How to Increase the Odds of Spotting Fraud in EB-5 Schemes
Kathy Bazoian Phelps, Financial Fraud Litigator,
Diamond McCarthy, LLP
Jon D. Fleming, Receiver and former principal of an EB-5 Regional Center
For foreigners looking to become citizens of the United States, the EB-5 Immigrant Investor Visa program can be an extraordinary gift if handled lawfully, or a financial nightmare if ripped apart by fraud. While foreign investors are primarily interested in gaining resident status in the United States, some EB-5 operators or agents are more interested in attracting and misappropriating the money. If the project or the money goes sideways, that can doom the entire immigration application process, leaving investors without both visa and cash.
The investor’s immigration lawyer is often the primary point of contact for the investor and may be the first one to sense that something has gone amiss. This article will discuss the importance of vetting an EB-5 program at the outset and continually monitoring the investment through to conclusion. The opportunities for theft or misdirection of investor funds are unfortunately too tempting and oversight over the funds is often not tight enough.
There are far too many well-publicized cases of misappropriation by developers, immigration brokers, and others who either steal investor funds or spend them in a manner inconsistent with EB-5 requirements. Even when a project is successfully completed, there is a risk that the funds may be stolen before the full adjudication of the visa application. On occasion, rather than redeploying the funds to keep them at risk, the fraudster misappropriates them. A few recent examples demonstrate the ease with which investor funds can end up in the wrong hands and potentially destroy the EB-5 immigration process.
In SEC v. AJN Investments LLC, Case No. 0:16-cv-63036-KMW, the SEC alleged that AJN Investments and its CEO had engaged in securities violations in connection with its EB-5 investment offering that defrauded 14 foreign investors out of $6.7 million. The investor funds were to be used to build and operate stores that were franchised from two other businesses controlled by the CEO. Investors were promised a 5% preferred return and other cash distributions on their financial investment, and the program was expected to be sufficient to qualify for an EB-5 visa and green card. AJN delivered a Confidential Private Placement Memorandum (PPM) to the investors, giving each investor the right to consult with the managing member on the location of their store. The books and records for each store would be maintained separately. The subscription fee was $550,000, of which $50,000 was a one-time administrative fee, $75,000 was for working capital, $25,000 was a reserve for management services, and $400,000 was for store construction, equipping and opening expenses. AJN and the CEO misappropriated the investor funds and did not use the funds as represented. At least $2 million was misappropriated to pay unrelated litigation expenses and loans and over $1 million on personal expenses. The $25,000 reserves were not held as represented, and funds that were to be invested in a job creating enterprise were not in fact so invested.
Potentially even more problematic than the loss of funds was the risk that AJN created that the investors would never receive their visas and green cards because of the potential loss of qualification to the EB-5 program. The reality of the actual economics meant that the project was not likely in conformance with EB-5 standards. Mid-way through the process of soliciting investors into the project, AJN changed its business model to smaller kiosk-type stores that were significantly cheaper to build than stores. Yet they kept paying the CEO’s company the full $400,000 construction services fee. The PPM was never updated to reflect the change or the fact that the change meant much less revenue from the business operations. Had accurate figures for costs and revenues been provided in the economic report, the change in business model could have led to fewer jobs than required by the EB-5 program’s 10 job threshold.
In another case, SEC v. Muroff, Case No. 1:17-cv-00180-EJL, the SEC sought an injunction and damages due to alleged securities violations in connection with an EB-5 investment program that raised approximately $140.5 million from over 280 foreign investors. While some of the money was invested for the purposes described in the offering materials – a real estate development and a gold mining venture – much of the money was used for other purposes. About $5 million was used by Muroff on personal expenses for things like two residential properties, a zip line operation, a Range Rover and BMW, and living expenses. Muroff also diverted $20 million to invest in options trading. He also used investor funds to purchase real estate and mining assets in his own name so he could “sell” them back to the investors at inflated prices and pocket the profit. As just one example of his scheme, Muroff took $7.8 million of investor funds to acquire a real estate development that he put in an affiliate’s name and developed it for 3 years in his company’s name, not in the EB-5 investment enterprise. Muroff then “sold” the development to the project owner pursuant to the PPM for $28 million. Not only did Muroff pocket the difference, but the investors did not hold title to the real estate in which they had invested for 3 years. Additionally, Muroff used about $5.6 million of the investor funds to pay commissions to agents who solicited investors in China, which was a use of funds that was not for job-creating purposes. The EB-5 regulations require that “the full amount of the immigrant’s investment must be made available to the business(es) most closely responsible for creating the jobs upon which EB-5 eligibility is based.”
