PPP Loans For Startups/Growth Companies—Former Attorney General’s Pers…


By Ed Zimmerman, Chris Porrino,Elie Honig, Kathleen McGee, Kim Lomot, & Lowell Citron (see “About the Authors” at end)

“If the money doesn’t come out fast enough, the politicians will be criticized.”

Chris Porrino, formerly 60th Attorney General of New Jersey

The U.S. government has been rapidly pushing[1] $349 billion of funding out the door[2] in SBA Section 7(a) Payroll Protection Program (PPP) Loans, while “encouraging” the public “to apply as quickly as you can because there is a funding cap.”[3] The ‘get it while it lasts’ nature of the program combined with the vague requirements regarding business qualifications for a PPP loan, will create very fertile grounds for future fraud claims.

Understanding how this scenario will play out informs how loan applicants should approach PPP loans. Several of us are former senior law enforcement officials who led investigations and prosecutions of the fraud cases that arose from relief funding in the wake of Hurricane Sandy (2012) and 9/11, and we see commonalities and differences between those past relief efforts and today’s PPP loans.

Last Thursday, we assembled approximately 600 people for a WebEx (viewable here) to apply our enforcement perspectives to these loans in the startup/growth company context.

We focused our discussion on how senior executives, board members and investors should think about whether their startup or growth company is a good fit for the PPP– and what their obligations might look like to a prosecutor or regulator six months or a few years after receiving a PPP loan.

Relief Programs Historically Lack Guidance, But PPP Is Perhaps Even More Vague: Here’s how Chris Porrino, former Attorney General of New Jersey, set the stage for the current PPP program by explaining that, just as with Hurricane Sandy, the federal government has appointed an Inspector General to review the relief funding. Porrino then referenced his experience as a senior enforcement official in a profoundly impacted state post-Hurricane Sandy[4] to illustrate how the government may act after these SBA PPP loans have been made:

I remember New York and New Jersey were still reeling from [Hurricane Sandy] and we had federal audit teams asking to meet with us — it seemed — even before the power went back on. To my surprise, the contact from these auditors wasn’t ‘hey, we’ve been through this before, we understand the process, you haven’t and it’s all new to you so let us help show you the way.’ It wasn’t like that at all. It was ‘we want to see your documents, we want to see your emails, we’re going to evaluate what you do and then we’re going to issue a report 18 months from now.’ I remember being utterly shocked by that. But that…was the system in place then and it’s the system that exists now.

In contrast to the issues surrounding prosecuting fraud claims after Hurricane Sandy and 9/11 relief funds (where the impact was geographically circumscribed and involved demonstrable physical and medical damage), the impact of the present pandemic is global and the entire nation is engulfed in “economic uncertainty.” How then do you determine right now – before the PPP loan funding dries up – whether you’re justified in applying, or whether applying is likely to trigger subsequent public disapproval, potential governmental inquiry, or worse?

Lessons from Hurricane Sandy and 9/11 Fraud Cases: Enforcement will Endure: Porrino quipped that post-Hurricane Sandy, the “subpoenas landed almost before the lights turned back on” — meaning that investigators began reviewing allegations of fraud with startling speed. While that may sound hyperbolic, on March 17, 2020, the New Jersey Attorney General had announced that “New Jersey is issuing 13 subpoenas and sending more than 80 warning letters to businesses suspected of illegally raising prices amid the coronavirus pandemic,”[5] and had already “completed at least 159 inspections…”[6]

The rapidity with which regulators commence their inquiries does not mean that the wave of enforcement is short-lived. As former prosecutor Elie Honig noted, “I didn’t start at the US Attorney’s [office] until 2004, and we were just hitting our stride on doing the post-9/11 [fraud] cases around ‘04 into ‘05. So, this could be months later, this could be years later.” Former Bureau Chief (New York Attorney General’s Office) Kathleen McGee commented that the City of New York settled[7] a post-Sandy fraud claim brought by the federal government in 2019. As the New York Times reported, “In the proposed settlement, the city admitted that it had filed false certifications to the federal government in order to receive relief funds.” (Emphasis added). Prosecutors will likely spend the next decade investigating and prosecuting PPP cases and many of those prosecutions will be based upon ‘filing false certifications to receive relief funding.’ As the New York Times wrote[8] regarding the 2019 settlement:

It’s an age-old tale: Time and again, federal relief money that is supposed to help people rebuild after a natural disaster is instead subject to fraud. Unscrupulous contractors swoop in. Insurance scams pop up. Cunning individuals use relief money to repair beachside vacation homes …New York City reached a tentative settlement to pay back the government more than $5.3 million as a result of having submitted fraudulent claims to the Federal Emergency Management Agency after Hurricane Sandy.

