Why client due diligence on EB-5 foreign investors is becoming critical
Congress created the EB-5 immigration category in 1990 to provide foreign investors an avenue to gain legal permanent residence in the U.S. Since 2008, over 33,000 visas have been issued. Unfortunately, the EB-5 program has incurred substantial fraud from the foreign investors and groups administrating the investment targets. Every time this fraud occurs, parties involved in the process, such as the law firms, lose money on reimbursed services. As the program has grown in popularity since its inception, the amount of fraud has increased in tandem. The financial and reputational risks incurred by law firms and Regional Centers in this process have proved wide-ranging. But they can be avoided, with more upfront caution and due diligence.
As background, the EB-5 immigration category was created to provide an expedited process for foreign investors to attain legal, permanent residence where they are willing to invest between $500,000 and $1 million in U.S. business projects. These investments can involve either standalone businesses and those administered by so called “Regional Centers”.
Today, many law firms and Regional Centers are exposing themselves to risk with EB-5 client work due to insufficient client due diligence. Many offer to reimburse a foreign investor for legal or administrative fees should a petition be denied. In 2016, 14,147 EB-5 petitions were filed and out of the 9,367 that were reviewed, 1,735 were denied and 20,804 were still pending. Yet the process, with current backlogs, can last several years, and can be tied up for many reasons, including difficult to verify political affiliations. Additionally, many law firms are relying on self-disclosed source of funds documentation – without any further verification. Should the funds come from illicit sources, this could lead to irreparable credibility damage to the law firm, and can even result in regulatory actions on the law firm.
Several members of Congress such as Senators Chuck Grassley (R-IA) and Patrick Leahy (D-VT) have called for reforming the EB-5 program. In 2016, EB-5 was on the high priority list for examination by the SEC and FINRA.
Fraud throughout the EB-5 program
Though the intentions of EB-5 are to provide investment capital to stimulate economic growth and create U.S. jobs, the program has unfortunately been subject to fraud perpetrated by both investors and businesses. The EB-5 program has been and can be exploited by criminals with ties to money laundering, and potential terrorists wanting to enter the U.S. Typical reports of fraud focus on misuse of EB-5 funds. One example is a January 2017 SEC investigation that found that a California businessman misused at least $9.6 million to purchase his home and other goods using capital raised from foreign investors. Fraud has also been found involving the foreign investors themselves. One such case of immigration fraud was the January 2017 case in which Chinese foreign investor Shilan Zhao submitted documents misrepresenting the source of her investment; the funds were laundered money related to fraudulent transactions from a grain storehouse in Zhoukou City, China.
The United States Citizenship and Immigration Services’s (“USCIS”) EB-5 policy memorandum on adjudication policy focuses on proving the legality of the “source of funds” from foreign investors used for capital investment. It does not explicitly state requirements for other types of due diligence such as an in-depth background investigation. However, many of the issues in the EB-5 program stem from the industry-wide practice of using self-disclosed materials as the sole verification of source of funds. Critics of EB-5 have pointed out that this lack of other due diligence requirements has resulted in immigration officers being more lenient on EB-5 investors than on petitioners in other visa categories.
Third-party due diligence firms can vet the petitioner’s self-disclosed materials
There’s obvious risk in basing due diligence predominantly on self-disclosed materials. Due diligence should be based on an analysis of public records sources to help law firms and other players in this space protect against fraud while being part of the EB-5 process. Such diligence is already common-place in the Foreign Corruption Practices Act and anti-money laundering compliance space.
Due diligence with a tailored approach to EB-5 industry-specific issues can be conducted early in the process to identify risk-relevant information for a petitioner. A trained open source investigator can corroborate much about a person’s self-declared source of wealth from public records, often in a short amount of time. For instance, wealth profiles of individuals are often complemented by cross-checking official business registries with indicators of wealth derived from traditional media and, increasingly, social media. Contradictory information or even a lack of information in the public record could indicate a higher risk to the legal firms and Regional Centers.
Political exposure can tie up the process indefinitely
Even though the regulatory onus is on examining the investor’s source of funds, other issues can also arise. A foreign investor’s petition can be rejected for failure to disclose a past communist party affiliation or criminal history to their representing law firm or Regional Center. It is possible a petition may not be rejected for the above reasons, but it can linger indefinitely in procedural purgatory. A third-party diligence firm can leverage local-language databases as well as official public records. For example, the Communist Party of China (“CPC”) discloses records of active CPC members with current political roles. Separately, the National Committee of the Chinese People's Political Consultative Conference records disclose names of its committee members along with their party affiliations, with CPC or one of the other seven political parties recognized by the PRC, though functionally controlled by the CPC.
Overall, these records that can indicate political exposure are used in conjunction with Chinese public records of disciplinary history, ongoing investigations, or other information disclosed by regulatory and judicial bodies in the PRC to greatly diminish the uncertainty associated with EB-5 petitions. A change in due diligence strategies to incorporating a thorough investigation of these potential issues could save EB-5 players valuable time and money.
Understanding the risks associated with a particular foreign investor could save parties thousands of dollars across a process that can, with current backlogs, last several years. With new potential SEC and FINRA reform on the horizon, legal firms should consider updating their onboarding practices with EB-5 client work. Already, this has been an area where law firms have left themselves exposed to reputational and financial risk. Adapting current practices of relying on self-disclosed source of funds documentation, and incorporating global public records research, would go a long way to addressing the risk connected with EB-5s.
By Piotr Pillardy at Exiger Diligence, the due diligence division of Exiger that provides global public records research and investigative due diligence to leading financial institutions and multinational corporations.