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Detecting and Preventing Fraud in EB-5 Projects

Recent actions by the Securities and Exchange Commission (SEC) have brought increased attention to the issue of fraud within the EB-5 Program, with notable cases having involved the misappropriation of funds. Regional centers, investors, and other EB-5 agents have taken notice of this issue, and many will conduct significant due diligence before committing to a project for this reason. This article outlines four strategies investors can use to detect and prevent misappropriation.

(1) Conduct Due Diligence on Fund Managers and the Project

Before entering into any agreement, investors should be satisfied with the integrity of the parties involved in the project, particularly in the management and disbursement of funds. Background checks can be used to verify the industry experience and legal standing of those who will have access to the investment funds, as can a call to relevant professional associations to confirm that a member is in good standing.

Investors should take note of arrangements in which the new commercial enterprise (NCE) is closely related to the job-creating entity (JCE). In a typical arrangement, the NCE collects funds and disburses them to the JCE, and each will review the flow of funds independently. In cases where the principals of the NCE and JCE are the same or where there is overlap, only one review would be conducted by those individuals. This is a common setup and not a red flag in and of itself, but investors should again take care to verify the integrity of the principals of both entities.

Investors can also take the step of investigating a project in person via a site visit. Legitimate projects will facilitate this sort of due diligence and will be eager to reassure investors by providing a live visual tour of the site via webcam to avoid the need for travel costs. Investors can also search online periodically for information about the project and any parties involved to remain apprised of local news.

Regional centers typically take care to work with experienced fund managers with good industry standing. Such managers will structure the project so as to deter fraud, and this foresight can prove invaluable. Nonetheless, investors are encouraged to confirm the backgrounds of all those with access to the investment funds.

(2) Carefully Account for Fund Disbursement

The disbursement agreement for the project should outline in detail how funds will be used at each stage of planning, construction, and operations. In a project involving multiple parties, each will be required to verify and authorize any expenditures according to this agreement. Investors especially must review the project documents to ensure that their investment funds are being used specifically to fund job creation as required by the EB-5 Program, as proving this will be necessary when investors file their I-829 petitions.

An investor must file his or her I-829 petition to remove the conditions of permanent residence within 90 days prior to the expiry of the two-year conditional residence period. The I-829 documentation requires the investor to show that the use of the funds has complied with EB-5 regulations and has been consistent with the documents submitted with the I-526 petition. The petitioner must trace the path of funds from escrow through to job creation using financial proof such as bank statements, payroll records, and other receipts.

If United States Citizenship and Immigration Services (USCIS) denies an investor’s I-829 petition on the grounds that the full investment fund amount was not used for job creation, this is a sign that misappropriation may have occurred, and the investor must look into the matter further.

(3) Work with an Institutional Lender

Regional centers typically work with institutional lenders to hold the investment funds in escrow until they are released to the JCE. Institutional lenders are an ally to investors in that they aim to protect the interests of all parties by overseeing the disbursement of funds from the moment the investor sends them to the NCE. The lender will generally also work with a title company to ensure that ownership of the project site is secure in that no liens or other claims are in place. The title company will therefore carefully document all expenditures. For example, each contractor will sign a lien waiver confirming receipt of payment for services and forfeiting the right to place a lien on the property. This introduces an increased level of oversight and deters misappropriation.

Institutional lenders may also wish to have an architect review monthly construction expenditures to detect any signs of fraud during that stage. Finally, most lenders will require that the developer sign a contract stating that the project will be completed regardless of cost. This is known as a completion guarantee and assures investors that the JCE will be operational in order to create the ten fulltime jobs required under the EB-5 Program.

(4) Seek Third-Party Reviews and Assistance

Investors should work with experienced advisors to safeguard their investments from fraud. While regional centers will generally work with an accountant to audit the performance of the fund manager, investors should ensure that this accountant is from an independent firm not associated with the project principals. If the project has received any national, state, or local funds, as with tax credits or grants, those governments will likely conduct their own audits of expenditures as well to ensure all funds have been spent as disclosed.

Investors should also work with their own attorneys to conduct due diligence and prepare any documentation necessary for the project and the EB-5 Program. An attorney experienced in the nuances of the program can offer valuable guidance when filing the I-526 and I-829 petitions and can assist the investor in detecting any signs of fraud by other parties.

Investors take on a considerable risk when participating in the EB-5 Program regardless of the possibility of fraud. As such, investors must use the strategies outlined above to confirm the integrity of any parties to the project and prevent their investments from falling victim to misappropriation.