Politicians Have A Different Mindset Than Regulators and Prosecutors: Porrino explained that “if the money doesn’t come out fast enough, the politicians will be criticized,” but contrasted that with the regulatory and enforcement agency that will later review these loans:

The regulators have a very different perspective. They’re not worried about the money going out. It’s not ‘hey our doors are open, let us help you.’ It’s much more ‘we’re knocking on your door.’ Maybe it’s an FBI agent, maybe it’s someone serving a subpoena… the regulators are interested in setting an example, in making headlines and punishing people who they feel may have bent the rules.

It’s Personal: PPP Loans Require That You Certify Your Application: Before you apply for a PPP loan, there’s a set of legal, public relations, and moral and ethical issues to consider. In the early days of the current pandemic, tech companies and venture investors (VCs) complained about confusion regarding startup eligibility[9] for the PPP loans (we released Lowenstein Sandler LLP’s #AffiliationChecklist to facilitate rapid analysis of key questions to determine if a startup/growth company is an “affiliate” of its equityholders). Soon, some VCs began to discuss the moral and ethical issues regarding whom the PPP money was supposed to help. Ethical considerations aside, significant legal issues arise from SBA’s short loan application, which requires certifications and references the words “fraud,” “criminal,” and “imprisonment.”

At our April 8th WebEx, we discussed how to approach the certifications loan applicants must provide when applying for PPP loans, as well as how to make the decision about whether to file, and how to document the requisite good faith in making those decisions. The government has provided virtually no guidance around the specific facts and circumstances entitling an “Authorized Representative” to “certify in good faith” that, for instance:

Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.

Neither has the government been clear about what authority a signatory must have in order to be an “Authorized Representative,” or what the ramifications are for personal liability. Despite that lack of clarity, the stakes are high: the Treasury’s FAQs – issued after more than $1.8 Billion[10] in loans had been processed — clarify that by signing, the “Authorized Representative” is representing to both the bank and the Federal government that they have the authority to sign on behalf of the borrower and all equityholders who own 20% or more of the borrower.[11]

The Act Doesn’t Provide a Glossary: The government has not provided definitions or metrics to help guide potential borrowers on whether they should apply. How then can a startup certify that the loan is “necessary to support ongoing operations,” without the government defining what constitutes “necessary,” for instance? Similarly, we are bereft of guidelines on requisite link between the pandemic and the borrower’s need for the loan. To illustrate, absent guidance, are we to presume that a company with revenue growth soaring due to pandemic-driven demand for its products should take the loan to “retain workers” as it leans into growth in uncertain times? That does not seem consistent with the legislative intent, but does the Treasury guidance prohibit or frown upon that interpretation? How do we differentiate between a startup that meets financial plan but is anxious about the financial uncertainty the pandemic has caused versus a concert venue-related startup that justifiably seeks a PPP loan because revenue has dropped to zero? Additional required certifications in the loan application[12] specify how to use the funds and acknowledge that the borrower could land in prison for up to 30 years for knowingly making false statements in the loan application:

The funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments, as specified under the Paycheck Protection Program Rule; I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable, such as for charges of fraud.

I further certify that the information provided in this application and the information provided in all supporting documents and forms is true and accurate in all material respects. I understand that knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law, including under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000 under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a federally insured institution under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.

