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EB5 INVESTORS MAGAZINE

Misappropriations Fraud Detection and Deterrence

by Robert Kraft

 It is hard to miss the numerous news articles and SEC actions citing cautionary tales of EB-5 gone wrong.  Allegations have revolved around misappropriation of funds, centering on diverting funds for other uses. The question that informed EB-5 practitioners are left with is who will be the antagonist in the next account of fraud? Will your firm be caught in the collateral damage zone, through association or client selections?  

It is impossible to prevent misappropriations fraud, but anyone can place themselves in a position to detect and deter.

People

Fund Administration

The first step in due diligence is generally to know the parties that will be involved in the fund management and disbursement. Conduct background checks to verify the resumes and resources of individuals within the organizational structure who will have access to the capital and ask for evidence of their track record. Once satisfied, confirm the results of the research with the third parties listed in the documents.

Most regional centers and New Commercial Enterprise (NCE) fund managers are members of industry trade associations like Invest In the USA (IIUSA®). Place a call to these associations to make sure the member is in good standing and has not been issued any past or present best practices sanctions.

Past experience of a fund manager can be crucial. In a rapidly growing and evolving industry, a proper appreciation of EB-5 from a historical perspective can provide clarity.  A good fund manager has already considered potential sources of fraud, and has likely structured the investment to detect and deter such actions.  Some fund managers even have a designated anti-money laundering compliance officer who develops internal policies, procedures, and controls to safeguard investor funds.

Related Parties

While most of the fraud allegations appear to have occurred at the NCE level it becomes easier to misappropriate funds when the Job-Creating Entity (JCE) and NCE are related parties. This related party structure is very common and does not mean that there is intent to defraud, but does mean that there is one less party reviewing the flow of funds. If the JCE and NCE are related parties, confirm that other parties, such as a bank or other organization, are monitoring the transactions.  While we have not seen many cases of misappropriation at the JCE level, it is still prudent to verify successful results, resumes and present commitments with independent third parties.

I-829 Approval

Within 90 days prior to the second anniversary of admission to conditional permanent residence status, an immigrant investor must file Form I-829 (Petition by Entrepreneur to Remove Conditions) to remove conditions on conditional permanent residence. An approved Form I-829 evidences regulatory compliance and past proper use of funds in the scope of the EB-5 requirements.

In Form I-829 the petitioner must evidence expenditure of the EB-5 funds, tracing each transaction from escrow to expenditure by the JCE.  Objective evidence may include bank statements, invoices, subcontractor receipts, payroll records, bank draws, title company disbursements, final lien waivers, and wire receipts. If the NCE Fund Manager misappropriated funds, the petition will most likely be denied on the basis that the full amount capital was not made available to the business most closely related to job creation.  In a model where the NCE is not the JCE it is vital that none of the $500,000 or $1 million capital contribution is expended at the NCE level.

Project

Escrow

Most regional center investments use some form of escrow. Investors and EB-5 practitioners are typically focused on the terms for release, but an equally good question might be: where do the funds go after release and who is monitoring the movement of funds though the structure? One of the benefits of having an institutional lender involved in the process is they will likely want to have oversight over the funds as soon as they are released to the NCE. They may even require that the funds are transferred to an account held by a title company or at their financial institution until the draws are processed and funds are ready to be leant to the JCE. 

Disbursement Agreement

Most EB-5 transactions are real estate construction based. Multi-party construction projects have a disbursing agreement in place at closing that documents how each party in the deal must verify, approve, and authorize expenditures before disbursement.  This agreement should indicate how loan proceeds, EB-5 funds, and investor equity are disbursed throughout the construction period. Typically, the lender, owner, developer, NCE, general contractor and title company are all parties to the agreement.

Title Company

The title company ensures there are no liens, claims, or ownership disputes on the property other than the liens placed by the first mortgage lender.  In order to monitor this, the title company requires all expenditures to be funded through a title company.  This third party procedure carefully documents expenditures and ensures that no funds are misappropriated by the owner, developer, sub-contractor and general contractor during this stage of the process. The title company receives a lien waiver from each contractor, confirming payment for work performed and waiving the right to put a lien on the property.  

Construction Review

An institutional lender will often also require a third party review architect to verify the monthly construction draws from commencement through completion. The review architect will audit charges for non-allowable costs and prevent failure to deliver items within the contracted scope. If the review detects possible sources of fraud, the institutional lender should not fund until they have resolved all material issues.  

Government Tax Credits or Grants

If the federal, state or local government has funds in the structure, they are likely conducting an audit to verify expenditures.   In addition, most institutional investors in tax credits require audited cost certificates or a third party audit verifying that project funds were spent on qualified project expenditures. In a tax credit investment, the developer typically personally guarantees that the funds were spent on the project, creating tangible accountability.

Visual Confirmation

Visual confirmation is the easiest detection measure. Research local news articles for information about the project.  If your client is ready to move forward with a project, it may be worth a site visit. Steer clear of groups that deter stakeholders from site visits. With today’s technology, many groups also provide a live web-cam of the project as it unfolds. This can be a great source of real time data without the travel expense. 

Completion Guarantee

Most third party lenders require a personal completion guarantee from the developer, ownership group, or general contractor that the project will be completed regardless of final costs.  This completion guarantee gives comfort that the project will be completed and the JCE will open for business creating (hopefully) all of the jobs needed to meet the 10 job per investor requirement. 

Advisors

Accounting

Identify which third party accounting firm the fund manager has hired and the main account manager. A third party review of the financial performance of the fund manager will help to reveal mismanagement and internal controls deficiencies.

 Attorney

Avoid inherent conflicts of interest by always using a third party attorney that is not related to the manager, regional center, or the project, for all due diligence and related legal services.

Select a Regional Center Fund Manager who uses an experienced attorney for their I-829 template. If the NCE Fund Manager is using the cheapest option or hasn’t given any thought to counsel, they likely have given limited consideration to immigration compliance. Due diligence should include a close examination of the attorney’s track record, since a good attorney will not have knowingly taken on a bad project.   

Final Thought

While you may think you have considered all possible factors which would confirm a solid investment make sure you revisit all of the due diligence. The importance of thoughtful review cannot be overstated.

 

 

 

Robert Kraft

Robert Kraft

Robert Kraft is Chairman, President, and CEO of FirstPathway Partners, a firm managing investment funds within the EB-5 Regional Center Program. Mr. Kraft is an active member of the IIUSA President's Advisory Council and serves on numerous Boards, including IIUSA, Metropolitan Milwaukee Association of Commerce World Trade Association, and Co-Chair of the China Council. Mr. Kraft has been participating in the EB-5 industry since 2006. He has been featured on television, radio, and in newspapers internationally.

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