant has been determined eligible and
benefit payments have been made. Front
end data sharing would avoid overpayments
and allow agencies to move from a “pay and
chase” mode to one that is far more proactive
and efficient.

The Internal Revenue Code (IRC §6103)
prohibits the IRS from sharing tax return
information with other Federal agencies
absent specific statutory authorization.
Individual taxpayers may authorize the IRS to
disclose their return information and some
Federal agencies have access to IRS data for
specific programs, without taxpayer consent,
through amendments to the Code. These
amendments, however, again provide only a
piecemeal framework for _ eligibility
verification and do not cover all Federal
programs.

The primary goal of a front end verification
procedure would be to improve the ability of
all Federal agencies to prevent fraudulent and
incorrect applications. In addition, stated the
Acting Inspector General, a verification
procedure using Federal and State data bases
could ultimately reduce the amount of
paperwork required of an applicant and
shorten the response time as more agencies
implement electronic application processing.
Preventing fraud and ensuring program
integrity would also increase public support
for these programs because taxpayers would
be more confident that only honest, deserving
applicants were receiving their hard-earned

52

tax dollars.

Achieving these reasonable goals involves a
three-part solution to providing the necessary
authorization for eligibility verification: (1)
passage of omnibus legislation that would
clearly authorize the use of Federal and State
data bases for the this purpose, (2)
amendment of IRC §6103 to allow the IRS to
share relevant tax information with all
Federal agencies administering such
programs, and (3) inclusion of a clearly
stated consent on all application forms that
advises applicants that their data will be
verified, they will be given an opportunity to
explain inconsistencies, and that consent does
not change any statutory eligibility criteria or
appeal procedures.

Government-wide legislation would establish
as a matter of public policy, the principle of
eligibility verification and demonstrate the
Government's commitment to preventing
fraud. It would also ensure consistency in
the treatment of applicants for all programs,
foster cooperation between agencies, and
assist the IRS in identifying non-filers. In
conclusion, the Acting Inspector General
stated that given the voluntary nature of
Federal benefit and credit programs, it is not
unreasonable for applicants to expect that
their eligibility will be verified and, as a
matter of fiduciary duty, that the Federal
Government will take all feasible steps to
safeguard the taxpayers' money.

Proposed Legislation Reviewed; Federal
Debt Collection

The OIG reviewed proposed legislation

entitled the Government Waste, Fraud, and
Error Reduction Act of 1998 (a bill to

Semiannual Report March 1998



Disaster Loan Program

Semiannual Report March 1998 25



accurately reflect the activity being
performed, explaining the meaning of the
“Rule of Two” in the internal approval
process, and clarifying —_counsel’s
responsibility when an actual or apparent
conflict of interest arises in a proposed
cosponsorship activity.

Activities to Enhance Fraud
Detection and Deterrence

Former SBA Employee in California
Pleads Guilty to Theft of Property

A former SBA employee from Van Nuys,
California, pled guilty to two counts of theft
of Government property. The SBA/OIG’s
joint investigation with the OIG of the
Federal Deposit Insurance Corporation
(FDIC), by which he was previously
employed, disclosed that after the man was
hired as a loan specialist by SBA’s Los
Angeles District Office in 1995, he
embezzled at least $64,929 in disaster loan
payments due SBA. In most of the cases, he
falsely told delinquent borrowers that SBA
had turned over their files to a collection
agency to which he directed the borrowers to
make their payments. The collection agency
was actually an entity which the employee
owned. The investigation also disclosed that
he had embezzled $5,883 from the FDIC by
depositing a payment due the FDIC into a
bank account which he owned. The
SBA/OIG initiated its investigation based on
a referral from SBA’s Santa Ana Home Loan
Servicing and Liquidation Center.

Semiannual Report March 1998

OIG Conducts Employee Awareness
Briefings

In addition to investigating complaints of
waste, fraud, and abuse involving SBA
programs, OIG Investigations Division staff
presented five Standards of Conduct
briefings to a total of 185 Agency
employees. The involvement and
cooperation of all SBA employees in
combating waste, fraud, and abuse is critical
to an effective OIG investigations program
and to the Agency's overall productivity and
efficiency.

During the reporting period, employee
contributions to our mission were significant.

As Figure 6 shows, more than 61 percent of
all investigative referrals originated from
within the Agency in the form of referrals
either from program heads or from other
SBA employees. This cooperation indicates
the strong commitment of SBA employees to
reducing waste, fraud, and abuse in Agency
programs and improving the Agency's
management and control of its programs.

55



Investigations Activities - Referral Program

A Cases Referred to FBI :

B. Referred to Other Agencies (Excluding FBI)

C. Indictments from Referrals

D. Convictions from Referrals -

E. Potential Recoveries and Fines as a Result of Referral Program

F. Reductions of Financial Risk as a Result of Referral Program ..

ee .
BBoosn

64

Semiannual Report March 1998



Executive Summary

This report on the activities of the Office of Inspector General (OIG) of
the Small Business Administration (SBA) is submitted pursuant to
Section 5(b) of P.L. 95-452, the Inspector General Act of 1978, as
amended. It summarizes OIG activities for the 6-month period from
October 1, 1997, to March 31, 1998.