 As Porrino explained:

You want to turn to the glossary and see a specific answer with percentage revenue drops…there’s none of that in the [CARES] Act. The truth is that those terms will be defined by the regulators six months, a year or two years from now. The thing that we’ve seen over the course of time both as policymakers and as prosecutors and now as defense lawyers, the rules sometimes change a bit. I’m sure there are a number of people listening who would like to see a change in November following the Presidential election. …Put aside the politics … what will come with a change in administration will be a change in enforcement priorities, and that may include a disagreement by the new administration about how the old administration defined terms like “affected” [by the pandemic]. We’ve seen this in lots of contexts: tax incentive programs, aid that’s provided in the wake of a crisis, where one administration is pushing out the aid and the incentives, there’s a change in the administration and then, all of a sudden, a different standard is applied in the regulatory context in the aftermath of that crisis… A year from now, it could feel like the goal posts have been moved even after the game was supposed to be over. One of the questions we all have to ask ourselves is, ‘with this backdrop and this reality, how close to the line (which may move a bit) are we willing to come?

Further fueling confusion, the U.S. Treasury Department has provided a one-pager, entitled “Top-line overview of the paycheck protection loan program,”[13] stating, in large bold type: “All Small Businesses Eligible” and “apply as quickly as you can because there is a funding cap.” This document does not mention requiring damage to the business, or any causal link between harm to the business and the pandemic, nor does it reference what constitutes need (or that need is a prerequisite). Yet, the certifications make clear that there must be need and it must result from the pandemic. Treasury’s promotion of SBA’s PPP loans in this manner nonetheless explains why we’ve heard executives describe the program as “free money” available from the government for a limited time.

Absent guidance, each potential borrower is forced to divine its own subjective answers. For instance, must revenues be shrinking? What if a startup recently raised a round and has six months of “burn rate” in the bank? If you had done a reduction in force in December (pre-pandemic), is avoiding further layoffs in April sufficiently linked to the pandemic’s impact and how do you substantiate that? We discussed other factors in this twitter thread.

Honig explained that “the subjectivity and lack of clarity in the criteria” for these loans makes it harder in both directions: “How are you going to prosecute someone for saying something affected their business?” Without further governmental guidance, how will you defend your position that you were sufficiently affected, when you didn’t know at the time of certification what “sufficient” meant in the context of these loans? Contrasting the vague wording in the PPP with the standards applicable to other relief funding, Honig observed: “The criteria [for PPP loans] are way more subjective than anything I ever saw and way more open-ended than what we, as prosecutors saw in the fraud cases we pursued after 9/11 and Sandy.”

The PPP Falls Outside SBA’s Experience as Speed Minimizes Underwriting: SBA specialist Kimberly Lomot has closed hundreds of SBA loans representing numerous lenders throughout her time on SBA 7(a) loans specifically. However, she explained how the new PPP loans differ dramatically:

It was completely different pre-PPP. The documentation [and]… underwriting process were so much more robust. When you were typically closing a 7(a) loan, there were numerous documents, months of underwriting process that went on between the lender and applicant, searches done on everybody [and] numerous certifications in the old package. Borrowers had a lot more clarity on what they were signing up for. Pre-PPP, [lenders] had background, information, conversations, they were meeting with all of these people. They could do all the digging in the background for their underwriting processes. [Now,] they’re being told ‘do not rely on anything but this application.’ They’re not doing that underwriting, that digging. They’re basically being told from SBA and Treasury that they [the lenders] are going to be held harmless…It obviously has some applicants nervous, because they don’t know where that line is.

Lomot is referencing Treasury’s FAQs,[14] which ask: “Are lenders required to make an independent determination regarding applicability of affiliation rules under 13 C.F.R. 121.301(f) to borrowers?” and answers:” No. It is the responsibility of the borrower to determine which entities (if any) are its affiliates and determine the employee headcount of the borrower and its affiliates. Lenders are permitted to rely on borrowers’ certifications.” (Emphasis added). Treasury’s FAQ confirm the banks reliance on borrower certifications (without verification): “Lenders may rely on that representation and accept a single individual’s signature on that basis.” This dramatically departs from the process these lenders have previously followed, though many PPP lenders are, in fact, new to SBA lending.[15] This too intensifies the odds that something will go awry, especially where the Treasury Department has pressured lenders to wire loans without independent diligence. While the process was clunky at first, we have now seen loans disbursed the business day after applying.

