On Jul 26 2016 by H. Ronald Klasko

Searching for a Silver Lining in Vermont

By H. Ronald Klasko and Tammy Fox-Isicoff

The article was published in NES Financial’s first EB-5 eBook Navigating a Changing EB-5 Sector: Insights from Experts.

No matter what your perspective, the report that the SEC has filed a complaint alleging fraud on the part of developers of Jay Peak and other related projects under the auspices of the State of Vermont Regional Center is terrible news. It’s terrible for the investors in those projects, it’s terrible for the State of Vermont, and it’s terrible for the EB-5 program. However, as with many examples of bad news, there are lessons to be gleaned that could, with the passage of time, enable us to look back on this event as the prod that stoked long term changes that benefit the EB-5 program and its investors.

There are several points on the matter that need to be brought up:

  1. The charges brought by the SEC are just that – charges. We have not heard the other side of the story. One can only hope that some or all of the charges prove to be unfounded.
  2. Every business, and certainly every government program, has bad actors. There is no example that can be cited of a government program, a profession, or an industry that does not have outliers (individuals and institutions that take advantage of weaknesses in a program and in government oversight). The fact that Bernie Madoff and other supposed luminaries in the investment industry bilked untold millions is not a reason to stop investing – it is only a reason to be more careful when doing so. The fact the banks have engaged in fraud and shoddy practices in connection with mortgages and investments is not a reason to shun banks. The fact that doctors and hospitals have engaged in Medicare fraud is not a reason to end Medicare or to condemn all doctors. The fact that a tiny percentage of EB-5 projects may be susceptible to the fraudulent activities of bad actors is equally no reason to condemn the EB-5 program or its many worthy projects, regional centers, principals, and representatives.
  3. It is good to know that the SEC and other government agencies are actively involved in monitoring the EB-5 program. The EB-5 community encourages this oversight. The EB-5 community also encourages the federal government to take action to ensure that innocent investors are not harmed by the actions of a few bad actors.
  4. As pointed out by the Governor of Vermont in his press conference, even if these allegations are true, the EB-5 program still produced economic revitalization for the Northeast Kingdom of Vermont and a large of jobs that will be ongoing and that never would have been created without the influx of EB-5 money. This does not lessen the significance of the alleged malfeasance; it does provide another example of the importance of the EB-5 program in producing jobs in areas of need. The potential for use of EB-5 funds in ways that will benefit the U.S. are limitless. EB-5 funds could be used to re-build this country’s crumbling infrastructure.

With all of that said, there are certainly prophylactic measures that should be taken to ensure a brighter future for the EB-5 program and to minimize the risk of bad actors bringing down a highly successful government program. When a neighbor’s house is burglarized, one looks to tighten security at one’s own home. What can be done to tighten security in the EB-5 program?

Here are some thoughts:

  1. The U.S. Congress, as part of an extension of the EB-5 program, should pass integrity measures that would go a long way toward preventing fraud in EB-5 projects. Senate Bill 1501 included extensive integrity measures that had bipartisan support. The problem was that they were surrounded by many non-consensus, controversial provisions. In order to alleviate that problem, bipartisan bills limited to integrity measures have been introduced in both the House and Senate. While some of the specific provisions of the integrity measures being proposed in the House and Senate are in need of some refinement in order to conform to the realities of these complex global transactions, virtually everyone agrees that, given the bipartisan support, these changes can be enacted and legislation passed that would enhance the integrity and transparency of the EB-5 program. These integrity measures have widespread support within all corners of the EB-5 industry.
  2. The government – the USCIS, the SEC, and other regulatory agencies – does not have to wait for legislation to enact oversight measures that will enhance the integrity of the program. While some may require regulation, other steps could be implemented tomorrow. In fact, the USCIS has already announced plans to implement programs that will enhance oversight of the EB-5 industry, including audits of regional centers, site visits of regional centers and projects, interviews of investors seeking condition removal, issuance of Notices of Intent to Terminate Regional Centers that may be non-complying and enhancing the annual reporting requirements of regional centers. This is just a small sample of what can and should be done. When one reads the legislative integrity measures in the various bills, one is left with a distinct impression that many or most could be implemented without legislation.
  3. It is unfortunate that an alleged scheme that diverted many millions of investor dollars from their intended use to uses not authorized under the business plan or offering documents would become Exhibit A in support of the importance of regional centers and projects having thorough compliance plans in place. This is critical for regional centers and project developers to protect themselves against bad actors. It is critical for migration agents to make certain that they are promoting projects that provide the greatest possible protections for their investors. It is critical for investors in their choice of projects in which to invest. We have stated previously that up front immigration and financial due diligence regarding project documents is not sufficient. Even a project with the most perfect business plan, economic report, marketing study, and offering documents can be the subject of fraudulent activities. While no program is a panacea, a regional center and/or project developer that has implemented from the onset a thorough compliance program toon an ongoing basis the flow of money from the investor to the escrow to the NCE to the JCE and to its ultimate use in the project and to monitor the timing and amount of construction expenditures of various types, provides the greatest protection available for agents and investors.
  4. It has always been critical for the EB-5 industry and all of its groups to work together toward the common goal of an EB-5 program that works in the manner intended and merits a long term and hopefully permanent extension by the U.S. Congress. Whether, for example, a specific location is or is not a targeted employment area will be of scant importance if the EB-5 program does not achieve a long term extension and if there is no legislation that addresses the untenable quota backlog. The chances of achieving those legislative goals are far greater if this small industry works together than if it works at counter purposes.
  5. This would be a great time to take a refresher look at the list of best practices that can be found through various industry associations, such as IIUSA. They are, if anything, even more important today than when crafted a few years ago.
  6. Two of the best practices bear emphasis in this article, especially given the events in Vermont. One relates to the importance of an individual or entity serving in a role as investor protector with full access to all necessary information to perform those duties. In the typical example of an EB-5 loan model, this means that the general partner or managing member of the new commercial enterprise should be an individual or institution that is independent of the job creating entity. Another suggested best practice of note is the importance of investors insisting on regular – no less than quarterly – reports of the activities, progress, and status of the project and the use of their funds. This is a best practice for regional centers and developers; it is critical for investors.
  7. Speaking of investors, any negative story involving EB-5 projects provides further evidence of the importance of investors being engaged in this process. Whether the investment is $500,000 or $1 million, it is a good deal of money. Investors should be involved in reviewing financial documents of projects in which they invest. They should demand accountability and review the progression of the investment to ascertain that it meets the representations made in the business plan and offering documents. They can certainly retain agents or other professionals to perform this function. What they shouldn’t do is just assume that, for example, because a project has some aura of government involvement or support, no further diligence is required.
  8. Redeployment of funds after their intended use enhances the possibility that funds will be used in a manner not approved by, or reviewed by, the investor or his agent or representative. The best way to avoid this result is for the USCIS to finally take a position that, once the EB-5 funds have been used in the manner intended to create the requisite number of jobs, even though the NCE cannot pay back the investor, the NCE does not have to redeploy the funds to keep them at risk. Unless or until the USCIS agrees to this position, which will both protect investors and comply with the law, regional centers and developers will want to develop mechanisms to ensure that the investors’ investment dollars remain at risk but at the least risk possible. This needs to be done in a manner that enables the investors to know in advance and to approve of the ultimate deployment of their investment dollars.

The SEC charges against Jay Peak and its principals have caused tremors in the EB-5 world. These charges have again shaken confidence in the EB-5 program. Though the recent allegations are chilling, there is no reason to believe that the EB-5 program is or will be an exception to the rule that, in every program, abuses will occur. That is no basis to draw conclusions about the program as a whole. It is a reason, however, for all parties – U.S. Congress, executive agencies, regional centers, developers, representatives, agents, and investors – to take action now to minimize the risk of more bad news and to maximize the integrity of the EB-5 program and its long term ability to bring foreign direct investment dollars to the U.S. to create employment in the U.S. at no cost to the U.S. taxpayer.