Summary of Accomplishments

OIG audits, inspections, and investigations
over the last 6 months achieved $18,229,077
in potential dollar results, 43 indictments,
and 26 convictions. The dollar results
consist of $3,858,627 in potential recoveries,
including judicially-awarded fines and
restitution; $13,302,630 in management
avoidances; $1,055,820 in disallowed costs
agreed to by SBA's management; and
$12,000 in management commitments to use
funds more efficiently.

The OIG alone could not have achieved the
accomplishments set forth in this report to
the Congress. The results for this reporting
period reflect the cooperation and support of
other Federal audit, inspection, and
investigative organizations such as the
Federal Bureau of Investigation (FBI); U.S.
Secret Service; U.S. Marshals Service;
Internal Revenue Service (IRS); other
Federal OIGs; Department of Justice (DOJ)
prosecutors; and, most importantly, the

Semiannual Report March 1998

actions of SBA program managers and
employees. Indeed, much of our success is
due to referrals made by conscientious SBA
employees

OIG Performance Plan for FY 1998

The OIG’s performance plan for 1998 is
derived from its Strategic Plan for Fiscal
Years 1997-2002. As is done by many
OIGs, this office will publish an outline
(below) of its plan in every Semiannual
Report to the Congress. The first two goals
of the strategic plan and their associated
objectives provide a roadmap for the
execution of the OIG’s mission. The OIG’s
first goal is to improve the economy,
efficiency, and effectiveness of SBA
programs through the Agency’s adoption of
recommendations resulting from the OIG’s
oversight activities. Achievement of this goal
will be accomplished by meeting the
following objectives:



Owner of Virginia Section 8(a) Firm
Understates Wealth to Gain Minority
Set-Aside Contracts

The owner of a Section 8(@) firm in
Chantilly, Virginia, was found to have
improperly understated his personal net
worth by approximately $600,000 in an
effort to participate in the program. For 2 of
the 4 years for which he provided the
incorrect financial information, OIG auditors
found that his true net worth would have
excluded him from participation. Through
1997, the firm had been awarded four
Section 8(a) contracts with a total estimated
value of $4.4 million. The audit determined
that the firm should not have been eligible for
two of those contracts. The OIG
recommended that SBA suspend the firm
immediately from Section 8(a) program
participation and initiate action to terminate
the company from the program. SBA
program officials concurred in the
recommendation.

Proposed Section 8(a) Regulations
Reviewed

The OIG reviewed and commented on a draft
of proposed final amendments to 13 CFR
Parts 121, 124, and 134 that would amend
both eligibility requirements for and
contractual assistance provisions within the
Section 8(a) Business Development (8(a) BD)
program. While the OIG endorses the efforts
to streamline the operations of the program
and clarify the eligibility requirements, it
raised a number of substantive concerns,
including the criteria for determining
economic disadvantage; the potential for
possible abuse by allowing SBA to accept a
SIC code for a Section 8(a) firm that is not

44

necessarily the most reasonable; the need for
clarification in determining when a company
should be graduated; and the need for further
criteria for granting a waiver of the sole
source ceiling in “the best interests of the
Government.”

Activities to Enhance Fraud
Detection and Deterrence

President of Maryland Section 8(a)
Contractor Indicted for Making False
Statements and Wire Fraud

The president of a computer and engineering-
services contractor in Lanham, Maryland,
was indicted on three counts of making false
statements to SBA and one count of wire
fraud. The indictment charged that he had
submitted a series of false Personal Financial
Statements for SBA’s 1992-94 annual
reviews of his status as a disadvantaged
owner of a firm participating in the Section
8(a) program. The man allegedly concealed
his true net worth when he failed to disclose
that he had, among other assets, ownership
interests in two other companies, various
pension and retirement accounts,
approximately $500,000 in a Swiss
investment account, and approximately
$190,000 in a bank account. He was charged
with falsifying his financial statements to
hide the fact that his net worth exceeded the
Section 8(a) program’s limit, making him
ineligible for participation in the program
During an SBA/OIG audit of his Section 8(a)
eligibility, he voluntarily withdrew his
company from the program, through which it
had been awarded more than $10 million in
contracts. This investigation, conducted
jointly with the OIGs of the Treasury and

Semiannual Report March 1998



Minority Enterprise Development

42 Semiannual Report March 1998



Statutory Reporting Requirements

The specific reporting requirements as prescribed in the Inspector General Act of 1978, as amended by
the Inspector General Act Amendments of 1988, are listed below.