SBA’s Form, Bank’s Form, Whatever:Almost upon enactment of the PPP loan program on March 26, the banks confronted an immediate and massive backlog of applicants pounding down their doors to access what some called the “free government money.” SBA and Treasury had not yet released a form of application nor a loan agreement. SBA issued the application on April 2, but SBA did not provide the form of promissory note (loan agreement) until April 7. Treasury issued roughly contemporaneous FAQ (re-issued multiple times between April 6 and April 13) providing: “Lenders may use their own promissory note or an SBA form of promissory note.” As Lomot noted, this “lack of uniformity” in the form of loan document means that whether you’re in default will depend on which form your lender used. That will add to future problems and likely, litigation. This seems to confirm Porrino’s analysis regarding the incompatibility between the political will to immediately send money to where it is needed, and the methodical approach enforcement officials will likely subsequently employ.

Honig’s Four Phases of a Fraud Claim: To provide a clearer picture of how this will unfold, Honig shared commonalities between his enforcement of post-9/11 fraud claims and his enforcement experience post-Sandy in New Jersey, into a four-phase process:

1.    “First, the money comes in. And it comes in fast and in enormous amounts. You will see billions of dollars hitting the coffers of agencies that have never handled a fraction of this money. We saw it with 9/11: money was pouring into governmental agencies, to the Red Cross. [After] Sandy, money was pouring into the State.

2.    “The pressure to get that money out the door. It’s days — not even weeks — days until the media starts saying, ‘it’s great all this money’s been allocated; who’s getting it, what’s taking so long?’ I’m sure those stories are already starting… [Honig is correct][16] [That speed leads to problems:] we prosecuted a series of 9/11 cases where the controls from the agency were so thin, people were getting five-figure loans literally on one page! I still remember, from the discovery, one-page applications. Unverified, sworn or not, still potentially punishable. Very [cursory]: ‘did you lose property, did you suffer physical injury, describe here in this box, how much are you claiming?’ That’s it. And money got shoved out the door so quickly, with such minimal controls, particularly with the 9/11 scenario.

3.     “Here Come the Regulators” — …at times, spurred by the media; at times, spurred by the natural behavior of governmental entities, here come the regulators; here come the audits; here come the Inspectors General. That can happen years later… sure enough and bet on it, the Inspectors General, the auditors, the comptrollers will be looking at this, will be looking at the books.

4.    Phase four: Then, finally, the most egregious cases end up on my former desk. [For] prosecutors… there’s pressure to produce results, there’s pressure to produce hides… where are the prosecutions? Every time we announced a [Hurricane] Sandy case: ‘how many of these have you done? Why haven’t there been more?’

Spurred by Media:” As Honig indicated, prosecution could be “spurred by media,” which is why public relations considerations are inextricably linked with legal considerations and prosecutorial discretion. As McGeeMatthew J. Moisan, and Jesse S. O’Connell of Lowenstein Sandler wrote,[17] the loan application is covered by the Freedom of Information Act (FOIA):

Information about approved loans that will be released includes, among other things, the borrower’s name (and the names of its officers, directors, stockholders, or partners), the amount of the loan, and its purpose in general terms and the maturity.

In discussing the Privacy Act[18] and the Freedom of Information Act (FOIA), the instructions specifically entitle SBA to “refer” information otherwise protected by the Privacy Act to law enforcement, when “this information indicates a violation or potential violation of law, whether civil, criminal or administrative in nature.”[19]

Remember, the Authorized Representative is certifying that “the information provided in this application and the information provided in all supporting documents and forms is true and accurate in all material respects.” As Porrino noted, “everything that government is involved in is public. After Sandy, the New Jersey comptroller had a running list of beneficiaries and those who received loans and aid … you have to assume that it is, or all becomes, available.”

How Will You Be Judged?  During this part of our discussion, Lowenstein Sandler Chair of Debt Financing Lowell Citron advised that you need the backup documentation, because in litigation involving loans, both backup documentation and process will matter. McGee confirmed that prosecutors will focus on the process and substantiation through documents: “When a prosecutor goes back two years from now, they’ll claw through your files looking for whether or not you had good faith substantiation.”

