Legal Due Diligence For Regional Centers and Immigrant Investors

Independent Due Diligence in the EB-5 Industry

For Regional Centers & Immigrant Investors

Many in the EB-5 industry and those who follow investment news closely have heard about the SEC’s investigation and civil complaint against Jay Peak, a Vermont ski resort.  Jay Peak relied heavily on EB-5 immigrant investors to finance its development.  The allegations are simply that the owner and high ranking company officials were using new investor money to cover over the misuse of funds from earlier investors, essentially a classic Ponzi scheme.  The activity violated EB-5 regulations related to use of funds both with regard to the early investors and the more recent investors.

In response, three things should be noted.  First, such schemes are far from new and have absolutely no stronger correlation to the EB-5 program than any other investment opportunity.  In fact Ponzi schemes are frighteningly common outside of the EB-5 world.  Most of my experience with Ponzi schemes relates to bankruptcy cases, not the EB-5 industry.  Second, the industry regulators investigated the business and found the fraud, evidencing the fact that the current regulatory scheme, though in need of some strengthening, works.  Third, it is absolutely necessary for both regional centers and individual investors to invest in legal due diligence not only before licensing a project or investing in a project, but also on an ongoing basis.

The fact that a Ponzi scheme turned up in the EB-5 industry is no more a condemnation on the EB-5 industry than it is a condemnation of the entire investment industry.  Arguing otherwise, or that the industry is tainted because of this Ponzi scheme is disingenuous, misleading and preying on prevailing emotion of the day.  After the Madoff scheme was uncovered, no one clamored for the closing of all investment advisers, wealth advisories or private equity investments.  Therefore, to assert that the EB-5 industry should be shuttered because some have used the program for their own nefarious purposes is an inappropriate reaction based upon an irrational knee jerk reaction to bad actors.  Stronger regulation and a maturing of the industry is necessary, and the tools are in place to move forward toward a more efficient and well regulated industry.

Ponzi schemes have been employed to scam people out of money for as long as investments have been available, and will continue to be employed in all sectors of investment.  The government’s goal must be to dissuade would be fraudsters, and catch those who are not dissuaded as early as possible.  Most Ponzi schemes rely upon the promise of exorbitant returns and short investment periods in order to generate investors.  This makes them relatively easy to spot for savvy investors.  Many also rely upon the fraudster’s standing and reputation in a community, making those schemes harder to turn up, without the help of an outsider who knows little of and puts little stock in the fraudster’s reputation.  Some more complex schemes may involve very complicated and technical issues that are difficult and expensive to understand, allowing a fairly smooth individual to use a track record of cash flows and complicated scheme to convince even banks to loan or invest money.  The Jay Peak situation highlights another draw that can lure unsuspecting, even fairly sophisticated investors; specifically, the allure of the United Sates Green Card.

The current regulatory framework works to turn up fraud, but there is a need for stronger regulatory controls to dissuade those who would perpetrate fraud.  There is absolutely no way to guaranty, in advance, that fraud will not creep into any investment scheme.  The best that any law or regulation can do is attempt to dissuade would be fraudsters and investigate suspected fraud.  While it is clear that stronger anti-fraud or integrity provisions are needed in the EB-5 law and regulations, the fact that the SEC is taking a more active role in the EB-5 industry is welcome and will help the integrity of the program.  What is evidenced by this case is that the SEC’s involvement in the EB-5 industry is effective at rooting out fraud even when those committing the fraud are highly regarded.  Further, the SEC has the ability to stop fraud in its tracks, once it is found, and protect investors on a going forward basis.

The most important takeaway here is that regional centers and investors need to spend more time and resources on due diligence.  While it would have been virtually impossible to find the likelihood of a Ponzi scheme during the first round of funding for Jay Peak, accomplishing appropriate due diligence in the latter phases could have turned up the fraud and protected both the regional center and investors.  Investors in the early phases are less likely to suffer losses, unless the company proceeds into bankruptcy, which is possible, but less likely after the engagement of a federal receiver.

Regional centers that partner with developers must do their due diligence on the developer before each project.  While the tendency may be to build a trusting relationship with a repeat developer, such a tendency should be avoided.  This simple fact can be clearly seen in the Jay Peak case.  The project was likely quite successful the first and second rounds, but a review of the financials may have raised some red flags, and protected both more recent investors and the regional center, allowing the avoidance of four additional ski resort projects and the medical research facility that the company is now funding.  This would have protected investors in those projects, and uncovered the fraud and looting of the company much earlier, lessening the impact.

Two things that can increase the likelihood of an investor avoiding losses from Ponzi schemes are healthy skepticism and appropriate due diligence.  There is a reason Ponzi schemes rely upon the allure of high quick returns, or another attractive element to draw in investors.  Keeping the investor’s eye away from the financials is an effective way to avoid both skepticism and appropriate due diligence.  In the case of Jay Peak, the allure of the Green Card proved to be an effective tool for avoiding any real scrutiny.  The case should serve as a reminder or a call to the industry and investors that legal due diligence is absolutely essential.  The need for more due diligence is heightened by the fact that most investors are not familiar with U.S. federal law.

Immigrant investors should insist on a full due diligence review on their acquisition of securities as part of their investment and immigration process.  Regional centers should engage independent and detailed due diligence on each project they sponsor, especially when the center has a preexisting relationship with the developer.

If you are an investor who would like to discuss independent due diligence in relation to your EB-5 visa application process, please call or email me, as I would be happy to discuss this.  If you operate a regional center, and would like to talk about due diligence and its impact on your project, please feel free to call me.  I’d be happy to discuss your options with you.