Source Pages
Section 4(a)(2 ) Review of Legislation and Regulations 7-56
Section 5(a)(1) Significant Problems, Abuses, and Deficiencies 7-56
Section 5(a)(2) Recommendations with Respect to Significant

Problems, Abuses, and Deficiencies 7-56
Section 5(a)(3) Prior Significant Recommendations Not Yet Implemented 14
Section 5(a)(4) Matters Referred to Prosecutive Authorities 7-56
Section 5(a)(5)
and 6(b)(2) Summary of Instances Where Information Was Refused None
Section 5(a)(6) Listing of Audit Reports Co)
Section 5(a)(7) Summary of Significant Audits 1-56
Section 5(a)(8) Audit Reports Containing Questioned Costs 70
Section 5(a)(9) Audit Reports Recommending that Funds Be Put to Better Use a
Section 5(a)(10) Summary of Reports Where No Management Decision Was Made 73
Section 5(a)(11) Significant Revised Management Decisions None
Section 5(a)(12) Significant Management Decisions with Which OIG Disagreed None

Semiannual Report March 1998

67



liquidations and that SBA initiate recovery
actions on specific loans where lender
deficiencies were identified. The Acting
Associate Administrator for Financial
Assistance (AA/FA) concurred and noted that
revised SOP 50 51 2 emphasized the
importance of lender oversight. The Acting
AA/FA also noted theat other improvements
in procedures resulted from the Agency's
Liquidation Improvement Project which
started in 1996.

Loan Accounting Audit Identifies Lack of
Coordination and Control Weaknesses
for Certain Agency Disbursements

An audit of 66,000 automatically processed
and 5,500 manually processed "rebate and
refund" type disbursements made in FY 1996
identified no errors in the automated
disbursements but 260 errors in manually
processed payments, resulting in about
$96,000 in inappropriate payments.

The manual errors included recording delays
-- 237 payments (18 percent of the manual
payments made in the first quarter) were not
recorded in the Agency’s Loan Accounting
System until more than 30 days after
confirmation by the Department of the
Treasury. Of these, 166 were not recorded
within 1 year. In addition, incorrect
transaction codes were used to record 30
transactions, and 28 duplicate or
inappropriate disbursements were identified.
The audit found that the errors were caused
by a lack of coordination between different
activities within the Office of Financial
Operations (OFO) and weaknesses in controls
for detecting and correcting errors.
According to the Office of the Chief
Financial Officer (OCFO), the transfer of

12

accounting operations from Washington, DC,
to Denver, CO, and an unprecedented level
of disbursement activity following the
Northridge earthquake also contributed to the
processing errors.

Consequently, SBA’s accounting records
reflected incorrect information and SBA was
due approximately $96,000 from overpaid
payees. The OIG recommended that the OFO
develop, document, and implement
procedures to improve controls for these
types of payments, periodically review
associated accounts for abnormal balances
and recover funds related to those abnormal
balances, and recover the $96,000 identified
during the audit as due SBA. The OFO
concurred with the findings and
recommendations and has already begun their
implementation.

Audits Find Record Keeping and Other
Deficiencies at Three Nevada Certified
Development Companies (CDC)

Audits of three CDCs in Nevada found
problems in project record keeping. While
the companies generally complied with
Section 504 loan program policies and
procedures, their files sometimes lacked
evidence of site visits, capital injection,
construction phases, borrower repayment
ability, and independent project appraisals.
The audits covered three CDCs that had
made 712 loans valued at over $228 million
since the inception of the program. The OIG
sampled 31 loans valued at $18.2 million.

At one of the three CDCs, compensation
practices for two employees gave the
appearance of conflict of interest because the
employees received compensation directly

Semiannual Report March 1998



small businesses be notified that there may be
other possible collections of information in
the upcoming year, so that the mere
exclusion of a given collection from the
annual listing would not be a defense by a
small business for failure to provide the
information sought.

Section 1(b) of the bill requires the
suspension of civil fines in the event of a
first-time violation of “a requirement
regarding collection of information” where
the violation does not result in actual serious
harm to the public health or safety. The OIG
believes that civil fines should be waived
only where the violation of “a requirement
regarding collection of information” involves
the failure to provide a timely response. The
OIG also recommended that this provision be
amended to prevent waivers of violations that
result in a significant threat to the
environment. Finally, language should be
added to prevent waivers of civil fines where
the small business provided false information
or otherwise acted in bad faith in response to
a collection of information.

Proposed Legislation Reviewed;
Government Performance and Results
Act Technical Amendments

In response to a request from the President's
Council on Integrity and Efficiency, the OIG
reviewed and commented on H.R. 2883, the
Government Performance and Results Act
Technical Amendments of 1997, which
would improve Federal agencies’ strategic
plans, data accounting systems, and
performance reports. The OIG believes that
implementation of such oversight functions
must be accomplished in a manner that does
not adversely affect the IGs’ general mission

54

to improve their host agencies’ management
effectiveness and to detect and deter fraud,
waste, and abuse. We therefore expressed
concern that the provision requiring an
assessment of agency data sources and
information and accounting systems would be
particularly burdensome, given the OIG's
current staffing levels and limited resources
The OIG recommended that the provision
clearly state that OIGs need not assess all of
their agencies’ data sources and
information/accounting systems; rather,
OIGs can choose a sampling of data sources
and systems to assess each year.

