Under the EB-5 program, foreign investors make significant outlays to new commercial enterprises in the United States and must not accept repayment of the investment funds until their I-829 petitions have been adjudicated. As the required investment sum is large, $1,800,000 or $900,000 depending on whether the new commercial enterprise is located in a targeted employment area (TEA), investors typically consult with experienced counsel and financial advisors to conduct due diligence on securities issuers and EB-5 projects.
However, investors frequently neglect to monitor a project’s financial activity following the initial offering, which is based solely on projections and may not be carried out entirely as specified. This has caused concern in recent years with widely publicized Securities and Exchange Commission (SEC) actions focusing on EB-5 projects. In 2015, for example, the SEC alleged that investors in a Seattle project managed by Path America had fallen victim to fraud, as the developer had misappropriated nearly $18,000,000 of investor funds for personal use.
Given that one of the requirements of the EB-5 program is that the entire investment amount be put toward job creation, investors have understandably sought more transparent reporting on the part of new commercial enterprises to monitor fund use and thereby safeguard their chances for successful visa adjudication through the program. Similarly, project developers must assure investors that their funds are being disbursed as planned according to U.S. securities law and EB-5 program requirements. This article therefore discusses several areas of focus in financial reporting for investors and project developers within the EB-5 regional center context.
Financial Reporting Goals and Requirements
Current EB-5 issuers conduct a range of financial reporting on an annual audited or quarterly unaudited basis, from reports to full financial statements including balance sheets. Investors must decide before committing funds whether the level of reporting a new enterprise will perform is sufficient for their purposes. In reviewing any financial reports provided, EB-5 investors generally aim to answer three central questions:
- Are the investment funds being put toward job creation as required?
- Will the project sustain the required number of jobs?
- Will investors receive a return on their investments?
While most projects are structured as limited partnerships or limited liability companies and therefore are not legally obligated to conduct any financial reporting in most states, entities taxed as partnerships are required to provide an annual statement on investors’ shares of income, losses, deductions, and credits. However, such statements do not answer the above central three questions.
Although project developers may not be obligated to provide ongoing financial information to investors except when investors must vote based on such information, projects can benefit from thorough financial reporting procedures. Developers must aim to reassure investors that funds are being disbursed as agreed in the EB-5 business plan and that investors are receiving appropriate distributions. Additionally, financial reports can indicate to investors whether the project is on track to meet the projections on which the offering was based and whether it will be able to create the required number of jobs and provide a return on investment. Most importantly, comprehensive financial reports and auditing procedures can serve to deter fraud by all parties involved in a project.
Investors should nonetheless acknowledge that fraud is possible even in projects that provide regular reports, as a developer committing fraud would likely have the foresight to falsify financial statements in that case. Nonetheless, investors can remain vigilant in reviewing this information and can notify the SEC and pursue legal action to safeguard their investments in cases where fraud is uncovered.
Fund Disbursement Structures
In the regional center model, foreign investors contribute to a new commercial enterprise (NCE), which in turn invests those funds in the job-creating entity (JCE) that operates the project and thereby creates the required number of jobs per investor. As such, investors should seek out projects that provide financial reports on the activities of both the NCE and the JCE. Projects working with lending institutions will likely be required to provide quarterly reports as well as annual audited reports to that institution, which should in turn be provided to EB-5 investors.
The regional center model also allows for investment in a “troubled business,” one that has been in operation for at least two years and has sustained a loss of more than 20% its net worth over the one to two years preceding the filing of an investor’s I-526 petition for conditional permanent residence. In this scenario, a detailed audited financial statement would be necessary at the time of investment to establish to the United States Citizenship and Immigration Services (USCIS) that the business is indeed troubled and that an EB-5 investment could preserve the required number of jobs.
In addition to seeking out projects that will provide sufficient financial reports, investors may wish to negotiate additional safeguards into their loan agreements to provide for the unique requirements of the EB-5 program. For example, because early repayment of a loan to the NCE by the JCE would break the conditions of the program in that the investment amount would no longer be at risk, investors may wish to specify that funds must be redeployed into another JCE immediately upon repayment to avoid this issue. Counsel and financial advisors experienced with the program can advise investors on how the loan agreements should thus be structured.
An additional safeguard is for the project to appoint a disbursing agent, who will apply the funding as needed for each stage of the project. This provides an extra level of security in ensuring the investment amount is applied as specified in the business plan according to EB-5 requirements.
Auditing requires that a certified public accountant review company records to verify that financial statements are accurate and correct according to the chosen reporting framework, typically the standard generally accepted accounting principles (GAAP). In addition to providing an opinion on the annual financial statements, the auditor will typically review the other quarterly statements as well without performing a formal audit. Despite the greater assurance provided by an audit, auditing procedures place a burden on companies both financially and in terms of the need to prepare financial statements on a deadline. As such, investors may agree that auditing is unnecessary, and audits are not often conducted for EB-5 projects.
The recent focus on discouraging fraud and misappropriation in the EB-5 market may require projects to commit to more regular audits of their financial statements. While projects already required to provide statements for lenders and senior investors should be able to provide these same reports to EB-5 investors with little inconvenience, other projects may be able to reduce costs by providing audited statements for the NCE, which typically has few operations and assets, and unaudited information about the JCE. This type of information combined with other oversight in the disbursement of funds would create a more transparent and reassuring environment for investors, but investors must again be aware that if financial statements have been falsified, misappropriation might remain undetected even through an audit.
Reporting Checklist for Investors
The limited partnership or operating agreement for the NCE should clearly outline the financial reporting regime and state which reports the enterprise is required to provide investors. In cases where the organizing document does not mention financial reporting, an EB-5 investor may not be provided with financial information until such time as he or she files the I-829 petition for removal of the conditions of permanent residence, which requires the USCIS to evaluate the project financials to ensure the investor has fulfilled EB-5 requirements. However, investors are more commonly provided with an annual or quarterly report.
The following checklist includes questions investors should ask when reviewing project organizing documents to evaluate the level of financial reporting to be provided:
- Will the NCE provide financial statements to investors?
- When and how often will these statements be provided?
- What financial information will these statements include?
- Will statements be prepared according to an accepted accounting framework?
- Will the statements be audited?
- Will the NCE also provide investors with financial information about the JCE?
In regional center projects involving multiple lenders, where job calculations are based on indirect job creation through the JCE as well as induced jobs created by the infusion of investment funds into the local economy, financial reporting is especially crucial in verifying that funds have been deployed as required. Investor funds must be applied only for job creation, and documentation of the appropriate movement of funds is essential for the I-829 petition.
Given the recent concerns with fraud and misappropriation of funds in EB-5 projects, securities issuers might consider providing more detailed financial information to investors regularly throughout the lifespan of the project to assure them of the proper and effective use of investment funds. Before committing to a project, investors must carefully evaluate the level of reporting promised in light of the unique circumstances of each project. With diligence, all parties can work to discourage fraud within EB-5 projects and increase the chances of success for new enterprises.