Porrino advised:[20]

It’s really important to remember that you may be judged by your internal deliberations and how you had them. If there’s email traffic that undercuts the conclusion that was ultimately made, for example, those emails are going to be front and center in an audit, prosecution or civil investigation three, four or five years from now. You have to be engaging in meaningful internal deliberations that are documented and can be relied upon if regulators ask questions later — engaging with your financial and legal professionals and board, where the board’s involvement and minutes recording that involvement will be important. Appropriately detailed board resolutions authorizing the action – all of that should be undertaken with the understanding that it (or the lack of it) will be available to regulators down the road. Focus on providing and preserving specifics that might be helpful to find in your files two years from now when someone comes knocking and says: ‘hey, explain to me how you got to this conclusion, because we’re not really sure you satisfied the program’s requirements.’

We understand – from sitting inside venture-backed growth company board rooms – that nobody wants to discuss board minutes. In 2015, Ed Zimmerman published[21] on the impact of Board minutes on litigation in Delaware courts, focusing on a speech by Chief Justice Strine (Delaware Supreme Court) along with the Disney/Ovitz case, which turned (in part) on what was reflected in the minutes, which are a record of what the Board actually did. In the present situation, we prefer that the boards meet to expressly authorize their “Authorized Representative,” rather than bypassing the deliberative process by using unanimous consents.

Honig advised that a subsequent reviewer will draw significant negative inferences if emails or texts, for instance, have been deleted. Despite the evident legal morass PPP loans will yield, Porrino remarked:

The vast majority of these applications, grants and loans will neither be investigated nor prosecuted. We had, I think, 100+ criminal cases in New Jersey in the aftermath of Sandy. That’s a relatively small percentage of all the claims paid. Most people use good judgment and never hear a word…

Let’s hope you’re among that group.

About the Authors:

Chris Porrino, previously, 60th Attorney General of the State of NJ, Chairs Lowenstein Sandler LLP’s Litigation Department.

Elie Honig, former Assistant U.S. Attorney, Southern District of New York (where he prosecuted post-9/11 fraud cases); former Assistant Attorney General, NJ (where he prosecuted both post-9/11 and post-Hurricane Sandy fraud cases); currently splits time between Lowenstein Sandler, serving as a CNN Legal Analyst and at the Rutgers Institute for Secure Communities.

Kathleen McGee, former Bureau Chief for Internet & Technology, NY Attorney General’s Office; served in Mayor Bloomberg’s Administration (Director, Mayor’s Office of Special Enforcement); prosecuted homicide and sex crimes as an Assistant District Attorney in the Bronx, now serves in Lowenstein Sandler’s Tech Group and White Collar Criminal Defense Group. 

Kimberly Lomot, previously certified as a Designated Attorney for SBA 504 Lending, serves as a debt financing and real estate lawyer at Lowenstein Sandler.

Lowell Citron, Chair, Debt Financing, Lowenstein Sandler LLP.

Ed Zimmerman, Chair, Tech Group, Lowenstein Sandler LLP & Adjunct Prof. of Venture Capital, Columbia Business School, Co-Founder, VentureCrush.

END NOTES:

[1] See tweet from Treasury Secretary Steve Mnuchin on April 3 (the day that loans went live for the SBA 7(a) Program under PPP, stating “UPDATE over $1800000000 #PPPloan now processed by @SBAgov mostly all from community banks. Big banks taking in large amounts but not yet submitted in these numbers! #CARESAct #SmallBusiness” at 2:08 p.m. He had tweeted that SBA had processed “over $875,000,000” at 11:40 a.m. that day. By April 7, 2020, Secretary Mnuchin had tweeted that he was in talks (at the President’s request) to add another $250 billion to the loan program.

[2] See, e.g., “ABA Data Bank: Paycheck Protection Program Loans Total $205 Billion,” ABA Banking Journal (April 12, 2020) Banks of all sizes have been working round-the-clock to provide PPP loans, processing 820,000 loans totaling roughly $205 billion as of Sunday at 3 p.m. There are now a little over 4,400 lenders participating in the program, up from 1,700 a week ago.”

[3] Treasury Department’s “Top-line overview of the paycheck protection loan program (we believe that this was released in early April 2020, but it is undated; site visited April 12, 2020).

[4] Hurricane Sandy hit New York and New Jersey (among other places) in late October 2012. Porrino served as Director, Division of Law at the New Jersey Attorney General’s Office and then Chief Counsel to the Governor of New Jersey from February 2012 through August 2015.