Heed Warning Signs of Potential Trouble with Basic Due Diligence
Of course, the problem of defrauding investors is not unique to EB-5, but the circumstances are unfortunately ripe for fraud in EB-5 schemes. The lack of oversight is troubling, but foreign investors and their lawyers can engage in some basic due diligence both at the outset and throughout the process to minimize the risk of loss. Due diligence is understandably more difficult for foreign investors as many of the prospective immigrants are not fluent in English or experienced in U.S. business practices and laws. They may find themselves unable to obtain a visa to visit the investment prior to committing funds and are therefore likely more vulnerable. Regardless, there are some basics that every investor and immigration lawyer should know before selecting an EB-5 program. Declining to conduct due diligence can put both dollars and visa at risk. Both USCIS and the SEC have issued Investor Alerts, cautioning immigrants to conduct due diligence before investing. Below are some of those tips and others to help investors and their professionals vet EB-5 programs before they invest:
- Confirm that the Regional Center is USCIS designated. Check www.uscis.gov for a list of currently approved regional centers, but recognize that inclusion on the list does not mean that the investment itself has been endorsed or approved. This approval can be lost through inactivity or misconduct.
- Ensure that the investment is SEC compliant - either registered or exempt from registration and that the seller is licensed and otherwise in compliance with federal and state securities laws.
- The fact that a regional center is approved does not mean that the USCIS, the SEC, or any other governmental agency has approved the offering of the investment opportunity. The promoter must provide important and accurate information about the investment or management.
- Watch out for unlicensed sellers. Designation as a regional center also does not satisfy the requirements under federal and state securities laws that require investment professionals and their firms who offer and sell investments to be licensed or registered.
- Review the Private Placement Memorandum, Subscription Agreement or other offering material carefully:
- Look for sufficient detail that describes a comprehensive and credible plan. If it lacks detail or does not make sense, don’t invest.
- Look for “At-Risk” language. The investors’ funds must be at risk in the project. The sponsor of an EB-5 project must not provide a guarantee that reduces or eliminates that risk. There can also be no guarantee that the investor will get a visa.
- Does the offering memorandum describe the timing and ultimate distribution of proceeds upon completion of the project? The EB-5 investor funds must remain “at risk” until final adjudication of the visa application.
- Review the regional center USCIS approval designation letter and all related documentation. Collect information about whether the project sponsor’s role is limited to regional center oversight or whether the project sponsor may also be the project developer. Discuss the track record regarding the investment project under consideration, as well as other projects.
- Does the project guarantee a visa? If so, don’t invest. An EB-5 project makes an immigrant investor eligible for a conditional visa, but does not guarantee either a conditional visa or permanent residency.
- Evaluate the promised investment returns carefully. Examine the timing and source of repayment of the investment capital. Is it realistic to assume a sale or refinance of the business or property so that the investor’s capital will be returned?
- Is there any collateral securing the investment? What is the value and how liquid is that collateral? Evaluate the level of risk involved in the project.
- Be careful of investments that offer a high rate of return to the investor. Most EB-5 projects provide a very minimal financial return on the investment. Most immigrant investors are more interested in the return of capital and the visa, but high returns can be tempting. Since this is unusual in the EB-5 market, consider whether the business is really that good or whether this is an attempt to lure investors into an otherwise unattractive venture.
- Consider the fees and benefits being provided to the promoters and any other professionals, sales agents or consultants who are paid in connection with the endorsement or recommendation of the investment. Some costs may be charged to investors beyond the required EB-5 investment, either directly or from the return on the investment. This is common and lawful, but important for an investor to understand. Verify this information with disclosure information contained in the offering memorandum.
- Review the credentials of the economist to ensure that he is qualified for the economic analysis.
- Watch for regional centers that may have manipulated guidelines for forming a TEA. Most EB-5 projects are in TEAs, but not all TEAs are created equal. Determine whether TEA is based on U.S. Census unemployment data for the census unit or whether the TEA relies on a state government amalgamation of many census tracts together to create a blended high unemployment area. Both are acceptable, but the USCIS and Congress are considering whether to move this authority from the states to the USCIS.
- Confirm the experience of the regional center and developer principals. What is their track record? Have they completed this type of project before? Look for independently verifiable information. Consider conducting background checks on the principals involved.
- Vet the developer of the project. Inquire about past projects and reputation.
- Seek independently verifiable information about the project itself, such as real property records, permits, tax assessments. Review the permits, entitlements and licenses that have been obtained or are required to complete the project. Look on Google Earth to verify the project site if a site visit is not possible or practical.
- Watch for overly complicated structures. While some level of complexity is common, a large number of entities run by the same individuals can be a cover for fraud. Identify the principals of the regional center, the developer, the lender and any other affiliated party. If they all lead back to the same person, ask why and consider potential conflicts of interest and fraud.
- Consider whether the principals of the regional center and developer have capital at risk in the project. If not, they may be lacking the financial incentive to see the project through to conclusion.
- Conduct a site visit. Meet the principals of the project and regional center. Is what they are telling you, and what you see, consistent with the offering documents and business plan?
- Monitor the progress of the project carefully. Are there extended delays in the construction and how does that impact the business plan and job creation promised?
