Several widely-publicized actions by the Securities Exchange Commission (SEC), and the inevitable litigation that has piled on in consequence, have pressure-tested the EB-5 ecosystem and found it defective. Simply stated, the system too likely and too often fails. Sadly, many EB-5 investors, after writing half-million-dollar or greater checks, ultimately have learned that no balances remain in their capital accounts and no green cards land or stay in their own and their family’s wallets.
Stripped of cash and cards, an unacceptable number of EB-5 investors find out that they have been fleeced. This calamity is not necessarily attributable to the ever-present moral hazard of failing to thoroughly investigate a proposed investment, and imprudently placing at-risk funds into an unsound business opportunity. Rather, the flaw lies in structural and process failures of misfeasant government officials and market participants to take care that EB-5 investors are adequately protected from errant or unscrupulous promoters, developers, regional-center principals and migration agents, and from sundry Ponzi schemers, garden-variety fraudsters and sophisticated con artists.
No EB-5 stakeholders and the ecosystem itself cannot continue to thrive if too many investors are defrauded of money and the promised permanent residency. Clearly, a healthy, sustainable EB-5 ecosystem cannot endure without meaningful investor protections and reliable safeguards that promote real job creation.
Why is this happening?
Culprit number one — thoughtless lawmakers. The successive Congresses that crafted and amended the EB-5 program surely must have known that some degree of fraud, waste, and abuse are the inevitable byproducts of all government programs. Yet, lawmakers never included investor protections in the enabling EB-5 legislation. Even more appalling, our legislators should have foreseen that foreign investors, many of whom lack rudimentary English fluency or business savvy, would at once be dazzled by the allure of a green card and likely unaware of the risk that the U.S. government’s own EB-5 program would be unsafe.
The Immigration Act of 1990, the law that ushered in the EB-5 program, and follow-on amendments, never authorized federal immigration administrators to debar from program participation blatantly out-of-compliance regional centers, developers, hucksters and their co-conspirators, or to protect investors from the harsh consequences of clearly foreseeable fraud and financial crimes. On the contrary, Congress knew from the outset that some deals will likely go south because scoundrels might hoodwink investors, or because other investments involve business plans with little likelihood of actual success.
Nonetheless, from inception, the law has provided that conditional residency would end and EB-5 investors brought before immigration judges in deportation proceedings if investments were not sustained — something that’s hard to do if one has been swindled — or the requisite jobs were not created.
Congress should also have known that securities law enforcers and immigration administrators would probably not quickly uncover the shenanigans hiding in some unregistered investments whose job-creating worthiness — by legislative design — would only be determined some two years hence.
Regrettably, Congress never provided for a real-time, on-the-scene watchdog to protect investors’ interests and make sure that promised actions supposedly leading to job creation for U.S. workers would actually happen.
Culprit number two — unaware and insensitive bureaucrats. As the SEC has acknowledged, it arrived several years late to the EB-5 program, having been oblivious for too many years to the Commission’s established statutory duty to protect investors in all securities transactions, including EB-5 deals. While SEC enforcement of EB-5 investments has fortunately intensified in the last few years and months, the Commission most often will likely play only an ex post facto enforcement role in punishing wrongdoers and trying to make investors whole once a deal has already failed or investors have been hurt, unless a whistleblower or grieving investor surfaces sooner.
So too have immigration administrators been derelict. Regulations of the legacy agency, the Immigration and Naturalization Service (INS), and the current Department of Homeland Security immigration components — U.S. Immigration & Customs Enforcement (ICE) and U.S. Citizenship and Immigration Services (USCIS) — offer defrauded investors no relief or even the possibility that discretion might be favorably exercised. To be sure, USCIS has tasked its Fraud Detection and National Security Directorate to make unannounced site visits to projects and regional centers and called for investor interviews when the issue of removing conditions on residency are to be ultimately adjudicated. These actions, however, have yet to occur in great numbers, may not be efficacious, or may just be too little too late.
Culprit number three — EB-5 market participants. The construction, lending and escrow industries — sectors especially active in EB-5 projects — have long been accustomed to the salutary, sentinel effect of meaningful oversight. Money doesn’t move from one contracting party to another unless predetermined and mutually agreed conditions are satisfied. The ever-present risk that funds or assets will be stolen, lost or wasted, or that desired outcomes might not be achieved, can be eliminated or mitigated if a real-time watchdog monitors contract compliance and fulfillment. The same safeguard could readily be applied for the protection of EB-5 investors and the assurance of job creation — but until now EB-5 market players seemed not to care. Instead, conflicts of interests continue to abound in the EB-5 industry and wrongdoers still go undetected until it’s too late.
What’s to be done?
All three culprits can expiate their sins if they act together or at least separately to introduce a new participant in the EB-5 ecosystem — the independent fiduciary — a person or firm that would represent the interests of investors in trying to assure the ultimate return of principal, the maximization of profits (once job creation at the requisite level has been confirmed by USCIS), and the ultimate prize — unconditional permanent residence.
An independent fiduciary would act much like a bank officer who decides whether agreed conditions have been satisfied before releasing progress payments of loan proceeds. The investors’ independent fiduciary could also perform:
- an auditing function to confirm that required business and accounting records are maintained, and only permissible expenditures are paid,
- corporate secretary/treasurer functions to make timely disclosures to investors of financial activities, monitor fund administration and job creation/hiring, give notice of the time, date and methodology for investors to vote on corporate matters, and report any significant developments or material changes to the business plan,
- a watchdog function to confirm that insurance underwriter conditions are fulfilled and required permits and licenses are maintained; and
- an education and information function to explain to investors the role and activities of the independent fiduciary, and formally confirm to government officials how EB-5 program requirements are met when and as they are due.
Other loss mitigation safeguards could also be established. These include (a) the expanded availability and acquisition of EB-5 insurance to pay a form of indemnity (the return of the investment) if investor petitions are not approved or conditions on residence are not removed, (b) the addition of other traditional forms of insurance protection (e.g., fidelity bonds, and coverage for errors and omissions, business interruption, directors and officers liability and general liability), and (c) the use of standby letters of credit.
Without eliminating moral hazard, Congress could provide in the forthcoming integrity measures that a regional center’s or project developer’s engagement of an independent fiduciary, purchase of particular types of insurance, and/or arrangement for a standby letter of credit would serve as a good-faith prohibition against the denial or loss of lawful permanent resident status in cases where the SEC, ICE or USCIS determines that EB-5 investors have been defrauded.
USCIS could add similar protections in its (reportedly) soon-to-be-published EB-5 regulations. The agency could also specify by regulation or policy memorandum circumstances where the exercise of prosecutorial discretion should be exercised and of the full range of its parole authority and employment authorization are granted to defrauded but otherwise admissible EB-5 investors.
Market players should also have “skin in the game” of protecting EB-5 investors. They should require the engagement of independent fiduciaries and procurement of appropriate insurance coverages or letters of credit that reduce but do not eliminate all investment risk so that USCIS’s at-risk capital requirements are nonetheless satisfied. Market participants should also recognize that risk reduction will add costs but likely generate overriding cost savings that will redound to the benefit of primary lenders, project developers and regional centers while also attracting migration agents, investment advisors and the EB-5 investors themselves. Ultimately and ideally, only deals with fiduciary and insurance protections will be marketable.
* * *
Checks and balances — the brainchildren of the Founding Fathers — established our constitutional form of government that has endured for centuries. One of these features is the protection of minorities against majority power. So too will a new system of checks and balances protect vulnerable EB-5 investors likely reduce the prospect that investors will write very sizable checks but yield no balances in their capital accounts or place green cards in their wallets.