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Fraud on Investors in EB-5 Investments: Caveat Emptor! Part 3

Fraud on Investors in EB-5 Investments: Caveat Emptor! Part 3

EB-5 Fraud Courtroom

EB-5 Fraud Buttressed by Systemic Problems in the Industry

Most industry members are troubled by the few fraud cases that occur, and are dedicated to creating greater industry integrity.  The clear majority of industry stakeholders are working ethically and simply working to provide appropriate service to investors, since the investors are the life-blood of each EB-5 related business.  The difficulty in making changes is that the problems are systemic, and amplified by cultural differences and the perceptions of different constituencies within the industry.  The systemic problems are clearly discussed below, but this list is not exhaustive or intended to cover all issues.  Instead the purpose of providing this description is to discuss some of the large problems which impede creation of a better system that protects the investors, while increasing trust and thus easing burdens on developers and regional centers.

1. General Fraud Motive and Opportunity

The first industry issue that is an impediment on industry integrity is a less scrupulous individual who understands the system or is able to gain an understanding of the system, immediately has the opportunity to defraud many investors of large sums of money in a short period of time.  By its own terms, EB-5 fund raising deals in extremely large sums of money.  Legitimate contemplated projects are often presented in hundreds of millions or even billions of U.S. Dollars.  Investors are conditioned to look at the ration of EB-5 Dollars to total project cost, and then view this in light of the economic impact and jobs created.  It is also safe to assume that the larger the cost of a project the more complexity will be involved in the financial structure of the deal, the make-up of the participants and how each is compensated, the legal requirements of the deal, and thus, the documentation will be much more complex.  Further, the investors are all foreign, and likely have limited knowledge of the U.S. legal system, how professionals are used within our system as a means to mitigate risk.  Also, the documents are not ordinarily written in the investor’s native language, and may have to be translated, but the English language version controls.  In the general course of things, the investor meets multiple parties and professionals, all providing information, but may have little clarity on what each professional is offering in the way of beneficial information.  So, the investor may consult a local attorney, accountant, or may just rely upon a migration agent’s statements.  Once a decision to invest is made, the investor has no idea how to approach a U.S. attorney to handle the immigration petition, and so he or she relies upon participants in the transaction to make a recommendation, which is provided, normally through an intermediary, and so there is a gatekeeper in relation to all information that gets into the hands of the investor.

All of these issues add up to opportunity for someone intent on defrauding an EB-5 investor.  First, motive is created by the large sums of money that change hands.  Ideally, the fraudster is able to get his hands on the actual investment, but doing so takes a long game, or a dishonest or otherwise conflicted attorney.  But, just the administrative fees alone add up to some serious money, if the project is big enough.  Tie that in with the fact that bigger projects can add layer upon layer of complexity in which to hide or gloss over relevant information that could be signs of fraud, and a conman can easily use EB-5 to bilk unsuspecting investors of millions of dollars.

Second, means and opportunity are created by the requirements of the system, and the nature in which business is carried out.  As a starting point, significant dense, legalese filled documents, designed and written not to inform, but rather to comply with legal requirements of the securities laws of the United States and different states that may have jurisdiction, are drafted.  Developers are required to provide a private placement memorandum (“PPM”) to each potential investor, and in that document, must be all the information that a rational investor may need to make a decision about the investment.  This includes page upon page of information regarding risks in the project, as well as pages of legal requirements for the project to move forward, and a description of the project, project financial projections and much more.  The PPM is written in language that proficient English speakers would find difficult to read and comprehend, but it is handed to a non-native English speaker.  This provides a perfect opportunity to write something so complicated that it sounds good, but conveys no pertinent information.

Beyond the PPM, various agreements related to the new business are created, which are designed to limit the investor’s involvement in management of the company and use of funds as possible within the framework of EB-5 immigration law.  An operating agreement, or limited partnership agreement, may be dense and complex, and thus easily misunderstood.  Further, the subscription agreement does not provide much information.  Between all the legal documents drafted, the investor is likely to skim the document (likely not in his or her native language), but only focus on a couple of key portions.  Because of this, the investor will place reliance upon the migration agent who is really representing the developer.  If the developer is a fraud, he is counting on the migration agent to sweep questionable issues under the rug and focus on the highlights and aspects that might attract investors.  This is because the fraudster is likely paying top dollar for a successful referral of an investor.

The economic analysis likely makes little to no sense to anyone not familiar with such documents, adding confusion, and by its complicated nature coupled with the complicated nature of the other documents, written in English, the investor is incentivized not to read the documents.  Translation is incredibly expensive for what may be hundreds of pages of written words, and the translation would not control anyway.

Therefore, the marketing documents become the key to securing investors rather than the legally binding documents.

Because of this, those bent on doing wrong have the upper hand throughout the transaction.  Motive, means and opportunity are all on the fraudster’s side.  Further, the U.S. government does not have the power to control what the non-United States individuals are doing in a foreign country in relation to marketing, without banning transactions with them.  Such draconian regulation is not warranted to combat a relatively small amount of fraud.

2. Market Conditions and Behaviors

A part of the opportunity for those bent on fraud is the market conditions in China, the largest consumer of EB-5 Visas.  As indicated above, the investor is not at fault for being defrauded, but typically, the investor does not avail himself or herself of the protections available for one reason or another.

Generally, neither migration agents nor investors use due diligence firms in the United States to conduct even rudimentary due diligence on a project.

Investors limit the involvement of United States attorneys in the transaction, thus receiving less bang for their buck.  They do not make efficient use of the attorneys who are best positioned to protect the investors’ interests.

The compensation structure discourages comprehensive due diligence, as plausible deniability is valued by those who have access to the investors.

Demand in the market far outstrips availability, tilting the balance of power in favor of the developer and against the investor, and increasing the desirability of flashy projects in interesting locations.