- Redeployment: If the project is completed and stabilized and the liquidity event occurs before the full adjudication of the permanent resident status, the investor’s capital must remain “at-risk.”
Due diligence is critical, not only at the outset, but during ongoing monitoring of the investment project's activities throughout the life of the investment. If the manager has gone radio-silent and no information can be obtained about the status of the project, this may be cause for concern. Investors and their lawyers should stay on high alert for signs of trouble and be prepared to take action to protect both the investment and the visa application. Some of the more glaring signs of a potential problem are as follows:
- The absence of regular reporting to EB-5 investors, including with regard to the status of the project and financial reporting
- Failure of the project developer to provide financial reporting, including expenses and projections
- Failure of the project developer to report on the status of the project, including construction updates, financing, and operations
- The absence of proof of financing for project development, including loans, equity investments and other financing.
- Failure to obtain necessary financing
- Notices of default from lenders to the EB-5 project
- Information that the project developer is not paying its contractors, suppliers and other expenses
- Commencement of litigation against any aspect of the EB-5 project, including the regional center, promoter, developer, sponsor or owner.
- Evidence that the EB-5 project has not obtained necessary approvals for development, that work has not commenced, or that work has ceased
- Failure to meet the deadlines and projections set forth in the PPM or construction schedule
If concerns arise, investors should take swift action to ascertain the status of both their investments and the status of the development of the EB-5 project. If answers are not forthcoming, investors and their immigration lawyers should consider consulting litigation counsel to discuss their options. Hopefully litigation will not be required, but if the situation has taken a wrong turn, the appointment of a receiver, or the commencement of litigation to demand an accounting and a freeze on the inappropriate expenditure of investor funds, may be a necessary course of action.
If done right, an EB-5 investment is a win-win for everyone. Jobs are created or saved for U.S. workers. Business owners receive access to funds to allow them to grow or save their business. Other businesses (along with their employees) benefit as they supply these new ventures with materials or services. Revenue is generated from the new business for federal, state and local governments in the form of income, sales and/or payroll taxes. Most importantly for the investor, the investor and investor's immediate family obtain a green card to live and work in the US.
However, EB-5 projects often involve large amounts of money and too often greed leads to the loss of not only investor dollars, but of highly desired immigration benefits. It is important to ask questions at the outset and to verify information throughout the entire EB-5 process. If foreign investors are not getting answers to their questions from the project sponsor, regional center or developer, and they are concerned about delays or possible fraud, they should be sure to consult with a professional experienced in EB-5 programs to assist in getting answers or, in a worst-case scenario, in pursuing litigation to preserve or recover invested funds.
 In one case, the SEC and USCIS commenced action against a fraudulent scheme that took in investor dollars before it was designated as a regional center. Investors were promised 5% returns and an opportunity to obtain an EB-5 visa and were told their funds would be held in escrow until USCIS approved the EB-5 model. The funds were misused and investors did not even obtain conditional visas. See SEC v. Marco A. Ramirez, Case No. 7:13-cv-00531 (S.D. Tex. Sept. 30, 3013).
 In another case, the SEC and USCIS stopped an alleged $156 million fraud in which investors were promised they would be paid back any administrative fees they had paid if their EB- visa applications were denied. More than 90% of the administrative fees were allegedly spent before USCIS adjudicated the visa applications. SEC v. A Chicago Convention Center, LLC, Case No. 1:13-cv-982 (N.D. Ill., Feb. 6, 2013).
 The SEC has recently initiated many civil enforcement actions alleging securities law violations in connection with EB- programs. See e.g., SEC v. A Chicago Convention Center, LLC, Case No. 1:13-cv-982 (N.D. Ill., Feb. 6, 2013); SEC v. Ramirez, Case No. 7:13-cv-00531 (S.D. Tex. Sept 30, 2013); SEC v. Lee, Case No. 2:14-cv-0686 (C.D. Ca. Set 3, 2014); SEC v. Luca Int’l Group, LLC, Case No. 3:15-cv-03101 (N.D. Cal. July 6, 2015); SEC v. Hui Feng, Case No. 2:15-cv-09420 (C.D. Cal. Dec. 7, 2015); SEC v Quiros, Case No. 16-21301 (S.D. Fla. Apr. 12, 2016); SEC v. Liu, Case No. 8:16-cv-00974 (C.D. Cal. May 26, 2016); SEC v. Francisco, Case No. 8:16-cv-02257 (C.D. Cal. Dec. 27, 2016); SEC v. AJN Investments, LLC, Case No. 0:16-cv-63036 (S.D. Fla. Dec. 28, 2016); SEC v. San Francisco Regional Center LLC, Case No. 3:17-cv-00223 (N.D. Cal. Jan. 17, 2017); SEC v. Muroff, Case No. 1:17-cv-00180-CWD (D. Idaho Apr. 28, 2017); SEC v. Chen, Case No. CV 17-6929(C.D. Cal. Sept 20, 2017).
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