Banks Cash In On PPE, But Risks Could Haunt Them
By Al Barbarino
June 19, 2020
U.S. banks are facilitating a flurry of deals to bring personal protective equipment into the country from China and elsewhere in exchange for hefty fees, but inherent risks could come back to bite them as regulators continue to expose underlying fraud.
Presiding over these anything-but-ordinary deals can be a risky business, with “know your customer” due diligence increasingly difficult when sorting through a newfound market that the latest headlines suggest is rampant with fraud, attorneys say.
“Everyone in the world has their hair on fire to get these masks and the rest of the PPE,” said Andrew S. Ittleman, a founding partner of Fuerst Ittleman David & Joseph. “With so much more risk of fraud out there … the banks certainly have their work cut out for them.”
The PPE deals often include a web of entities, including brokers in the U.S. calling on relationships in China to access the products. Banks may provide so-called back-to-back letters of credit that guarantee the payments — one bank for the U.S. buyer, and a foreign bank for the seller — which attorneys say could prove problematic down the road.
Ittleman said his work dealing with PPE transactions has made him aware of at least one “very large bank” on the U.S. side executing letters of credit on the deals.
“I would imagine that a bunch of the bigger [banks] are involved too,” he said. “There are going to be all sorts of fees for the letters. … They’re not doing it as a charity. They’re doing it because they have the capabilities and they know how to make money doing it.”
While the attractive fees may be enticing, banks could find themselves in a vulnerable position as they seek to comply with KYC and anti-money laundering rules around customers who may have little to no experience selling PPE.
“They were selling Chinese widgets in the United States yesterday. They were selling plastic flowers or ping pong tables,” Ittleman said. “That requires a lot of trust on behalf of the bank to work with the broker to make sure everything is being conducted the way it should be.”
Regulators have begun to expose fraud in this newfound booming market for PPE. This month, the U.S. Department of Justice charged a Chinese manufacturer with producing and exporting nearly half a million misbranded and defective masks to the U.S. And 3M has now filed at least a dozen lawsuits accusing companies of everything from price-gouging legitimate 3M products to selling counterfeit masks.
Last week, New York State Attorney General Letitia James brought a suit against a Buffalo-area businessman for “soliciting the state of New York” and hospitals across the country with “fake offers of critically needed PPE.” And in late May, a New Jersey used car salesman was arrested and charged in federal court with running a $45 million scheme to sell price-gouged N95 face masks to New York City.
While no banks were indicated in the cases, actions — most likely from the DOJ’s civil division — could start trickling down in the coming weeks or months as more fraud is exposed and the role of banks in any potential transactions is uncovered, attorneys say.
While these types of investigations typically begin with the alleged fraudsters, investigators will ultimately explore all facets of the transactions, said William Barry, a member of Miller & Chevalier who assists clients with a range of financial compliance and regulatory issues.
This will include whether the bank was knowingly involved in its customer’s scheme, if it was “willfully ignorant” of wrongdoing, and if it took the necessary KYC and AML precautions.
“Step one will be to look at the actual suspected fraudster,” Barry said. “Step two is to get the bank’s help in understanding the transaction record. Step three, they’ll consider whether the bank’s processes were deficient or worse than deficient in connection with the fraudulent conduct.”
“The primary risk area is letters of credit and any looseness in those relationships,” he added. “Of course, any bank is interested in having that customer relationship and the fees that it generates, but may not do sufficient diligence to understand who the beneficiary of the letter of credit is or who the client is.”
Community to mid-sized banks are at risk, as many of them lack the safety net of “sophisticated electronic risk monitoring systems” that are commonplace at larger banks, Barry said. But he added that larger banks could face still issues, as their automated processes could fail to identify the PPE transactions as materially significant.
Instances of criminal activity, such as a bank employee being involved directly in a fraudulent scheme, would fall into an entirely separate, and rarer, bucket, experts say.
Clifford Stanford, a partner with Alston & Bird LLP’s bank regulatory team and former assistant general counsel at the Federal Reserve, echoed that most potential penalties will come down to whether KYC and AML standards have been met, with more aggressive action taken if systemic issues are found.
“If it’s systemic … that’s when you start to see banking regulators and the DOJ coming after banks,” he said. “If a bank has failed in performing that KYC and AML discipline and has allowed transactions to move through without appropriate monitoring or reporting, they could also be swept up in a broader review.”
Despite the growing instances of PPE fraud coming to light, attorneys noted the bad apples aren’t representative of the broader lot of legitimate brokers who are simply businesspeople looking to make deals.
Rachel Wolkinson, a partner in Brown Rudnick LLP’s white collar defense and government investigations group, said she’s worked with a number of well-intentioned brokers seeking legal assistance as they look to nail down prospective PPE transactions.
“I don’t know why the bank wouldn’t want to deal with them,” she said, noting many brokers are sophisticated, informed and well-intentioned. “I think it really is going to be very specific to the individual broker. Not every broker is a shady cat looking to exploit the COVID pandemic. Just because you are entrepreneurial, that doesn’t make you a criminal.”
–Additional reporting by Rachel O’Brien and Bill Donahue. Editing by Philip Shea and Marygrace Murphy.