The OIG suggested that language be changed
to allow OIGs greater flexibility in
determining the type and manner of review
and providing the necessary resources to
audit, evaluate, and/or assess specific
program performance results. In addition to
recommending that the OIGs be granted a
period of 150 days from the host agencies’
submission to complete audits of performance
reports, the OIG recommended a phase-in
period before requiring OIGs to review a
significant percentage of their host agencies’
specific performance reports and
accounting/information systems.

Agency Office of General Counsel SOP
Reviewed

As part of SBA’s initiative to update and
streamline its SOPs, the OIG reviewed SOP
70 50 3, Legal Responsibilities, setting forth
the legal responsibilities of SBA attorneys
nationwide. The OIG review led to
comments suggesting clarification as to when
quality reviews of legal services are to be
performed and by whom, deleting the word
“audit” and substituting “review” to more

Semiannual Report March 1998



Grant and Loan Offices, surveyed the
procedures used by OIGs and their respective
agencies to review Federal assistance
projects. The purpose of the report was to
assist OIGs in establishing more effective
methods for preventing as well as detecting
waste, fraud, and abuse by Federal grant and
loan recipients. The survey also found
strong support among OIGs for greater
coordination in identifying problem recipients
of Federal financial assistance. It
recommended that the PCIE consider
developing a community-wide clearinghouse
to facilitate the exhange of information on
problem grantees and loan recipients.

The Committee also issued a report on
Working Relationships of OIG Inspection
and Evaluation Units. It surveyed the
working relationships of 15 inspection and
evaluation units with components inside and
outside their OIGs. Its aim was to identify
practices for developing successful working
relations between the units and the groups
with which they work.

60

Semiannual Report March 1998



assignment of primary SIC codes, because
this is important in the size determination
process; requiring lenders to secure serial
numbers or vehicle identification numbers of
collateral; requiring tax return verification
for the principals of a start up business if the
personal income and assets of the principals
are relied upon in approving the loan request;
clarifying the provisions on packagers,
referral agents, and lender service providers;
and adding criteria concerning the timing,
nature, and result of certified lender program
performance reviews.

Acti s to Enhance Fraud
Detection and Deterrence

Investigation of California Loan
Brokerage Firm Yields Host of Charges

As a result of an investigation of an
Inglewood, California, loan brokerage firm,
criminal charges were filed against the
following individuals:

© A former principal of the
brokerage firm was charged with
three counts of aiding and abetting
the making of false statements to a
Federally-insured lender by causing
the submission to a participating
lender bank of Individual Income Tax
Returns which he knew had been
altered to overstate the applicants’
adjusted gross income. The loans
applied for totaled $1,850,000.

@ The former owner of a Burbank,
California, gas station was charged
with one count of making false
statements to a Federally-insured

lender by submitting altered
Individual Income Tax Returns for
the years 1988-90 while applying for
a $160,000 SBA-guaranteed loan.

The man subsequently defaulted on
the loan, leaving an unpaid principal
balance of $151,472.

© The owner of a Manhattan Beach,
California, gas station was charged
with one count of making false
statements to a Federally-insured
lender by submitting altered
Individual Income Tax Returns for
the years 1988-90 while applying for
a $350,000 SBA-guaranteed loan.
The man also defaulted on his loan,
Jeaving an unpaid principal balance of
$292,617.

© The former owner of a gas station
in Compton, California, was charged
with one count of making a false
statement to a Federally-insured
Iender by submitting altered
Individual Income Tax Returns for
1987-89 with his application for a
$225,000 SBA-guaranteed loan. The
man subsequently defaulted on the
Joan, leaving an unpaid balance of
$225,000.

© The owner of a car wash in
Lomita, California, was charged with
one count of making a false
statement to a Federally-insured
lender by submitting altered
Individual Income Tax Returns for
1987-89 with his application for a
$1,000,000 SBA-guaranteed loan.
He also submitted altered Individual
Income Tax Returns for 1990 and

Semiannual Report March 1998



TABLE OF CONTENTS

Title Page

Table of Contents

oii
Executive Summary . . bebe e cece e eset eee eeveeeeees veveeeeeeed
Business Loan Program... 2.00.00. eee cece cece ee eee cece “7
Disaster Loan Program... 2.26.0 cece cece eee ee veces eee eeeceeeeees 25
Small Business Investment Companies ... . . . _ bee eee eee eee we 84
Surety Bond Guarantees ..........0.... bcd bce v eee eee eeee .. 38
Government Contracting Programs . 40
Minority Enterprise Development .........-..2 00000 eee ees voce e eee es A2
Entrepreneurial Development (Business Education and Training)............. we 46
Agency Management and Financial Activities ............ Lec ecee ee eees 48
Organization, Resources, and Management Initiatives ................ .. 57
Profile of Operating Results... 0.0.2... e eee eee eee e eee e teens 62
FY 1998 Productivity Statistics ©... 2 cee 65
Statutory Reporting Requirements ............. bee e eee e eee e vent ees 61
Table of Appendices ..........2.....0- eee e eens bocce ees 68

ii Semiannual Report March 1998



Summary of OIG Activity / Small Business investment Companies
Indictments Resulting from Investigations 3
Convictions Resulting from Investigations 3
Investigations Closed / Remaining Inventory 1112
Investigations : Restitutions / Fines / Other Recoveries $0 / $162,550 / $1,972,000"
Reviews of Proposed Regulations 2
Reviews of Standard Operating Procedures 1