[5] Blake Nelson, “N.J. businesses hit with 80 warning letters for price gouging during coronavirus crisis,” NJ.com (March 17,2020).

[6] Press Release: “AG Grewal on Price-Gouging: Stop, or Face Consequences,” New Jersey Attorney General (March 17, 2020).

[7] See Luis Ferré-Sadurní, “City Admits Defrauding FEMA After Hurricane Sandy; Agrees to Pay $5.3 Million,” New York Times (Feb. 20, 2019).

[8] Id.

[9] See, e.g., Ed Zimmerman, “Wait, What?! Treasury Clarifies “Affiliation” Rules For SBA Section 7(a) Loans (& Startups Are…),” Forbes (April 5, updated April 7, 2020).

[10] See prior footnote referencing Secretary Mnuchin’s tweets from April 3, 2020 and note the Treasury Department’s “FAQ,” first issued three days later on April 6, revised repeatedly through April 13, 2020.

[11] See Treasury Department’s “FAQ” (April 6, revised repeatedly through April 13, without showing revisions). Question 11: “An individual’s signature as an “Authorized Representative of Applicant” is a representation to the lender and to the U.S. government that the signer is authorized to make the certifications, including with respect to the applicant and each owner of 20% or more of the applicant’s equity, contained in the Borrower Application Form. Lenders may rely on that representation and accept a single individual’s signature on that basis”

[12] We refer to SBA’s form Loan Application released on this part of SBA’s web site on April 3, 2020, bearing the stamp “OMB Control No.: 3245-0407 Expiration Date: 09/30/2020.” SBA had released prior versions, none of which appear to have had a date/time stamp. Link (visited April 12, 2020).

[13] This release, like many others from Treasury in connection with PPP, is undated but we believe it dates from late March/early April 2020. Link (visited April 12, 2020):

[14] See Treasury Department’s “FAQ” (April 6, revised repeatedly without showing revisions). The April 10, 2020 version at Questions 4 and 11.

[15] Numerous market participants have remarked that one popular lender to startups has advised that though the bank has been authorized to make SBA loans for years, the bank has not done so in many years so it took time to restart that process and make SBA lending “operational” again.

[16] See, e.g., Emily Birnbaum & Biz Carlson, “Startups are racing against time for stimulus funds — and Washington’s efforts are falling short,” Protocol (April 7, 2020).

[17] Kathleen A. McGee Matthew J. Moisan and Jesse S. O’Connell, “The Paycheck Protection Program: FOIA and Potential Implications for Applicants and Investors,” Lowenstein Sandler (April 8, 2020).

[18] See 5 U.S.C. 552a (available at here on Justice.gov, visited April 12, 2020) referenced on page 3 of the Loan Application.

[19] See Loan Application at page 3, under “Disclosure of Information,” which states: “The Privacy Act authorizes SBA to make certain “routine uses” of information protected by that Act. One such routine use is the disclosure of information maintained in SBA’s system of records when this information indicates a violation or potential violation of law, whether civil, criminal, or administrative in nature. Specifically, SBA may refer the information to the appropriate agency, whether Federal, State, local or foreign, charged with responsibility for, or otherwise involved in investigation, prosecution, enforcement or prevention of such violations.”

[20] This quote underwent minor clarifying edits, as the video clip referenced other parts of our WebEx discussion.

[21] See Ed Zimmerman, “Did It In The Minutes: In Favor of More Detailed Startup Board Minutes for Important Decisions,” Forbes (2015):

Experts involved in the case published analysis following the Delaware Supreme Court’s decision, stating that the court underscored the inadequacy of the minutes, although arguing that the process itself was better than the minutes indicated. This led to the conclusion (shared by other commentators who remarked on the case) that better and more detailed board minutes may have shortcut this protracted litigation in a way that would have materially benefitted the board and the company’s stockholders: “The Disney case shows the complexity of recording board and board committee minutes,” concluding “in light of the tidal wave of litigation, much of which attacks CEOs and boards, a school of thought has developed advocating more comprehensive minutes, providing more detail about what actually occurred at the meetings.





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