Nov 13, 2014
Raising The Bar

The SEC continues its pursuit of fraud in the EB-5 program. As with their previous enforcement actions, they are targeting garden variety fraud. In the current case, filed on September 3rd, the SEC alleges that the sponsors unlawfully withdrew funds from escrow accounts and used such funds for purposes that were not part of the business plan. In this case, which was to build and ethanol plant in Kansas. You can find the SEC’s press release on the case here: The generic nature or the fraud itself nor the size at $11.5 million is particularly notable. What is notable is that I believe this case marks the first criminal prosecution of an EB-5 sponsor in well over a decade as the Justice Department filed criminal charges against the sponsors based on their violations of the US securities laws. What is also notable is how the sponsors were able to get access to the investor’s investment capital despite the fact that escrow structures were in place. It goes without saying that people shouldn’t commit fraud. I think this case can be used to focus counsel on the role and structure of escrow within EB-5 investment structures. As this case illustrates, not all escrow structures are the same. The SEC alleges that the sponsor, “took money out of investor escrow accounts without their knowledge prior to the approval of an investor’s application for residency.” This begs the question, how did they do this? Were the escrow agreements designed to prevent exactly this? I have seen structures in which a member of the sponsor is the appointed representative of the subscriber in an EB-5 transaction. This effectively defeats the protections of what escrow is supposed to do, which is to create a neutral mechanism to ensure that funds are only released to a sponsor when the agreed upon conditions are met. There are other structures widely used in EB-5 (particularly among regional center projects), which involved early or phased releases of capital prior to the positive adjudication of the investor’s I-526 petition, or where the approval of one investor causes the release of all investors’ escrowed funds. Mind you, there is nothing illegal or wrong with these structures so long as there is clear disclosure to investors (that being said, the appointed representative structure, in my opinion, is pushing the line even with disclosure). Investors and counsel should take careful note of exactly how the escrow agreements are structured. Be sure to ask and understand who holds the funds, who has the ability to release funds, who administers the funds and what are the exact terms and conditions for timing and amount of release of the funds. In the present case, if the allegations are true, it is particularly egregious that attorneys, members of the immigration bar, were the source of the fraud. If they were acting both as project sponsors and counsel to the investors, then the investors never stood a chance. Whenever possible it is always best for the investor to have his or her own independent counsel to provide advice free from conflicts of interests (waivers notwithstanding).

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