* During this reporting period, two licensees which the OIG investigated negotiated administrative setlements with SBA totaling
$1,972,000,

Outstanding SBIC Financings

ETIMM  1,839,871,565

CT $1,782,899,088
9/30/95

9/30/94

140
Bilions of Dollars

Figure 3

Semiannual Report March 1998 35



California Automobile Repair Shop
Owner Sentenced for Making False
Statements

The owner of an auto repair center in North
Hollywood, California, was sentenced to 5
years probation, a $5,000 fine, and $144,000
restitution. He had pled guilty to one count
of making false statements in a loan
application to a Federally-insured bank.
The man had obtained a $276,000 SBA-
guaranteed loan based on an application
containing altered individual and corporate
income tax returns for 1987-89. Information
concerning this borrower came to light as
part of the extensive investigation involving
loan applications prepared by two California
brothers acting as loan packagers.

Illinois Machine Manufacturer Sentenced
for Making False Statement

The former owner of an industrial machine
manufacturing company in Dolton, Illinois,
was sentenced to 2 years probation (including
6 months home detention) and $21,403
restitution to SBA and the participating
lender bank. The man previously pled guilty
to one count of knowingly making a false
statement to influence SBA. The company
was approved in 1992 for a $325,000 SBA-
guaranteed business loan, of which $42,500
was to be used to purchase machinery and
equipment. The owner subsequently
submitted an SBA settlement sheet that
certified that he already had spent $38,500 of
the loan proceeds to purchase a milling
machine and would spend an additional
$4,000 to purchase more machinery. The
investigation documented that __his
certification was false as he actually spent
only $2,000 on machinery and equipment.

Semiannual Report March 1998

Washington Restaurant Chain Executive
Pleads Guilty to Making False Statements

The president of a corporation which owned
several sandwich stores in the Tacoma,
Washington, area was sentenced to 1 year
and 1 day imprisonment, 5 years probation,
and $184,683 in restitution. He had pled
guilty to making false statements on a loan
application to a Federally-insured financial
institution. To obtain a $322,197 SBA-
guaranteed business loan, the man provided
fraudulent guaranties, financial statements,
and other documents to a participating lender
bank and SBA. The investigation found that
he had forged the signature of one
shareholder and had several employees forge
the signature of another shareholder on the
guaranties, financial statements, and other
documents. In addition, the investigation
found that the president converted SBA
collateral by selling it to a leasing company
through a third party and leasing the
equipment back from the leasing company.

Two California Business Owners Plead
Guilty to Bank Fraud

Two California businessmen-a car wash
owner and a grocery store owner--pled guilty
on January 12, 1998, to one count each of
bank fraud committed while applying for an
SBA-guaranteed loan. SBA records revealed
that the owner of the car wash had received
SBA-guaranteed loans for $700,500 and
$105,000 and that the owner of the grocery
had received a $255,000 SBA-guaranteed
loan. The investigation confirmed that the
“copies” of their Federal tax returns,
submitted to the participant bank with their
loan applications, had been altered from
those submitted to the IRS in an effort to

23



|
I Manory
.

Inspector General James F. Hoobler, a
distinguished and innovative public official
for over 35 years, died of acute respiratory
failure on December 22, 1997, at Georgetown.
University Hospital. He
was appointed Inspector
General of the Small
Business Administration
in 1991. He was 59 years
old.

Dr. Hoobler’s _ public
service career spanned
three decades during
which his leadership and
management skills have
been widely recognized.
He personified the
professional Government
manager who was able to
bring his expertise and
intelligence to a diverse
range of public policy
arenas. He began his
career at the Central
Intelligence Agency and
moved to a series of
progressively senior
positions at the
Department of Justice, the
Department of Energy, the
Veterans Administration,
the Office of Management and Budget, the
Department of State, and the Small Business
Administration.

Semiannual Report March 1998

Games F. Hoabler
1938 - 1997

Throughout his remarkable career, Dr.
Hoobler was a consistent advocate for
making public employees. more
professional and for making public
institutions more
accountable. As a
recognized authority on
strategic planning and
resource management,
Dr. Hoobler was a
frequent writer and
lecturer on public policy
and performance
management. His
greatest contribution to
public service is the
legacy of his former
employees and
colleagues whom he has
mentored and who
continue in
Dr. Hoobler’s tradition
of dedicated public
service.

