The EB-5 backlash: federal audits cite potential fraud, national security threats, bogus job creation, recommend elimination of regional center program, increased minimum investment

Also see coverage today regarding how Forest City Ratner spent its first round of EB-5 financing and its plans for a new round.

From industry org. IIUSA

The federal government's immigrant investor program (known as EB-5) has faced a recent backlash, with two highly critical governmental reports on a program that typically has organized supporters while few skeptics look at the public interest.

For example, the Department of Homeland Security's Inspector General said the federal agency overseeing EB-5 is "limited in its ability to prevent fraud or national security threats." Nor can it "demonstrate that the program is improving the U.S. economy and creating jobs for U.S. citizens as intended by Congress."

That's harsh criticism for a program that's a hot topic in development finance, with aggressive supporters enjoying the benefit of marketing something they don't own--green cards--and turning it into cheap financing, money they say is often unavailable due to to a tight lending market.

They do that as long as they can get a paid economist to produce a report claiming immigrant investor's $500,000 payment will create 10 jobs, even indirect or "induced" jobs.

The investors, most from China, willingly forego interest on the money--they're supposed to ultimately get their $500,000 back--as long as they get green cards for themselves and their families. Forest City Ratner's Atlantic Yards project has been among the most prominent examples.

Regional centers key

The vehicle is a government-approved private entity known as a regional center that can pool investors' money and reap fees and profits while doing so.

The gold rush is such that Crain's New York Business last year wrote about how individual developers were setting up regional centers to attract cheap capital, as noted in the screenshot below.

from Crain's NY Business, 10/25/13

Though they've generated relatively little publicity, the two federal reports raise huge questions about the EB-5 program.

Those conclusions dovetail with my own examination of Forest City Ratner's use of EB-5 funds to raise $228 million, and the developer's new effort--as part of a planned joint venture with the Chinese government-owned Greenland Group--to raise $249 million.

The ICE warning: seven areas of program vulnerability

In mid-December, Sen. Charles Grassley (R-IA) released an internal memo from Homeland Security Investigations (HSI), the investigative arm of U.S. Immigration and Customs Enforcement. The latter is an agency within the Department of Homeland Security, which also houses United States Citizenship and Immigration Services (USCIS), which oversees the EB-5 program.

The investigation, it turns out, was prompted by a review in which someone in the EB-5 world--investor or employee--was indicted for his role in exporting electronics to Iran.

According to the HSI memo, ICE identified seven areas of program vulnerability with EB-5, including the potential for espionage, terrorists, and money laundering, as well as investment fraud in multiple variations.

HSI advised that more information be collected on the regional centers, the investors, and the source of the investor’s funds.

Policy changes

But it also proposed huge policy changes, including doubling the minimum investment amount from $500,00 to $1,000,000, which would make the program much more of a hurdle for both investors and the developers/entrepreneurs who hope to benefit from cheap capital.

In another blow, HSI recommended that the program be limited to only active investors involved in managing and directing a business--again, a huge change, given that the program allows investors to live anywhere in the country.

HSI also recommended that "induced jobs"--resulting from workers' spending in the local economy--be eliminated from the job creation calculations.

HSI noted that such suggestions were not included in the technical assistance USCIS provided in June 2012 when the EB-5 program was reauthorized for three years--a sign that the agency may be in some way "captured" by beneficiaries.

Getting rid of regional centers

And the largest change of all: “The principal change proposed by HSI was that the Regional Center Model be allowed to sunset, as HSI maintains there are no safeguards that can be put in place that will ensure the integrity of the RC model.”

The regional centers get a significant fee from each investor for packaging the deal, and then keep the spread between the low or no interest paid to the investor and the below-market interest for the developers. They obviously want to keep the cash cow going.

From the report:

In the absence of the elimination of the RC Model, HSI proposed raising the minimum investment amount to $2,000,000 or $1,000,000 for Targeted Employment Areas, as the minimum investment amounts had not changed since the inception of the RC Model in 1992. Raising the required investment amount would make fraud more inconvenient and provide a more legitimate basis to meet the job creation goals of the program.

Fraud in job creation

It's fairly obvious that the job creation numbers for Atlantic Yards used in the EB-5 process are bogus, if legal.

HSI seems equally skeptical. According to the report:

HSI conducted research using job creation statistics used by large corporations and the U.S. government stimulus package, and has reason to believe that the RCs are greatly exaggerating their indirect and induced job creation figures. By not having to provide evidence of jobs directly created, the RC inherently creates an opportunity for fraud, where the business goal can be initiating projects that give the appearance of creating job growth, with the sole intent to meet USCIS criteria rather than produce jobs.

The OIG report

The Department of Homeland Security in December released an evaluation of EB-5 by its Office of Inspector General. It raised major concerns:

• The laws and regulations governing the program do not give USCIS the authority to deny or terminate a regional center’s participation... based on fraud or national security concerns;
• The program extends beyond current USCIS mission to secure America’s promise as a nation of immigrants; and
• USCIS is unable to demonstrate the benefits of foreign investment into the U.S. economy.

