EB-5 Enforcement on the Uptick
The EB-5 Immigrant Investor Program is one that attracts its fair share of attention, not all of it good, and too much of it from organizations named with that part of the alphabet — SEC and DOJ — that can strike fear in the heart of a business person.
And Texas is often the center of the investigators’ focus.
Case in point: Presently playing out in Dallas, a developer is being sued based on claims it owes more than $1 million in commissions for finding foreign investors for a large hotel redevelopment in downtown Dallas. The IRS and the SEC are reportedly investigating the financing of the hotel.
And that case is only the latest. In 2018, the SEC announced that three Houston-area developers agreed to settle charges they misused investor funds raised from 90 Chinese investors under the EB-5 program. Fortunately, and in a rare instance for EB-5 actions, the developers repaid the $49.5 million that they raised from those investors.
The list goes on. In 2013, the Texas EB-5 market took center stage as home of one of the first significant federal EB-5 enforcement actions. In SEC. v. Marco A. Ramirez, the SEC filed fraud charges against a husband and wife based in McAllen, Texas. These defendants had allegedly fraudulently obtained $5 million from foreign investors from Mexico, Egypt and Nigeria by promising to invest the funds in EB-5 investment projects when in reality they used it for personal gain including funding their Cajun-themed restaurant in Texas.
Some background is helpful. In 1990, Congress created the EB-5 Immigrant Investor Program in an effort to stimulate the U.S. economy through job creation and capital investment by foreign investors. Under the program, a foreign national becomes eligible for a U.S. green card through his or her investment in a new venture (usually a real estate development project) that directly or indirectly creates 10 jobs per investor. The investor’s spouse and unmarried children under the age of 21 are also eligible for green cards. The U.S. Citizenship and Immigration Services (USCIS), an agency of the U.S. Department of Homeland Security (DHS), administers and oversees the program.
After limited regulatory tweaks since the program’s inception, on November 21, 2019, DHS instituted a regulatory overhaul of the program under the EB-5 Immigrant Investor Program Modernization regulation that raised the minimum investment level from $1 million to $1,800,000, and from $500,000 to $900,000 for investments in certain high-unemployment and rural areas.
Although EB-5 investment activity was limited for the first 27 years, EB-5 investment flourished during the Great Recession due to a lack of financing options available to domestic real estate developers combined with the emergence of wealth among the Chinese who apply for the vast majority of the EB-5 visas. From 2008 to date, about $40 billion of EB-5 capital has been invested in U.S. projects creating over 1 million jobs. In Texas, about $818 million of EB-5 investment created more than 14,000 jobs from just the peak EB-5 years of 2014 to 2015. However, analogous to other federal economic stimulus programs, the EB-5 Program has been inundated with fraud, money laundering, and other economic crimes. In 2016, both the SEC and FINRA named the program as an examination priority, which brings us back to enforcement.
The most common EB-5 related enforcement actions have involved SEC prosecutions alleging investor placement commissions paid to unregistered broker dealers. Most EB-5 financings are structured as a security offering, and consequently, U.S. law prohibits an unregistered broker dealer from earning commissions from a security-based transaction. From an EB-5 market perspective, the total placement commissions paid to EB-5 finders frequently exceed 20% or 30% of the actual investment amount. These hefty commissions are workable for the developers because most EB-5 investors do not gross more than a 1% or 2% return per year (since these investors consider their return to be a green card). Therefore, such abnormally large commissions for the finders in tandem with super cheap capital for the developers fashions an economic model that may be too rich to inspire obedience to longstanding U.S. securities laws for certain EB-5 players.
Despite protests from EB-5 defendants, the SEC has continually used disgorgement in such cases to ensure the repayment of ill-gotten gains imposed on wrongdoers. In 2016, the SEC sued Charles Liu and Lisa Wang for their roles in an alleged EB-5 scheme whereby at least 50 Chinese investors were purportedly defrauded of some $27 million. The U.S. District Court for the Central District of California ordered that Liu and Wang were jointly and severally liable for disgorgement of $26,733,018.81. Last summer, this EB-5 case paved the way for a landmark decision as the United States Supreme Court upheld the authority of the SEC to seek disgorgement as an equitable remedy so long as it “does not exceed a wrongdoer’s net profits and is awarded for victims.”
On top of regulatory and prosecutorial enforcement, the industry recently has witnessed a spike in civil litigation. Many industry participants (including the authors) forecast that this trend is only the tip of the iceberg as the projects that came on board during the EB-5 boom from 2012 to 2018 are either due to be fully constructed or to have their investors repaid. In many instances relating to EB-5, federal enforcement commences subsequent to civil litigation as the allegations are brought forth by plaintiffs. Hence, with looming EB-5 litigation expected, industry experts also predict that federal enforcement actions will accompany these claims.
These actions will directly impact Texas since Texas has been a top 10 state for EB-5 investment.
The EB-5 Program will sunset this summer without the arrival of new legislation. The EB-5 industry and many key legislators on both sides of the aisle are supporting the EB-5 Reform and Integrity Act of 2020 (“Act”) sponsored by Senators Grassley (R-IA) and Leahy (D-VT). If enacted, it would create an EB-5 Integrity Fund bankrolled by a tax on the industry to reduce further economic crime and provide greater transparency via enhanced federal monitoring, investigating, and auditing of EB-5 projects and their stakeholders.
Republished with permission. This article, "EB-5 Enforcement on the Uptick," was published by the Texas Lawyer on March 18, 2021. For the full article, visit the Texas Lawyer website. (login required)