Dr. Hoobler was born in
Rochester, New York,
and received his BS.
degree from Kent State
University and his M.A.
and Ph.D. from the
University of Maryland
at College Park. He is survived by his
wife, Mary; his parents, Frank and Jean;
and his sister, Gail.



Summary of OIG Activity / Economic Development

Audits Issued

Investigations Closed / Remaining Inventory

Inspections Underway

Reviews of Standard Operating Procedures

Efforts to Improve SBA
Program Management

Hawaiian Small Business Development
Center (SBDC) to Improve Counseling
and Fund Raising Practices

Improvements in counseling services and
fund raising were recommended by the OIG
in an audit of a Hawaiian SBDC’s operations.
Although counseling services are considered
the major service of the SBDC program, the
center averaged only 15.6 percent of its total
staff hours in providing counseling services.
The audit also found that funding cuts by its
sponsoring university made it important that
the center develop new funding sources.

The audit report recommended that the
Honolulu District Director (DD) require the
SBDC to submit a plan to increase counseling
hours and to increase fund raising from
private sector and local government entities.
The DD said that the center compared
favorably to other SBDCs when counseling,
training, advocacy, and research were
considered, but he directed the SBDC to
develop a plan to maximize client service
delivery. The SBDC director disagreed that
counseling is the primary SBDC service, but
agreed to enhance client service delivery in
the next annual strategic plan. The DD and
the SBDC director concurred with the fund

Semiannual Report March 1998

raising recommendation.
SBDC SOP Reviewed

As part of SBA’s initiative to update and
streamline its SOPs, the OIG reviewed and
commented on SOP 60 16, Small Business
Development Center (SBDC) Oversight. The
review led to comments suggesting that
guidelines be added to the SOP providing for
the frequency of site visits to lead
organizations and service delivery locations
and specifying what is to be accomplished
during the visits; and that prior Agency
approval should be required for travel outside
the United States by any SBDC employee
when the travel is performed during SBDC
working hours or is charged to the cooperative
agreement.

47



statement to the Federal Emergency
Management Agency (FEMA). The
investigation revealed that he submitted three
disaster home loan applications--two under
fictitious names. All three applications
contained false claims for damages from the
1994 Northridge earthquake. A total of
$27,100 was disbursed in connection with his
first two loans, and both loans defaulted
without a single payment having been made.
The third loan, for $113,000, was approved
but was not disbursed because SBA's
Disaster Assistance Area 4 Office detected
inconsistencies in supporting documentation.

California Pharmacy Owner Sentenced
for Making False Statement

The former owner of a pharmacy in Sherman
Oaks, California, was sentenced to 3 years
probation, 300 hours community service, and
a $1,050 fine. He was also ordered to
continue making timely payments on all his
SBA disaster loans. The man had pled guilty
to one count of making a false statement to
SBA. The store owner had received a
$100,000 disaster home loan (following the
1993 severe winter storms), a $45,000
disaster home loan, and a $218,000 disaster
business loan (following the 1994 Northridge
earthquake). In 1996, he requested that SBA
release its lien on his business assets.
Information supporting the request
contradicted information in his loan
applications, and the investigation revealed
that he had given SBA fictitious Wage and
Tax Statements (Form W-2), altered
Individual Income Tax Returns, a fictitious S
Corporation Income Tax Return, and a
fraudulent Corporation Profit and Loss
Statement.

Semiannual Report March 1998

‘Texas Computer Services Company
Owner Sentenced for Forgery

The owner of a computer services company
in Clute, Texas, was sentenced to 4 months
incarceration, 6 months home confinement,
30 months supervised release, $22,000
restitution, and a $150 special assessment.
He previously pled guilty to three counts of
forging endorsements on U.S. Treasury
checks, which represented a portion of the
proceeds of a $183,400 economic injury
disaster loan his business had obtained from
SBA. The man fraudulently negotiated three
Treasury checks (totaling approximately
$27,000), each jointly-payable to himself
(doing business as the computer services
company) and another business whose
endorsement was falsely made.

Nebraska Businessman Sentenced for
Making False Statement

A guarantor of economic injury and physical
damage disaster loans received by a
Plattsmouth, Nebraska, resort was sentenced
to 5 years probation (including 6 months
home confinement), $63,000 restitution to
SBA, and a $100 special assessment. He
previously pled guilty to one count of
making a false statement to SBA. The
investigation had shown that the man
defrauded SBA by submitting a false invoice
in order to cause the release of loan
proceeds. The resort received disaster loan
proceeds totaling $206,400 following the
1993 flood of the Platte River; it has made no
repayment to SBA.