The operation of the regional center program is poorly overseen, with different interpretations by USCIS officials regarding federal policy. And "when external parties inquired about program activities"--such as project proponents--USCIS did not always document their decisions and responses.

Thus, "USCIS is limited in its ability to prevent fraud or national security threats that could harm the U.S.; and it cannot demonstrate that the program is improving the U.S. economy and creating jobs for U.S. citizens as intended by Congress."

A mission too broad?

From OIG report

Though EB-5 is as much an economic development or investment program as an immigration one, USCIS, according to the audit, is limited in its expertise.

"Because agencies other than USCIS have missions that USCIS could leverage to its advantage for the EB-5 program," the report says, "USCIS needs to improve coordination and rely on the expertise at these agencies during the adjudication process."

Questionable job creation

As the report notes, federal law "allows foreign investors to take credit for jobs created by U.S. investors." According to the report:

In one case we reviewed, an EB-5 project received 82 percent of its funding from U.S. investors through a regional center. The regional center was able to claim 100 percent of the projected job growth from the project to apply toward its foreign investors even though the foreign investment was limited to 18 percent of the total investment in the project. Every foreign investor was able to fulfill the job creation requirement even though the project was primarily funded with U.S. capital. When we questioned USCIS about this practice, the officials explained that the EB-5 project would not exist if not for the foreign investment.

That, of course, is questionable, especially when, as with Atlantic Yards, the money is being used to substitute for a high-interest loan. The EB-5 money is thus developer margin.

I'd add that, with Atlantic Yards, the law allowed foreign investors to take credit for jobs created by New York City and state taxpayers.

Atlantic Yards site in blue, high unemployment area
in red. Graphic by Abby Weissman

Though USCIS allows the creation of new commercial enterprises that collected EB-5 capital to make loans to other job-creating entities, the agency cannot oversee such additional job-creating entities and therefore can't verify job creation.

Gerrymandering the map

The OIG report confirms reporting by me and others of how state government agree to gerrymander the map--I call it the "Bed-Stuy Boomerang," regarding Atlantic Yards--to create a zone of "high unemployment."

That allows a $500,000 investment instead of the original $1 million. According to the report:

Another example is the designation of high-unemployment areas by state governments. The regulations provide for state governments to designate high-unemployment areas for determining whether the EB-5 regional center project qualifies for the lower foreign investment of $500,000. However, the regulations do not instruct the states on how to make the designation. Because of how the regulations are written, USCIS adjudicators said that they must accept what the state designates as a high-unemployment area without validation even when it appears as if these designations are areas of low unemployment.

Reasons to push for influence

The report suggests evidence that "internal and external parties may have influenced the adjudication of EB-5 regional center applications and petitions." There's strong reasons to lobby:

• The estimated job creation and economic improvements to local economies are convincing and important reasons for lawmakers and citizens to have an interest in advocating the EB-5 program.
• USCIS documents show that regional centers generally obtain between $25,000 and $50,000 in unregulated fees from foreign investors, and as such, we believe that may contribute to them losing sight of the integrity of the EB-5 program in the interest of making money.

Recommendations

The OIG recommends that USCIS:

• update and clarify federal regulations to push for greater authority to investigate national security and fraud, and to assess job creation
• work with the Departments of Commerce and Labor and the Securities and Exchange Commission to use their expertise to evaluate EB-5 applications and petitions
• conduct comprehensive reviews to determine how EB-5 funds have actually stimulated growth in the U.S. economy 
• establish quality assurance steps to promote program integrity 

The report notes that USCIS agreed with three of the four recommendations, and was in the process of  hiring new economists, among other things. Still, OIG reported that  "five USCIS economists expressed concern that their expertise was not being used in the adjudication process because they did not perform any substantive analysis of economic plans or predictions."

USCIS said it does not believe it's in a position to quantify the impact of the EB-5 program on the. economy, or assess the program's impact. OIG disagreed.

The industry response

In response, the Association to Invest in the USA, a trade group of EB-5 businesses, issued a statement saying:

many of the reforms the OIG identifies as necessary are already underway, and other criticisms of USCIS’ administration of the Program are effectively refuted in a statement by USCIS included at the end of the OIG report.
...For example, recognizing the complexity of the EB-5 Program, USCIS has created a new Immigrant Investor Program Office staffed by trained economists, experts in business and immigration law, as well as fraud and national security specialists – now led by a former director of the Treasury department’s Financial Crimes Enforcement Network. USCIS plans for all EB-5 related adjudications to be relocated to this office over the next six months.

Defending gerrymandering?

Maybe, but it's tough to defend USCIS, for example, on the gerrymandering issue. As long as the federal agency defers to states, as noted in the excerpt below, and the states have an interest in gerrymandering to get favored projects a low-interest loan, such bizarre map-making will continue. 

 Department of Homeland Security, OIG report on EB-5, Dec. 2013

EB-5 memo by Homeland Security Investigations, va. Sen. Grassley, Dec. 2013