31



Government Contracting Programs

40 Semiannual Report March 1998



‘Summary of OIG Activity / Disaster Loan Program
Audits Underway 3
Indictments Resulting from Investigations 8
Convictions Resulting from Investigations 10
Investigations Closed / Remaining Inventory 9179
Investigations : Restitutions / Fines / Other Recoveries $408,567 / $4,450 / $0
Investigations :Reductions to the Agency's Financial Risk $145,600
Investigations: Dectination of Loans Due to Name Checks $228,326
Investigations: Cases Referred to Other Agencies 1
Reviews of Proposed Regulations 3
Reviews of Other issuances 1

SBA Disaster Portfolio

EKUEIME $7,155,135,998

ETE $6,969,759,194
CRIES Em $6,747,768,714

TRESS $5,444,272,458

3.50 4.00 4.50 5.00 5.50 6.00 6.50 7.00
Billions of Dollars

26

Figure 2

Semiannual Report March 1998



deficiencies per loan
with deficiencies 2.0 2.04

The sample was drawn from loans approved
from inception of the program in December
1993 through September 1996. A deficiency
was defined as an instance of noncompliance
by lenders or SBA district offices with either
the Authorization and Loan Agreement or
other SBA processing and disbursing
procedures.

Deficiencies were found in 84 of the 120
sampled loans, with 171 deficiencies in all.
For 13 loans, there were 14 deficiencies
serious enough that the loans should not have
been made under LowDoc procedures.
These “fatal” deficiencies involved problems
in repayment ability, character, credit
worthiness, or eligibility. In addition,
lenders had a conflict of interest on two
loans. Other deficiencies related to IRS
verifications, equity injections, verification
of use of loan proceeds, and use of joint
payee checks. All but 11 of the 157 “non-
fatal” deficiencies involved non-compliance
with general Section 7(a) program
requirements as opposed to LowDoc-specific
requirements.

Lenders said the primary reasons for
deficiencies were loan officer error or lack of
knowledge of requirements. The auditors
noted that performance improved after SBA
issued detailed program guidance in April
1996.

The report recommended that the Acting
Associate Administrator for Financial
Assistance (AA/FA) (1) review those cases
where district offices disagreed with repair of
guarantees on defective loans, and (2)
develop a training program for new LowDoc

410

lenders. Regarding the _ first
recommendation, the Acting AA/FA stated
that the Office of Financial Assistance (OFA)
has long held that a guarantee called into
question is not addressed in a conclusive
manner until the loan is purchased. She
further stated that OFA and OIG are
currently identifying circumstances which
may lead to denial or repair of the guarantee
prior to purchase. The Acting AA/FA
agreed with the second recommendation to
provide training.

Inspection Identifies Ways to Minimize
Loan Agent Fraud

An OIG inspection identified cost-effective
ways to prevent loan agent fraud in the
Section 7(a) program. Loan agents, who
provide referral and loan application services
for a fee to prospective borrowers and
lenders, can provide valuable assistance to
small businesses seeking access to capital.
Some loan agents, however, have perpetrated
fraudulent schemes that have resulted in
defaulted loans that had to be purchased by
SBA. As of the end of FY 1997, in the
Section 7(a) program alone, criminal
investigations had been initiated on 354
individuals involving loan applications
handled by 18 loan agents. Twenty-eight
percent of these agents had prior criminal
records.

Over the past few years, SBA officials have
been examining ways to make loan agents
more accountable. Any approach adopted
would have to take into consideration the
severe limitations of SBA staff resources and
the potential for loan agents to use the
Internet to commit fraud on a national scale.
An important preventive measure, which was

Semiannual Report March 1998



Profile of Operating Results

October 1, 1997, to March 31, 1998

Audit Activities Totals
A. Reports Issued... 1.1. eee ence 211
B. Desk Reviews of CPA ‘Audit Reports Issued ................0..00- +0
C. Audit Recommendations Issued .
D. Dollar Value of Costs Questioned
£. Dollar Value of Recommendations that Funds Be Put to Better Use wees $0

Audit Followup Activities

F. Audit Recommendations Closed ........... 35
G. Disallowed Costs Agreed to by Management . $1, 055; 820
H. Dollar Value of Recommendations That Funds Be Put to Better Use

Agreed to by Management .
1. Unresolved Audit Recommendations
J. Dollar Value of Unresolved Audit Recommendations
K. Settlement Recoveries .

Inspection Activities
A. Reports Issued ..........2.0.0..0000000. bocce eens Leese .2
Legislation/Regulation/SOP/Other Reviews

Legislation Reviewed . .
Regulations Reviewed .

Standard Operating Procedures Reviewed .
Other Issuances Reviewed”

DOMD>

This includes policy notices, procedural notices, Administrator's action memoranda, and
other communications which frequently involve the implementation of new programs and
policies.

Semiannual Report March 1998



Agency Management and Financial Activities

Summary of OIG Activity / Agency Management and Financial

Audit Reports Issued

Audits Underway

Indictments Resulting from Investigations

Convictions Resulting from investigations

Investigations Closed / Remaining Inventory

Inspections Underway

Reviews of Proposed Legislation

Reviews of Proposed Regulations

Reviews of Standard Operating Procedures

Semiannual Report March 1998



computer security and —_ applications
development standards. Cotton considered
reportable conditions (1) and (2) to be
material control weaknesses.

In the section on compliance with laws and
regulations, the auditors found SBA financial
management systems were not in compliance
with the requirements referred to in the
Federal Financial Management Improvement
Act of 1996.

The Agency’s Chief Financial Officer and
Chief Information Officer both concurred
with the recommendations and agreed to take
corrective actions.

Inspection Finds that Some Agencr
Programs Fail to Collect Information
Necessary to Conduct Criminal History
Checks and IRS Tax Verifications on
Applicants

The OIG issued an inspection report that
assesses the use of criminal history and tax
verification information to detect fraud in
SBA programs. To support the Agency’s
policy of providing assistance only to persons
of good character, applicants must submit a
Statement of Personal History (Form 912),
which includes specific questions about prior
criminal record and requests the information
necessary for the OIG to conduct a criminal
history check. SBA also uses Internal
Revenue Service (IRS) verification of tax
return and financial statement information to
detect fraud by program applicants and
participants.

The inspection found that the Office of

Disaster Assistance (ODA) and several of the
specialized loan guarantee programs neither

50

use the Form 912 nor collect the information
necessary for the OIG to conduct criminal
history checks on applicants. Given evidence
that a significant number of applicants fail to
disclose their prior criminal records when
applying for SBA financial assistance, OIG
recommended that the Office of Financial
Assistance (OFA) and the ODA obtain the
information necessary for the OIG to perform
criminal history checks. In addition, Preferred
Lenders in the business loan programs should
include the completed Form 912 in the loan
materials submitted to SBA’s Preferred
Lender Program Processing Center.

Although SBA requires that financial data
submitted by applicants and participants in the
Section 7(a) and 8(a) programs be verified
using tax information from the IRS, the OIG
found that lenders and Minority Enterprise
Development (MED) officials do not always
request the IRS verification data. The OIG
recommended that the OFA develop
procedures to ensure that all loan applicants”
tax returns and financial statements are
verified with IRS information prior to loan
disbursement and that MED officials revise
program procedures to require IRS
verification in processing electronic
applications and in establishing a firm’s
continuing eligibility for the Section 8(a)
program.

The OIG also found that SBA’s Size
Standards and Surety Guarantee programs,
each of which makes decisions that are highly
time-sensitive, do not obtain verification
information due to the occasional delays
expected in IRS responses. The OIG
recommended permanent use of tax
verification in the Size Standards program and
a one-year pilot test in the Surety Guarantee

Semiannual Report March 1998



related to each loan approval. One employee
received commissions, the other received
fees.

OIG auditors recommended that the CDCs
maintain loan files in accordance with SBA
requirements and disclose to SBA any
financial arrangements that would give the
appearance of a conflict of interest. The
Deputy District Director stated he discussed
these problems with at least one of the CDC
presidents, who has begun to take steps to
improve operations.

Auditors also recommended that the Las
Vegas District Director (DD) direct each of
the CDCs to maintain their loan files in
accordance with SBA’s SOP 50 22 3. The
DD and the CDCs concurred.

Review of Proposed Regulations; Section
7(a) Lenders

The OIG reviewed and commented on a
proposed amendment to 13 CFR Part 120
that would allow participating lenders to sell,
securitize, or pledge the unguaranteed
portion of Section 7(a) loans. The proposed
regulations would impose a minimum capital
requirement, incorporate a retention
requirement, provide for suspension of
preferred lender program (PLP) privileges
and impose collection of supplemental
payments to SBA if the loss rate of
securitized loans deteriorate.

While generally concurring with the
proposed regulations, the OIG raised several
issues for consideration. For instance, when
a small business lending company (SBLC) is
a subsidiary of a larger corporation, SBA
often receives a consolidated financial

Semiannual Report March 1998

statement from only the parent corporation,
thereby making a determination of the
financial condition of the subsidiary SBLC
difficult. The OIG recommended that SBA
require audited financial statements from the
SBLC itself. Additionally, the proposal
states that SBA will “conduct appropriate
oversight” of securitizers’ compliance with
the capital requirement. Because SBA will
most likely rely on annual audited financial
statements for nondepository lenders, the
OIG questioned whether an annual review is
sufficient to ensure lender compliance.

The OIG also recommended clarification of
the definition of “good standing” and of the
relationship between _the
suspension/revocation of PLP status and the
procedures contained in Part 120.455. The
OIG further recommended that
inconsistencies in the provision governing
supplemental payments, and between the
preamble and the regulatory language
regarding suspension of a PLP’s unilateral
loan approval privilege, be resolved.

Review of Standard Operating
Procedures (SOP); Loan Processing

As part of SBA’s initiative to update and
streamline its SOPs, the OIG reviewed and
commented on SOP 50 10(4), Loan
Processing. The review of the SOP led to
comments that the applications for the
LowDoc and FASTRAK loan programs
needed revision to capture the information
needed by the FBI to conduct criminal
history checks (these are the only two
business loan programs that do not use the
SBA Form 912, Statement of Personal
History). Other recommendations included
providing examples that illustrate the

13